CORPORATE FINANCE 13TH EDITION STEPHEN ROSS, RANDOLF WESTERFIELD, JEFFREY JAFFE, BRANDON JORDAN TEST by QuentinAxel

CORPORATE FINANCE 13TH EDITION STEPHEN ROSS, RANDOLF WESTERFIELD, JEFFREY JAFFE, BRANDON JORDAN TEST BANK (ANSWERS AT THE END OF EACH CHAPTER) Chapter 1: 1) Generally, among those who report directly to the

are the treasurer and the

controller of a corporation. A) board of directors B) chairperson of the board C) chief executive officer D) president E) chief financial officer

2) A typical chain of command in a corporation is described by which one of the following

statements? A) The information systems manager reports to the treasurer. B) The credit manager reports to the treasurer. C) The controller reports to the chief executive officer. D) The tax manager reports to the treasurer. E) The capital expenditures manager reports to the controller.

3) Answering which one of the following questions involves making a capital budgeting

decision? A) How much debt should the firm borrow from a particular lender? B) Should the firm build a new production facility? C) Should the firm issue new equity to pay for its growth goals? D) How much inventory should the firm keep on hand? E) How much credit should the firm extend to a particular customer?

4) Which one of the following statements is accurate? A) Net working capital equals current assets plus current liabilities. B) Current liabilities are debts that must be repaid in 18 months or less. C) Current assets are assets with short lives, such as accounts receivable. D) Long-term debt is defined as a residual claim on a firm’s assets. E) Tangible assets are fixed assets such as patents.

5) Among the typical responsibilities of the corporate controller is: A) capital expenditures management. B) cash management. C) tax reporting. D) financial planning. E) credit management.

is typically the responsibility of the corporate treasurer. A) Financial planning B) Cost accounting C) Tax reporting D) Information systems E) Financial accounting

7) A firm’s define(s) its capital structure. A) mixture of various types of production equipment B) investment selections for its excess cash reserves C) combination of cash and cash equivalents D) combination of accounts appearing on the left side of its balance sheet E) proportions of financing from debt and equity

8) The focus of short-term finance is on: A) the timing of cash flows. B) acquiring and selling fixed assets. C) financing long-term projects. D) capital budgeting. E) issuing additional shares of common stock.

9) Net working capital includes: A) copyrights. B) manufacturing equipment. C) common stock. D) long-term debt. E) inventory.

10)

is defined as planning and managing a firm’s long-term assets. A) Working capital management B) Cash management C) Cost accounting management D) Capital budgeting E) Capital structure management

11) An amount the firms owes, which it must repay within twelve months, is called a(n): A) current liability. B) long-term debt. C) intangible asset. D) accounts receivable. E) current asset.

12) The business entity that is typically the least expensive to form is the: A) limited liability company. B) joint stock company. C) general partnership. D) limited partnership. E) sole proprietorship.

13) A

is a business owned by a single individual. A) corporation B) sole proprietorship C) general partnership D) limited partnership E) limited liability company

14) Regarding a sole proprietorship, which one of the following statements is accurate? A) It is more difficult to form than other forms of business. B) Its business profits are taxed twice at the federal level. C) Its business profits are taxed separately from the personal income of the owner. D) The owner may be forced to sell his or her personal assets to pay the company's debts. E) It has an unlimited life span.

15) Regarding a sole proprietorship, which one of the following statements is accurate? A) The ability to raise capital is limited by the owner’s personal wealth. B) It pays taxes at the corporate tax rate. C) Ownership of the firm is easy to transfer to another individual. D) It must pay income taxes separately from the taxes paid by the owner. E) The legal costs to form it are usually substantial.

16) The primary advantage of being a limited partner rather than a general partner is: A) being entitled to a larger portion of the partnership’s income. B) having responsibility for day-to-day management of the business. C) earning profits that are free from income taxation. D) the ability to have overall control of the partnership. E) one’s personal financial liability is limited to the amount of capital invested.

17) A general partner: A) has less legal liability than a limited partner. B) can end the partnership by withdrawing. C) faces double taxation of profits whereas a limited partner does not. D) cannot lose more than the amount of his or her equity investment. E) is the term applied only to corporations that invest in partnerships.

18) A partnership: A) is taxed in the same fashion that a corporation is taxed. B) terminates upon the death of any limited partner. C) creates for all general partners an unlimited liability for the partnership's debts. D) has the same ability as a corporation to raise capital. E) allows for easy transfer of ownership from one general partner to another.

19) One advantage of a partnership is the: A) personal liability for all of the firm’s debts. B) limited life of the entity. C) limited liability protection for all of the partners. D) relatively low cost of formation. E) ease of transferring full ownership to others.

20) One disadvantage of the corporate form of business ownership is the: A) limited liability protection provided for all owners. B) firm’s ability to raise cash. C) unlimited life of the firm. D) difficulties encountered when changing ownership. E) double taxation of business profits.

21) Which one of the following statements is correct? A) Both partnerships and corporations are subject to double taxation. B) Sole proprietorships and partnerships are taxed in a similar fashion. C) Partnerships are the most complicated type of business to form. D) Both partnerships and corporations have limited liability for all owners. E) All types of business formations have limited lives.

22) The articles of incorporation: A) can be used to remove the firm’s management. B) C) D) E)

are amended annually by the firm’s stockholders. set forth the rights granted to shareholders. set forth the rules by which the corporation regulates its existence. can set forth the conditions under which the firm can avoid double taxation.

23) Corporate bylaws: A) establish the name of the corporation. B) establish the rights granted to its shareholders. C) set forth the purpose of the firm. D) establish the rules by which the corporation regulates its existence. E) set forth the number of members of the initial board of directors.

24) Regarding corporations, which one of the following statements is accurate? A) After a predetermined number of years, ownership can no longer be transferred. B) The ability to raise capital is limited by the personal wealth of the owners. C) Primary shareholders have unlimited liability for corporate debts. D) The entity can outlive all of its initial owners. E) When the last original owner dies or withdraws, the entity is terminated.

25) If a business is formed as a corporation, ownership of the business: A) must be granted with equal rights assigned to each and every shareholder. B) can be transferred an unlimited number of times. C) can only be transferred with the approval of the board of directors. D) is controlled by the corporate officers. E) must be held by non-management owners.

26) The owners of a limited liability company typically would prefer to: A) be taxed like a corporation. B) have liability exposure similar to that of a sole proprietor. C) be taxed personally on all business income. D) have liability exposure similar to that of a general partner. E) be taxed like a corporation, and have liability like a partnership.

27) In a general partnership, the general partners have

liability for the firm’s debts and

have

control over day-to-day operations. A) limited; no B) unlimited; total C) limited; total D) unlimited; no E) unlimited; limited

28) Which one of the following business types is best for raising large amounts of capital? A) Sole proprietorship B) Limited liability company C) Corporation D) General partnership E) Limited partnership

29) Which type of business organization has the same rights and privileges accorded to a legal

person? A) Sole proprietorship B) General partnership C) Limited partnership D) Corporation E) Limited liability company

30) A

is a business formed by two or more individuals who each have unlimited personal liability for all of the firm’s debts. A) corporation B) sole proprietorship C) general partnership D) limited partnership E) limited liability company

31) The

describes the fraction of the work and cash to be contributed to a partnership by each member of that partnership. A) indemnity clause B) indenture contract C) statement of purpose D) partnership agreement E) group charter

32) A(n) A) B) C) D) E)

is a business created as a distinct legal entity, separate from its owners. corporation sole proprietorship general partnership limited partnership unlimited liability company

33) In a limited partnership, each limited partner’s liability for the partnership’s debts is: A) limited to his or her personal net worth. B) limited to the amount he or she invested into the partnership. C) limited to his or her total earnings received from the partnership. D) unlimited. E) limited to the total amount invested by all partners.

34) A

provides each owner with limited liability, and is operated and taxed like a

partnership. A) limited liability company B) general partnership C) limited proprietorship D) limited partnership E) corporation

35) The profits earned by a partnership are: A) fully distributed as taxable income to the partners. B) distributed to general partners after interest is paid to limited partners. C) distributed to the partners after the partnership pays its income taxes. D) generally reinvested in the firm to fund future growth, rather than being distributed to

owners. E) generally held by the partnership for several years before being distributed as dividend payments.

36) Financial managers primarily create firm value by: A) maximizing current dividends. B) investing in assets that generate cash in excess of their cost. C) lowering the earnings per share. D) increasing the firm’s market share. E) maximizing current sales.

37) Accounting profits and cash flows are generally: A) equal because they reflect current laws and accounting standards. B) equal because accounting profits reflect the timing of cash flows. C) unequal because of how income is recognized according to GAAP. D) unequal because cash inflows must occur before revenue recognition. E) equal because of the requirements of GAAP.

38) Which one of the following transactions will result in a cash outflow from the corporation? A) Selling an asset B) Paying income taxes C) Issuing common stock D) Borrowing from a lender E) Retaining profit earned by the firm

39) A firm creates value by: A) having a greater cash inflow from its stockholders than its outflow to them. B) paying more cash to its creditors and stockholders than the amount it received from

them. C) borrowing long-term debt. D) generating sales whether or not payment is received for all of those sales. E) purchasing assets that create cash inflows equal to the cost of those assets.

40) If a firm is profitable, it follows that: A) its cash inflows exceed its cash outflows. B) its sales exceed its costs. C) its cash flows are known with certainty. D) it has sufficient cash to pay its bills in a timely manner. E) the timing of its cash flows is irrelevant.

41) Which one of the following statements is accurate? A) Individuals generally prefer later cash flows rather than current cash flows. B) The value of an investment depends on the size, timing, and risk of the investment’s

cash flows. C) When selecting one of two projects, managers should select the project with the higher total expected cash flow. D) Most investors prefer greater risk rather than less risk. E) Accountants record sales and expenses after the related cash flows occur.

42) A firm is considering a new project. Analysts at the firm would be justified in having the

greatest level of certainty in the: A) amount of the project’s cash inflow in Year 3. B) timing of the last cash inflow from the project. C) project’s initial cost. D) risk of a pessimistic scenario occurring. E) amount of the cash inflow from the project in Year 1.

43) Financial managers should primarily strive to: A) minimize costs while increasing current dividends. B) maximize the current profits of the firm. C) maximize the current value per share of existing stock. D) maximize current dividends even if doing so adds financial distress costs to the firm. E) maximize current market share in every market in which the firm participates.

44) Financial managers should make decisions in such a way as to increase the: A) size of the firm. B) growth rate of the firm. C) marketability of the managers. D) market value of the existing owners’ equity. E) firm’s current sales.

45) Which one of the following actions by a financial manager creates an agency problem? A) Borrowing money, when doing so creates value for the firm B) Lowering selling prices, which will result in increased firm value C) Agreeing to expand the company at the expense of stockholders’ value D) Agreeing to pay management bonuses based on the market value of the firm’s stock E) Refusing to spend current cash on an unprofitable project

46) The primary goal of financial management is to: A) maximize current dividends per share of the existing stock. B) maximize the current value per share of the existing stock. C) avoid financial distress. D) minimize operational costs and maximize firm efficiency. E) maintain steady growth in both sales and net earnings.

47) Of the following choices, is the best way to increase current shareholder value. A) maximizing the firm’s amount of available cash B) increasing the current value of the overall firm C) postponing all new projects D) minimizing the overall size of the firm E) decreasing the number of employees

48) A financial manager should make decisions based on: A) the effects those decisions will have on current profits. B) the best interests of the manager and his or her peers. C) the welfare of the current shareholders. D) minimizing the firm's tax liability. E) their personal goals and ambitions.

49) A(n)

is defined as a conflict of interest between the stockholders and managers of

a firm. A) B) C) D) E)

stockholders’ liability corporate breakdown agency problem corporate activist legal liability

50) Of the following choices, is most likely to create an agency problem. A) increasing the dividend payments to shareholders B) paying off debt in a timely manner C) increasing the sales of a profitable division D) abandoning a profitable project because it involves some risk E) selling an unprofitable division of the firm

51) Of the following choices,

is least likely to convince managers to work in the best

interest of the stockholders. A) being threatened with a takeover of the firm by unsatisfied stockholders B) implementing a stock option plan C) raising managers’ salaries based on their length of service D) tying management compensation to the market value of the firm’s stock E) receiving a threat of a proxy fight

52) Which form of business structure typically has the greatest potential for agency problems? A) Sole proprietorship B) General partnership C) Limited partnership D) Corporation E) Limited liability company

53) A proxy fight occurs when: A) the board of directors disagree on the members of the management team. B) a group solicits voting rights to replace the board of directors. C) a competitor offers to sell its ownership interest in the firm. D) the firm files for bankruptcy. E) the firm is declared insolvent.

54) Ultimately, the control(s) the corporation. A) board of directors B) stockholders C) president D) chief executive officer E) chairperson of the board

55) Members of the board of directors are selected by: A) shareholder voting. B) company management. C) the firm’s chief executive officer. D) the largest five shareholders. E) the firm’s managers and employees.

56) What is the main reason that corporations grant stock options to managers? To: A) reduce agency costs. B) increase current profits. C) replace salary increases. D) reward long-term employment. E) replace promotions.

57) Of the following choices, which one best fits the description of an agency cost? A) The costs of increasing the dividend payment per share B) The benefits received from reducing production costs per unit C) The payment of corporate income taxes D) The payment required for an outside audit of the firm E) The payment of interest on a firm’s debts

58) Which one of the following parties is considered a stakeholder of a firm? A) Customer B) Short-term creditor C) Long-term creditor D) Preferred stockholder E) Common stockholder

59) A stakeholder is any person or entity: A) owning shares of stock of a corporation. B) owning bonds or other long-term debt issued by a corporation. C) that initially started a firm and currently has management control over that firm. D) to whom the firm currently owes money. E) other than a stockholder or creditor who potentially has a financial interest in a firm.

60) One intent of the Sarbanes-Oxley Act of 2002 is to: A) prevent minority investors from making demands on corporations. B) protect corporate directors from frivolous lawsuits. C) guarantee the repayment of all future personal loans to corporate officers and

directors. D) protect investors from corporate abuses. E) require all public corporations to “go dark” within the next twenty years.

61) The Sarbanes-Oxley Act requires public corporations to: A) assess the company’s internal control structure at least quarterly. B) distribute at least 90 percent of their profits as dividends on an annual basis. C) list any deficiencies in internal controls. D) file annual audit reports if the firm has “gone dark.” E) disclose all personal loans to corporate officers or directors made after 2002.

62) Insider trading is: A) prohibited by the Securities Act of 1933. B) prohibited by the Securities Exchange Act of 1934. C) impossible in today’s efficient markets. D) highly discouraged, but still legal. E) prohibited by the Sarbanes-Oxley Act of 2002.

63) The

established the basic regulatory framework for the public trading of securities in the United States. A) New York Stock Exchange, when it was founded, B) Securities Exchange Act of 1934 C) Federal Reserve Bank, when it was first authorized by Congress, D) Securities Act of 1933 and the Securities Exchange Act of 1934 E) Sarbanes-Oxley Act of 2002

64) The Securities Act of 1933 focuses on: A) all stock transactions. B) the sales of existing securities. C) the issuance of new securities. D) insider trading. E) Federal Deposit Insurance Corporation (FDIC) insurance.

65) The intent of the registration statement required for all new securities by the Securities Act of

1933 is to: A) provide a governmental evaluation of the risks associated with those new securities. B) set the price at which the securities will be offered. C) guarantee the profitability of the new securities. D) prevent any insider trading. E) provide all necessary information to allow a potential investor to make an informed decision.

66) Which one of the following results have been reported as a consequence of a corporation

“going dark?” A) Increased market liquidity and lower costs B) Lower audit costs and lower interest rates on bank loans C) Increased access to capital and lower costs associated with that capital D) Increased audit costs and stock price increases E) Limited access to capital markets and stock price declines

67) List and briefly describe the three basic areas addressed by a financial manager.

68) What advantages and disadvantages does the corporate form of organization have compared

to sole proprietorships and general partnerships?

69) Why might a professional group select the LLC form of business over a general partnership

or a corporate structure?

70) Why might a highly successful sole proprietor change the structure of his or her firm to the

corporate form of ownership if that change results in the sharing of profits with other investors?

71) What should be the primary goal of the financial manager of a corporation? Explain why this

is appropriate.

Answer Key Test name: Chapter 1 1) E 2) B 3) B 4) C 5) C 6) A 7) E 8) A 9) E 10) D 11) A 12) E 13) B 14) D 15) A 16) E 17) B 18) C 19) D 20) E 21) B 22) C 23) D 24) D 25) B 26) C 27) B 28) C 29) D 30) C 31) D 32) A 33) B 34) A 35) A 36) B 37) C

38) B 39) B 40) B 41) B 42) C 43) C 44) D 45) C 46) B 47) B 48) C 49) C 50) D 51) C 52) D 53) B 54) B 55) A 56) A 57) D 58) A 59) E 60) D 61) C 62) B 63) D 64) C 65) E 66) E 67) Essay 68) Essay 69) Essay 70) Essay 71) Essay

Chapter 2: 1) The right-hand side of the balance sheet is where A) property, plant, and equipment B) accumulated retained earnings C) accumulated depreciation D) cash and equivalents E) intangible assets

2) The line on the balance sheet called

is reported.

represents the entire book value of the residual

ownership of a corporation. A) total equity B) total long-term liabilities C) retained earnings D) capital surplus E) total assets

3) The book value of all of a corporation’s net profits, minus all of its dividend payments, is

reported on the line of the balance sheet. A) capital surplus B) accumulated retained earnings C) treasury stock D) common stock E) total equity

4) Which one of the following is a current liability? A) An invoice due to a supplier 14 months from today B) A note payable to a lender in nine months C) Estimated income taxes which were just paid today D) A loan payment due to a bank 14 months from today E) An invoice due from a customer in 30 days

5) If total assets increase: A) net working capital must also increase. B) an investment in fixed assets must have occurred. C) stockholders’ equity must also increase. D) the change must be offset by an equal increase in liabilities and stockholders’ equity. E) net income must be positive.

6) Of the following choices, the most liquid asset is typically: A) inventory. B) land. C) accounts receivable. D) equipment. E) patents.

7) Regarding liquidity, which one of the following statements is accurate? A) Liquid assets generally earn higher rates of return than fixed assets. B) If you can sell an asset next year at a price equal to its actual value, the asset is highly

liquid. C) Liquid assets are defined as those assets obtained within the past year. D) The less liquidity a firm has, the lower the probability the firm will encounter financial difficulties. E) Balance sheet accounts are listed in order of decreasing liquidity.

8) Liquidity is: A) a measure of the use of debt in a firm’s capital structure. B) equal to the book value of a firm’s total assets minus its total liabilities. C) equal to the market value of a firm’s total assets minus its total liabilities. D) valuable to a firm even though liquid assets tend to be less profitable to own. E) generally most closely associated with intangible, rather than tangible, assets.

10)

is a component of total stockholders’ equity. A) Long-term debt B) Deferred taxes C) Property, plant and equipment D) Accumulated retained earnings E) Dividends paid

Which of the following statements is accurate? Book value is: A) equivalent to market value for firms with fixed assets. B) based on historical cost. C) always more than market value. D) more of a financial than an accounting valuation. E) adjusted whenever the market value of an asset changes.

11) Assume you sell an asset today. Which of the following amounts are you most likely to

receive? A) Market value B) Original cost minus accumulated depreciation C) Historical value D) Book value E) Carrying value

12) The accounting definition that underlies the balance sheet can be expressed accurately as: A) Assets ≡ Liabilities − Stockholders’ equity B) Stockholders’ equity ≡ Assets + Liabilities C) Liabilities ≡ Stockholders’ equity − Assets D) Assets ≡ Stockholders’ equity − Liabilities E) Stockholders’ equity ≡ Assets − Liabilities

13) On a balance sheet, A) intangible assets B) accounts payable C) preferred stock D) inventory E) accounts receivable

is (are) reported with fixed assets.

14) Deferred taxes are a component of A) stockholders’ equity B) current assets C) long-term liabilities D) fixed assets E) current liabilities

on a balance sheet.

15) If a firm’s financial managers successfully meet their primary goal, then the firm’s: A) debts will exceed its equity. B) market value will exceed its book value. C) net working capital will exceed its long-term debt. D) carrying value will exceed its market value. E) equity will exceed its assets.

16) A(n)

asset is one that can be readily converted into cash without a significant loss

in its value. A) marketable B) tangible C) intangible D) liquid E) fixed

17) Assume a profitable firm has neither issued nor repurchased any shares of its common stock,

nor has it ever paid dividends. If the book value of the firm’s stockholders’ equity has increased, it follows that the: A) book value of the firm’s inventory has decreased. B) firm’s earnings per share has increased. C) market value of the firm’s buildings has increased. D) market value of the firm’s long-term debt has increased. E) noncash expenses have increased.

18) The balance sheet reports assets in order of: A) decreasing liquidity. B) date of acquisition. C) increasing size. D) market value relative to book value. E) book value.

19) If a firm’s treasury stock balance increases, the: A) total equity of the firm increases. B) firm has issued new shares of stock to the federal government. C) number of shares outstanding increases. D) firm repurchased outstanding shares of stock. E) total liabilities of the firm increases.

20) The book value of a firm’s assets: A) is determined under Generally Accepted Accounting Principles (GAAP) and is based

on the cost of those assets. B) represents the true market value of those assets according to GAAP. C) is always the best measure of the company’s value to an investor. D) is always higher than the replacement cost of the assets. E) is reported on the firm’s income statement.

21) Under Generally Accepted Accounting Principles (GAAP), a firm’s assets are reported at: A) market value. B) liquidation value. C) market value less accumulated depreciation. D) historical cost less accumulated depreciation. E) liquidation value less accumulated depreciation.

22) The income statement: A) measures performance of the firm for one specific day. B) ignores any income other than operating revenues. C) excludes deferred tax expense. D) treats dividends paid as a cash expense. E) includes noncash expenses.

23) Generally Accepted Accounting Principles (GAAP) require revenue to be recognized as

income when: A) a contract is signed to perform a service or deliver a good. B) the transaction is complete and the goods or services are delivered. C) payment is requested. D) income taxes are paid on the revenue earned. E) the end of the financial reporting period arrives.

24) A firm’s accounting performance during a particular period of time is reported on the: A) income statement. B) balance sheet. C) statement of cash flows. D) tax reconciliation statement. E) statement of equity.

25) The term “noncash items” is referring to: A) the credit sales of a firm. B) the accounts payable of a firm. C) the costs incurred for the purchase of intangible fixed assets. D) expenses charged against revenues that do not directly affect cash flow. E) all accounts on the balance sheet other than cash on hand.

26) If a firm has long-term debt, net income must equal: A) Pretax income − Interest expense − Taxes. B) C) D) E)

EBIT − Taxes. Taxes + Addition to retained earnings. Operating income × (1 − Marginal tax rate). Dividends + Addition to retained earnings.

27) As seen on the income statement of a tax-paying firm: A) interest is deducted from income and increases the total taxes incurred. B) the tax rate is applied to the earnings before interest and taxes when the firm pays

interest. C) depreciation is shown as an expense but does not affect the tax expense. D) depreciation reduces both the pretax income and the net income. E) interest expense is added to earnings before interest and taxes to compute pretax income.

28) All else held constant, the earnings per share will decrease as the: A) net income increases. B) number of shares outstanding increases. C) total revenue of the firm increases. D) tax rate decreases. E) costs decrease.

29) Which one of the following statements is correct? A) Pretax income is equal to net income minus taxes. B) The addition to retained earnings is equal to net income plus dividends. C) Operating income is equal to operating revenue minus cost of goods sold. D) Only current taxes are included in the tax expense. E) Earnings per share can be negative but dividends per share cannot.

30) Earnings per share: A) will increase if net income increases and the number of shares outstanding decreases. B) will increase if net income decreases and the number of shares outstanding increases. C) is defined as the addition to retained earnings divided by the number of shares

outstanding. D) is the total amount of dividends paid per year on a per share basis. E) must increase at the same rate as the net income.

31) Earnings per share will increase when: A) depreciation decreases. B) the number of shares outstanding increases. C) operating income decreases. D) dividends per share decrease. E) the average tax rate increases.

32) If the number of shares outstanding and total earnings both remain constant, an increase in

dividends per share will: A) reduce the earnings per share. B) reduce the addition to retained earnings. C) reduce net income. D) increase total equity. E) increase total assets.

33) Which one of the following items is a noncash item? A) Deferred taxes B) Interest expense C) Current taxes D) Dividends E) Selling expenses

34) Assume a firm is profitable and pays income taxes. For each $1 increase in the firm’s

depreciation expense: A) net income will decrease by $1. B) net income will increase by $1. C) net income will decrease by more than $1. D) net income will decrease by less than $1. E) net income will increase by less than $1.

35) According to Generally Accepted Accounting Principles (GAAP), the cost of goods sold is: A) recorded when inventory is acquired. B) recorded when payables are paid. C) matched with revenues. D) matched with production levels. E) expensed at the end of the production cycle.

36) If a firm is profitable and pays income taxes, depreciation expense: A) decreases both operating income and net income. B) increases net fixed assets. C) reduces both net fixed assets and total operating costs. D) is a noncash expense that increases net operating income. E) decreases net fixed assets, net income, and operating cash flows.

37) During a period of one year, which one of the following choices is most likely to be a fixed,

rather than variable, cash expense? A) Raw materials cost B) Bond interest C) Commissions paid to sales representatives D) Depreciation E) Manufacturing labor costs

38) Assume a firm is either a proprietorship, partnerships, or LLC. When an analyst at the firm is

evaluating a financial decision, the analyst should employ the A) average B) fixed C) marginal D) total E) variable

39) The A) B) C) D) E)

tax rate.

tax rate applies to the next dollar of taxable income earned. deductible residual total average marginal

40) As of 2018, the U.S. corporate tax rate is: A) based on a progressive tax rate schedule. B) based on a tiered, multi-rate flat tax. C) a flat tax of 34 percent. D) zero with all corporate taxable income passed to shareholders. E) a flat rate of 21 percent.

41) A firm starts its year with positive net working capital. During the year, the firm acquires

more short-term debt than it does short-term assets. This means that: A) the ending net working capital must be negative. B) both accounts receivable and inventory decreased during the year. C) the beginning current assets were less than the beginning current liabilities. D) accounts payable and inventory increased during the year. E) the ending net working capital can be positive, negative, or equal to zero.

42) For a growing firm, the change in net working capital is generally: A) positive. B) negative. C) highly erratic. D) highly negative. E) equal to zero.

43) An increase in will cause the operating cash flow of a profitable firm to increase. A) depreciation B) cash C) net working capital D) taxes E) administrative expenses

44) The cash flow to creditors is not impacted by: A) interest paid on long-term debt. B) a new mortgage on a building. C) an increase in accounts payable. D) a mortgage interest payment. E) a reduction in long-term debt.

45) A firm’s equals its dividend payments less any net new equity raised. A) operating cash flow B) capital spending C) net working capital D) cash flow from creditors E) cash flow to stockholders

46)

will cause the current year’s cash flow to creditors to increase. A) Collection of a refund for the overpayment of a loan B) Payoff of a 36-month loan after the first 15 months C) Payment of a late charge on an account payable to a supplier D) Acquiring a new loan that will be repaid in one lump sum 24 months from now E) Purchasing inventory using credit offered by a supplier

47) The cash flow to stockholders must be positive when: A) the dividends paid are less than the amount of net new equity raised. B) the net sale of common stock exceeds the amount of dividends paid. C) no income is distributed but new shares of stock are sold. D) the cash flow from assets is positive and exceeds the cash flow to creditors. E) both the cash flow to assets and the cash flow to creditors are positive.

48) Cash flow from assets: A) equals net income plus noncash items. B) can be positive, negative, or equal to zero. C) equals operating cash flow minus net capital spending. D) equals the addition to retained earnings. E) equals operating cash flow minus the cash flow to creditors.

49) Net capital spending is equal to the: A) net change in total assets plus depreciation. B) net change in fixed assets plus depreciation. C) net income plus depreciation. D) difference between the market and book values of the total assets. E) change in total assets.

50) Cash flow to stockholders is defined as: A) cash dividends paid. B) repurchases of equity less new equity sold minus cash dividends paid. C) cash flow from financing less cash flow to creditors. D) cash dividends paid plus repurchases of equity minus new equity financing. E) cash flow from assets plus cash flow to creditors.

51) Free cash flow refers to: A) the money generated from the sale of new shares of stock. B) operating cash flow. C) the cash generated by decreasing net working capital. D) cash that the firm can distribute to creditors and stockholders. E) the net income of a firm after taxes have been paid.

52) The cash flow of the firm must be equal to the: A) cash flow to stockholders minus the cash flow to creditors. B) cash flow to creditors minus the cash flow to stockholders. C) cash flow to governments plus the cash flow to stockholders. D) cash flow to stockholders plus the cash flow to creditors. E) aftertax operating cash flow.

53)

is the cash flow resulting from a firm’s ongoing, normal business activities. A) Operating cash flow B) Net capital spending C) Additions to net working capital D) Free cash flow E) Cash flow to investors

54) Capital spending is equal to: A) ending net fixed assets minus beginning net fixed assets. B) ending net fixed assets minus beginning net fixed assets plus depreciation. C) ending total assets minus beginning total assets. D) ending total assets minus beginning total assets plus depreciation. E) beginning total assets plus asset purchases minus asset sales.

55) Operating cash flow is defined as: A) Pretax income − Taxes. B) Net income − Dividends. C) EBIT + Depreciation − Taxes. D) Pretax income + Depreciation. E) Cash flow to investors + Taxes.

56) Payments to creditors that include both interest and repayment of principal are referred to as: A) the cash flow to stockholders. B) deferred tax payments. C) debt service payments. D) operating cash flow. E) net working capital payments.

57) In the accounting statement of cash flows,

is calculated by adding back noncash expenses to net income, and then adjusting for changes in current assets and current liabilities. A) cash flow from investing activities B) cash flow from financing activities C) net working capital D) cash flow from operations E) cash flow to investors

58) The accounting statement of cash flows reports the cash flows from: A) operations, investing activities, and financing activities. B) operations, investing activities, and divesting activities. C) internal activities, external activities, and financing activities. D) balance sheet accounts only. E) income statement accounts only.

59) In the accounting statement of cash flows, interest expense is: A) ignored completely. B) included as a financing activity. C) included both as an operating and as a financing activity. D) included as an investing activity. E) included in operations.

60) One of the reasons why cash flow analysis is popular is because: A) cash flows are more subjective than net income. B) deferred taxes require future cash payment. C) cash flows are strictly defined by Generally Accepted Accounting Principles

(GAAP). D) it is difficult to manipulate, or spin the cash flows. E) operating cash flows are found on the income statement.

61) Tejado Supply has total equity of $1,830, fixed assets of $2,170, long-term debt of $740, and

short-term debt of $430. What is the amount of Tejado’s current assets? A) $400 B) $830 C) $340 D) $660 E) $1,090

62) Olmos Packaging has equipment with a book value of $3,560 that could be sold today for

$3,900. Its inventory is valued at $1,780 and could be sold immediately to a competitor at a discount of 25 percent. The firm has $260 in cash and customers owe the firm $950, of which 98 percent is collectible. What is the current market value of the firm's assets? A) $6,086 B) $5,536 C) $6,426 D) $6,316 E) $5,946

63) Hudson Enterprises spent $6,400 to purchase equipment three years ago. This equipment is

currently valued at $4,600 on today’s balance sheet but could actually be sold for $5,100. Net working capital is $800 and long-term debt is $3,700. Assuming the equipment is the firm’s only fixed asset, what is the book value of shareholders’ equity? A) $1,700 B) $3,500 C) $2,200 D) $100 E) $600

64) Soto Marketing has sales of $760,000 and costs of $630,000. Interest expense is $21,000 and

depreciation is $48,000. The tax rate is 23 percent. What is the net income? A) $83,930 B) $61,000 C) $46,970 D) $63,140 E) $115,970

65) Arroyo Industries has revenues of $64,480, interest expense of $1,740, depreciation of

$3,960, cost of goods sold of $25,840, dividends paid of $5,200, and administrative expenses of $7,040. The combined federal and state income tax rate is 22 percent. What is the addition to retained earnings? A) $18,091 B) $20,700 C) $16,359 D) $15,002 E) $20,202

66) Yang Services has annual revenue of $37,800, cost of goods sold of $23,200, and

administrative expenses of $6,300. The firm paid $700 in dividends, $280 in interest, and has a total tax rate of 21 percent. The firm will add $2,810 to retained earnings. What is the depreciation expense? A) $2,300 B) $3,709 C) $2,640 D) $780 E) $3,577

67) Margolin & Li has total revenues of $4,315, selling and administrative expenses of $611,

depreciation of $309, cost of goods sold of $2,403, taxes of $178, dividends of $80, and interest expense of $168. What is the amount of the noncash items? A) $481 B) $477 C) $248 D) $309 E) $567

68) Mahesri Excavations added $411 to retained earnings last year on sales of $24,646. The

administrative expenses were $4,370, depreciation was $812, dividends paid were $285, and the interest expense was $103. What was the cost of goods sold if the total tax rate was 23 percent? A) $20,225 B) $24,385 C) $18,457 D) $14,815 E) $21,393

69) Gupta Global has operating income of $68,200, interest expense of $210, dividends paid of

$320, depreciation of $12,400, other income of $2,100, common stock of $48,500 with a par value of $1 per share, and retained earnings of $29,700. What is the earnings per share if the tax rate is 21 percent? A) $1.14 B) $1.21 C) $.82 D) $.96 E) $1.33

70) Given the personal income tax rates as shown, what is the average tax rate for an individual

with taxable income of $96,000? Taxable Income $0 − 9,950 9,950 − 40,525 40,525 − 86,375 86,375 − 164,925

Tax Rate 10% 12 22 24

A) 24.00% B) 2.41% C) 11.38% D) 17.77% E) 21.00%

71) Rahman Motors is a sole proprietorship that earned $156,000 in taxable income. Given the

personal income tax rates shown below, what is the total tax? Taxable Income $0 − 9,950 9,950 − 40,525 40,525 − 86,375 86,375 − 164,925 A) B) C) D) E)

Tax Rate 10% 12 22 24

$16,710.00 $37,440.00 $25,326.50 $32,760.00 $31,461.00

72) Hasan Restaurant Group is a sole proprietorship that has taxable income of $147,200. Based

on the partial individual tax schedule shown below, how much additional tax will be owed if the taxable income increases by $12,800? Assume this is the sole source of income for the owner. Taxable Income $0 − 9,950 9,950 − 40,525 40,525 − 86,375 86,375 − 164,925 A) B) C) D) E)

Tax Rate 10% 12 22 24

$3,072.00 $2,816.00 $2,688.00 $1,338.50 $1,536.00

73) Assume Kiolbassa Books paid $368,060 in taxes on taxable income of $1,673,000 last year.

This year, the firm paid $401,545 in taxes on taxable income of $1,818,586. Assume the tax rates were the same for both years. What are the marginal and average tax rates for this year? A) 21%; 21% B) 22%; 21% C) 23%; 22% D) 22%; 22% E) 23%; 21%

74) A firm has $1,120 in inventory, $2,780 in fixed assets, $1,470 in accounts receivable, $930 in

accounts payable, and $540 in cash. What is the amount of the net working capital? A) $4,980 B) $2,200 C) $3,130 D) $4,060 E) $5,910

75) A firm has $760 in inventory, $2,740 in fixed assets, $930 in accounts receivable, $480 in

accounts payable, $270 in long-term debt, and $120 in cash. What is the amount of the net working capital? A) $3,800 B) $1,810 C) $1,330 D) $2,290 E) $4,550

76) At the end of the year, Kiehnau Kicks had $11,400 in inventory, $23,470 in fixed assets,

$13,240 in accounts receivable, $9,760 in accounts payable, $5,350 in long-term debt, and $4,820 in cash. How much net working capital did the firm have? A) $19,700 B) $37,820 C) $29,460 D) $39,220 E) $52,930

77) At the beginning of the year, a firm had total assets of $51,400, fixed assets of $32,800, and

current liabilities of $13,280. At the end of the year, the current assets are $14,800, the fixed assets are $34,100, and the current liabilities are $14,210. What is the change in net working capital for the year? A) −$18,930 B) −$6,950 C) $11,470 D) −$4,730 E) $9,110

78) Wilson Corporation started the year with $280 in cash, $924 in inventory, $361 in accounts

payable, $1,687 in equipment, and $414 in accounts receivable. At year's end, the firm had $311 in cash, $1,594 in equipment, $1,003 in inventory, $426 in accounts receivable, and $398 in accounts payable. What was the change in net working capital during the year? A) −$860 B) $191 C) $85 D) −$94 E) −$206

79) Gonzalez Awnings has net fixed assets of $38,215, long-term debt of $22,400, cash of $560,

accounts payable of $4,611, inventory of $11,408, and accounts receivable of $3,462. How much net working capital does the firm have? A) $11,634 B) $26,634 C) $13,117 D) $10,819 E) $14,736

80) A firm with no debt has total sales of $22,980, costs of $14,715, and depreciation of $6,045.

The combined federal and state tax rate is 23 percent. What is the operating cash flow? A) $1,465.20 B) $2,410.80 C) $8,340.00 D) $7,754.40 E) $9,019.80

81) McSherry Interiors has beginning net fixed assets of $234,100 and ending net fixed assets of

$243,600. Assets valued at $42,500 were sold during the year. Depreciation was $62,500. What is the amount of net capital spending? A) −$42,500 B) $9,500 C) $72,000 D) $53,000 E) $29,500

82) At the beginning of the year, long-term debt of a firm was $2,400 and total debt was $3,150.

At the end of the year, long-term debt is $2,800 and total debt is $4,370. The interest paid was $40. What is the amount of the cash flow to creditors? A) $440 B) −$40 C) $1,260 D) $1,180 E) −$360

83) Walker Custom Boots has beginning long-term debt of $840 and ending long-term debt of

$790. The beginning and ending total debt balances are $1,220 and $1,360, respectively. The interest paid is $30. What is the amount of the cash flow to creditors? A) $80 B) −$110 C) $110 D) $20 E) −$80

84) For the year, Andrus Event Management had net income of $8,110. The firm paid out 30

percent of the net income to its shareholders as dividends and also paid $210 in interest. During the year, the company repurchased $500 worth of common stock and borrowed $250. What is the cash flow to stockholders? A) $2,933 B) $1,893 C) $1,933 D) $2,433 E) $2,893

85) Zhao Pediatrics has operating cash flow of $11,618. Depreciation is $2,345 and interest paid

is $395. A net total of $485 was paid on long-term debt. The firm spent $6,180 on fixed assets and decreased net working capital by $420. What is the cash flow of the firm? A) $5,858 B) $8,203 C) $9,228 D) $5,018 E) $7,363

86) Trevino Pet Care has total revenues of $3,811, costs of $2,902, depreciation of $315, interest

expense of $168, and taxes of $89. At the beginning of the year, the firm had current assets of $2,150, total assets of $4,908, and total liabilities of $1,964. At the end of the year, the current assets are $2,202, total assets are $5,103, and total liabilities are $1,952. What is the amount of net capital spending for the year? A) −$182 B) $133 C) $458 D) $510 E) $285

87) Grimaldi, Incorporated, has total revenue of $4,116, depreciation of $319, selling and

administrative expenses of $554, interest expense of $162, dividends of $75, cost of goods sold of $2,354, and taxes of $186. What is the operating cash flow? A) $1,118 B) $795 C) $1,147 D) $1,022 E) $720

88) Reed & Barr has interest expense of $168, total revenues of $38,411, costs of $28,515,

depreciation of $306, and taxes of $1,979. The beginning balance sheet has total assets of $48,354, net fixed assets of $31,202, current liabilities of $14,207, and total liabilities of $29,407. The ending balance sheet shows total assets of $49,305, net fixed assets of $33,406, current liabilities of $17,318, and total liabilities of $30,404. What is the annual cash flow of the firm? A) $9,771 B) −$2,160 C) $15,168 D) $8,474 E) $2,857

89) Batiste Corporation had taxable income of $1,630 and a tax rate of 23 percent for the year.

The firm neither issued nor repurchased shares of stock but did decrease its retained earnings by $310. What is the cash flow to stockholders? A) $1,749.50 B) $535.50 C) $959.50 D) $1,242.50 E) $1,565.10

90) Goodwin Transport paid $85 in dividends and $110 in interest expense during a given year.

During that same year, the firm issued $40 in new equity shares, issued new debt of $65, and repaid $23 of old debt. What is the cash flow to creditors for that year? A) $152 B) $146 C) $237 D) $68 E) $46

91) At the beginning of this year, Basit Framing had net fixed assets of $21,506 and total assets

of $32,687. At year’s end, net fixed assets are $20,492 and total assets are $32,915. The annual depreciation expense is $1,520. What is net capital spending for this year? A) −$850 B) $506 C) −$1,292 D) −$2,534 E) $1,748

92) For the year, Gripka Fashion has depreciation of $2,058, dividends paid of $125, interest

expense of $382, an addition to retained earnings of $3,408, and an increase in common stock of $2,500. The total tax rate is 21 percent. What is the operating cash flow? A) $6,460 B) $5,973 C) $5,325 D) $5,735 E) $6,408

93) Kotara Equipment has the following financial information:

Revenues Administrative expenses Interest expense Cost of goods sold Depreciation Net fixed assets Current liabilities Common stock Current assets Long-term debt Retained earnings Dividends paid

Current Year

Prior Year

$ 48,915 12,106 816 29,715 1,408 32,711 14,652 15,000 16,506 12,200 7,365 290

$ 43,610 11,602 468 26,309 1,387 31,984 14,625 14,000 14,687 ? 4,246 275

What is the cash flow of the firm for the current year if the tax rate is 22 percent? A) $1,885 B) $1,042 C) $2,297 D) $2,096 E) $2,517

94) For a given year, Goolsby Travel paid $318 in interest, $460 in dividends, and $368 in taxes.

The firm had a net income of $1,220, depreciation of $1,560, an increase in net working capital of $220, an increase in net fixed assets of $950, and a decrease in long-term debt of $260. There were no changes in the equity accounts other than the change in retained earnings. What is the annual cash flow of the firm? A) $3,148 B) $1,610 C) $2,780 D) $1,038 E) $50

95) Ortegon Service Corporation has beginning current liabilities of $14,602 and total liabilities

of $35,418. At the end of the year, the current liabilities are $15,311 and the total liabilities are $37,604. During the year, the firm paid $680 in dividends and $1,320 in interest. What is the cash flow to creditors? A) $3,230 B) $2,797 C) $3,135 D) −$157 E) −$267

96) During the year, Dharia’s repaid $12,500 in long-term debt, borrowed $8,400, paid $611 in

interest and $740 in dividends, and had an operating cash flow of $16,207. The firm acquired $33,500 in new fixed assets and sold $8,400 of old assets. Net working capital declined by $1,592 during the year. What is the annual cash flow to stockholders? A) $1,200 B) −$2,590 C) −$8,828 D) −$12,012 E) $2,800

97) Last year, Perez Professional Group had annual revenue of $87,200, depreciation of $11,600,

cost of goods sold of $54,700, and administrative expenses of $8,300. The firm paid $3,200 in dividends and paid taxes of $2,646. What was the operating cash flow? A) $21,500 B) $18,300 C) $23,100 D) $21,554 E) $23,700

98) Last year, Amargol Media had a cash flow to creditors of $2,840 and a cash flow to

stockholders of $1,630. The firm spent a net of $1,420 on fixed assets and reduced net working capital by $330. What was the operating cash flow? A) $6,190 B) $5,560 C) $3,500 D) $1,320 E) $4,901

99) Good & Well increased its cash by $418 this year. The firm's statement of cash flows shows

total cash flow from financing activities of $246 and total cash flow from investing activities of −$184. What is the total cash flow from operations on this accounting statement? A) $480 B) $356 C) $427 D) $367 E) $391

100)

Hildebrand Farms has net sales of $48,920, depreciation of $711, cost of goods sold of $31,890, administrative costs of $11,210, interest expense of $680, dividends paid of $450, and taxes of $974. What is the cash flow from operations as it will appear on the accounting statement of cash flows if the firm spent $274 on net working capital? A) $3,892 B) $3,056 C) $4,066 D) $3,667 E) $3,391

101)

Define liquidity and explain what a firm would need to do to ensure all of the current assets displayed on its balance sheet are liquid.

102)

Discuss the difference between book values and market values on the balance sheet and explain the best method for determining the value of a firm to its stockholders.

103)

Note that in all of our computations to determine the cash flows of a firm, we never include the addition to retained earnings. Why not? Is this an oversight?

104)

From a financial perspective, why is interest expense excluded from the operating cash flow?

105)

Explain why the income statement is not a good representation of cash flow.

106)

Depreciation is classified as a noncash item because no cash is spent when depreciation is recorded. Why are expenses that have been accrued, but not yet paid, not also considered to be noncash items and therefore excluded from operating cash flow just as depreciation is excluded?

107)

Interpret, in words, what the cash flow of the firm represents by discussing operating cash flow, changes in net working capital, and additions to fixed assets.

108)

Why is cash flow management important?

Answer Key Test name: Chapter 2(1) 1) B 2) A 3) B 4) B 5) D 6) C 7) E 8) D 9) D 10) B 11) A 12) E 13) A 14) C 15) B 16) D 17) B 18) A 19) D 20) A 21) D 22) E 23) B 24) A 25) D 26) E 27) D 28) B 29) E 30) A 31) A 32) B 33) A 34) D 35) C 36) A 37) B

38) C 39) E 40) E 41) E 42) A 43) A 44) C 45) E 46) B 47) D 48) B 49) B 50) D 51) D 52) D 53) A 54) B 55) C 56) C 57) D 58) A 59) E 60) D 61) B 62) C 63) A 64) C 65) D 66) E 67) D 68) C 69) A 70) D 71) E 72) A 73) C 74) B 75) C 76) A 77) D

78) C 79) D 80) D 81) C 82) E 83) A 84) A 85) A 86) C 87) D 88) A 89) E 90) D 91) B 92) B 93) D 94) D 95) D 96) D 97) D 98) B 99) B 100) 101) 102) 103) 104) 105) 106) 107) 108)

A Essay Essay Essay Essay Essay Essay Essay Essay

Student name: 1) A firm has common stock of $84, paid-in surplus of $200, total liabilities of $380, current

assets of $330, and net fixed assets of $540. What is the amount of the shareholders' equity? A) $510 B) $160 C) $664 D) $870 E) $490

2) Recently, the owner of Martha's Wares encountered severe legal problems and is trying to

sell her business. The company built a building at a cost of $1,220,000 that is currently appraised at $1,420,000. The equipment originally cost $700,000 and is currently valued at $447,000. The inventory is valued on the balance sheet at $390,000 but has a market value of only one-half of that amount. The owner expects to collect 97 percent of the $215,200 in accounts receivable. The firm has $10,300 in cash and owes a total of $1,420,000. The legal problems are personal and unrelated to the actual business. What is the market value of this firm? A) $1,056,044 B) $642,000 C) $861,044 D) $1,271,244 E) $1,661,244

3) Ivan's, Incorporated, paid $460 in dividends and $575 in interest this past year. Common

stock increased by $185 and retained earnings decreased by $111. What is the net income for the year? A) $575 B) $349 C) $460 D) $924 E) $760

4) The tax rates for a particular year are shown below: Taxable Income $0 − 50,000 50,001 − 75,000 75,001 − 100,000 100,001 − 335,000

Tax Rate 15% 25% 34% 39%

What is the average tax rate for a firm with taxable income of $123,013? A) 27.87% B) 20.00% C) 25.38% D) 36.28% E) 39.00%

5) The tax rates are as shown below: Taxable Income $0 − 50,000 50,001 − 75,000 75,001 − 100,000 100,001 − 335,000

Tax Rate 15% 25% 34% 39%

Your firm currently has taxable income of $81,600. How much additional tax will you owe if you increase your taxable income by $22,800? A) $7,582 B) $7,752 C) $7,972 D) $7,592 E) $8,892

6) Your firm has net income of $260 on total sales of $1,160. Costs are $650 and depreciation is

$110. The tax rate is 35 percent. The firm does not have interest expenses. What is the operating cash flow? A) $660 B) $510 C) $260 D) $400 E) $370

7) Teddy's Pillows had beginning net fixed assets of $475 and ending net fixed assets of $558.

Assets valued at $323 were sold during the year. Depreciation was $50. What is the amount of net capital spending? A) $133 B) $83 C) $33 D) $285 E) $456

8) At the beginning of the year, a firm has current assets of $321 and current liabilities of $225.

At the end of the year, the current assets are $479 and the current liabilities are $265. What is the change in net working capital? A) $0 B) $198 C) $158 D) –$118 E) $118

9) At the beginning of the year, long-term debt of a firm is $288 and total debt is $329. At the

end of the year, long-term debt is $259 and total debt is $339. The interest paid is $25. What is the amount of the cash flow to creditors? A) $29 B) $54 C) –$54 D) –$29 E) $25

10) Peggy Grey's Cookies has net income of $340. The firm pays out 30 percent of the net

income to its shareholders as dividends. During the year, the company sold $79 worth of common stock. What is the cash flow to stockholders? A) $78.30 B) $102.00 C) $181.00 D) $238.00 E) $23.00

11) A company has total equity of $2,055, net working capital of $205, long-term debt of $1,000,

and current liabilities of $3,030. What is the company's net fixed assets? A) $6,085 B) $3,055 C) $3,235 D) $4,085 E) $2,850

12) Disturbed, Incorporated, had the following operating results for the past year: sales =

$22,530; depreciation = $1,290; interest expense = $1,040; costs = $16,480. The tax rate for the year was 30 percent. What was the company's operating cash flow? A) $3,720 B) $2,718 C) $7,166 D) $4,934 E) $2,604

13) A company has net working capital of $1,915. If all its current assets were liquidated, the

company would receive $5,845. What are the company's current liabilities? A) $3,880 B) $3,930 C) $7,760 D) $4,888 E) $7,415

14) You are examining a company's balance sheet and find that it has total assets of $19,842, a

cash balance of $1,938, inventory of $4,593, current liabilities of $5,189 and accounts receivable of $2,467. What is the company's net working capital? A) $1,871 B) $5,377 C) $3,809 D) $784 E) $14,653

15) You find the following financial information about a company: net working capital = $951;

fixed assets = $5,897; total assets = $8,446; and long-term debt = $4,489. What are the company's total liabilities? A) $6,778 B) $2,051 C) $7,878 D) $5,440 E) $6,087

16) You find the following financial information about a company: net working capital = $1,179;

fixed assets = $7,553; total assets = $11,814; and long-term debt = $4,485. What is the company's total equity? A) $8,827 B) $4,261 C) $4,247 D) $6,293 E) $9,863

17) Hoodoo Voodoo Company has total assets of $66,300, net working capital of $20,350,

owners' equity of $32,270, and long-term debt of $23,830. What is the company's current assets? A) $32,270 B) $56,100 C) $30,550 D) $35,750 E) $45,950

18) A company has net working capital of $2,781, current assets of $6,750, equity of $22,710,

and long-term debt of $10,700. What is the company's net fixed assets? A) $40,160 B) $26,660 C) $25,491 D) $29,441 E) $30,629

19) Micro, Incorporated, started the year with net fixed assets of $74,425. At the end of the year,

there was $95,475 in the same account, and the company's income statement showed depreciation expense of $12,605 for the year. What was the company's net capital spending for the year? A) $39,140 B) $21,050 C) $41,550 D) $33,655 E) $82,870

20) At the beginning of the year, Shinedown, Corporation, had a long-term debt balance of

$46,755. During the year, the company repaid a long-term loan in the amount of $12,630. The company paid $4,795 in interest during the year, and opened a new long-term loan for $11,145. How much is the ending long-term debt account on the company's balance sheet? A) $50,065 B) $6,280 C) $48,240 D) $53,105 E) $45,270

21) At the beginning of the year, Nothing More, Corporation, had a long-term debt balance of

$38,554. During the year, the company repaid a long-term loan in the amount of $11,714. The company paid $4,710 in interest during the year, and opened a new long-term loan for $10,250. What was the cash flow to creditors during the year? A) $6,174 B) $7,004 C) $1,464 D) $11,880 E) $5,540

22) For the past year, Momsen, Limited, had sales of $47,552, interest expense of $4,322, cost of

goods sold of $17,709, selling and administrative expense of $12,336, and depreciation of $7,285. If the tax rate was 40 percent, what was the company's net income? A) $5,900 B) $1,811 C) $4,130 D) $10,942 E) $3,540

23) For the past year, Kayla, Incorporated, has sales of $47,357, interest expense of $4,244, cost

of goods sold of $17,534, selling and administrative expense of $12,241, and depreciation of $7,140. If the tax rate is 35 percent, what is the operating cash flow? A) $6,198 B) $4,029 C) $11,169 D) $14,040 E) $15,413

24) HUD, Company had a beginning retained earnings of $27,875. For the year, the company

had net income of $4,790 and paid dividends of $1,600. The company also issued $3,000 in new stock during the year. What is the ending retained earnings balance? A) $28,065 B) $29,475 C) $30,875 D) $34,065 E) $31,065

25) At the beginning of the year, Vendors, Incorporated, had owners' equity of $48,095. During

the year, net income was $4,575 and the company paid dividends of $3,395. The company also repurchased $7,045 in equity. What was the owners' equity account at the end of the year? A) $36,475 B) $41,050 C) $47,170 D) $37,655 E) $42,230

26) At the beginning of the year, Vendors, Incorporated, had owners' equity of $49,460. During

the year, net income was $5,800 and the company paid dividends of $4,060. The company also repurchased $8,060 in equity. What was the cash flow to stockholders for the year? A) −$12,120 B) $4,000 C) $9,800 D) −$4,000 E) $12,120

27) Simon's Hot Chicken purchased its building seven years ago at a price of $140,935. The

building could be sold for $180,575 today. The company spent $66,855 on other fixed assets that could be sold for $59,305. The company has accumulated depreciation of $81,475 on its fixed assets. Currently, the company has current liabilities of $37,590 and net working capital of $19,165. What is the ending book value of net fixed assets? A) $126,315 B) $170,200 C) $163,905 D) $158,405 E) $207,790

28) Last year, Bad Tattoo Company had additions to retained earnings of $4,865 on sales of

$95,805. The company had costs of $75,885, dividends of $3,040, and interest expense of $2,120. If the tax rate was 35 percent, what the depreciation expense? A) $6,986 B) $7,905 C) $6,035 D) $5,638 E) $13,123

29) Thornton, Incorporated, had taxable income of $130,607 for the year. The company's

marginal tax rate was 35 percent and its average tax rate was 23.2 percent. How much did the company have to pay in taxes for the year? A) $27,355 B) $30,301 C) $28,713 D) $29,058 E) $45,712

30) Red Barchetta Company paid $27,545 in dividends and $28,374 in interest over the past year.

During the year, net working capital increased from $13,530 to $18,244. The company purchased $42,110 in fixed assets and had a depreciation expense of $16,850. During the year, the company issued $25,025 in new equity and paid off $21,035 in long-term debt. What was the company's cash flow from assets? A) $45,789 B) $50,950 C) $53,277 D) $51,929 E) $52,326

31) Evil Pop Company began the year with net fixed assets of $17,348 and had $18,617 in the

account at the end of the year. During the year, the company paid $4,246 in interest and expensed $3,740 in depreciation. The company purchased $8,500 in fixed assets during the year. How much in fixed assets did the company sell during the year? A) $5,523 B) $3,921 C) $763 D) $9,277 E) $3,491

32) The Primus Corporation began the year with $7,496 in its long-term debt account and ended

the year with $9,180 in long-term debt. The company paid $1,083 in interest during the year and issued $2,460 in new long-term debt. How much in long-term debt must the company have paid off during the year? A) $1,684 B) −$1,684 C) $539 D) $776 E) −$601

33) Rousey, Incorporated, had a cash flow to creditors of $17,190 and a cash flow to

stockholders of $7,874 over the past year. The company also had net fixed assets of $49,830 at the beginning of the year and $57,280 at the end of the year. Additionally, the company had a depreciation expense of $12,372 and an operating cash flow of $51,471. What was the change in net working capital during the year? A) $9,316 B) $6,585 C) $5,153 D) $7,450 E) $5,860

34) A company is obligated to pay its creditors $7,000 at the end of the year. If the value of the

company's assets equals $7,350 at that time, what is the value of shareholders' equity? A) −$350 B) $350 C) $0 D) −$175 E) $14,350

35) Maynard Enterprises paid $1,328 in dividends and $969 in interest over the past year. The

common stock account increased by $1,224 and retained earnings decreased by $333. What was the company's net income? A) $995 B) $891 C) $1,557 D) $2,219 E) $1,661

36) Mariota Industries has sales of $368,520 and costs of $174,410. The company paid $31,110

in interest and $14,200 in dividends. It also increased retained earnings by $68,690 during the year. If the company's depreciation was $19,130, what was its average tax rate? A) 73.57% B) 34.18% C) 23.59% D) 16.55% E) 42.39%

37) During the past year, a company had cash flow to creditors, an operating cash flow, and net

capital spending of $28,783, $63,269, and $25,020, respectively. The net working capital at the beginning of the year was $10,960 and it was $12,250 at the end of the year. What was the company's cash flow to stockholders during the year? A) $10,756 B) $8,176 C) $6,430 D) $1,290 E) $9,466

38) During the past year, a company had cash flow to stockholders, an operating cash flow, and

net capital spending of $16,271, $39,228, and $18,140, respectively. The net working capital at the beginning of the year was $6,909 and it was $8,630 at the end of the year. What was the company's cash flow to creditors during the year? A) $3,096 B) $1,350 C) $1,721 D) $4,817 E) $6,538

39) Hurricane Industries had a net income of $123,900 and paid 35 percent of this amount to

shareholders in dividends. During the year, the company sold $76,500 in new common stock. What was the company's cash flow to stockholders? A) $43,365 B) −$33,135 C) −$43,365 D) $47,400 E) $33,135

40) A company has $558 in inventory, $1,831 in net fixed assets, $240 in accounts receivable,

$101 in cash, and $274 in accounts payable. What are the company's total current assets? A) $659 B) $899 C) $2,730 D) $933 E) $1,173

41) A company has $1,399 in inventory, $4,854 in net fixed assets, $682 in accounts receivable,

$310 in cash, $650 in accounts payable, $1,082 in long-term debt, and $5,449 in equity. What are the company's total assets? A) $10,303 B) $8,234 C) $7,245 D) $12,694 E) $7,895

42) A company has $1,357 in inventory, $4,800 in net fixed assets, $646 in accounts receivable,

$286 in cash, $602 in accounts payable, and $5,395 in equity. What is the company's longterm debt? A) $1,129 B) $1,271 C) $1,694 D) $1,650 E) $1,092

43) Lola Corporation has shareholders' equity of $128,600. The company has a total debt of

$120,950, of which 55 percent is payable in the next 12 months. The company also has net fixed assets of $174,320. What is the company's net working capital? A) $53,370 B) $13,020 C) $9,697 D) $7,650 E) $8,708

44) Smashed Pumpkins Company paid $192 in dividends and $617 in interest over the past year.

The company increased retained earnings by $516 and had accounts payable of $678. Sales for the year were $16,510 and depreciation was $748. The tax rate was 35 percent. What was the company's EBIT? A) $1,706 B) $1,977 C) $5,779 D) $1,411 E) $1,089

45) Kerch Company had beginning net fixed assets of $216,478, ending net fixed assets of

$211,652, and depreciation of $40,411. During the year, the company sold fixed assets with a book value of $7,918. How much did the company purchase in new fixed assets? A) $43,503 B) $41,340 C) $35,585 D) $32,493 E) $34,157

46) Adison Winery had beginning long-term debt of $37,516 and ending long-term debt of

$42,867. The beginning and ending total debt balances were $46,387 and $51,296, respectively. The company paid interest of $4,183 during the year. What was the company's cash flow to creditors? A) $9,092 B) −$1,168 C) −$726 D) $5,351 E) $726

47) A company has net working capital of $843. Long-term debt is $4,402, total assets are

$6,633, and fixed assets are $4,272. What is the amount of total liabilities? A) $5,245 B) $5,920 C) $8,674 D) $5,790 E) $7,476

48) Muffy's Muffins had net income of $2,185. The firm retains 60 percent of net income.

During the year, the company sold $175 in common stock. What was the cash flow to shareholders? A) $1,049 B) $699 C) $1,136 D) $1,486 E) $874

49) A firm has $760 in inventory, $1,465 in fixed assets, $525 in accounts receivable, $295 in net

working capital, and $165 in cash. What is the amount of current liabilities? A) $1,745 B) $990 C) $985 D) $705 E) $1,155

50) A balance sheet has total assets of $2,044, fixed assets of $1,406, long-term debt of $744,

and short-term debt of $261. What is the net working capital? A) $1,300 B) $638 C) $377 D) $401 E) $483

Answer Key Test name: Chapter 2(2) 1) E 2) C 3) B 4) C 5) C 6) E 7) A 8) E 9) B 10) E 11) E 12) D 13) B 14) C 15) E 16) C 17) C 18) E 19) D 20) E 21) A 22) E 23) E 24) E 25) E 26) E 27) A 28) D 29) B 30) D 31) E 32) D 33) B 34) B 35) A 36) E 37) B

38) A 39) B 40) B 41) C 42) E 43) E 44) A 45) A 46) B 47) B 48) B 49) E 50) C

Chapter 3: 1) All account values on the are expressed as a percentage of total assets. A) pro forma balance sheet B) common-size income statement C) statement of cash flows D) pro forma income statement E) common-size balance sheet

2) Assume you need to compare a firm’s costs with those of its competitors, all of which are

significantly larger than the firm you are analyzing. Preparing way to compare costs across the industry. A) pro forma balance sheets B) common-size income statements C) statements of cash flows D) pro forma income statements E) common-size balance sheets

would be the best

3) The term “income from operations” is synonymous with: A) TTM. B) EBIT. C) LTM. D) EBITDA. E) EPS.

are an effective way to measure a firm’s ability to pay its bills over the short run without undue stress. A) Asset management ratios B) Long-term solvency measures C) Liquidity measures D) Profitability ratios E) Market value ratios

5) The current ratio equals: A) current assets minus current liabilities. B) current assets divided by current liabilities. C) current liabilities minus inventory, divided by current assets. D) cash on hand divided by current liabilities. E) current liabilities divided by current assets.

6) The quick ratio equals: A) current assets divided by current liabilities. B) cash on hand plus current liabilities, divided by current assets. C) current liabilities divided by current assets, plus inventory. D) current assets minus inventory, divided by current liabilities. E) current assets minus inventory minus current liabilities.

ratios measure a firm’s use of financial leverage. A) Asset management B) Long-term solvency C) Short-term solvency D) Profitability E) Market value

8) The debt-equity ratio equals: A) total equity divided by long-term debt. B) total equity divided by total debt. C) total debt divided by total equity. D) long-term debt divided by total equity. E) total assets minus total debt, divided by total equity.

9) The equity multiplier equals: A) total equity divided by total assets. B) total equity plus total debt. C) total assets minus total equity, divided by total assets. D) total assets plus total equity, divided by total debt. E) total assets divided by total equity.

10)

ratios measure how efficiently a firm uses its assets to generate sales. A) Asset management B) Long-term solvency C) Short-term solvency D) Profitability E) Market value

11) The inventory turnover ratio equals: A) sales divided by inventory. B) inventory times total sales. C) cost of goods sold divided by inventory. D) inventory divided by cost of goods sold. E) inventory divided by sales.

12) Days’ sales in inventory equals: A) inventory turnover plus 365 days. B) inventory turnover times 365 days. C) inventory divided by cost of goods sold, times 365 days. D) 365 days divided by the inventory. E) 365 days divided by the inventory turnover.

13)

The receivables turnover ratio equals: A) sales plus accounts receivable. B) sales divided by accounts receivable. C) sales minus accounts receivable, divided by sales. D) accounts receivable times sales. E) accounts receivable divided by sales.

14) The total asset turnover ratio reveals the amount of: A) total assets needed for every $1 of sales. B) sales generated by every $1 in total assets. C) fixed assets required for every $1 of sales. D) net income generated by every $1 in total assets. E) net income that can be generated by every $1 of fixed assets.

15)

ratios reveal how efficiently a firm’s management uses the firm’s assets and equity to generate net income. A) Asset management B) Long-term solvency C) Short-term solvency D) Profitability E) Market value

16) Net income divided by sales is called: A) net profit margin. B) return on assets. C) return on equity. D) asset turnover. E) earnings before interest and taxes.

17) The measure called

reveals the amount of net income generated from every dollar

invested in total assets. A) net profit margin B) return on assets C) return on equity D) asset turnover E) earnings before interest and taxes

18) The accounting profit per dollar of book equity is called the: A) net profit margin. B) price-earnings ratio. C) return on equity. D) equity turnover. E) market profit-to-book ratio.

19) The

shows the amount that investors are willing to pay for each dollar of annual

earnings. A) return on assets B) return on equity C) debt-equity ratio D) price-earnings ratio E) DuPont identity

20) The market-to-book ratio equals: A) market price per share divided by the par value per share. B) net income per share divided by the market price per share. C) market price per share divided by the net income per share. D) market price per share divided by the dividends per share. E) market value per share divided by the book value per share.

21)

Regarding ratio analysis, which one of the following statements is correct? A) A single ratio is often computed differently by different individuals. B) No ratio can address the problem of size differences among firms. C) Only a very limited number of ratios can be used for analytical purposes. D) Every ratio is an income statement entry divided by a balance sheet item. E) Ratios cannot be used for comparison purposes over periods of time.

22) The A) B) C) D) E)

is considered to be a liquidity ratio. quick ratio cash coverage ratio total debt ratio EV multiple times interest earned ratio

23) An increase in will increase a firm’s current ratio, but will not affect its quick ratio. A) accounts payable B) cash C) inventory D) accounts receivable E) fixed assets

24) When granting credit to its customers, a supplier that requires payment within ten days

should be most concerned with which one of the following ratios? A) Current B) Cash C) Debt-equity D) Quick E) Total debt

25) Assume a firm has a total debt ratio of .36. An analyst would be justified in concluding that

the firm has 36 cents in debt for every: A) $1 in total equity. B) $.64 in total assets. C) $1 in current assets. D) $.64 in total equity. E) $1 in fixed assets.

26) The long-term debt ratio is probably of most interest to a firm's: A) credit customers. B) employees. C) suppliers. D) mortgage holder. E) stockholders.

27) A bank is evaluating whether to lend money to a firm for a ten-year term. Of the following

choices, the bank would most likely prefer the firm have a debt ratio of times interest earned ratio of . A) .50; .75 B) .50; 1.00 C) .45; 1.75 D) .40; .75 E) .40; 1.75

, and a

28) From a cash flow position, which one of the following ratios best measures a firm's ability to

pay the interest on its debts? A) Times interest earned ratio B) Cash coverage ratio C) Cash ratio D) Quick ratio E) Interval measure

29) The greater the inventory turnover value, the: A) less time inventory remains on hand before being sold. B) higher the inventory as a percentage of total assets. C) longer it takes a firm to sell its inventory. D) greater the amount of inventory held by a firm. E) greater the selection of goods available for sale.

30) Assume a firm has a receivables turnover value of 10. Which one of the following statements

is correct? A) It takes the firm 10 days to collect payment from its customers. B) It takes the firm 36.5 days to sell its inventory and collect the payment from the sale. C) It takes the firm an average of 36.5 days to sell its items. D) The firm collects its credit sales in an average of 36.5 days. E) The firm has ten times more in accounts receivable than it does in cash.

31) A firm with a capital intensity ratio of .98 has $.98 in: A) total debt for every $1 in equity. B) equity for every $1 in total debt. C) sales for every $1 in total assets. D) total assets for every $1 in sales. E) long-term assets for every $1 in short-term assets.

32) Float Swimwear generates six cents of net income for every $1 in equity. Thus, Float has a(n)

of 6 percent. A) return on assets B) net profit margin C) return on equity D) EV multiple E) price-earnings ratio

33) Assume a firm’s return on assets and return on equity are both 15 percent. An analyst would

be justified in concluding that the firm: A) has no debt of any kind. B) is using its assets as efficiently as possible. C) pays all its earnings out in dividends. D) also has a current ratio of 15. E) has an equity multiplier of 2.

34) If stockholders want to know how much profit the firm is making on their entire investment

in that firm, the stockholders should refer to the: A) net profit margin. B) return on assets. C) return on equity. D) equity multiplier. E) earnings per share.

35) Assume Puffy’s Pastries increases its operating efficiency by lowering its costs, but holds its

sales constant. As a result, given all else constant, the: A) return on equity will increase. B) return on assets will decrease. C) net profit margin will decline. D) total debt ratio will decrease. E) price-earnings ratio will increase.

36) Alpha Corporation owns only fully depreciated equipment. Beta Corporation owns only new

equipment, which will be depreciated over ten years. If Alpha and Beta have the same sales, costs, tax rate, and enterprise value, then: A) Alpha will have the lower net profit margin. B) Alpha will have the lower return on equity. C) Beta will have the higher net income. D) Alpha and Beta will have the same EV multiple. E) Beta will have the lower EV multiple.

37) Last year, Seo & Stewart had a price-earnings ratio of 12 and earnings per share of $.97. This

year, the price-earnings ratio is 16 and the earnings per share is $.97. Based on this information, it can be stated with certainty that: A) the price per share decreased. B) the earnings per share decreased. C) investors are paying a lower price per share this year as compared to last year. D) investors are receiving a higher rate of return this year. E) the investors' outlook for the firm has improved.

38) Anand, Incorporated, has a price-earnings ratio of 16. Burleson, Incorporated, has a price-

earnings ratio of 19. Thus, you can state with certainty that one share of Burleson stock: A) has a higher market price than one share of Anand stock. B) has a higher market price per dollar of earnings than does one share of Anand stock. C) sells at a lower price per share than one share of Anand stock. D) represents a larger percentage of firm ownership than does one share of Anand stock. E) earns a greater net profit per share than does one share of Anand stock.

39) Which one of the following circumstances is most apt to cause a profitable, stable firm to

have a higher than average price-earnings ratio? A) Slow industry outlook B) Very low current earnings C) Low market share D) Low prospect of firm growth E) Low investor opinion of firm

40) Riaz Restaurant Group has a market-to-book ratio of 3.4. The book value per share is $34

and earnings per share are $1.36. Holding the market-to-book ratio and earnings per share constant, a $1 increase in the book value per share will: A) decrease the price-earnings ratio. B) decrease the EV multiple. C) decrease the market price per share. D) increase the price-earnings ratio. E) increase the return on equity.

41) Which one of the following sets of ratios would generally be of the most interest to

stockholders? A) Return on assets and net profit margin B) Quick ratio and times interest earned C) Price-earnings ratio and debt-equity ratio D) Return on equity and price-earnings ratio E) Cash coverage ratio and equity multiplier

42) If a firm decreases its operating costs, all else constant, the: A) net profit margin will decrease. B) return on assets will decrease. C) total asset turnover rate will increase. D) cash coverage ratio will decrease. E) price-earnings ratio will decrease.

43) A public firm’s market capitalization equals the: A) total book value of assets less the book value of debt. B) par value of common equity. C) price per share multiplied by number of shares outstanding. D) stock price per share multiplied by the number of shares authorized. E) maximum value an acquirer would pay for the firm in an acquisition.

44) Enterprise value equals the: A) market value of interest-bearing debt plus the market value of equity minus cash. B) book values of debt and assets, other than cash. C) market value of equity plus the book value of total debt minus cash. D) book value of debt plus the market value of equity. E) book values of debt and equity less cash.

45) Assume you want to acquire a firm and pay off all of its debt. The total amount of funds you

require is called the: A) market value of total assets. B) book value of equity. C) return on assets. D) market value of equity. E) enterprise value.

46) A firm with a high level of growth opportunities is most apt to have a: A) high PE ratio and a high EV multiple. B) high cash ratio and a low EV multiple. C) high PE ratio and a low EV multiple. D) low PE ratio and a high EV multiple. E) low cash ratio and a low PE ratio.

47) The equity multiplier measures: A) financial leverage. B) returns to stockholders. C) operating efficiency. D) management efficiency. E) asset use efficiency.

48) The return on equity equals: A) ROA × Equity multiplier. B) Net profit margin × ROA. C) Net profit margin × ROA × Total asset turnover. D) ROA × Net income/Total assets. E) ROA × Debt-equity ratio.

49) The DuPont identity can be computed as: A) Net income × Net Profit margin × (1 + Debt-equity ratio). B) Net profit margin × 1/Capital intensity ratio × (1 + Debt-equity ratio). C) Net income × Total asset turnover × Equity multiplier. D) Net profit margin × Total asset turnover × Debt-equity ratio. E) Return on equity × Net profit margin × Total asset turnover.

50) The A) B) C) D) E)

reveals the efficiency with which a firm employs its assets. net profit margin return on equity equity multiplier P/E ratio total asset turnover

51) The process of evaluating a firm using its financial statements is simplified when the firm: A) is a conglomerate. B) is global in nature. C) uses the same accounting procedures as other firms in its industry. D) has a different fiscal year than other firms in its industry. E) tends to have one-time events such as asset sales and property acquisitions.

52) The most effective method of directly evaluating the financial performance of a firm is to

compare the financial ratios of the firm to: A) the firm's ratios from prior time periods and to the ratios of firms with similar operations. B) the average ratios of all firms within the same country over a period of time. C) those of other firms located in the same geographic area that are similarly sized. D) the average ratios of the firm's international peer group. E) those of the largest conglomerate that has operations in the same industry as the firm.

53) When comparing the financial statements of one firm with those of another firm, the least

number of issues will arise if the two firms: A) are in different lines of business. B) have geographically diverse operations. C) use different methods of depreciation. D) are both classified as conglomerates. E) have the same fiscal year-end.

54) In the financial planning model, the external financing needed (EFN) as shown on a pro

forma balance sheet is equal to the changes in assets: A) plus the changes in liabilities minus the changes in equity. B) minus the changes in both liabilities and equity. C) minus the changes in liabilities only. D) plus the changes in both liabilities and equity. E) minus the change in retained earnings.

55)

is least likely to vary directly with sales. A) Notes payable B) Inventory C) Cost of goods sold D) Accounts payable E) Accounts receivable

56)

statements are projected future financial statements. A) Composite B) Pro forma C) Reconciled D) Aggregated E) Comparative

57) The projected addition to retained earnings can be calculated as: A) PM × Δ Sales. B) PM × Δ Sales × (1 − Dividend payout ratio). C) PM × Projected sales × (1 − Dividend payout ratio). D) Projected sales × (1 − Dividend payout ratio). E) PM × Projected sales.

58) The maximum rate at which a firm can grow without issuing new equity, and while

maintaining a constant debt-equity ratio, is best defined by its: A) rate of return on assets. B) internal rate of growth. C) average historical rate of growth. D) rate of return on equity. E) sustainable rate of growth.

59) The sustainable growth rate will be equivalent to the internal growth rate when, and only

when: A) B) C) D) E)

a firm has no debt. the growth rate is positive. the plowback ratio is positive but less than 1. a firm has a debt-equity ratio equal to 1. the retention ratio is equal to 1.

60) The sustainable growth rate: A) assumes there is no external financing of any kind. B) is normally higher than the internal growth rate. C) assumes the debt-equity ratio is variable. D) is based on receiving additional external equity financing. E) assumes the dividend payout ratio is equal to zero.

61) If a firm bases its growth projection on the rate of sustainable growth, shows positive net

income, and has a dividend payout ratio of 30 percent, then the: A) fixed assets will have to increase at the sustainable growth rate, even if the firm is currently operating at only 78 percent of capacity. B) number of common shares outstanding will increase at the same rate of growth. C) debt-equity ratio will have to increase. D) debt-equity ratio will remain constant while retained earnings increase. E) fixed assets, debt-equity ratio, and number of common shares outstanding will all increase.

62) Paulhill Organic Produce wants to maintain its current dividend policy, which is a payout

ratio of 25 percent. The firm does not want to increase its equity financing but is willing to maintain its current debt-equity ratio. Given these requirements, the maximum rate at which Paulhill can grow is equal to: A) 25 percent of the internal rate of growth. B) 75 percent of the internal rate of growth. C) the internal rate of growth. D) the sustainable rate of growth. E) 75 percent of the sustainable rate of growth.

63) The value of the variable “b” as used in the internal growth rate formula equals: A) 1 + Growth rate. B) Total dividends/Net income. C) 1 − Dividend payout ratio. D) Net income/Total sales. E) 1 − PE ratio.

64) One way to increase a firm’s sustainable rate of growth is to: A) decrease the debt-equity ratio. B) decrease the net profit margin. C) increase the dividend payout ratio. D) increase the capital intensity ratio. E) increase the total asset turnover.

65) Financial planning models are most likely to omit: A) the changes in net working capital required for additional sales. B) the increases in costs required to increase sales. C) any change in retained earnings due to changes in the income statement. D) the timing, risk, and size of the cash flows. E) any additions that might be needed to fixed assets.

66) Burds Feed Store has sales of $22,400, net income of $3,600, net fixed assets of $18,700,

inventory of $2,800, and total current assets of $6,300. What is the common-size statement value of inventory? A) 10.07% B) 13.67% C) 11.20% D) 12.50% E) 9.84%

67) Viqar’s has sales of $41,700, net income of $3,950, total assets of $22,100, and total equity

of $11,800. Interest expense is $600. What is the common-size statement value of the interest expense? A) 1.52% B) 1.44% C) 15.19% D) 2.71% E) 5.08%

68) Proctor Systems has sales of $91,300, net income of $7,800, costs of $47,600, and

depreciation expense of $7,500. What is the common-size statement value of EBIT? A) 76.05% B) 23.95% C) 39.65% D) 16.76% E) 47.86%

69) Park Media has cash of $218, accounts receivable of $457, accounts payable of $398, and

inventory of $647. What is the value of the quick ratio? A) .55 B) 1.05 C) 1.70 D) 1.32 E) 1.52

70) Blue Sky has a debt-equity ratio of .56. What is the equity multiplier? A) 1.56 B) .44 C) 2.27 D) 1.76 E) 1.44

71) Shepherd Management has total debt of $6,800 and a debt-equity ratio of .36. What is the

value of the total assets? A) $18,889 B) $24,480 C) $23,520 D) $25,689 E) $25,360

72) Moorhead Consulting has sales of $684,000, costs of $437,000, interest paid of $13,800, total

assets of $712,000, and depreciation expense of $109,400. The tax rate is 21 percent and the equity multiplier is 1.6. What is the return on equity? A) 21.30% B) 23.92% C) 20.06% D) 19.48% E) 21.98%

73) Mora-Ramos Brands paid $11,310 in interest and $16,500 in dividends last year. The times

interest earned ratio is 2.9, the depreciation expense is $7,900, and the tax rate is 21 percent. What is the value of the cash coverage ratio? A) 3.71 B) 2.58 C) 3.60 D) 2.78 E) 3.10

74) Ceramic Coast has sales of $312,800, cost of goods sold of $218,400, inventory of $46,300,

and accounts receivable of $62,700. How many days, on average, does it take the firm to both sell its inventory and collect payment on the sale? A) 142.10 B) 96.37 C) 178.21 D) 150.54 E) 124.03

75) Plateau Partners has accounts receivable of $760,000, inventory of $550,000, sales of $

4,370,000, and cost of goods sold of $ 1,950,000. How many days, on average, does it take the firm to sell its inventory? A) 8 B) 2 C) 807 D) 103 E) 29

76) Hendrickson, Incorporated, has net working capital of $43,800, net fixed assets of $232,400,

net income of $43,900, and current liabilities of $51,300. The tax rate is 21 percent and the net profit margin is 9.3 percent. How many dollars of sales are generated from every $1 in total assets? A) $1.44 B) $1.32 C) $1.73 D) $.97 E) $1.06

77) Lakhani Consulting has sales of $418,000, total equity of $224,400, a tax rate of 23 percent,

a debt-equity ratio of .37, and a net profit margin of 5.1 percent. What is the return on assets? A) 6.93% B) 9.50% C) 11.08% D) 7.13% E) 13.13%

78) Guillory Group has sales of $363,000, total assets of $323,500, and a net profit margin of

14.6 percent. The firm has a total debt ratio of 54 percent. What is the return on equity? A) 28.45% B) 35.61% C) 23.29% D) 31.74% E) 7.88%

79) May & Gray has $876,400 in sales with a net profit margin of 3.8 percent. There are 32,500

shares of stock outstanding at a market price per share of $21.60. What is the price-earnings ratio? A) 23.40 B) 22.60 C) 19.21 D) 21.08 E) 18.47

80) New Metals has depreciation expense of $28,300, interest expense of $11,400, EBIT of

$62,700, a price-earnings ratio of 8.6, a net profit margin of 7.2 percent, a tax rate of 21 percent, and 37,500 shares of stock outstanding. What is the market price per share? A) $13.48 B) $7.09 C) $9.29 D) $12.48 E) $10.92

81) A firm has 12,000 shares of stock outstanding, sales of $638,100, a net profit margin of 8.2

percent, a tax rate of 21 percent, a price-earnings ratio of 11.3, and a book value per share of $7.98. What is the market-to-book ratio? A) 6.08 B) 5.42 C) 5.16 D) 6.17 E) 6.90

82) Bastek, Incorporated, has 17,500 shares of stock outstanding along with $408,000 of interest-

bearing debt. The market and book values of the debt are the same. The firm has sales of $697,000 and a net profit margin of 6.8 percent. The tax rate is 21 percent, the debt-equity ratio is 40 percent, and the price-earnings ratio is 11.8. The firm has $130,000 of current assets of which $41,200 is cash. What is the enterprise value multiple? A) $1,106,308 B) $994,520 C) $830,479 D) $1,018,097 E) $926,073

83) Morales Corporation has sales of $317,000, a net profit margin of 8.6 percent, an equity

multiplier of 1.8, and total debt of $144,400. What is the return on equity? A) 15.48% B) 14.46% C) 7.05% D) 15.10% E) 11.25%

84) Kwok Electronics has the following balance sheet values: inventory $70,500; accounts

receivable $50,700; accounts payable $58,900; cash $32,300, notes payable $20,000, longterm debt $134,700, and net fixed assets $504,500. What is the current ratio? A) 1.95 B) .95 C) 2.11 D) 1.98 E) .98

85) Morgan Furniture has total revenues of $684,350, costs of goods sold of $472,500, net

income of $11,520, and average inventory of $91,600. What is the days' sales in inventory? A) 69.84 days B) 70.76 days C) 71.51 days D) 5.16 days E) 4.08 days

86) Gonzalez Brothers has current assets of $26,900, net working capital of $8,200, long-term

debt of $21,500, and total equity of $57,800. What is the equity multiplier? A) 1.70 B) 1.59 C) 1.66 D) 1.80 E) 1.99

87) Hettrick Inspections has net sales of $642,100, depreciation expense of $138,400, interest

expense of $15,600, cost of goods sold of $409,800, and taxes of $16,400. What is the cash coverage ratio? A) 11.06 B) 6.02 C) 13.79 D) 14.89 E) 8.78

88) Fahy Foods has net income of $39,900, net sales of $318,600, total assets of $663,000,

common stock of $106,800 with a par value of $1 per share, and retained earnings of $224,400. The stock has a market value of $5.45 per share. What is the price-earnings ratio? A) 17.12 B) 19.94 C) 12.82 D) 14.59 E) 16.64

89) Gondi Irrigation paid dividends of $3,300 and total equity of $39,450. The debt-equity ratio

is 1 and the plowback ratio is 40 percent. What is the return on assets? A) 6.24% B) 6.09% C) 7.23% D) 6.97% E) 5.72%

90) Torres Flooring has total assets of $48,700, net working capital of $1,100, and retained

earnings of $21,200. The firm has 12,500 shares of stock outstanding with a par value of $1 per share and a market value of $7.10 per share. The stock was originally issued to the firm's founders at par value. What is the market-to-book ratio? A) 3.19 B) 2.22 C) 2.78 D) 3.03 E) 2.63

91) Audacious Coffee has sales of $318,200, net income of $41,400, current assets of $118,400,

net fixed assets of $238,300, net working capital of $18,900, and long-term debt of $175,000. What is the equity multiplier? A) 1.71 B) 4.34 C) 1.44 D) 3.82 E) 2.92

92) Vaz & Diaz Financial Services has an enterprise value ratio of 9.8, a net profit margin of 6.5

percent, sales of $946,200, costs of $631,400, depreciation expense of $17,900, interest expense of $4,500, and a total tax rate of 23 percent. What is the value of the enterprise? A) $3,102,900 B) $3,085,040 C) $2,748,300 D) $3,206,780 E) $2,918,640

93) Merritt Stoneworks is all-equity financed and has net sales of $217,800, taxable income of

$32,600, a return on assets of 11.5 percent, a tax rate of 21 percent, and total debt of $63,700. What are the values for the three components of the DuPont identity? A) 11.82%; .9725; 1.3975 B) 11.82%; 1.0282; 1.3975 C) 11.82%; .9725; .7156 D) 10.24%; 1.0282; .7156 E) 10.24%; 1.0282; 1.3975

94) Audino Audio has a return on equity of 16.2 percent, a debt-equity ratio of 44 percent, a

capital intensity ratio of 1.08, a current ratio of 1.25, and current assets of $138,000. What is the net profit margin? A) 12.15% B) 9.72% C) 7.48% D) 15.19% E) 13.69%

95) Table Top Floral has total sales of $642,100, EBIT of $93,900, net income of $50,800,

current assets of $153,500, total assets of $658,000, current liabilities of $78,900, and total liabilities of $213,600. What are the values of the three components of the DuPont identity? A) 7.91%; 1.02; 1.48 B) 8.57%; 1.02; .68 C) 7.91%; .98; 1.48 D) 11.43%; .98; .68 E) 11.43%; 1.02; 1.48

96) Crampton Machine has net income of $29,600, a total asset turnover of 1.4, total assets of

$318,600, and a debt-equity ratio of .35. What is the return on equity? A) 16.72% B) 8.40% C) 12.54% D) 14.67% E) 17.56%

97) Gbenda Corporation has sales of $91,200, net income of $18,240, dividends paid of $3,830,

total assets of $456,000, and total liabilities of $182,400. Assume that all costs and assets change spontaneously with sales. The tax rate and dividend payout ratios remain constant. If the firm’s managers project a firm growth rate of 10 percent for next year, what will be the amount of external financing needed to support this level of growth? Assume the firm is currently operating at full capacity. A) $65,664 B) $25,536 C) $45,600 D) $41,387 E) $29,749

98) Freeze Ice Creams has total assets of $591,600, current liabilities of $49,700, dividends paid

of $12,000, net sales of $68,400, and net income of $55,400. Assume that all costs, assets, and current liabilities change spontaneously with sales. The tax rate and dividend payout ratios remain constant. If the firm's managers project a firm growth rate of 6 percent for next year, what will be the amount of external financing needed to support this level of growth? Assume the firm is currently operating at full capacity. A) $3,200 B) −$13,490 C) −$17,520 D) $15,640 E) $16,380

99) Willard Windows has total sales of $387,200 on total assets of $429,600, current liabilities of

$45,000, and $24,000 of dividends paid on net income of $57,700. Assume that all costs, assets, and current liabilities change spontaneously with sales. The tax rate and dividend payout ratios remain constant. If the firm's managers project a firm growth rate of 12 percent for next year, what will be the amount of external financing needed to support this level of growth? Assume the firm is currently operating at full capacity. A) $11,706 B) $14,350 C) $9,911 D) $5,667 E) $8,408

100)

For the year just ended, Shriftman Fabrics reported total sales of $12,000, costs of 8,952, total assets of $27,200, total liabilities of $7,400, and total equity of $19,800. The company does not pay dividends. Assume that all costs and assets change spontaneously with sales. The tax rate and dividend payout ratios remain constant. Next year’s revenue is expected to be $14,820. What will be the amount of external financing needed to support this increase in sales? Assume the firm is currently operating at full capacity. A) $2,628 B) $29,828 C) $10,028 D) $33,592 E) $3,344

101)

Truong Bakery has net sales of $642,100, net income of $50,800, dividends paid of $12,700, total assets of $658,000, and total equity of $444,400. What is the internal growth rate? A) 5.83% B) 6.24% C) 6.15% D) 5.18% E) 7.70%

102)

Adeoya Corporation reported $703,000 in sales and $140,600 in net income. The company paid $56,240 in dividends and ended the year with $1,304,000 in total assets. Assume the dividend payout ratio will be constant. At what annual rate can the company grow without having to raise external funds? The company is operating at full capacity. A) 6.9% B) 4.5% C) 11.0% D) 27.5% E) 47.8%

103)

Mauve Inns has total assets of $913,600, total debt of $424,500, net sales of $848,600, and net income of $94,000. The tax rate is 21 percent and the dividend payout ratio is 30 percent. What is the firm's sustainable growth rate? A) 13.97% B) 14.46% C) 15.54% D) 12.63% E) 14.91%

104)

Flash eBikes has a net profit margin of 6.2 percent and a dividend payout ratio of 40 percent. The capital intensity is 1.08 and the debt-equity ratio is .54. What is the sustainable rate of growth? A) 6.30% B) 5.53% C) 5.60% D) 6.41% E) 5.89%

105)

You are comparing the common-size financial statements for two firms in the same industry that have very similar operations. You note that their sales revenues are similar in dollar value but yet the common-size EBIT for one firm is 30 percent compared to only 26 percent for the other firm. What are some possible explanations for this difference given the strong similarities of the two firms?

106)

Which is a more meaningful measure of profitability for a firm, return on assets or return on equity? Why?

107)

A retail store has days' sales in inventory of 68 days and an average collection period of 32 days. The firm pays its suppliers in an average of 42 days. Taken together, what do these average values imply about the firm's operations and its cash flows?

108)

Suppose a firm calculates its external financial need for a growth rate of ten percent and finds that the need is a negative value. What are the firm's options in this case?

109)

New Tek has a sustainable growth rate of 11.2 percent. However, the firm's managers are determined that the firm should grow by at least 20 percent next year. What must the firm do if the managers are to reach their desired level of growth for the firm?

110)

State the assumptions that underlie the internal growth rate and interpret what that rate means.

Answer Key Test name: Chapter 3(1) 1) E 2) B 3) B 4) C 5) B 6) D 7) B 8) C 9) E 10) A 11) C 12) E 13) B 14) B 15) D 16) A 17) B 18) C 19) D 20) E 21) A 22) A 23) C 24) B 25) D 26) D 27) E 28) B 29) A 30) D 31) D 32) C 33) A 34) C 35) A 36) D 37) E

38) B 39) B 40) D 41) D 42) E 43) C 44) A 45) E 46) A 47) A 48) A 49) B 50) E 51) C 52) A 53) E 54) B 55) A 56) B 57) C 58) E 59) A 60) B 61) D 62) D 63) C 64) E 65) D 66) C 67) B 68) C 69) C 70) A 71) D 72) E 73) C 74) D 75) D 76) A 77) A

78) B 79) D 80) C 81) D 82) E 83) D 84) A 85) B 86) A 87) D 88) D 89) D 90) E 91) B 92) B 93) A 94) A 95) C 96) C 97) E 98) B 99) E 100) 101) 102) 103) 104) 105) 106) 107) 108) 109) 110)

A C A C C Essay Essay Essay Essay Essay Essay

Student name: 1) A firm has sales of $1,050, net income of $209, net fixed assets of $510, and current assets of

$266. The firm has $84 in inventory. What is the common-size balance sheet value of inventory? A) 16.47% B) 31.58% C) 8.00% D) 10.82% E) 40.19%

2) A firm has total debt of $1,340 and a debt–equity ratio of .19. What is the value of the total

assets? A) B) C) D) E)

$1,594.60 $2,546.00 $8,392.63 $1,900.00 $7,052.63

3) A firm has sales of $4,850, costs of $2,650, interest paid of $180, and depreciation of $495.

The tax rate is 30 percent. What is the cash coverage ratio? A) 16.37 times B) 5.93 times C) 9.47 times D) 8.68 times E) 12.22 times

4) Mario's Home Systems has sales of $2,870, costs of goods sold of $2,210, inventory of $514,

and accounts receivable of $435. How many days, on average, does it take Mario's to sell its inventory? A) 84.89 days B) 55.32 days C) 83.73 days D) 65.37 days E) 71.84 days

5) A firm has net working capital of $480, net fixed assets of $2,226, sales of $5,900, and

current liabilities of $790. How many dollars worth of sales are generated from every $1 in total assets? A) $2.65 B) $1.65 C) $2.18 D) $1.69 E) $1.96

6) Lee Sun's has sales of $4,050, total assets of $3,750, and a profit margin of 5 percent. The

firm has a total debt ratio of 41 percent. What is the return on equity? A) 5.40 percent B) 5.00 percent C) 9.15 percent D) 4.94 percent E) 10.93 percent

7) Jupiter Explorers has $9,000 in sales. The profit margin is 5 percent. There are 6,300 shares

of stock outstanding, with a price of $1.80 per share. What is the company's price–earnings ratio? A) 12.60 times B) 25.20 times C) 12.86 times D) 31.75 times E) 15.30 times

8) Samuelson's has a debt–equity ratio of 45 percent, sales of $11,000, net income of $2,300,

and total debt of $11,700. What is the return on equity? A) 19.66% B) 4.50% C) 6.10% D) 20.91% E) 8.85%

9) A firm has a return on equity of 14 percent. The total asset turnover is 1.3 and the profit

margin is 7 percent. The total equity is $5,000. What is the net income? A) $700 B) $455 C) $538 D) $910 E) $350

10) Use the following information to answer this question. Windswept, Incorporated 2017 Income Statement ($ in millions) Net sales $ 9,390 Cost of goods sold 7,660 Depreciation 455 Earnings before $ interest and taxes 1,275 Interest paid 100 Taxable income $ 1,175 Taxes 411 Net income $ 764 Windswept, Incorporated 2016 and 2017 Balance Sheets ($ in millions) 2016 2017 Cash

$ 210

$ 240

Accounts receivable Inventory

960 1,750

860 1,665

Total

$ 2,920 3,370

$ 2,765 3,910

Retained earnings

$ 6,290

$ 6,675

Total liability & equity

Net fixed assets Total assets

Accounts payable Long-term debt Common stock

2016

2017

$ 1,290 1,080 3,300

$ 1,335 1,280 3,190

620

870

$ 6,290

$ 6,675

What is the quick ratio for 2017? A) 1.89 times B) 2.07 times C) .82 times D) 1.25 times E) .80 times

11) Use the following information to answer this question. Windswept, Incorporated 2017 Income Statement ($ in millions) Net sales $ 9,150 Cost of goods sold 7,590 Depreciation 435 Earnings before $ interest and taxes 1,125 Interest paid 98 Taxable income $ 1,027 Taxes 359 Net income $ 668 Windswept, Incorporated 2016 and 2017 Balance Sheets ($ in millions) 2016 2017 Cash

$ 190

$ 220

Accounts receivable Inventory

920 1,700

820 1,625

Total

$ 2,810 3,370

$ 2,665 3,810

Retained earnings

$ 6,180

$ 6,475

Total liability & equity

Net fixed assets Total assets

Accounts payable Long-term debt Common stock

2016

2017

$ 1,230 1,080 3,300

$ 1,385 1,290 2,980

570

820

$ 6,180

$ 6,475

What is the days' sales in receivables for 2017? A) 66.60 days B) 32.26 days C) 46.22 days D) 32.71 days E) 34.70 days

12) Use the following information to answer this question. Windswept, Incorporated 2017 Income Statement ($ in millions) Net sales $ 11,750 Cost of goods sold 7,750 Depreciation 475 Earnings before $ 3,525 interest and taxes Interest paid 92 Taxable income $ 3,433 Taxes 1,202 Net income $ 2,231 Windswept, Incorporated 2016 and 2017 Balance Sheets ($ in millions) 2016 2017 Cash

$ 220

$ 250

Accounts receivable 1,030 Inventory 1,880 Total $ 3,130

930 1,675 $ 2,855 3,950

Net fixed assets Total assets

3,450 $ 6,580

$ 6,805

2016

2017

Accounts payable Long-term debt Common stock Retained earnings

$ 1,660 1,030 3,280 610

$ 1,595 1,350 3,000 860

Total liability & equity

$ 6,580

$ 6,805

What is the fixed asset turnover for 2017? A) 1.73 times B) 4.12 times C) 2.25 times D) .34 times E) 2.97 times

13) Use the following information to answer this question. Windswept, Incorporated 2017 Income Statement ($ in millions) Net sales $ 9,300 Cost of goods sold 7,450 Depreciation 370 Earnings before $ interest and taxes 1,480 Interest paid 91 Taxable income $ 1,389 Taxes 486 Net income $ 903 Windswept, Incorporated 2016 and 2017 Balance Sheets ($ in millions) 2016 2017 Cash

$ 180

$ 210

Accounts receivable Inventory

880 1,630

780 1,595

Total

$ 2,690 3,280

$ 2,585 3,760

Retained earnings

$ 5,970

$ 6,345

Total liability & equity

Net fixed assets Total assets

Accounts payable Long-term debt Common stock

2016

2017

$ 1,230 1,020 3,230

$ 1,422 1,253 2,930

490

740

$ 5,970

$ 6,345

What is the equity multiplier for 2017? A) 3.17 times B) 2.17 times C) 2.53 times D) 1.73 times E) 1.28 times

14) Use the following information to answer this question. Windswept, Incorporated 2017 Income Statement ($ in millions) Net sales $ 9,600 Cost of goods sold 7,750 Depreciation 390 Earnings before $ interest and taxes 1,460 Interest paid 92 Taxable income $ 1,368 Taxes 479 Net income $ 889 Windswept, Incorporated 2016 and 2017 Balance Sheets ($ in millions) 2016 2017 Cash

$ 230

$ 260

Accounts receivable Inventory

1,030 1,700

930 1,695

Total

$ 2,960 3,470

$ 2,885 3,940

Retained earnings

$ 6,430

$ 6,825

Total liability & equity

Net fixed assets Total assets

Accounts payable Long-term debt Common stock

2016

2017

$ 1,510 1,030 3,280

$ 1,632 1,343 2,990

610

860

$ 6,430

$ 6,825

What is the cash coverage ratio for 2017? A) 15.87 times B) 3.98 times C) 7.12 times D) 2.83 times E) 20.11 times

15) Use the following information to answer this question. Windswept, Incorporated 2017 Income Statement ($ in millions) Net sales $ 10,200 Cost of goods sold 8,050 Depreciation 480 Earnings before interest and taxes Interest paid Taxable income Taxes

$ 1,670

Net income

$ 1,018

104 $ 1,566 548 Windswept, Incorporated 2016 and 2017 Balance Sheets ($ in millions) 2016 2017

Cash

$ 300

$ 335

Accounts receivable 1,150 Inventory 1,820 Total $ 3,270

1,050 1,775 $ 3,160 4,120

Net fixed assets Total assets

3,560 $ 6,830

$ 7,280

2016

2017

Accounts payable Long-term debt Common stock Retained earnings

$ 1,670 1,090 3,400 670

$ 1,895 1,415 3,050 920

Total liability & equity

$ 6,830

$ 7,280

What is the return on equity for 2017? A) 25.64% B) 54.75% C) 42.07% D) 33.38% E) 31.57%

16) Use the following information to answer this question. Windswept, Incorporated 2017 Income Statement ($ in millions) Net sales $ 10,150 Cost of goods sold 8,000 Depreciation 375 Earnings before interest and taxes Interest paid Taxable income Taxes

$ 1,775

Net income

$ 1,171

102 $ 1,673 502 Windswept, Incorporated 2016 and 2017 Balance Sheets ($ in millions) 2016 2017

Cash

$ 290

$ 310

Accounts receivable 1,130 Inventory 1,800 Total $ 3,220

1,030 1,670 $ 3,010 4,100

Net fixed assets Total assets

3,500 $ 6,720

$ 7,110

2016

2017

Accounts payable Long-term debt Common stock Retained earnings

$ 1,600 1,080 3,380 660

$ 1,892 1,268 3,040 910

Total liability & equity

$ 6,720

$ 7,110

Windswept, Incorporated, has 560 million shares of stock outstanding. Its price–earnings ratio for 2017 is 12. What is the market price per share of stock? A) $14.14 B) $20.91 C) $38.04 D) $25.09 E) $19.50

17) Use the following information to answer this question. Windswept, Incorporated 2017 Income Statement ($ in millions) Net sales $ 9,900 Cost of goods sold 7,650 Depreciation 340 Earnings before $ interest and taxes 1,910 Interest paid 88 Taxable income $ 1,822 Taxes 547 Net income $ 1,275 Windswept, Incorporated 2016 and 2017 Balance Sheets ($ in millions) 2016 2017 Cash

$ 310

$ 325

Accounts payable

Accounts receivable Inventory

990 1,760

890 1,710

Long-term debt Common stock

Total

$ 3,060 3,510

$ 2,925 4,020

Retained earnings

$ 6,570

$ 6,945

Total liability & equity

Net fixed assets Total assets

2016

2017

$ 1,790 1,010 3,240

$ 1,615 1,470 3,080

530

780

$ 6,570

$ 6,945

What were the total dividends paid for 2017? A) $950 million B) $655 million C) $455 million D) $250 million E) $1,025 million

18) Use the following information to answer this question. Bayside, Incorporated 2017 Income Statement ($ in millions) Net sales $ 5,970 Cost of goods sold 4,320 Depreciation 340 Earnings before $ interest and taxes 1,310 Interest paid 33 Taxable income $ 1,277 Taxes 447 Net income $ 830 Bayside, Incorporated 2016 and 2017 Balance Sheets ($ in millions) 2016 2017 Cash

$ 90

$ 195

Accounts receivable Inventory

980 1,585

820 2,020

Total

$ 2,655 3,640

$ 3,035 3,320

Retained earnings

$ 6,295

$ 6,355

Total liability & equity

Net fixed assets Total assets

Accounts payable Long-term debt Common stock

2016

2017

$ 1,480 770 3,205

$ 1,455 570 3,240

840

1,090

$ 6,295

$ 6,355

How many dollars of sales were generated from every dollar of fixed assets during 2017? A) $1.80 B) $.94 C) $.95 D) $1.72 E) $1.64

19) Use the following information to answer this question. Bayside, Incorporated 2017 Income Statement ($ in millions) Net sales $ 7,620 Cost of goods sold 4,740 Depreciation 405 Earnings before $ interest and taxes 2,475 Interest paid 50 Taxable income $ 2,425 Taxes 849 Net income $ 1,576 Bayside, Incorporated 2016 and 2017 Balance Sheets ($ in millions) 2016 2017 Cash

$ 160

$ 265

Accounts payable

Accounts receivable Inventory

1,190 1,880

1,030 2,170

Long-term debt Common stock

Total

$ 3,230 3,890

$ 3,465 3,890

Retained earnings

$ 7,120

$ 7,355

Total liability & equity

Net fixed assets Total assets

2016

2017

$ 1,790 910 3,440

$ 2,235 710 3,180

980

1,230

$ 7,120

$ 7,355

What is the equity multiplier for 2017? A) 1.00 times B) 1.67 times C) 2.19 times D) 2.31 times E) .56 times

20) Use the following information to answer this question. Bayside, Incorporated 2017 Income Statement ($ in millions) Net sales $ 6,240 Cost of goods sold 4,600 Depreciation 440 Earnings before $ interest and taxes 1,200 Interest paid 38 Taxable income $ 1,162 Taxes 349 Net income $ 813 Bayside, Incorporated 2016 and 2017 Balance Sheets ($ in millions) 2016 2017 Cash

$ 155

$ 260

Accounts receivable Inventory

1,150 1,865

990 2,120

Total

$ 3,170 3,860

$ 3,370 3,680

Retained earnings

$ 7,030

$ 7,050

Total liability & equity

Net fixed assets Total assets

Accounts payable Long-term debt Common stock

2016

2017

$ 1,780 890 3,400

$ 1,790 690 3,360

960

1,210

$ 7,030

$ 7,050

What is the return on equity for 2017? A) 18.65% B) 17.79% C) 18.22% D) 25.43% E) 11.53%

21) The Green Giant has a 8 percent profit margin and a 67 percent dividend payout ratio. The

total asset turnover is 1.3 times and the equity multiplier is 1.6 times. What is the sustainable rate of growth? A) 17.42% B) 16.64% C) 9.30% D) 5.81% E) 2.08%

22) A firm wants a sustainable growth rate of 3.43 percent while maintaining a dividend payout

ratio of 33 percent and a profit margin of 7 percent. The firm has a capital intensity ratio of 2. What is the debt–equity ratio that is required to achieve the firm's desired rate of growth? A) .67 times B) .71 times C) .59 times D) .41 times E) .22 times

Answer Key Test name: Chapter 3(2) 1) D 2) C 3) E 4) A 5) D 6) C 7) B 8) E 9) A 10) C 11) D 12) E 13) D 14) E 15) A 16) D 17) E 18) A 19) B 20) B 21) D 22) D

Chapter 4: 1) The net present value of a project is equal to the: A) present value of the future cash flows. B) present value of the future cash flows minus the initial cost. C) future value of the future cash flows minus the initial cost. D) future value of the future cash flows minus the present value of the initial cost. E) sum of the project's anticipated cash inflows.

2) Of the following choices regarding the time value of money, which one is accurate? A) Increasing the initial cost of a project increases the project's NPV. B) Increasing the discount rate, increases the PV of a project. C) Increasing the FV decreases the PV. D) Decreasing the PV decreases the FV. E) Decreasing the discount rate increases the FV.

3) Of the following choices, which one is the correct formula for computing the PV of $1 to be

received two years from today? Assume the discount rate is 7 percent. A) $1/1.07 B) $1 C) $1 × 1.07 2 D) $1 × 1.07 E) $1/1.072

4) Assume a project has an initial cash outflow followed by seven years of cash inflows. If the

discount rate increases, the present value will: A) remain unchanged. B) change, but the direction of the change is unknown. C) remain unchanged, but the timing of the cash flows must change. D) increase. E) decrease.

5) An analyst is evaluating two projects. Project A has projected cash flows of $7,500, $6,000,

and $4,500 for the next three years, respectively. Project B has projected cash flows of $4,500, $6,000, and $7,500 for the next three years, respectively. Assuming both projects have the same initial cost, the analyst knows that: A) there are no conditions under which the projects can have equal values. B) Project B has a higher net present value than Project A. C) Project A is more valuable than Project B, given the same positive discount rate for each project. D) both projects offer the same rate of return. E) given any positive discount rate, both projects have equal net present values.

6) An interest rate that is compounded monthly, but is expressed as if the rate were compounded

annually, is called the A) stated interest B) compound interest C) effective annual D) periodic interest E) daily interest

7) The

rate.

rate equals the interest rate per period multiplied by the number of periods per

year. A) B) C) D) E)

effective annual annual percentage periodic interest compound interest daily interest

8) The annual percentage rate: A) considers interest on interest. B) reveals the actual cost of a loan that has monthly payments. C) is higher than the effective annual rate when interest is compounded quarterly. D) is the interest rate per period divided by (1 + m), where m is the number of periods

per year. E) equals the effective annual rate when the interest on an account is designated as simple interest.

9) You would be making a wise decision if you chose to: A) base decisions regarding investments on effective rates and base decisions regarding

loans on annual percentage rates. B) assume all loans and investments are based on simple interest. C) accept the loan with the lower effective annual rate rather than the loan with the lower annual percentage rate. D) invest in an account paying 6 percent, compounded quarterly, rather than an account paying 6 percent, compounded monthly. E) ignore the effective rates and concentrate on the annual percentage rates for all transactions.

10) Assume the annual percentage rate is 8 percent. The highest effective annual rate that can be

derived from it is computed as: A) (1 + .08/365)(365). B) e08q. C) 1.08e. 08 D) e − 1. E) (1 + .09/365)365 − 1.

11) For any given interest rate,

compounding will yield the highest effective annual

rate. A) B) C) D) E)

annual monthly daily continuous semiannual

12) In which way does a perpetuity differ from an annuity? A) Perpetuity cash flows vary with the rate of inflation. B) Perpetuity cash flows vary with the market rate of interest. C) Perpetuity cash flows are variable while annuity payments are constant. D) Perpetuity cash flows never cease. E) Annuity cash flows occur at irregular intervals of time.

13) Assume you are comparing two investments, each of which will result in $20,000 of total

cash inflow. Investment A pays $8,000 in Year 1, followed by four annual payments of $3,000 each. Investment B pays five annual payments of $4,000 each. Which one of the following statements regarding the investments is correct? A) Both options are of equal value today. B) Given a positive rate of return, Option A has a higher present value than Option B. C) Given a positive rate of return, Option B has a higher present value than Option A. D) Given a zero rate of return, Option B has a lower present value than Option A. E) Option A is preferable because it is an annuity due.

14) An annuity is a stream of: A) equal cash flows occurring at equal time periods during a fixed length of time. B) equal cash flows occurring at equal time periods forever. C) either equal or varying cash flows occurring at set intervals of time for a fixed length

of time. D) increasing cash flows occurring at set intervals of time that go on forever. E) arbitrary cash flows occurring each time period for no more than 10 years.

15)

annuities have payments that occur at the end of each period, whereas annuities have payments that occur at the beginning of each period. A) Ordinary annuities; early annuities B) Delayed annuities; straight annuities C) Straight annuities; delayed annuities D) Annuities due; ordinary annuities E) Ordinary annuities; annuities due

16) A(n)

is a stream of unending payments that increase by a set percentage each year and occur at regular intervals of time. A) annuity due B) growing annuity C) growing perpetuity D) variable annuity E) variable perpetuity

17) Aubrey just purchased an annuity that will pay $2,500 per month for five years. The first

payment was issued today. Bennett just purchased an annuity that will pay $2,500 per month for five years. The first payment will be issued one month from today. Which one of the following statements is correct concerning these two annuities? A) Both annuities are of equal value today. B) Bennett’s annuity is an annuity due. C) Aubrey’s annuity has a higher present value than Bennett’s. D) Bennett’s annuity has a higher present value than Aubrey’s. E) Aubrey’s annuity is an ordinary annuity.

18) An annuity will pay you $5,000 per year for six years. The first payment will occur at the end

of Year 5. When you employ the PV formula to compute the present value of the annuity, the result will be the PV as of the end of: A) Today, Year 0. B) Year 1. C) Year 3. D) Year 4. E) Year 2.

19) Ramirez Wellness borrowed $150,000 for five years and is now making monthly payments

that include both principal and interest. Paying off the debt by making installment payments, such as this firm is doing, is referred to as: A) foreclosing on the debt. B) amortizing the debt. C) funding the debt. D) calling the debt. E) refunding the debt.

20) Assume you borrow $12,000 for four years. How much will you still owe at the end of the

four years if you pay all of the payments as set forth in the loan's amortization schedule? A) $3,000 B) $0 C) $6,000 D) $12,000 E) $9,000

21) Assume you borrow $20,000 for 6 years with equal annual repayments. If the interest rate on

the actual loan turns out to be higher than you anticipated, then the: A) total principal repaid will be less than anticipated. B) loan will still have a balance due at the end of the 6-year amortization period. C) first annual payment will repay more of the principal than anticipated. D) anticipated amortization schedule will still apply as the loan is still a 6-year loan. E) annual payments will be higher than anticipated.

22) Your firm is considering the purchase of a company called Frost. What rate of return should

be used to compute the NPV of the proposed purchase? A) A discount rate equal to Frost’s current return on equity B) The discount rate applicable to other investments with similar risks C) A discount rate equal to Frost’s net profit percentage D) The rate of interest charged by a bank for a loan similar in size to the cost of the purchase E) A discount rate that makes the NPV of the proposed purchase positive

23) For a proposed purchase to be acceptable, the PV of the future cash flows must: A) be positive at the relevant discount rate. B) be less than the cost of the purchase. C) equal or exceed the cost of the purchase. D) equal the purchase price. E) be positive at all discount rates.

24) What is the present value of $21,797 to be received in one year if the discount rate is 5.1

percent? A) $20,715.46 B) $20,739.30 C) $42,739.22 D) $207.39 E) $21,406.39

25)

Jannat is purchasing a house today for $172,800, and expects to resell it in one year for $197,100. Using a discount rate of 6.75 percent, what is the expected net present value? A) $11,469.68 B) $11,837.00 C) $20,305.04 D) $19,310.50 E) $18,463.70

26) You have been awarded an insurance settlement of $211,400 that is payable one year from

today. What is the minimum amount you should accept today in exchange for this settlement if you can earn 6.3 percent on your investments? A) $198,525.36 B) $224,718.20 C) $198,871.12 D) $207,239.13 E) $335,555.56

27) You plan to invest $6,500 for three years at 4 percent simple interest. What will your

investment be worth at the end of the three years? A) $7,280.00 B) $7,311.62 C) $7,250.00 D) $6,924.32 E) $6,760.00

28) Marco invested $50,000 in account that he predicts will earn 5.25 percent per year,

compounded annually. What does he expect his account to be worth in 45 years? A) $499,994 B) $504,359 C) $2,916,706 D) $2,969,456 E) $1,571,312

29) Beatrice invests $1,000 in an account that pays 5 percent simple interest. How much more

could she have earned over a period of 10 years if the interest had compounded annually? A) $132.45 B) $135.97 C) $128.89 D) $117.09 E) $121.67

30) A project is expected to produce cash flows of $140,000, $225,000, and $200,000 over the

next three years, respectively. After three years, the project will be worthless. What is the net present value of this project if the applicable discount rate is 10.1 percent and the initial cost is $522,765? A) −$99,428 B) $51,317 C) −$9,595 D) $46,262 E) −$60,141

31) Aaron plans to invest $20,000 at the end of Year 1, $44,000 at the end of Year 2, and

$53,000 at the end of Year 3. You want to have the same amount of money as Aaron three years from now, but you want to make one lump sum investment today. What amount must you invest today if you both earn 9.7 percent per year, compounded annually? A) $88,627 B) $94,942 C) $106,655 D) $154,456 E) $151,047

32) You have been offered an insurance settlement that provides for annual payments of $29,000,

$42,000, and $53,000 over the next three years, respectively. The first payment will be made one year from today. If you would rather receive a lump sum settlement today, what is the minimum amount you should accept? Assume your discount rate is 8.7 percent. A) $159,261 B) $156,364 C) $103,490 D) $96,546 E) $114,075

33) You have been offered a consulting opportunity that will pay $33,000, $35,000, and $48,000

over the next three years, respectively. The offer also includes a retainer of $5,000, payable immediately. What is this opportunity worth to you today if your discount rate is 7.9 percent? A) $97,341 B) $112,507 C) $150,721 D) $103,856 E) $148,492

34) You are considering a project with projected annual cash flows of $32,000, $33,000, and

$70,000 for the next three years, respectively. What is the present value of these cash flows at a discount rate of 10.9 percent? A) $98,978 B) $121,731 C) $184,132 D) $179,145 E) $107,009

35) You expect an investment to return $11,300, $14,600, $21,900, and $38,400 annually over

the next four years, respectively. What is this investment worth to you today if you desire a rate of return of 16.5 percent? A) $64,253.91 B) $58,700.89 C) $63,732.41 D) $55,153.57 E) $59,928.16

36) Assume a cash flow of $82,400 in the first year and $148,600 in the second year. Also

assume a present value of $303,764.34 at a discount rate of 12.75 percent. What is the cash flow in the third year if that is the only other cash flow? A) $163,100 B) $163,800 C) $164,900 D) $164,400 E) $163,700

37) Assume you deposited $3,200 in an account two years ago and are depositing another $5,000

today. You will make a final deposit of $3,500 one year from now. What will your account balance be three years from now if the account pays 4.85 percent interest, compounded annually? A) $13,033.95 B) $13,430.84 C) $12,431.05 D) $14,328.90 E) $13,666.10

38) Anna has $38,654 in a savings account that pays 2.3 percent interest. Assume she withdraws

$10,000 today and another $10,000 one year from today. If she waits and withdraws the remaining entire balance four years from today, what will be the amount of that withdrawal? A) $20,916.78 B) $20,109.08 C) $20,676.53 D) $19,341.02 E) $19,608.07

39) Theo will deposit $3,500 in an account one year from today, an additional $6,500 two years

from today, and $9,000 three years from today. If the account earns 7.35 percent per year, compounded annually, what will his account balance be 14 years from today? A) $43,661 B) $15,358 C) $51,284 D) $22,382 E) $16,176

40) You want to save an equal amount each year for the next 38 years, at which time you will

retire. What amount of annual savings are needed if you desire a retirement income of $55,000 per year for 25 years and earn 7.5 percent, compounded annually? A) $3,333.33 B) $2,640.85 C) $3,146.32 D) $2,889.04 E) $3,406.16

41) Leo received $7,500 today and will receive another $5,000 two years from today. If he

invests these funds immediately at 11.5 percent, what will his investment be worth five years from now? A) $18,758.04 B) $18,806.39 C) $19,856.13 D) $20,314.00 E) $19,904.36

42) Suzette is receiving $10,000 today, $15,000 one year from today, and $25,000 four years

from today. If she invests these funds immediately and earns 9.6 percent annually, how much will she have in savings 30 years from today? A) $586,124.93 B) $591,414.14 C) $646,072.91 D) $620,008.77 E) $641,547.39

43) You would like to have $50,000 saved at the end of Year 5. At the end of Year 2, you can

deposit $7,500 for this purpose. If you earn 4.5 percent, how much must you deposit today to reach your goal assuming no other deposits are made? A) $33,254.58 B) $33,108.09 C) $34,276.34 D) $34,642.28 E) $34,912.63

44) The government imposed a fine on a firm that requires a payment of $100,000 today,

$150,000 one year from today, and $200,000 two years from today. The government will hold the funds until the final payment is collected and then donate the entire amount to charity. How much will be donated if the government pays 3 percent interest on the held funds? A) $475,000 B) $460,590 C) $447,174 D) $451,050 E) $474,407

45) If you invest $15,000 today, an investment guarantees that 24 years from today you will have

$54,750. What annual rate of interest will you earn? A) 5.25% B) 5.54% C) 5.68% D) 5.93% E) 5.71%

46) Twenty-two years ago, a particular violin cost $2,000. Today, that same violin costs $21,472.

What has been the inflation rate on this instrument? A) 12.19% B) 8.43% C) 11.39% D) 10.23% E) 9.92%

47) Several years ago, Jacquelyn invested $6,000. Today, that investment is worth $97,920. It

has earned an average annual rate of return of 9.5 percent, compounded annually. How long ago did Jacquelyn make her investment? A) 41.85 years B) 16.32 years C) 17.13 years D) 30.77 years E) 26.77 years

48) Some years ago, Zaid purchased a small parcel of land for $5,500. That land has appreciated

at 11 percent annually and is now valued at $89,760. How long has Zaid owned this land? A) 26.76 years B) 23.28 years C) 36.39 years D) 29.12 years E) 32.43 years

49) Twenty-four years ago, your relative invested $3,000. Today that investment is worth

$19,522. What annual rate of return has been earned on this investment? A) 7.51% B) 8.12% C) 0.05% D) 9.25% E) 8.68%

50) Your credit card company charges you 1.35 percent per month. What is the annual

percentage rate on your account? A) 16.45% B) 16.30% C) 16.39% D) 16.20% E) 16.56%

51) What is the annual percentage rate on a loan that charges interest of 1.65 percent per quarter? A) 6.50% B) 6.45% C) 6.54% D) 6.60% E) 6.72%

52) A credit card compounds interest monthly and has an effective annual rate of 12.67 percent.

What is the annual percentage rate? A) 12.35% B) 12.00% C) 11.99% D) 11.87% E) 11.93%

53) What is the effective annual rate if your credit card charges you 10.64 percent compounded

daily? (Assume a 365-day year.) A) 10.79% B) 11.22% C) 11.95% D) 11.48% E) 12.01%

54) Rojas Watercraft offers credit at an APR of 13.8 percent and compounds interest monthly.

What actual rate of interest are they charging? A) 14.7% B) 14.5% C) 16.1% D) 15.0% E) 15.7%

55) The pawn shop adds 2 percent to loan balances for every two weeks a loan is outstanding.

What is the effective annual rate of interest? A) 79.97% B) 73.08% C) 51.21% D) 67.34% E) 83.43%

56) You have $2,500 to deposit into a savings account. The five banks in your area offer the

following rates. In which bank should you deposit your savings? A) Bank A: 3.75%, compounded annually B) Bank B: 3.69%, compounded monthly C) Bank C: 3.70% compounded semiannually D) Bank D: 3.67% compounded continuously E) Bank E: 3.65% compounded quarterly

57) What is the effective annual rate of 10.25 percent compounded continuously? A) 10.98% B) 11.11% C) 10.79% D) 11.04% E) 10.86%

58) Marcy invested in an annuity that will pay her $2,500 every two years for the next ten years.

The first payment is due two years from today. What is the present value of this annuity at a discount rate of 5 percent? A) $10,466.67 B) $11,221.08 C) $9,416.75 D) $10,052.48 E) $8,949.60

59) Credit Fast offers loans at an annual percentage rate of 7.9 percent. What is the maximum

effective rate the bank can actually earn based on this quoted rate? A) 7.90% B) 8.18% C) 8.20% D) 8.22% E) 8.39%

60) What is the future value of investing $5,650 for 14 years at a continuously compounded rate

of 8.6 percent? A) $17,933.54 B) $16,685.44 C) $19,369.83 D) $18,833.85 E) $13,183.85

61) Assume you could invest $25,000 at a continuously compounded rate of 10 percent. What

would your investment be worth at the end of 50 years? A) $2,933,054 B) $3,500,824 C) $3,911,215 D) $3,710,329 E) $3,648,029

62) Jun Hin invested $4,500 at 6.2 percent, compounded continuously. What will his investment

be worth after 15 years? A) $15,557.78 B) $9,240.03 C) $11,405.29 D) $12,308.84 E) $8,685.00

63) A trust has been established to fund scholarships in perpetuity. The first annual distribution,

in the amount of $6,000, will take place one year from today. Future payments will increase by 4 percent per year. What is the value of this trust at a discount rate of 9 percent? A) $133,200 B) $130,800 C) $66,667 D) $120,000 E) $90,000

64) Zhu Equity established a trust fund that provides $125,000 in college scholarships each year.

The trust fund earns 6.15 percent and distributes only its annual income. How much money did Zhu contribute to establish this fund? A) $2,291,613 B) $2,032,520 C) $2,150,000 D) $2,018,970 E) $1,987,408

65) A preferred stock pays an annual dividend of $6.50 per share and has an annual rate of return

of 7.35 percent. What is the stock price? A) $74.50 B) $71.78 C) $92.09 D) $88.44 E) $77.78

66) You want to establish a charitable trust that will provide $50,000 per year forever to a

particular charity. If the fund can earn a guaranteed rate of return of 4.5 percent, how much must you deposit in a solitary lump sum to establish this trust? A) $1,333,333 B) $2,250,000 C) $1,250,000 D) $1,666,667 E) $1,111,111

67) You just paid $525,000 for a security that will pay you and your heirs $25,000 per year

forever. What rate of return will you earn? A) 4.95% B) 4.39% C) 4.76% D) 5.00% E) 4.50%

68) Anusha’s relative established a trust and deposited $250,000 into it. The trust pays a

guaranteed 4.25 percent annual rate of return. Anusha will receive all the interest earnings on an annual basis. How much income will Anusha receive each year? A) $10,000 B) $8,500 C) $12,400 D) $10,625 E) $12,750

69) The preferred stock of Estrada Properties offers a rate of return of 7.87 percent. The stock is

currently priced at $63.53 per share. What is the amount of the annual dividend? A) $5.20 B) $5.00 C) $4.60 D) $5.50 E) $6.00

70) Kwame is willing to pay $185 per month for four years for a car payment. If the interest rate

is 4.9 percent per year, compounded monthly, and he makes a cash down payment of $2,500, what price car can he afford to purchase? A) $10,961.36 B) $10,549.07 C) $8,533.84 D) $8,686.82 E) $8,342.05

71) Sanghyuk will receive payments of $550 per month for ten years. What are these payments

worth today at a discount rate of 6 percent, compounded monthly? A) $49,540.40 B) $51,523.74 C) $53,737.08 D) $49,757.69 E) $48,808.17

72) Assume your employer will contribute $50 per week for twenty years to your retirement

plan. At a discount rate of 5 percent, compounded weekly, what is this employee benefit worth to you today? A) $29,144.43 B) $35,920.55 C) $32,861.08 D) $26,446.34 E) $36,519.02

73) Mercy has a consulting contract that calls for annual payments of $50,000 per year for five

years, with the first payment due today. What is the current value of this contract if the discount rate is 8.4 percent? A) $214,142.50 B) $201,867.47 C) $195,618.19 D) $197,548.43 E) $224,267.10

74) Geller & Lao will deposit $3,000 per quarter for the next three years. The first deposit will be

made today. The money is expected to earn 2.75 percent per year, compounded quarterly. If the company had wanted to deposit one lump sum today, rather than make quarterly deposits, how much would it have had to deposit to have the same amount saved at the end of the three years? A) $34,441.56 B) $34,678.35 C) $33,428.87 D) $33,687.23 E) $34,998.01

75) Michaela has been offered an employment contract for ten years at a starting salary of

$65,000 with guaranteed raises of 5 percent per year. What is the current value of this offer at a discount rate of 7 percent? A) $638,724.17 B) $602,409.91 C) $558,845.85 D) $630,500.00 E) $525,000.00

76) Your friend agreed to lend you money today, in exchange for payments of $20 per month for

the next six months. The first payment must be paid today. The interest rate is 1.5 percent per month. How much total interest does your friend expect to earn? A) $3.94 B) $4.35 C) $1.34 D) $3.63 E) $5.96

77) Benjamin purchased an annuity that will pay $5,000 annually for 20 years. He will receive

the first payment today. What is the value of the annuity today, given a discount rate of 7 percent? A) $54,282.98 B) $52,970.07 C) $56,677.98 D) $56,191.91 E) $66,916.21

78) Victoria will receive annual payments of $10,000 for the next 25 years. The discount rate is

6.8 percent. What is the difference in the present value of this stream of payments if they are paid at the beginning of each year rather than at the end of each year? A) $8,069.29 B) $9,216.67 C) $9,706.67 D) $8,382.04 E) $8,850.00

79) You are comparing two annuities with equal present values. The applicable discount rate is

6.5 percent per year, compounded annually. One annuity will pay $2,000 per year, starting today, for 20 years. The second annuity will pay an annual amount, starting one year from today, for 20 years. What is the annual payment for the second annuity? A) $2,225 B) $2,075 C) $2,000 D) $2,130 E) $2,405

80) Bailey owns two annuities that will each pay $500 per month for the next 12 years. One

payment is received at the beginning of each month while the other is received at the end of each month. At a discount rate of 7.25 percent, compounded monthly, what is the difference in the present values of these two annuities? A) $289.98 B) $265.42 C) $299.01 D) $308.00 E) $312.50

81) What is the future value of $845 per year for seven years at an interest rate of 11.3 percent? A) $6,683.95 B) $6,075.69 C) $8,343.51 D) $8,001.38 E) $8,801.91

82) What is the future value of $3,100 per year for six years at interest rate of 8.9 percent? A) $20,255.40 B) $26,847.26 C) $27,134.16 D) $23,263.57 E) $24,414.67

83) Ryan saves $3,000 per year at an interest rate of 4.2 percent. What will his savings be worth

at the end of 35 years? A) $229,317.82 B) $230,702.57 C) $230,040.06 D) $234,868.92 E) $236,063.66

84) You plan to save $2,400 per year and earn an average rate of interest of 5.6 percent. How

much more will your savings be worth at the end of 40 years if you save at the beginning of each year rather than at the end of each year? A) $17,822.73 B) $18,821.10 C) $18,911.21 D) $19,103.04 E) $18,115.31

85) Assume you borrowed $19,600 to buy a car. The terms of the loan call for monthly payments

for five years at an interest rate of 6.25 percent, compounded monthly. What is the amount of each payment? A) $3,981.46 B) $1,258.11 C) $381.21 D) $4,684.66 E) $390.39

86) You borrow $199,000 to buy a house. The mortgage rate is 5.5 percent, compounded

monthly. The loan period is 30 years, and payments are made monthly. If you pay for the house according to the loan agreement, how much total interest will you pay? A) $218,086 B) $198,161 C) $207,764 D) $211,086 E) $185,059

87) Assume you borrowed $460,000 to buy a house. The loan period is 30 years, with monthly

payments of $1,700. If you pay for the house according to the loan agreement, how much total interest will you pay? A) $51,000 B) $61,200 C) $167,200 D) $144,400 E) $152,000

88) Starting today, Hector is going to contribute $100 per month to his retirement account. His

employer will make matching contributions equal to 50 percent of Hector’s contributions. If the total contributions remain constant, and he earns a monthly rate of .55 percent, how much will his savings be worth 40 years from now? A) $399,459.44 B) $352,151.04 C) $347,297.43 D) $362,948.21 E) $375,437.86

89) On the day she retired, Kate had $101,900 in retirement savings. She expects to earn 4.5

percent, compounded monthly, and live 24 more years. How much can she withdraw from her savings each month during her retirement if she plans to die on the day she spends her last penny? A) $592.07 B) $609.21 C) $539.87 D) $604.86 E) $579.22

90) Malatak Manufacturing purchased a warehouse for $1,562,500, paid 20 percent down in

cash, and financed the balance for 13 years at 9.5 percent, compounded monthly. What is the amount of each monthly mortgage payment? A) $101,566.39 B) $118,750.08 C) $171,440.07 D) $13,982.15 E) $14,286.67

91) Assume you graduate with $26,800 in student loan debt at an interest rate of 4.25 percent,

compounded monthly. If you want to have this debt paid in full within seven years, how much must you pay each month? A) $4,506.48 B) $369.42 C) $1,174.60 D) $3,883.00 E) $375.54

92) You are buying a car for $7,500, paying $900 down in cash, and financing the balance for 24

months at 6.5 percent, compounded monthly. What is the amount of each monthly loan payment? A) $318.64 B) $294.01 C) $302.02 D) $264.78 E) $245.09

93) Your parents plan to give you $200 per month for four years while you are in college. At a

discount rate of 6 percent, compounded monthly, what are these payments worth to you when you first start college? A) $8,797.40 B) $8,409.56 C) $8,198.79 D) $8,516.06 E) $8,279.32

94) You just won the lottery! As your prize you will receive $1,500 per month for 150 months. If

you can earn 7 percent, compounded monthly, on your money, what is this prize worth to you today? A) $137,003.69 B) $149,676.91 C) $137,962.77 D) $148,104.26 E) $150,723.76

95) You want to purchase an annuity that will pay you $1,200 per quarter for 15 years and earn a

return of 5.5 percent, compounded quarterly. What is the most you should pay to purchase this annuity? A) $52,988.16 B) $48,811.20 C) $47,455.33 D) $48,450.67 E) $52,806.30

96) A car dealer is willing to lease you a car for $319 per month for 60 months. Payments are due

on the first day of each month starting with the day you sign the lease contract. If your cost of money is 4.9 percent, compounded monthly, what is the current value of the lease? A) $17,882.75 B) $17,906.14 C) $17,014.34 D) $16,235.42 E) $16,689.54

97) Sara is the recipient of a trust that will pay her $500 on the first day of each month, starting

immediately and continuing for 40 years. What is the value of this inheritance today if the applicable discount rate is 7.3 percent, compounded monthly? A) $76,811.30 B) $67,557.52 C) $89,204.04 D) $78,192.28 E) $80,006.09

98) Starting today, Hector is going to contribute $100 per month to his retirement account. His

employer will make matching contributions equal to 50 percent of Hector’s contributions. If the total contributions remain constant, and he earns a monthly rate of .55 percent, how much will his savings be worth 40 years from now? A) $399,459.44 B) $300,456.74 C) $349,981.21 D) $299,189.16 E) $354,087.88

99) An annuity costs $70,000 today, pays $3,500 per year, and earns a return of 4.5 percent.

What is the length of the annuity time period? A) 54.96 years B) 49.48 years C) 52.31 years D) 43.08 years E) 48.00 years

100)

You are borrowing $5,200 at 7.8 percent, compounded monthly. The monthly loan payment is $141.88. How many loan payments must you make before the loan is paid in full? A) 30 B) 36 C) 40 D) 42 E) 48

101)

You are retired, have $264,500 in your savings, withdraw $2,000 each month, and earn 4.5 percent, compounded monthly. How long will it be until you run out of money? A) 13.67 years B) 15.25 years C) 22.08 years D) 13.02 years E) 18.78 years

102)

A growing perpetuity is currently valued $6,225.81. The next annuity payment will be $386 and the discount rate is 9 percent. What is the annuity's rate of growth? A) 2.45% B) 3.10% C) 2.80% D) 2.50% E) 2.95%

103)

Christina will receive annuity payments of $1,200 per year for five years, with the first payment occurring at Year 4. What is the value of this annuity to her today at a discount rate of 7.25 percent? A) $4,209.19 B) $4,774.04 C) $3,961.80 D) $4,887.48 E) $4,111.08

104)

Jisoo expects to live 30 years after she retires. At the end of the first year of her retirement, she wants to withdraw $35,000 from her savings. Each year thereafter, she wants to increase her annual withdrawal by 3.5 percent. If she can earn 5.5 percent on her savings, how much does she need to have in retirement savings on the day she retires? A) $862,001.34 B) $648,909.18 C) $764,458.87 D) $919,028.56 E) $832,004.01

105)

Ross plans to set aside an equal amount of money each year, starting today, so that he will have $25,000 saved at the end of three years. If he can earn 4.7 percent per year, how much does he have to save annually? A) $7,596.61 B) $7,689.16 C) $8,004.67 D) $8,414.14 E) $8,333.33

106)

Seven years ago, Carlos took out a mortgage for $185,000 at 5.6 percent, compounded monthly, for 30 years. He has made all of the monthly payments as agreed. What is his current loan balance? A) $157,308.74 B) $141,833.33 C) $164,621.06 D) $148,211.09 E) $142,779.47

107)

Assume mortgage rates increase to 7.5 percent and you borrow $329,000 for 30 years to purchase a house. What will your loan balance be at the end of the first 15 years of monthly payments? A) $238,854.07 B) $194,311.64 C) $248,153.73 D) $207,308.09 E) $192,938.72

108)

Vaughn borrowed $5,000 for five years at an APR of 6.2 percent. The loan calls for equal, annual principal payments. Interest will also be paid annually. What will be her loan payment in Year 2? A) $1,248 B) $1,310 C) $1,016 D) $1,274 E) $1,157

109)

A small craft store located in a kiosk expects to generate annual cash flows of $6,800 for the next three years. At the end of the three years, the business is expected to be sold for $15,000. What is the value of this business at a discount rate of 15 percent? A) $30,100.07 B) $29,408.27 C) $25,388.67 D) $17,409.09 E) $19,477.67

110)

Horton Books expects to generate cash flows of $129,600 for the next two years. At the end of the two years, the business will be sold for an estimated $3.2 million. What is the value of this business at a discount rate of 14 percent? A) $2,704,655 B) $2,284,644 C) $2,675,703 D) $2,848,392 E) $2,900,411

111)

Hernandez Tailors has expected net annual cash flows of $16,200, $18,600, $19,100, and $19,500 for the next four years, respectively. At the end of the fourth year, the firm is expected to be worth $57,900. What is the present value of the firm at a discount rate of 11.6 percent? A) $93,090.25 B) $87,492.16 C) $101,016.38 D) $104,998.02 E) $98,411.20

112)

Explain the net present value formula and also explain what the net present value represents. NPV = −Cost + PV

113)

Marlene and Darlene are each the recipients of an annuity that pays $1,000 at the end of each year for twelve years. They both received their first payment on the same day. Explain how Marlene and Darlene could have different NPVs for their annuities.

114)

There are four factors that affect the value of an annuity. Explain what these four factors are and discuss how a change in each factor will impact both the present value and the future value of the annuity.

115)

Moro owns a perpetuity that will pay $1,500 per year, starting one year from now. He offers to sell you all the payments remaining after the first 25 payments have been paid. What price should you offer him today for payments 26 onward if the discount rate is 8 percent? What does your offer price illustrate about the value of perpetuities?

116)

What is the difference between an ordinary annuity and an annuity due? What value can be used to quickly convert both the present value and the future value of an ordinary annuity into annuity due values?

Answer Key Test name: Chapter 4(1) 1) B 2) D 3) E 4) E 5) C 6) C 7) B 8) E 9) C 10) D 11) D 12) D 13) B 14) A 15) E 16) C 17) C 18) D 19) B 20) B 21) E 22) B 23) C 24) B 25) B 26) C 27) A 28) A 29) C 30) E 31) B 32) C 33) D 34) E 35) D 36) A 37) E

38) C 39) A 40) C 41) C 42) E 43) A 44) B 45) B 46) C 47) D 48) A 49) B 50) D 51) D 52) C 53) B 54) A 55) D 56) B 57) C 58) C 59) D 60) D 61) D 62) C 63) D 64) B 65) D 66) E 67) C 68) D 69) B 70) B 71) A 72) C 73) A 74) B 75) C 76) B 77) C

78) A 79) D 80) A 81) C 82) D 83) C 84) B 85) C 86) C 87) E 88) B 89) E 90) D 91) B 92) B 93) D 94) B 95) B 96) C 97) D 98) E 99) C 100) 101) 102) 103) 104) 105) 106) 107) 108) 109) 110) 111) 112) 113) 114) 115) 116)

D B C C C A C C A C C A Essay Essay Essay Essay Essay

Student name: 1) Thomas invests $109 in an account that pays 6 percent simple interest. How much money

will Thomas have at the end of 4 years? A) $141.70 B) $128.62 C) $137.61 D) $135.16 E) $129.82

2) Beatrice invests $1,440 in an account that pays 3 percent simple interest. How much more

could she have earned over a 4-year period if the interest had been compounded annually? A) $28.37 B) $7.93 C) $17.61 D) $31.73 E) $21.28

3) You can invest in an account that pays simple interest or an account that pays compound

interest. In either case, you plan to invest $1,800 today and both accounts have an annual interest rate of 7 percent. How much more interest will you receive in the 9th year in the account that pays compound interest? A) $107.65 B) $103.34 C) $90.49 D) $104.16 E) $126.00

4) What is the future value of $2,988 invested for 8 years at 5.1 percent compounded annually? A) $4,448.38 B) $3,645.79 C) $3,654.82 D) $6,498.80 E) $6,622.53

5) Five years from today, you plan to invest $5,200 for 6 additional years at 8.4 percent

compounded annually. How much will you have in your account 11 years from today? A) $12,756.47 B) $8,870.08 C) $8,436.82 D) $8,483.63 E) $8,987.31

6) Today, your dream car costs $49,000. You feel that the price of the car will increase at an

annual rate 2 percent. If you plan to wait 4 years to buy the car, how much will it cost at that time? A) $54,099.96 B) $53,039.18 C) $53,542.86 D) $54,086.83 E) $51,999.19

7) You are going to deposit $2,500 in an account that pays .51 percent interest per quarter. How

much will you have in 5 years? A) $2,753.70 B) $2,765.62 C) $2,767.74 D) $2,781.86 E) $2,770.82

8) You are going to deposit $4,000 in an account that pays .46 percent interest per month. How

much will you have in 8 years? A) $6,220.69 B) $6,186.02 C) $6,243.06 D) $6,214.48 E) $6,148.06

9) Retirement Investment Advisors, Incorporated, has just offered you an annual interest rate of

4 percent until you retire in 40 years. You believe that interest rates will increase over the next year and you would be offered 4.6 percent per year one year from today. If you plan to deposit $11,000 into the account either this year or next year, how much more will you have when you retire if you wait one year to make your deposit? A) $10,740.65 B) $14,811.38 C) $15,981.67 D) $2,429.32 E) $13,973.72

10) You just purchased two coins at a price of $1,090 each. Because one of the coins is more

collectible, you believe that its value will increase at a rate of 5.8 percent per year, while you believe the second coin will only increase at 5.2 percent per year. If you are correct, how much more will the first coin be worth in 12 years? A) $141.45 B) $81.12 C) $1,073.76 D) $124.36 E) $1,171.12

11) You are going to deposit $25,500 today. You will earn an annual rate of 5.9 percent for 12

years, and then earn an annual rate of 5.3 percent for 15 years. How much will you have in your account in 27 years? A) $50,733.14 B) $119,875.69 C) $102,826.77 D) $110,082.24 E) $94,282.73

12) You Save Bank has a unique account. If you deposit $5,000 today, the bank will pay you an

annual interest rate of 3 percent for 6 years, 3.6 percent for 5 years, and 4.3 percent for 9 years. How much will you have in your account in 20 years? A) $9,795.57 B) $10,407.61 C) $8,794.55 D) $7,937.23 E) $9,030.56

13) The most recent census for a city indicated that there were 857,382 residents. The population

of the city is expected to increase at an annual rate of 3.1 percent each year for the next 7 years. What will the population be at that time? A) 1,094,570 B) 1,081,973 C) 1,098,228 D) 1,128,502 E) 1,061,659

14) What is the present value of $12,300 to be received 2 years from today if the discount rate is

6 percent? A) $10,545.27 B) $11,603.77 C) $9,720.87 D) $10,946.96 E) $7,380.00

15) You need to have $35,000 for a down payment on a house in 4 years. If you can earn an

annual interest rate of 4.9 percent, how much will you have to deposit today? A) $28,039.36 B) $28,904.54 C) $28,359.96 D) $25,040.31 E) $27,554.38

16) A company has a pension liability of $530,000,000 that it must pay in 28 in years. If it can

earn an annual interest rate of 4.9 percent, how much must it deposit today to fund this liability? A) $132,369,129.25 B) $138,855,216.58 C) $112,247,383.15 D) $38,161,375.39 E) $121,545,466.57

17) You want to have $86,000 in 18 years to help your child attend college. If you can earn an

annual interest rate of 4.2 percent, how much will you have to deposit today? A) $20,376.44 B) $37,623.41 C) $39,356.08 D) $41,009.03 E) $35,734.78

18) A small business has determined that the machinery they currently use will wear out in 16

years. To replace the new machine when it wears out, the company wants to establish a savings account today. If the interest rate on the account is 1.3 percent per quarter and the cost of the machinery will be $265,000, how much will the company have to deposit today? A) $117,758.98 B) $115,942.16 C) $118,518.65 D) $215,523.56 E) $117,488.05

19) You want to have $17,000 in 10 years for a dream vacation. If you can earn an interest rate of

.4 percent per month, how much will you have to deposit today? A) $10,529.39 B) $10,669.79 C) $10,763.38 D) $10,637.41 E) $16,334.72

20) Your bank will pay you an interest rate of .097 percent per week. You want to have $22,000

in 10 years. How much will you have to deposit today? Assume 52 weeks per year. A) $20,918.35 B) $13,288.34 C) $13,583.64 D) $13,465.52 E) $13,449.62

21) Both you and your older brother would like to have $21,000 in 12 in years. Because of your

success in this class, you feel that you are a more savvy investor than your brother and will be able to earn an annual return of 10.6 percent compared to your brother's 9.1 percent. How much less than your brother will you have to deposit today? A) $1,240.12 B) $1,395.13 C) $1,004.49 D) $1,756.14 E) $1,116.10

22) You need to have $31,250 in 7 years. You can earn an annual interest rate of 4 percent for the

first 4 years, and 4.6 percent for the next 3 years. How much do you have to deposit today? A) $22,810.15 B) $23,747.43 C) $23,341.12 D) $22,349.91 E) $23,207.23

23) You need to have $34,000 in 20 years. You can earn an annual interest rate of 3 percent for

the first 6 years, 3.6 percent for the next 5 years, and 4.3 percent for the final 9 years. How much do you have to deposit today? A) $15,801.55 B) $14,944.23 C) $14,186.77 D) $16,334.21 E) $18,824.98

24) Three years ago, you invested $2,750. Today, it is worth $3,500. What rate of interest did

you earn? A) 8.37 percent B) .70 percent C) 3.67 percent D) 4.19 percent E) 4.67 percent

25) You need to have $30,000 in 20 in years. You can earn an annual interest rate of 3 percent

for the first 6 years, 3.6 percent for the next 5 years, and 4.3 percent for the final 9 years. How much do you have to deposit today? A) $13,942.55 B) $16,610.27 C) $12,517.74 D) $13,085.23 E) $14,412.53

26) When your father was born 49 years ago, his grandparents deposited $600 in an account for

him. Today, that account is worth $58,000. What was the annual rate of return on this account? A) 10.76 percent B) 9.78 percent C) 9.39 percent D) 7.30 percent E) 9.13 percent

27) Rick deposited $2,750 into an account 8 years ago for an emergency fund. Today, that

account is worth $4,220. What annual rate of return did Rick earn on this account assuming no other deposits and no withdrawals? A) 5.28 percent B) 6.05 percent C) 4.11 percent D) 5.50 percent E) 5.13 percent

28) An investor who was not as astute as he believed invested $260,000 into an account 9 years

ago. Today, that account is worth $200,400. What was the annual rate of return on this account? A) 3.42 percent B) −2.66 percent C) −2.50 percent D) 2.94 percent E) −2.85 percent

29) You made an investment of $10,000 into an account that paid you an annual interest rate of

3.3 percent for the first 7 years and 7.7 percent for the next 8 years. What was your annual rate of return over the entire 15 years? A) 5.50 percent B) 5.62 percent C) 5.06 percent D) 4.50 percent E) 6.25 percent

30) You purchased a bond at a price of $2,100. In 30 years when the bond matures, the bond will

be worth $15,000. It is exactly 22 years after you purchased the bond and you can sell the bond today for $11,100. If you hold the bond until it matures, what annual rate of return will you earn from today? A) 4.3 percent B) 6.8 percent C) 3.8 percent D) 7.9 percent E) 3.5 percent

31) Bob bought some land costing $16,190. Today, that same land is valued at $46,417. How

long has Bob owned this land if the price of land has been increasing at 4 percent per year? A) 27.91 years B) 26.85 years C) 11.03 years D) 11.47 years E) 29.03 years

32) Maxxie purchased a tract of land for $30,000. Today, the same land is worth $44,900. How

many years have passed if the price of the land has increased at an annual rate of 5.9 percent? A) 6.33 years B) 6.25 years C) 5.28 years D) 6.03 years E) 7.03 years

33) You expect to receive a payout from a trust fund in 3 years. The payout will be for $12,600.

You plan to invest the money at an annual rate of 5.7 percent until the account is worth $21,400. How many years do you have to wait from today? A) 12.56 years B) 11.16 years C) 11.30 years D) 9.42 years E) 9.56 years

34) You have $12,500 and will invest the money at an interest rate of .36 percent per month until

the account is worth $19,000. How many years do you have to wait until you reach your target account value? A) 8.50 years B) 9.06 years C) 9.71 years D) 9.90 years E) 10.46 years

35) You expect to receive $3,500 upon your graduation and will invest your windfall at an

interest rate of .51 percent per quarter until the account is worth $5,050. How many years do you have to wait until you reach your target account value? A) 18.02 years B) 15.77 years C) 18.15 years D) 16.82 years E) 19.40 years

36) If you earn an annual interest rate of 9.5 percent, how many years will it take to quadruple

your money? A) 15.28 years B) 13.89 years C) 13.37 years D) 12.22 years E) 14.10 years

37) You currently have $6,400. First United Bank will pay you an annual interest rate of 7.5,

while Second National Bank will pay you an annual interest rate of 8.8. How many fewer years must you wait for your account value to grow to $22,900 at Second National Bank? A) 3.01 years B) 2.32 years C) 2.83 years D) 2.51 years E) 2.28 years

38) Your sister just deposited $10,000 into an investment account. She believes that she will earn

an annual return of 9.7 percent for the next 6 years. You believe that you will only be able to earn an annual return of 9 percent over the same period. How much more must you deposit today in order to have the same amount as your sister in 6 years? A) $391.56 B) $1,326.80 C) $466.46 D) $365.46 E) $417.66

39) The winner of the first annual Tom Morris Golf Invitational won $150 in the competition

which was held in 1908. In 2015, the winner received $1,550,000. If the winner's purse continues to increase at the same interest rate, how much will the winner receive in 2042? A) $15,968,748.26 B) $14,740,383.01 C) $14,517,043.87 D) $17,964,841.79 E) $12,774,998.61

40) You have just deposited $10,500 into an account that promises to pay you an annual interest

rate of 6.4 percent each year for the next 5 years. You will leave the money invested in the account and 15 years from today, you need to have $29,750 in the account. What annual interest rate must you earn over the last 10 years to accomplish this goal? A) 7.59% B) 7.00% C) 6.90% D) 8.54% E) 6.07%

41) Marko, Inc., is considering the purchase of ABC Co. Marko believes that ABC Co. can

generate cash flows of $5,300, $10,300, and $16,500 over the next three years, respectively. After that time, they feel the business will be worthless. Marko has determined that a rate of return of 15 percent is applicable to this potential purchase. What is Marko willing to pay today to buy ABC Co.? A) $21,010.99 B) $24,910.35 C) $32,100.00 D) $23,245.99 E) $35,791.50

42) Myca Corp. has a project with the following cash flows. What is the value of the cash flows

today assuming an annual interest rate of 10.2 percent? Year 1

A) B) C) D) E)

Cash Flow $ 1,860

2,360

2,710

2,720

$8,265.58 $7,500.52 $9,650.00 $6,667.13 $8,575.26

43) You are in talks to settle a potential lawsuit. The defendant has offered to make annual

payments of $38,000, $42,000, $86,000, and $129,000 to you each year over the next four years, respectively. All payments will be made at the end of the year. If the appropriate interest rate is 3.4 percent, what is the value of the settlement offer today? A) $237,046.85 B) $295,000.00 C) $275,744.74 D) $280,838.85 E) $266,677.70

44) The value today of the following cash flows is $6,191.73 at an interest rate of 5.2 percent.

What is the value of the Year 3 cash flow? Year 1

Cash Flow $ 1,575

1,725

2,355

A) $1,412.39 B) $1,213.13 C) $1,312.76 D) $536.73 E) $3,767.67

45) One year ago, the Jenkins Family Fun Center deposited $4,200 into an investment account

for the purpose of buying new equipment four years from today. Today, they are adding another $6,000 to this account. They plan on making a final deposit of $8,200 to the account next year. How much will be available when they are ready to buy the equipment, assuming they earn a rate of return of 5 percent? A) $22,145.95 B) $21,651.59 C) $19,689.57 D) $20,701.92 E) $21,269.30

46) Assuming an interest rate of 7.3 percent, what is the value of the following cash flows four

years from today? Year 1

A) B) C) D) E)

Cash Flow $ 3,475

4,420

6,360

8,545

$25,374.87 $26,165.70 $26,956.52 $24,751.09 $23,761.04

47) Assuming an interest rate of 6.7 percent, what is the value of the following cash flows five

years from today? Year 1

A) B) C) D) E)

Cash Flow $ 3,640

4,735

5,730

7,030

$24,879.87 $23,514.71 $22,956.41 $23,918.14 $24,494.49

48) The value of the following cash flows four years from today is $8,056.56. The interest rate is

5.3 percent. What is the value of the Year 3 cash flow? Year 1

A) B) C) D) E)

Cash Flow $ 1,660

1,852

2,890

$1,174.87 $1,115.74 $1,132.49 $1,051.94 $1,218.92

49) Your parents are giving you $210 a month for 4 years while you are in college. At an interest

rate of .49 percent per month, what are these payments worth to you when you first start college? A) $8,962.85 B) $8,664.09 C) $8,796.77 D) $8,514.71 E) $11,332.94

50) We Pay Insurance Co. will pay you $1,125 each quarter for 25 years. You want to earn a

minimum interest rate of .86 percent per quarter. What is the most you are willing to pay today for these payments? A) $75,254.54 B) $72,746.05 C) $71,491.81 D) $177,185.86 E) $74,776.72

51) Todd can afford to pay $355 per month for the next 6 years in order to purchase a new car.

The interest rate is 6.1 percent compounded monthly. What is the most he can afford to pay for a new car today? A) $30,771.10 B) $21,113.21 C) $20,291.65 D) $21,359.64 E) $22,071.62

52) You just won the $114 million Ultimate Lotto jackpot. Your winnings will be paid as

$3,800,000 per year for the next 30 years. If the appropriate interest rate is 7.1 percent, what is the value of your windfall? A) $48,240,662.16 B) $46,684,511.77 C) $46,199,112.11 D) $44,350,286.18 E) $49,999,112.11

53) Your crazy uncle left you a trust that will pay you $17,000 per year for the next 25 years with

the first payment received one year from today. If the appropriate interest rate is 7.3 percent, what is the value of the payments today? A) $173,047.24 B) $183,226.49 C) $199,298.99 D) $189,949.50 E) $192,869.99

54) You will receive 24 annual payments of $33,500. The first payment will be received 8 years

from today and the interest rate is 6.2 percent. What is the value of the payments today? A) $255,105.35 B) $279,952.61 C) $255,870.67 D) $270,921.89 E) $461,496.75

55) A friend wants to borrow money from you. He states that he will pay you $2,900 every 6

months for 11 years with the first payment exactly 7 years and six months from today. The interest rate is an APR of 5.2 percent with semiannual compounding. What is the value of the payments today? A) B) C) D) E)

$33,376.28 $33,748.84 $34,717.34 $33,597.43 $32,746.03

56) What is the future value of $2,875 per year for 22 years at an interest rate of 6.93 percent? A) $127,945.74 B) $139,687.38 C) $133,816.56 D) $134,870.57 E) $133,614.02

57) You have just started a new job and plan to save $4,350 per year for 38 years until you retire.

You will make your first deposit in one year. How much will you have when you retire if you earn an annual interest rate of 10.73 percent? A) $1,843,339.99 B) $1,720,241.63 C) $1,909,173.56 D) $1,826,166.01 E) $1,814,707.59

58) To fund your dream around-the-world vacation, you plan to save $1,275 per year for the next

13 years starting one year from now. If you can earn an interest rate of 5.77 percent, how much will you have saved for your vacation? A) $22,904.08 B) $22,690.69 C) $23,722.09 D) $21,222.54 E) $22,472.32

59) Bob has saved $540 each month for the last 4 years to make a down payment on a house. The

account earned an interest rate of .35 percent per month. How much money is in Bob's account? A) $27,199.57 B) $27,599.16 C) $25,920.00 D) $28,170.98 E) $26,946.16

60) Your employer contributes $95 at the end of each week to your retirement account. The

account will earn a weekly interest rate of .22 percent. How much will the account be worth when you retire in 25 years? A) $708,473.70 B) $661,242.12 C) $677,670.50 D) $123,500.00 E) $604,450.50

61) You plan to save $5,700 per year for the next 10 years. After the last deposit, you will keep

the money in the account for 4 more years. The account will earn an interest rate of 6 percent. How much will there be in the account 14 years from today? A) $169,862.92 B) $119,785.88 C) $94,850.56 D) $24,935.31 E) $75,130.53

62) Noma plans to save $4,700 per year for the next 35 years. If she can earn an annual interest

rate of 10.5 percent, how much will she have in 35 years? A) $1,579,648.69 B) $1,334,243.24 C) $164,500.00 D) $1,367,392.14 E) $1,429,546.32

63) Gerritt wants to buy a car that costs $29,250. The interest rate on his loan is 5.53 percent

compounded monthly and the loan is for 6 years. What are his monthly payments? A) $502.21 B) $462.35 C) $476.10 D) $478.29 E) $488.40

64) You want to buy a house and will need to borrow $290,000. The interest rate on your loan is

6.31 percent compounded monthly and the loan is for 30 years. What are your monthly mortgage payments? A) $1,814.31 B) $1,886.76 C) $1,737.01 D) $1,796.91 E) $1,787.51

65) You want to buy a house that costs $255,000. You will make a down payment equal to 20

percent of the price of the house and finance the remainder with a loan that has an APR of 5.37 percent compounded monthly. If the loan is for 30 years, what are your monthly mortgage payments? A) $1,152.95 B) $1,141.71 C) $1,198.79 D) $1,136.62 E) $1,103.65

66) Your grandparents put $11,000 into an account so that you would have spending money in

college. You put the money into an account that will earn an APR of 4.35 percent compounded monthly. If you expect that you will be in college for 4 years, how much can you withdraw each month? A) $249.19 B) $262.60 C) $241.76 D) $250.10 E) $254.62

67) Ken just purchased new furniture for his house at a cost of $15,100. The loan calls for

weekly payments for the next 6 years at an annual interest rate of 10.21 percent. How much are his weekly payments? A) $68.01 B) $64.77 C) $48.40 D) $66.93 E) $67.09

68) You have just won the lottery and will receive a lump sum payment of $22.53 million after

taxes. Instead of immediately spending your money, you plan to deposit all of the money into an account that will earn 4.81 percent. If you make equal annual withdrawals for the next 25 years, how much can you withdraw each year starting exactly one year from now? A) $1,496,282.68 B) $901,200.00 C) $1,568,253.87 D) $1,646,666.57 E) $1,620,529.00

69) The Nashville Geetars, a professional foosball team, has just signed its star player Harold

"The Wrist" Thornton to a new contract. One of the terms requires the team to make a lump sum payment of $13.55 million to the The Wrist exactly 10 years from today. The team plans to make equal annual deposits into an account that will earn 5.41 percent in order to fund the payment. How much must the team deposit each year? A) $1,789,896.06 B) $1,355,000.00 C) $1,842,738.12 D) $1,002,600.38 E) $1,056,841.06

70) You want to retire exactly 35 years from today with $2,020,000 in your retirement account. If

you think you can earn an interest rate of 10.35 percent compounded monthly, how much must you deposit each month to fund your retirement? A) $4,809.52 B) $481.77 C) $485.93 D) $518.32 E) $572.97

71) Starling wants to retire with $2,080,000 in his retirement account exactly 38 years from

today. He will make annual deposits at the end of each year to fund his retirement account. If he can earn 9.61 percent per year, how much must he deposit each year? A) $6,729.84 B) $6,309.23 C) $5,756.07 D) $5,404.22 E) $54,736.84

72) Travis International has a debt payment of $2.17 million that it must make 5 years from

today. The company does not want to come up with the entire amount at that time, so it plans to make equal monthly deposits into an account starting 1 month from now to fund this liability. If the company can earn a return of 4.48 percent compounded monthly, how much must it deposit each month? A) $36,166.67 B) $33,068.03 C) $32,334.29 D) $32,214.02 E) $34,489.91

73) You want to have $31,000 saved 5 years from today in order to make a down payment on a

house. To fund this, you will make deposits each week from your paycheck into an account that will earn 5.48 percent compounded weekly. How much must you deposit each week? A) $106.86 B) $110.62 C) $103.70 D) $114.07 E) $119.23

74) One of your customers has just made a purchase in the amount of $29,600. You have agreed

to payments of $650 per month and will charge a monthly interest rate of 1.5 percent. How many months will it take for the account to be paid off? A) 34.97 months B) 77.18 months C) 45.54 months D) 72.03 months E) 83.12 months

75) You have just received an offer in the mail from Friendly Loans. The company is offering to

loan you $5,500 with low monthly payments of $140 per month. If the interest rate on the loan is an APR of 15.8 percent compounded monthly, how long will it take for you to pay off the loan? A) 39.29 months B) 51.96 months C) 13.46 months D) 59.96 months E) 55.68 months

76) Thom owes $4,000 on his credit card. The credit card carries an APR of 16.8 percent

compounded monthly. If Thom makes monthly payments of $100 per month, how long will it take for him to pay off the credit card assuming that he makes no additional charges? A) 55.11 months B) 40.00 months C) 63.59 months D) 13.16 months E) 59.05 months

77) You have a credit card with a balance of $15,100 and an APR of 18.5 percent compounded

monthly. You have been making monthly payments of $285 per month, but you have received a substantial raise and will increase your monthly payments to $360 per month. How many months quicker will you be able to pay off the account? A) 36.81 months B) 42.94 months C) 40.08 months D) 38.65 months E) 11.04 months

78) Bad Company, Inc., has a major outlay of $1.85 million that is needed to renovate the

company's manufacturing facility. Because the company's management is conservative, it won't undertake the renovation until it has the cash necessary to fund the renovation. The company plans to deposit $143,000 each quarter into an account that will earn 1.65 percent per quarter. How many years will it be until the company has the money saved for the renovation? A) 3.18 years B) 2.73 years C) 2.96 years D) 3.23 years E) 2.53 years

79) You feel that you will need $3.8 million in your retirement account and when you reach that

amount, you plan to retire. You feel you can earn an APR of 10.1 percent compounded monthly and plan to save $545 per month until you reach your goal. How many years will it be until you reach your goal and retire? A) 42.50 years B) 48.42 years C) 34.85 years D) 40.66 years E) 37.53 years

80) You have researched your dream around-the-world vacation and determined that the total

cost of the vacation will be $25,000. You feel you can earn an APR of 10 percent compounded monthly and plan to save $275 per month until you reach your goal. How many years will it be until you reach your goal and enjoy your well-deserved vacation? A) 5.66 years B) 7.58 years C) 5.23 years D) 5.92 years E) 6.47 years

81) You want to have $2.9 million when you retire in 36 years. You feel that you can save $675

per month until you retire. What APR do you have to earn in order to achieve your goal? A) 10.75% B) 11.52% C) 10.08% D) 11.20% E) 9.30%

82) Fifth Fourth National Bank has a savings program which will guarantee you $17,000 in 8

years if you deposit $130 per month. What APR is the bank offering you on this savings plan? A) 7.46% B) 8.67% C) 6.89% D) 8.53% E) 8.29%

83) Bob has been investing $2,500 in stock at the end of every year for the past 11 years. If the

account is currently worth $49,300, what was his annual return on this investment? A) 12.39% B) 10.59% C) 11.15% D) 12.74% E) 10.29%

84) You have just purchased a car and, to fund the purchase, you borrowed $28,000. If your

monthly payments are $454.18 for the next 6 years, what is the APR of the loan? A) 5.38% B) 5.25% C) 6.00% D) 4.85% E) 4.62%

85) Fancy Cat Products has a project that will cost $241,000 today and will generate monthly

cash flows of $5,730 for the next 55 months. What is the rate of return of this project when expressed as an APR? A) 10.41% B) 13.83% C) 12.47% D) 12.10% E) 11.17%

86) You want to purchase a new motorcycle that costs $29,600. The most you can pay each

month is $555 over the life of the 72-month loan. What is the highest APR that you could afford? A) 10.44% B) 9.31% C) 11.93% D) 10.68% E) 9.64%

87) Your insurance agent is trying to sell you an annuity that costs $85,000 today. By buying this

annuity, your agent promises that you will receive payments of $480 per month for 25 years. What is the rate of return expressed as an APR on this investment? A) 4.55% B) 4.30% C) 5.32% D) 3.88% E) 4.66%

88) George Jefferson established a trust fund that will provide $200,500 per year in scholarships.

The trust fund earns an annual return of 3.1 percent. How much money did Mr. Jefferson contribute to the fund assuming that only income is distributed? A) $6,467,741.94 B) $5,970,223.33 C) $7,391,705.07 D) $5,389,784.95 E) $5,659,274.19

89) Your grandparents would like to establish a trust fund that will pay you and your heirs

$165,000 per year forever with the first payment one year from today. If the trust fund earns an annual return of 3.2 percent, how much must your grandparents deposit today? A) $5,892,857.14 B) $5,156,250.00 C) $4,759,615.38 D) $4,296,875.00 E) $4,511,718.75

90) Your grandparents would like to establish a trust fund that will pay you and your heirs

$210,000 per year forever with the first payment 13 years from today. If the trust fund earns an annual return of 4.1 percent, how much must your grandparents deposit today? A) $5,121,951.22 B) $2,918,268.35 C) $4,727,954.97 D) $3,162,471.96 E) $4,268,292.68

91) You just paid $440,000 for a policy that will pay you and your heirs $17,600 per year forever

with the first payment in one year. What rate of return are you earning on this policy? A) 4.13% B) 3.85% C) 4.20% D) 4.27% E) 4.00%

92) A prominent alumnus of your university has just donated $2,900,000 to fund a scholarship

that will distribute $107,000 per year forever beginning in one year. For this to be true, what rate of return is expected on the donation? A) 3.69% B) 3.55% C) 3.94% D) 3.81% E) 3.87%

93) You have just leased a car that has monthly payments of $320 for the next 4 years with the

first payment due today. If the APR is 5.76 percent compounded monthly, what is the value of the payments today? A) B) C) D) E)

$13,689.75 $14,150.11 $13,755.46 $13,379.46 $12,504.96

94) Jenny Enterprises has just entered a lease agreement for a new manufacturing facility. Under

the terms of the agreement, the company agreed to pay rent of $15,000 per month for the next 9 years with the first payment due today. If the APR is 7.08 percent compounded monthly, what is the value of the payments today? A) $1,195,520.60 B) $1,251,509.46 C) $1,202,574.17 D) $1,093,249.24 E) $1,168,761.17

95) Red Sun Rising Corp. has just signed a lease for its new manufacturing facility. The lease

agreement calls for annual payments of $1,250,000 for 10 years with the first payment due today. If the interest rate is 3.31 percent, what is the value of this liability today? A) $10,496,029.08 B) $9,971,227.63 C) $11,385,620.02 D) $11,114,533.83 E) $10,843,447.64

96) You have decided to buy a car that costs $27,000. Since you do not have a big down

payment, the lender offers you a loan with an APR of 6.07 percent compounded monthly for 6 years with the first monthly payment due today. What is the amount of your loan payment? A) $311.79 B) $378.94 C) $446.10 D) $448.36 E) $310.22

97) Roger has just lost a lawsuit and has agreed to make equal annual payments of $16,400 for

the next 6 years with the first payment due today. The value of this liability today is $83,000. What is the interest rate on the payments? A) 7.36% B) 5.09% C) 6.10% D) 4.84% E) 6.86%

98) You plan to save $200 per month starting today for the next 40 years "just to start the month

off right." You feel that you can earn an interest rate of 9.6 percent compounded monthly. How much will there be in the account 40 years from today? A) $1,129,464.87 B) $1,120,500.86 C) $1,044,545.56 D) $953,052.52 E) $1,036,776.69

99) Your credit card company charges you 1.45 percent per month. What is the APR on your

credit card? A) 18.13% B) 16.53% C) 18.86% D) 17.40% E) 19.80%

100)

Your credit card company charges you 1.43 percent per month. What is the EAR on your credit card? A) 17.87% B) 19.50% C) 16.30% D) 17.16% E) 18.58%

101)

What is the effective annual rate for an APR of 11.90 percent compounded quarterly? A) 12.44% B) 11.94% C) 12.51% D) 13.06% E) 12.57%

102)

What is the effective annual rate for an APR of 16.80 percent compounded monthly? A) 18.02% B) 18.16% C) 19.06% D) 16.99% E) 17.89%

103)

You are considering the purchase of new living room furniture that costs $1,440. The store will allow you to make weekly payments of $30.79 for one year to pay off the loan. What is the EAR of this arrangment? A) 20.16% B) 22.40% C) 21.22% D) 24.76% E) 23.58%

104)

Mo will receive a perpetuity of $21,000 per year forever, while Curly will receive the same annual payment for the next 35 years. If the interest rate is 6.5 percent, how much more are Mo's payments worth? A) $35,650.83 B) $31,751.52 C) $33,422.65 D) $34,536.74 E) $37,433.37

105)

You are set to receive an annual payment of $12,000 per year for the next 16 years. Assume the interest rate is 6.9 percent. How much more are the payments worth if they are received at the beginning of the year rather than the end of the year? A) $7,012.71 B) $7,627.86 C) $8,267.61 D) $7,381.80 E) $7,873.92

Answer Key Test name: Chapter 4(2) 1) D 2) B 3) C 4) A 5) C 6) B 7) C 8) D 9) A 10) A 11) D 12) B 13) E 14) D 15) B 16) B 17) D 18) B 19) A 20) B 21) E 22) C 23) D 24) A 25) E 26) B 27) D 28) E 29) B 30) C 31) B 32) E 33) A 34) C 35) A 36) A 37) D

38) A 39) A 40) A 41) D 42) B 43) E 44) A 45) A 46) D 47) E 48) B 49) A 50) A 51) D 52) B 53) E 54) D 55) D 56) B 57) C 58) C 59) D 60) A 61) C 62) E 63) D 64) D 65) B 66) D 67) B 68) C 69) E 70) C 71) B 72) C 73) C 74) B 75) E 76) E 77) B

78) C 79) D 80) A 81) C 82) A 83) C 84) B 85) D 86) A 87) E 88) A 89) B 90) D 91) E 92) A 93) C 94) C 95) E 96) C 97) A 98) A 99) D 100) 101) 102) 103) 104) 105)

E A B E A E

Chapter 5: 1) The

is the difference between the present value of an investment’s future cash flows and its initial cost. A) net present value B) internal rate of return C) payback period D) profitability index E) discounted payback period

2) Assume a project has been assigned a required rate of return of zero. Accordingly: A) the timing of the project’s cash flows has no bearing on the value of the project. B) the project will always be accepted. C) the project will always be rejected. D) whether the project is accepted or rejected will depend on the timing of the cash

flows. E) the project can never add value for the shareholders.

3) Of the following statements about net present value (NPV), which one is correct? A) A financing type project should be accepted if, and only if, the NPV is exactly equal

to zero. B) An investment type project should be accepted only if the NPV is equal to the initial cash flow. C) Both investing and financing type projects should be accepted if their NPVs are positive and rejected if they are negative. D) Both investing and financing type projects should always be accepted if they have greater total cash inflows than total cash outflows. E) An investment type project that has positive cash flows for every time period after the initial investment should be accepted.

4) The net present value of an investment project increases when , all else constant. A) the discount rate increases B) each cash inflow is delayed by one year C) the initial cost of a project increases D) the required rate of return decreases E) all cash inflows occur during the last year instead of periodically throughout the

project’s life

5) If a proposed project , the project should be accepted. A) creates value for the owners of the firm B) has a positive rate of return C) returns the initial cash outlay within the life of the project D) has required cash inflows that exceed the actual cash inflows E) has an initial cost that exceeds the present value of the future cash flows

6) If a project has a net present value equal to zero, then: A) the initial cost of the project exceeds the present value of the project’s subsequent

cash flows. B) the internal rate of return exceeds the discount rate. C) the project produces cash inflows that exceed the minimum required inflows. D) any delay in receiving the projected cash inflows will cause the project’s NPV to be negative. E) the discount rate exceeds the internal rate of return.

7) Net present value: A) cannot be relied upon when deciding between two mutually exclusive projects. B) rule for project acceptance must be modified when comparing projects of varying

sizes. C) is less commonly used in business than the profitability index method of analysis. D) is not as widely used in practice as payback and discounted payback. E) provides the means for considering the risks associated with a specific project.

8) A project has an initial cost of $26,000, a discount rate of 11.7 percent, a life of 5 years, and

an NPV of $11,216. Given this, you know that the project is expected to earn a return: A) equal to 11.7 percent on $26,000 plus an additional $11,216. B) of $11,216 in total. C) equal to 11.7 percent of $37,216. D) of 11.7 percent of $11,216. E) of $26,000 minus $11,216.

9) Assume a firm accepts a positive net present value project. An analyst would be most

justified in concluding that: A) the project will pay back within the required payback period. B) the present value of the expected cash flows is equal to the project’s cost. C) the inherent risks within the project have been ignored. D) that all the projected cash flows will occur as expected. E) the stockholders’ value in the firm is expected to increase.

10) The net present value method of capital budgeting analysis does all of the following except: A) incorporate risk into the analysis. B) consider all relevant cash flow information. C) discount all future cash flows to their current value. D) consider the initial cost of the project. E) provide a specific anticipated rate of return.

11) The payback method of analysis: A) discounts cash flows. B) ignores the initial cost. C) considers all project cash flows. D) applies an industry-standard recoupment period. E) has a timing bias.

12) The payback method: A) is the most frequently used method of capital budgeting analysis. B) is a more sophisticated method of analysis than the profitability index. C) considers the time value of money. D) applies mainly to projects where the actual results will be known relatively soon. E) generally results in decisions that conflict with the decision suggested by NPV

analysis.

13) Assume a firm is more concerned about quickly recovering its initial investment than it is

about the amount of value created. Accordingly, the firm is most likely to employ the method of capital project analysis. A) internal rate of return B) net present value C) modified internal rate of return D) payback E) profitability index

14) One reason payback may be employed to analyze independent capital projects is because: A) it considers the time value of money. B) all relevant cash flows are included in the analysis. C) it is easy and quick to calculate. D) it is the most desirable of all the available analytical methods from a financial

perspective. E) it produces better decisions than those made using either NPV or IRR.

15) One characteristic of the payback method of project analysis is the: A) use of variable discount rates. B) standardized cutoff point for cash flow consideration. C) bias towards liquidity. D) consideration of the risk level of each project. E) discounting of all cash flows.

16) All else equal, the payback period for a project will decrease whenever the: A) initial cost increases. B) required return for a project increases. C) assigned discount rate decreases. D) cash inflows are moved earlier in time. E) duration of a project is lengthened.

17) The

is the length of time required for an investment to generate cash flows sufficient to recover the initial cost of the investment. A) cash period B) net working capital period C) payback period D) profitability index E) internal rate of return

18) An investment is acceptable if the payback period: A) is less than some pre-specified period of time. B) exceeds the life of the investment. C) is negative. D) is equal to or greater than some pre-specified period of time. E) is equal to, and only if it is equal to, the investment’s life.

19) Which method(s) of project analysis is(are) best suited for use by a department manager who

has no knowledge of time value of money but can fairly accurately estimate the cash flows of small projects with short lives? A) Payback B) Discounted payback C) Profitability index D) Net present value E) Either payback or profitability index

20) The payback method: A) determines a cutoff point so that all projects accepted by the NPV rule will be

accepted by the payback period rule. B) determines a cutoff point equal to the point where all initial capital investments have been fully depreciated. C) requires an arbitrary choice of a cutoff point. D) varies the cutoff point with the market rate of interest. E) is irrelevant to the accept/reject decision.

21) Which of the following methods of project analysis are biased towards short-term projects? A) Profitability index and internal rate of return B) Discounted payback and payback C) Net present value and payback D) Payback and profitability index E) Profitability index and discounted payback

22) The length of time required for a project’s discounted cash flows to equal the initial cost of

the project is called the: A) net present value. B) discounted net present value. C) payback period. D) discounted profitability index. E) discounted payback period.

23) The discounted payback period of a project will decrease whenever the: A) discount rate applied to the project is increased. B) initial cash outlay of the project is increased. C) time period of the project is increased. D) amount of each cash inflow is increased. E) costs of the fixed assets utilized in the project increase.

24) The discounted payback method: A) considers the time value of money. B) discounts the cutoff point. C) discounts the initial cost. D) is preferred to the NPV method. E) ignores project risks.

25) The discounted payback rule may cause: A) projects with discounted payback periods in excess of the project’s life to be accepted. B) the most liquid projects to be rejected in favor of less liquid projects. C) projects to be incorrectly accepted due to ignoring the time value of money. D) some projects with negative net present values to be accepted. E) some positive net present value projects to be rejected.

26) For investment type projects, the internal rate of return (IRR): A) rule indicates acceptance of an investment when the IRR is less than the discount rate. B) is the rate generated solely by the cash flows of the investment. C) is used primarily to rank projects of varying sizes. D) is the rate that causes the net present value of a project to equal the project's initial

cost. E) can effectively be used to compare all types and sizes of mutually exclusive projects.

27) The internal rate of return for a project will increase if: A) the initial cost of the project can be reduced. B) the total amount of the cash inflows is reduced. C) each cash inflow is moved such that it occurs one year later than originally projected. D) the required rate of return is reduced. E) the discount rate is increased.

28) An investment type project has an internal rate of return of 12.3 percent, a net present value

of $798, and a payback period of 3.12 years. Given this information, which one of the following statements is correct? A) The discount rate used in computing the net present value was less than 12.3 percent. B) The discounted payback period will be less than 3.12 years. C) The discount rate used to compute the net present value is equal to the internal rate of return. D) The required payback period must be greater than 3.12 years. E) This project should be rejected based on the net present value.

29) The internal rate of return is: A) more reliable than net present value whenever you are considering mutually exclusive

projects. B) equivalent to the discount rate that makes the net present value equal to 1.0. C) computed using a project’s cash flows as the only source of inputs. D) dependent on the interest rates offered in the marketplace. E) a better methodology than net present value when dealing with unconventional cash flows.

30) The internal rate of return tends to be: A) easier for managers to comprehend than the net present value. B) extremely accurate even when cash flow estimates are faulty. C) ignored by most financial managers. D) used primarily to differentiate between mutually exclusive projects. E) utilized in project analysis only when multiple net present values apply.

31) The

, when employed as a project’s discount rate, makes the net present value of the project exactly equal to zero. A) external rate of return B) internal rate of return C) average accounting return D) profitability index E) equalizer rate

32) A conventional investment project should be accepted if the internal rate of return is: A) equal to, and only if it is equal to, the discount rate. B) equal to or greater than the discount rate. C) less than the discount rate. D) negative. E) positive.

33)

The internal rate of return for a capital project is best defined as the: A) discount rate that causes the net present value to equal zero. B) difference between the market rate of interest and the discount rate. C) market rate of interest less the risk-free rate. D) minimum project acceptance rate set by management. E) maximum rate that can be earned for a project to be accepted.

34) Which one of the following statements is true? A) You must know the discount rate to compute the NPV but not the IRR. B) You must have a discount rate to compute NPV, IRR, PI, and discounted payback. C) Payback uses the same discount rate as that applied in the NPV calculation. D) Financing projects can only ever have one IRR. E) Financing projects are acceptable if the NPV is negative.

35) A financing type project is acceptable if its internal rate of return is: A) exactly equal to its net present value. B) exactly equal to zero. C) greater than the discount rate. D) less than the discount rate. E) negative.

36) The elements that cause problems with the use of the IRR in projects that are mutually

exclusive are referred to as the: A) discount rate and scale problems. B) timing and scale problems. C) discount rate and timing problems. D) scale and reversing flow problems. E) timing and reversing flow problems.

37) Assume you use all available methods to evaluate two mutually exclusive capital projects. If

the IRR method results in a conflict in the indicated accept/reject decision, you should: A) accept both projects if both are acceptable according to NPV. B) combine both projects into one larger project. C) ignore the IRR and rely on the decision indicated by the NPV method. D) base the final decision on the payback method. E) reject both projects due to ambiguity in the decision-making process.

38) Project A involves building a fitness center on a particular lot. Project B involves building a

parking garage on the same lot. The lot is not large enough to accommodate both projects. Both projects have unconventional cash flows, that is, both projects have positive and negative cash flows that occur following the initial investment. When trying to decide which project to accept, given sufficient funding to accept either project, you should rely most heavily on the method of analysis. A) profitability index B) internal rate of return C) payback D) net present value E) discounted payback

39) The possibility that more than one discount rate will make the NPV of an investment equal to

zero presents the problem referred to as: A) net present value profiling. B) operational ambiguity. C) the mutually exclusive investment decision. D) issues of scale. E) multiple rates of return.

40) A situation in which accepting one investment prevents the acceptance of another investment

is called the: A) net present value profile. B) operational ambiguity decision. C) mutually exclusive investment decision. D) issues of scale problem. E) multiple rates of return decision.

41) The modified internal rate of return: A) is used as the discount rate for all NPV calculations. B) applies only to profitability calculations. C) is used to make accept/reject decisions when no discount rate can be assigned. D) is computed by combining cash flows until only one change in sign remains. E) assumes all projects are financing projects.

42) A mutually exclusive project is a project whose: A) acceptance or rejection has no effect on the acceptance of other projects. B) NPV is always negative. C) IRR is always negative. D) acceptance or rejection affects the acceptance of other projects. E) cash flow pattern exhibits more than one sign change.

43) A project will have more than one IRR if and only if the: A) primary IRR is positive. B) primary IRR is negative. C) NPV is zero. D) cash flow pattern exhibits more than one sign change. E) cash flow pattern exhibits exactly one sign change.

44) You are trying to determine whether to accept Project A or Project B. These projects are

mutually exclusive. As part of your analysis, you should compute the incremental IRR by determining the: A) internal rate of return for the cash flows of each project. B) net present value of each project using the internal rate of return as the discount rate. C) discount rate that equates the discounted payback periods for each project. D) discount rate that makes the net present value of each project equal to 1.0. E) internal rate of return for the differences in the cash flows of the two projects.

45) Comparing the NPV profile of an investment type project to that of a financing type project

demonstrates why the: A) incremental IRR is computed differently for financing projects than for investment projects. B) IRR decision rule for investment projects is the opposite of the rule for financing projects. C) life span of a project affects the decision as to which project to accept. D) NPV rule for financing projects is the opposite of the rule for investment projects. E) profitability index and the net present value are related.

46) Crawford Coffee is considering a project with an initial cost of $53,200, and cash flows of

$19,600, $22,000, $38,000, and −$13,200 for Years 1 to 4, respectively. How many internal rates of return do you expect this project to have? A) 0 B) 1 C) 2 D) 3 E) 4

47) Which of the following provides the best example of two mutually exclusive projects? A) Planning to build a warehouse and a retail outlet side by side B) Buying sufficient equipment to manufacture both desks and chairs simultaneously C) Renting out a company warehouse or selling it outright D) Using the company’s sales force to promote sales of both shoes and socks E) Buying both inventory and fixed assets using funds from the same bank loan

48) An investment with an initial cost of $4,000 produces cash flows of $3,400, −$500, $2,800,

−$100, and $6,000 for Years 1 to 5, respectively. How many IRRs does this project have? A) 4 B) 3 C) 5 D) 6 E) 2

49) How should a profitability index of zero be interpreted? A) The present value of the cash flows subsequent to the initial cash flow is equal to (−1

× Initial cash flow). B) The project has an internal rate of return equal to the discount rate. C) The project produces a net income of zero for every year of its life. D) The project’s cash flows subsequent to the initial cash flow have a present value of zero. E) The project also has a net present value of zero.

50) The profitability index: A) rule often results in decisions that conflict with the decisions based on the net present

value rule. B) is useful as a decision tool when investment funds are limited and all available funds are allocated. C) method is most commonly used when deciding between mutually exclusive projects of varying size. D) rule states that the project with the lower index value should be accepted. E) produces results which typically are difficult to comprehend.

51) If you want to review a project from a benefit-cost perspective, you should use the

method of analysis. A) net present value B) payback C) internal rate of return D) discounted payback E) profitability index

52) The profitability index of an investment project is the ratio of the: A) average net income from the project to the average investment cost. B) internal rate of return to the current market rate of interest. C) net present value of the project’s cash outflows divided by the net present value of its

inflows. D) net present value of every cash flow related to the project compared to the initial cost. E) present value of the cash flows subsequent to the initial cost compared to the initial cost.

53) An independent investment is acceptable if the profitability index (PI) of the investment is: A) greater than 1.0. B) less than 1.0. C) greater than the internal rate of return. D) less than the internal rate of return. E) greater than a pre-specified rate of return.

54) No matter how many methods of investment analysis you employ: A) the actual results from a project may vary significantly from the expected results. B) the internal rate of return will always produce the most reliable results. C) a project will never be accepted unless the payback period is met. D) the initial costs will generally vary considerably from the estimated costs. E) only the first three years of a project ever affect its final outcome.

55) Why do managers suggest that ignoring all cash flows following the required payback period

is not a major flaw of the payback method of capital budgeting analysis? A) Payback is never used in real practice so it makes no difference how academics apply the method in their studies. B) All projected cash flows after the required period are highly inaccurate so including them lessens the reliability of the resulting decision. C) If the cash flows after the required period are significant, managers will use their discretion to override the payback rule. D) All cash flows after the required period are relatively worthless in today’s dollars so ignoring them has no consequence. E) Any consideration of the cash flows after the required period rarely has any effect on the accept/reject decision.

56) Graham and Harvey (2001) found that

were the two most popular capital budgeting

methods. A) IRR and payback B) IRR and NPV C) NPV and PI D) IRR and modified IRR E) discounted payback and NPV

57) What is the net present value of a project with an initial cost of $6,640 and cash inflows of

$400, $1,300, and $2,500 for Years 1 to 3, respectively? The discount rate is 17 percent. A) −$3,788 B) $1,473 C) $2,547 D) $2,547 E) −$4,018

58) What is the net present value of a project that has an initial cash outflow of $7,670 and cash

inflows of $1,280 in Year 1, $6,980 in Year 3, and $2,750 in Year 4? The discount rate is 12.5 percent. A) $86.87 B) $270.16 C) $68.20 D) $249.65 E) $371.02

59) A project costing $102,000 initially should produce cash inflows of $54,000 per year for six

years. At the end of the six years, the project will be shut down and will be sold for an estimated net cash amount of $48,000. What is the net present value of this project if the required rate of return is 11 percent? A) −$202,786 B) $202,786 C) $152,112 D) $228,449 E) $54,533

60) Anxin Fashion is considering two mutually exclusive projects that will not be repeated. The

required rate of return is 13.9 percent for Project A and 12.5 percent for Project B. Project A has an initial cost of $54,500, and should produce cash inflows of $16,400, $28,900, and $31,700 for Years 1 to 3, respectively. Project B has an initial cost of $69,400, and should produce cash inflows of $0, $48,300, and $42,100, for Years 1 to 3, respectively. Which project, or projects, if either, should be accepted and why? A) Project A; because its NPV is positive while Project B’s NPV is negative B) Project A; because it has the higher required rate of return C) Project B; because it has the largest total cash inflow D) Project B; because it has a negative NPV which indicates acceptance E) Neither project; because neither has an NPV equal to or greater than its initial cost

61) You are considering two independent projects that have differing requirements. Project A has

a required return of 12 percent compared to Project B’s required return of 13.5 percent. Project A costs $75,000 and has cash flows of $21,000, $49,000, and $12,000 for Years 1 to 3, respectively. Project B has an initial cost of $70,000 and cash flows of $15,000, $18,000, and $41,000 for Years 1 to 3, respectively. Based on the NPV, you should: A) accept both Project A and Project B. B) accept Project A and reject Project B. C) accept Project B and reject Project A. D) reject both Project A and Project B. E) accept whichever one you want but not both.

62) A project costs $25,000 and is expected to return cash flows of $8,500 per year for five years

and then be worthless. What is the payback period for this project? A) 2.9 years B) 7.1 years C) 1.9 years D) 2.1 years E) 1.2 years

63) You are considering a project with an initial cost of $10,140. What is the payback period for

this project if the cash inflows are $2,300, $4,500, $9,100, and $13,000 for Years 1 to 4, respectively? A) 2.85 years B) 1.57 years C) 2.56 years D) 2.37 years E) 3.78 years

64) A project has an initial cost of $2,250. The cash inflows are $0, $500, $900, and $700 for

Years 1 to 4, respectively. What is the payback period? A) 2.97 years B) 2.84 years C) 3.98 years D) 3.92 years E) Never

65) Jack is considering adding toys to his general store. He estimates the cost of toy inventory

will be $4,200. The remodeling and shelving costs are estimated at $1,500. Toy sales are expected to produce net annual cash inflows of $1,200, $1,500, $1,600, and $1,750 over the next four years, respectively. Should Jack add toys to his merchandise if he requires a threeyear payback period? Why or why not? A) Yes; because the payback period is 2.94 years B) Yes; because the payback period is 2.02 years C) Yes; because the payback period is 3.80 years D) No; because the payback period is 2.02 years E) No; because the payback period is 3.80 years

66) Consider an investment with an initial cost of $20,000 that expected to last for 5 years. The

expected cash flows in Years 1 and 2 are $5,000 each, in Years 3 and 4 are $5,500 each, and the Year 5 cash flow is $1,000. Assume each annual cash flow is spread evenly over its respective year. What is the payback period? A) 3.18 years B) 3.82 years C) 4.00 years D) 4.55 years E) None of these

67) A project costing $218,000 has equal annual cash inflows over its 7-year life. If the

discounted payback period is seven years and the discount rate is zero percent, what is the amount of the cash flow in each of the seven years? A) $31,142.86 per year for each of the seven years. B) $0 for Years 1 to 6 and $218,000 in Year 7. C) Any amount between $0 and $218,000 for any one year, provided the sum of the seven cash flows totals $218,000. D) $218,000 for Year 1 and $0 for Years 2 through 7. E) $0 for each of the seven years.

68) A project has an initial cost of $10,600 and produces cash inflows of $3,700, $4,900, and

$2,500 for Years 1 to 3, respectively. What is the discounted payback period if the required rate of return is 7.5 percent? A) 2.65 years B) 2.78 years C) 2.94 years D) 2.88 years E) Never

69) An investment project has an initial cost of $260 and cash flows $75, $105, $100, and $50 for

Years 1 to 4, respectively. The cost of capital is 12 percent. What is the discounted payback period? A) 3.76 years B) Never C) 3.42 years D) 3.68 years E) 3.92 years

70) An investment project has an initial cost of $382 and cash flows $105, $130, $150, and $150

for Years 1 to 4, respectively. The cost of capital is 9 percent. What is the discounted payback period? A) 2.76 years B) 3.57 years C) 3.42 years D) 3.68 years E) 2.92 years

71) Kumail is considering a project with cash inflows of $950 per year for Years 1 to 4,

respectively. The project has a required discount rate of 11 percent and an initial cost of $2,100. What is the discounted payback period? A) 3.05 years B) 2.68 years C) 3.39 years D) 2.21 years E) Never

72) Leslie is charged with determining which small projects should be funded. Along with this

assignment, she has been granted the use of $15,000 for a maximum of two years on a discounted basis. She is considering three projects. Project A costs $7,500 and has cash flows of $4,000 per year for Years 1 to 3. Project B costs $8,000 and has cash flows of $3,000, $4,000, and $3,000 for Years 1 to 3, respectively. Project C costs $2,000 and has a cash inflow of $2,500 in Year 2. What decisions should she make regarding these projects if she assigns them a mandatory discount rate of 8.5 percent? Explain why. A) Accept either Projects A and C or Projects B and C, but not all three as there is insufficient financing B) Accept Project C and reject Projects A and B because only Project C has a discounted payback that is less than two years C) Accept Projects A and C and reject Project B as they have the shortest discounted payback periods that fit within the $15,000 allocation D) Accept Projects A and C and reject Project B as A and B payback within two years E) Accept Projects B and C and reject Project A as this combination uses the most initial capital

73) An investment with an initial cost of $15,000 produces cash flows of $5,000 annually for 5

years. At a discount rate of 10 percent, what is the discounted payback period? A) 3.00 years B) 3.21 years C) 3.75 years D) 3.89 years E) Never

74) An investment cost $10,000 with expected cash flows of $3,000 per year for 5 years. At what

discount rate will the project’s IRR equal its discount rate? A) 15.24% B) 27.22% C) 0% D) 16.67% E) 21.08%

75) An investment costing $25 returns $27.50 at the end of one year with no risk. Given this, you

know that the NPV: A) is zero at any given discount rate. B) is negative if the required return is less than 10 percent. C) equals 1.0 if the required return is 10 percent. D) is zero if the required rate of return is 10 percent. E) must be positive at any given discount rate.

76) Rachel is reviewing a project with an initial cost of $38,700 and cash inflows of $9,800,

$16,400, and $21,700 for Years 1 to 3, respectively. Should the project be accepted if it has been assigned a required return of 9.75 percent? Why or why not? A) Yes; because the IRR exceeds the required return by .34 percent B) Yes; because the IRR is less than the required return by .28 percent C) Yes; because the IRR exceeds the required return by .28 percent D) No; because the IRR exceeds the required return by .34 percent E) No; because the IRR is only 9.69 percent

77) An analyst is considering two mutually exclusive projects that have been assigned the same

discount rate of 10.5 percent. Project A has an initial cost of $54,500, and should produce cash inflows of $16,400, $28,900, and $31,700 for Years 1 to 3, respectively. Project B has an initial cost of $79,400, and should produce cash inflows of $0, $48,300, and $42,100, for Years 1 to 3, respectively. What is the incremental IRR? A) −15.40% B) −11.23% C) 4.08% D) 7.83% E) 13.89%

78) Project A costs $84,500 and has cash flows of $32,300, $36,400, and $30,000 for Years 1 to

3, respectively. Project B has an initial cost of $79,000 and has cash flows of $30,000, $36,000, and $29,000 for Years 1 to 3, respectively. What is the incremental IRR of these two mutually exclusive projects? A) 18.11% B) −13.01% C) 14.91% D) 16.75% E) −20.37%

79) Project A has an initial cost of $75,000 and annual cash flows of $33,000 for three years.

Project B costs $60,000 and has cash flows of $25,000, $30,000, and $25,000 for Years 1 to 3, respectively. Projects A and B are mutually exclusive. The incremental IRR is percent and if the required rate is higher than the crossover rate then Project should be accepted. A) 13.94; A B) 12.89; B C) 12.89; A D) 13.94; B E) 15.86; A

80) A proposed project has an initial cost of $128,600 and cash flows of $64,500, $98,300, and

−$15,500 for Years 1 to 3 respectively. If all negative cash flows are moved to Time 0 at a discount rate of 10 percent, what is the modified internal rate of return? A) 10.00% B) 9.82% C) 10.04% D) 9.69% E) 9.97%

81) You are considering two independent projects with the same discount rate of 11 percent.

Project A costs $284,700 and has cash flows of $75,900, $106,400, and $159,800 for Years 1 to 3, respectively. Project B costs $115,000, and has a cash flow of $50,000 per year for Years 1 to 3. You have sufficient funds to finance any decision you make. Which project or projects, if either, should you accept and why? A) Project A; because it is the larger-sized project with a positive IRR B) Project A; because it has the larger NPV C) Neither project; because their NPVs are less than their initial costs D) Project B; because its IRR exceeds the discount rate E) Both projects; because their NPVs are both positive

82) A financing type project has an initial cash inflow of $42,000 and cash flows of −$15,600,

−$22,200, and −$18,000 for Years 1 to 3, respectively. The required rate of return is 13 percent. What is the internal rate of return? Should the project be accepted? A) 15.26%; accept B) 15.26%; reject C) 13.44%; reject D) 13.44%; accept E) 10.33%; accept

83) Down Under Stores is considering an investment with an initial cost of $236,000. In Year 4,

the project will require an additional investment and finally, the project will be shut down in Year 7. The annual cash flows for Years 1 to 7, respectively, are projected as $64,000, $87,000, $91,000, −$48,000, $122,000, $154,000, and −$30,000. If all negative cash flows are moved to Time 0 using a discount rate of 13 percent, what is the project’s modified IRR? A) 15.44% B) 17.67% C) 18.54% D) 14.91% E) 22.08%

84) Project X has an initial cost of $20,000 and a cash inflow of $25,000 in Year 3. Project Y

costs $40,700 and has cash flows of $12,000, $25,000, and $10,000 in Years 1 to 3, respectively. The discount rate is 6 percent and the projects are mutually exclusive. Based on the individual project’s IRRs you should accept Project ; based on NPV you should accept Project ; the final decision should be to accept Project . A) Y; Y; Y B) Y; X; X C) X; Y; Y D) X; X; X E) Y; X: Y

85) Two mutually exclusive projects have 3-year lives and a required rate of return of 10.5

percent. Project A costs $75,000 and has cash flows of $18,500, $42,900, and $28,600 for Years 1 to 3, respectively. Project B costs $72,000 and has cash flows of $22,000, $38,000, and $26,500 for Years 1 to 3, respectively. Using the IRR, which project, or projects, if either, should be accepted? A) Accept both projects. B) Select either project as there is no significant difference between them. C) Accept Project A and reject Project B. D) Accept Project B and reject Project A. E) Reject both projects.

86) Write On! has a proposed project with an initial cost of $101,000 and cash flows of $74,000

per for Years 1 to 5. At the end of the Year 5 there will be an additional net cash inflow of $68,000. Based on the profitability index rule, should the project be accepted if the discount rate is 12.5 percent? Why or why not? A) Yes; because the PI is 2.2 B) Yes; because the PI is 3.0 C) Yes; because the PI is 2.6 D) No; because the PI is 0.8 E) No; because the PI is 3.3

87) Gabriel is considering two independent projects with 2-year lives. Both projects have been

assigned a discount rate of 13 percent. She has sufficient funds to finance one or both projects. Project A costs $38,500 and has cash flows of $19,400 and $28,700 for Years 1 and 2, respectively. Project B costs $41,000, and has cash flows of $25,000 and $22,000 for Years 1 and 2, respectively. Which project, or projects, if either, should Gabriel accept based on the profitability index method and what is the correct reason for that decision? A) You should accept both projects since both of their PIs are positive. B) You should accept Project A since it has the higher PI and you can only select one project. C) You should accept both projects since both of their PIs are greater than 1. D) You should only accept Project A since it is the only project with a PI greater than 1. E) Neither project is acceptable.

88) Corey’s Scrap Metal projects cash flows of $13,500, $20,400, and $32,900 for Years 1 to 3

for a project with an initial cost of $45,000. What is the profitability index given an assigned discount rate of 15 percent? A) .92 B) .97 C) 1.03 D) 1.08 E) 1.14

89) A project manager wants to invest in a project with an initial cost of $58,500 and cash flows

of $32,400 and $38,500 in Years 1 and 2. The manager’s employer requires a discount rate of 10 percent and also a return of $1.10 in today’s dollars for every $1 invested. Will the project be approved? Why or why not? A) Yes; because the NPV is positive. B) Yes; because the PI is greater than 1. C) Yes; because both criteria are met. D) No; because the project does not meet either requirement. E) No; while the project returns more than 10 percent it does meet the $1.10 per $1 requirement.

90) Jaime is evaluating two independent projects. Project A costs $74,600 and has projected cash

flows of $18,700, $46,300, and $12,200 for Years 1 to 3, respectively. Project B costs $70,000 and has cash flows of $10,600, $15,800, and $67,900 for Years 1 to 3, respectively. Jaime assigns a discount rate of 10 percent to Project A and 12 percent to Project B. Which project or projects, if either, should he accept based on the profitability index rule? A) Accept both projects. B) Accept Project A and reject Project B. C) Accept either A or B, but not both. D) Reject both projects. E) Accept Project B and reject Project A.

91) A proposed project costs $300 and has cash flows of $80, $200, $75, and $90 for Years 1 to

4, respectively. Because of its high risk, the project has been assigned a discount rate of 16 percent. How much will this project return in today’s dollars for every $1 invested? A) $1.01 B) $.99 C) $1.05 D) $.97 E) $1.03

92) Vyshali is evaluating an investment costing $55,000 that has cash flows of $35,000 in Year

2, $36,000 in Year 3, and −$5,000 in Year 4. Her employer requires a rate of return of 8 percent and has a required discounted payback period of three years. Should this project be accepted? Why? A) Yes; The project pays back on a discounted basis within the assigned time period and also produces a positive NPV. B) Yes; The discounted payback requirement is met and other methods of analysis are less desirable. C) No; Although the project earns more than 8 percent, there is no situation where the project can pay back on a discounted basis within three years. D) No; The discounted payback period is too short. E) No; The NPV indicates rejection as does discounted payback when all cash flows are considered.

93) A proposed new venture will cost $175,000 and should produce annual cash flows of

$48,500, $85,000, $40,000, and $40,000 for Years 1 to 4, respectively. The required payback period is 3 years and the discounted payback period is 3.5 years. The required rate of return is 9 percent. Which methods indicate project acceptance and which indicate project rejection? A) Accept: NPV, IRR, PI, payback; B) Accept: NPV, IRR, PI; C) Accept: payback, PI; D) Accept: payback, discounted payback; E) Accept: NPV, IRR;

Reject: discounted payback Reject: payback, discounted payback Reject: NPV, IRR, discounted payback Reject: NPV, IRR, PI

Reject: PI, payback, discounted payback

94) Given the goal of maximization of firm value and shareholder wealth, we have stressed the

importance of net present value (NPV). And yet, some financial decision-makers continue to use less desirable measures such as the payback method. Why do you think this is the case?

95) List and briefly discuss the advantages and disadvantages of the internal rate of return (IRR).

96) The IRR rule is said to be a special case of the NPV rule. Explain why this is so and why IRR

has some limitations NPV does not.

97) Explain the differences and similarities between net present value (NPV) and the profitability

index (PI).

98) Most financial experts will agree that net present value is the best capital budgeting method.

However, even NPV can be unreliable when projecting project results. Explain why this is so.

Answer Key Test name: Chapter 5(1) 1) A 2) A 3) C 4) D 5) A 6) D 7) E 8) A 9) E 10) E 11) E 12) D 13) D 14) C 15) C 16) D 17) C 18) A 19) A 20) C 21) B 22) E 23) D 24) A 25) E 26) B 27) A 28) A 29) C 30) A 31) B 32) B 33) A 34) A 35) D 36) B 37) C

38) D 39) E 40) C 41) D 42) D 43) D 44) E 45) B 46) C 47) C 48) C 49) D 50) B 51) E 52) E 53) A 54) A 55) C 56) B 57) A 58) A 59) C 60) A 61) D 62) A 63) D 64) E 65) E 66) B 67) A 68) E 69) B 70) B 71) B 72) B 73) C 74) A 75) D 76) A 77) A

78) E 79) B 80) B 81) D 82) B 83) C 84) C 85) E 86) B 87) D 88) D 89) E 90) E 91) C 92) E 93) B 94) Essay 95) Essay 96) Essay 97) Essay 98) Essay

Student name: 1) A project that costs $22,500 today will generate cash flows of $8,500 per year for seven

years. What is the project's payback period? A) 3.00 years B) 2.21 years C) 2.12 years D) 2.65 years E) .38 years

2) Guerilla Radio Broadcasting has a project available with the following cash flows : Year 0 1 2 3 4

Cash Flow −$15,000 6,200 7,500 4,900 4,500

What is the payback period? A) 2.52 years B) 2.64 years C) 3.00 years D) 2.27 years E) 1.73 years

3) There is a project with the following cash flows : Year 0 1 2 3 4

Cash Flow −$27,800 8,100 8,250 7,650 6,200

What is the payback period? A) 3.61 years B) 3.81 years C) 3.89 years D) 4.00 years E) 2.50 years

4) There is a project with the following cash flows : Year 0 1 2 3 4 5

Cash Flow −$28,300 8,200 9,300 7,700 8,300 7,800

What is the payback period? A) 3.65 years B) 3.71 years C) 4.00 years D) 3.37 years E) 2.60 years

5) A project with an initial cost of $25,500 is expected to generate cash flows of $6,100, $8,200,

$8,850, $7,750, and $6,900 over each of the next five years, respectively. What is the project's payback period? A) 3.73 years B) 3.51 years C) 3.30 years D) 3.42 years E) 3.67 years

6) Filter Corporation has a project available with the following cash flows: Year Cash Flow 0 −$13,600 1 6,500 2 7,800 3 4,300 4 3,900

What is the project's IRR? A) 26.78% B) 29.75% C) 31.24% D) 29.01% E) 27.89%

7) Blinding Light Company has a project available with the following cash flows: Year 0 1 2 3 4 5

Cash Flow −$32,670 8,420 10,170 14,610 16,210 11,240

What is the project's IRR? A) 20.49% B) 24.66% C) 23.71% D) 25.29% E) 22.77%

8) A project with an initial cost of $73,600 is expected to generate annual cash flows of $16,360

for the next 8 years. What is the project's internal rate of return? A) 14.18% B) 14.92% C) 13.43% D) 16.17% E) 16.58%

9) Your company has a project available with the following cash flows: Year 0 1 2 3 4 5

Cash Flow −$82,000 21,050 24,100 29,900 25,550 18,900

If the required return is 13 percent, should the project be accepted based on the IRR? A) Yes, because the IRR is 14.65 percent. B) No, because the IRR is 15.24 percent. C) Yes, because the IRR is 14.07 percent. D) No, because the IRR is 14.07 percent. E) Yes, because the IRR is 15.24 percent.

10) Iron Works International is considering a project that will produce annual cash flows of

$39,100, $47,800, $58,500, and $24,000 over the next four years, respectively. What is the internal rate of return if the project has an initial cost of $111,900? A) 18.03% B) 16.39% C) 17.48% D) 18.84% E) 19.66%

11) A project will generate annual cash flows of $237,600 for each of the next three years, and a

cash flow of $274,800 during the fourth year. The initial cost of the project is $760,600. What is the internal rate of return of this project? A) 11.98% B) 9.83% C) 9.22% D) 10.45% E) 11.06%

12) You are evaluating two projects with the following cash flows: Year 0 1 2 3 4

Project X −$542,400 219,400 229,300 236,500 196,200

Project Y −$512,500 209,100 218,900 226,800 187,600

What is the crossover rate for these two projects? A) .61% B) 23.04% C) 11.93% D) 13.12% E) 23.65%

13) Matterhorn Mountain Gear is evaluating two projects with the following cash flows: Year 0 1 2 3

Project X −$317,000 147,300 164,800 129,900

Project Y −$294,850 137,900 155,100 120,850

What interest rate will make the NPV for the projects equal? A) .45% B) 11.64% C) 13.10% D) 19.49% E) 19.05%

14) You are considering the following two mutually exclusive projects. The crossover rate

between these two projects is percent and Project return is greater than the crossover rate. Year 0 1 2 3

Project A −$44,000 21,500 13,500 13,500

should be accepted if the required

Project B −$44,000 13,770 11,500 26,100

A) 7.24%; B B) 15.39%; A C) 15.39%; B D) 5.51%; A E) 5.51%; B

15) A project has the following cash flows : Year 0 1 2 3 4

Cash Flows −$12,000 5,290 7,630 5,040 −1,580

Assuming the appropriate interest rate is 10 percent, what is the MIRR for this project using the discounting approach? A) 17.77% B) 11.63% C) 13.96% D) 19.21% E) 15.23%

16) Yellow Day has a project with the following cash flows: Year 0 1 2 3 4

Cash Flows −$25,800 9,950 15,500 9,000 −3,000

What is the MIRR for this project using the reinvestment approach? The interest rate is 7 percent A) 11.08% B) 9.11% C) 9.50% D) 7.59% E) 11.85%

17) Green Submarine has a project with the following cash flows: Year

1 2 3 4

Cash Flows −$17,800 7,030 12,500 7,910 −3,000

The discounting rate is 8 percent and the reinvestment rate is 10 percent. What is the MIRR for this project using the combination approach? A) 12.96% B) 17.22% C) 13.49% D) 15.29% E) 19.50%

18) POD has a project with the following cash flows: Year 0 1 2 3

Cash Flows −$273,000 145,900 163,400 128,500

The required return is 8.7 percent. What is the profitability index for this project? A) 1.365 B) 1.137 C) .733 D) .916 E) 1.251

19) A project has the following cash flows: Year 0 1 2 3 4

Cash Flows −$128,400 50,600 63,800 51,600 28,100

The required return is 8.9 percent. What is the profitability index for this project? A) 1.144 B) 1.040 C) 1.002 D) .802 E) 1.248

20) A project with an initial cost of $31,200 is expected to provide cash flows of $11,700,

$12,300, $15,400, and $9,900 over the next four years, respectively. If the required return is 8.2 percent, what is the project's profitability index? A) 1.196 B) 1.304 C) .767 D) 1.087 E) 1.468

21) A project is expected to provide cash flows of $12,000, $12,500, $15,600, and $10,100 over

the next four years, respectively. At a required return of 8.4 percent, the project has a profitability index of .909. For this to be true, what is the project's cost at Time 0? A) $45,401 B) Insufficient information. C) $37,514 D) $41,618 E) $31,887

22) A project with an initial cost of $58,000 is expected to provide annual cash flows of $11,250

over the 7-year life of the project. If the required return is 9.4 percent, what is the project's profitability index? A) .963 B) 1.084 C) 1.038 D) .883 E) .803

23) A project has an initial cost of $93,400, a life of 7 years, and equal annual cash inflows. The

required return is 9.4 percent. According to the profitability index decision rule, what is the minimum annual cash flow necessary to accept the project? A) $20,517.26 B) $17,360.76 C) $13,342.86 D) $22,227.04 E) $18,807.49

24) Living Colour Company has a project available with the following cash flows: Year 0 1 2 3 4 5

Cash Flow −$31,870 8,570 10,370 14,960 16,410 11,540

If the required return for the project is 9.9 percent, what is the project's NPV? A) $16,264.48 B) $14,231.42 C) $29,980.00 D) $7,033.33 E) $15,417.37

25) A company. has a project available with the following cash flows: Year 0 1 2 3 4

Cash Flow −$32,870 12,960 14,740 20,570 11,780

If the required return for the project is 9.2 percent, what is the project's NPV? A) $17,645.80 B) $7,155.79 C) $14,153.40 D) $27,180.00 E) $15,440.07

26) Blink of an Eye Company is evaluating a 5-year project that will provide cash flows of

$36,900, $68,190, $62,690, $60,590, and $43,690, respectively. The project has an initial cost of $166,240 and the required return is 8.6 percent. What is the project's NPV? A) $13,804.10 B) $12,549.19 C) $15,912.69 D) $46,982.37 E) $20,640.07

27) A project with an initial investment of $434,900 will generate equal annual cash flows over

its 10-year life. The project has a required return of 7.7 percent. What is the minimum annual cash flow required to accept the project? A) $61,064.10 B) $68,752.64 C) $63,938.63 D) $59,028.63 E) $73,072.72

28) A project that will last for 12 years is expected to have equal annual cash flows of $100,900.

If the required return is 8.6 percent, what maximum initial investment would make the project acceptable? A) $653,161.74 B) $737,307.69 C) $1,984,296.96 D) $701,182.48 E) $699,816.15

29) Rossdale Flowers has a new greenhouse project with an initial cost of $321,000 that is

expected to generate cash flows of $44,700 for 9 years and a cash flow of $60,100 in Year 10. If the required return is 7.7 percent, what is the project's NPV? A) $87,790.25 B) −$16,958.00 C) $11,665.15 D) $110,718.25 E) −$9,623.62

30) Carland, Incorpoated, has a project available with the following cash flows. If the required

return for the project is 8.6 percent, what is the project's NPV? Year 0 1 2 3 4 5 A) B) C) D) E)

Cash Flow −$265,000 74,700 98,100 121,300 73,700 −12,700

$34,651.77 $43,059.04 $19,207.80 $26,244.51 $21,951.77

31) Maud'Dib Intergalactic has a new project available on Arrakis. The cost of the project is

$39,500 and it will provide cash flows of $22,600, $28,800, and $29,100 over each of the next three years, respectively. Any cash earned in Arrakis is "blocked" and must be reinvested in the country for one year at an interest of 2.8 percent. The project has a required return of 9.2 percent. What is the project's NPV? A) $27,694.94 B) $45,006.82 C) $23,756.78 D) $36,523.29 E) $41,256.25

Answer Key Test name: Chapter 5(2) 1) D 2) D 3) A 4) D 5) C 6) A 7) E 8) B 9) C 10) E 11) E 12) C 13) C 14) B 15) A 16) B 17) C 18) A 19) E 20) B 21) A 22) A 23) E 24) B 25) E 26) D 27) C 28) B 29) E 30) D 31) C

Chapter 6: 1)

cash flows are the changes in a firm’s future cash flows that are a direct result of accepting a project. A) Incremental B) Stand-alone C) Opportunity D) Equivalent annual E) Erosion

2) A cost that has already been paid, or a liability that has already been incurred, is classified as

a(n): A) B) C) D) E)

3) A(n)

salvage value expense. net working capital expense. sunk cost. opportunity cost. erosion cost.

is the most valuable investment forgone if an alternative investment is

chosen. A) salvage value expense B) net working capital expense C) sunk cost D) opportunity cost E) erosion cost

4) A decrease in a firm’s current cash flows resulting from the implementation of a new project

is referred to as: A) salvage value expenses. B) net working capital expenses. C) sunk costs. D) opportunity costs. E) erosion costs.

5) When identifying all the incremental cash flows related to a proposed project, and analyst

must: A) isolate the total sunk costs so they can be evaluated to determine if they will add

value to the firm. B) eliminate any cost which has previously been incurred so that it can be omitted from the analysis of the project. C) make each project appear as profitable as possible for the firm. D) include both the proposed and the current operations of a firm in the analysis of the project. E) identify any and all changes in the cash flows of the firm for the past year so they can be included in the analysis.

6) Sunk costs include any costs that: A) will change if a project is undertaken. B) will be incurred if a project is accepted. C) have previously been incurred and cannot be changed. D) will be paid to a third party and cannot be refunded for any reason whatsoever. E) will occur if a project is accepted and once incurred, cannot be recouped.

7) Assume you spent $800 last week repairing your car. Now a new problem is occurring and

you are trying to decide whether to fix the car or trade it in for a newer model. In analyzing the situation, the $800 repair expense is a(n) cost. A) opportunity B) fixed C) incremental D) sunk E) relevant

8) Erosion can be explained as the: A) additional income generated from the sales of a newly added product. B) loss of current sales due to a new project being implemented. C) loss of revenue due to employee theft. D) loss of revenue due to customer theft. E) decrease in expected annual revenues as a new product ages.

9) Of the following choices, which one is an example of erosion and should be included in a

capital project analysis? A) The anticipated loss of current sales when a new product is launched. B) The expected decline in sales as the market for a product becomes saturated. C) The reduction in sales that occurs when a competitor introduces a new product. D) The sudden loss of sales due to a major employer in your community implementing massive layoffs. E) The reduction in sales price that will most likely be required to sell inventory that has aged.

10)

should be excluded from the analysis of a capital project. A) Erosion costs B) Incremental fixed costs C) Incremental variable costs D) Sunk costs E) Opportunity costs

11) The cash flows of a project should: A) be computed on a pretax basis. B) include all sunk costs and opportunity costs. C) include all incremental and opportunity costs. D) be applied to the year when the related expense or income is recognized by GAAP. E) include all financing costs related to new debt acquired to finance the project.

12) All of the following are anticipated effects of a proposed project. Which of them should be

considered when computing the cash flow for the final year of the project? A) Operating cash flow and salvage values only B) Salvage values and net working capital recovery only C) Operating cash flow, net working capital recovery, salvage values D) Net working capital recovery and operating cash flow only E) Operating cash flow only

13) Changes in net working capital: A) can affect the cash flows of a project every year of the project's life. B) only affect the initial cash flows of a project. C) are included in project analysis only if they represent cash outflows. D) are generally excluded from project analysis due to their irrelevance to the total

project. E) can only affect the initial and the final cash flows of a project.

14) The net working capital of a firm will decrease if there is: A) a decrease in accounts payable. B) an increase in inventory. C) a decrease in accounts receivable. D) an increase in the checking account balance. E) a decrease in fixed assets.

15) Net working capital: A) can be ignored in project analysis because any expenditure is normally recouped by

the end of the project. B) requirements generally, but not always, create a cash inflow at the beginning of a project. C) expenditures commonly occur at the end of a project. D) is frequently affected by the additional sales generated by a new project. E) is the only expenditure where at least a partial recovery can be made at the end of a project.

16) A company that opts to forego bonus depreciation and instead uses the MACRS system of

depreciation: A) will have equal depreciation costs for each year of an asset’s life. B) will expense the largest percentage of the cost during an asset’s first year of life. C) can depreciate the cost of land, if it so desires. D) will fully depreciate the entire cost of an asset over the asset’s class life. E) cannot expense any of the cost of a new asset during the first year of the asset’s life.

17) Champion Toys just purchased some MACRS 5-year property at a cost of $230,000. The

MACRS rates are 20 percent, 32 percent, 19.2 percent, 11.52 percent, 11.52 percent, and 5.76 percent for Years 1 to 6, respectively. Assuming the firm foregoes all bonus depreciation, the book value of the asset as of the end of Year 2 can be calculated as: A) $230,000(1 − .20 − .32). B) $230,000([1 − (.20)(.32)]. C) $230,000(1 − .20)(1 − .32). D) $230,000/(1 − .20 − .32). E) $230,000(.20)(.32).

18) Reema Remodels just purchased some equipment at a cost of $650,000. What is the proper

methodology for computing the depreciation expense for Year 3 if the equipment is classified as 5-year property for MACRS? The MACRS rates are 20 percent, 32 percent, 19.2 percent, 11.52 percent, 11.52 percent, and 5.76 percent for Years 1 to 6, respectively. Ignore bonus depreciation. A) $650,000(1 − .20)(1 − .32)(1 − .192) B) $650,000(1 − .20)(1 − .32) C) $650,000(1 − .20)(1 − .32)(.192) D) $650,000(1 − .192) E) $650,000(.192)

19) The book value of an asset is primarily used to compute the: A) annual depreciation tax shield. B) amount of cash received from the sale of the asset. C) amount of tax saved annually due to the depreciation expense. D) amount of tax due on the sale of that asset. E) change in depreciation needed to reflect the market value of the asset.

20) The salvage value of an asset creates an aftertax cash flow in an amount equal to the sales

price: A) of the asset. B) minus the remaining book value. C) minus [Tax rate × (Sales price − Book value)]. D) minus [Tax rate × (Book value − Sales price)]. E) plus the remaining book value.

21) The pretax salvage value of an asset is equal to the: A) book value if straight-line depreciation is used. B) book value if MACRS depreciation is used. C) market value minus the book value. D) book value minus the market value. E) market value.

22) Which depreciation method currently permitted under U.S. tax law provides the fastest

means of depreciating an asset? A) MACRS depreciation B) Bonus depreciation C) Straight-line depreciation D) Sum-of-years digits depreciation E) Partial bonus depreciation combined with MACRS

23) For a tax-paying firm, the net present value of a project will increase when: A) the initial net working capital requirement increases. B) depreciation is decreased during the early years of a project’s life. C) the life of the fixed assets used by that project is increased. D) the operating cash flows increase. E) the tax rate increases.

24) When a project’s , its operating cash flow will increase. A) depreciation expense increases B) sales projections are lowered C) interest expense is lowered D) net working capital requirement increases E) earnings before interest and taxes decreases

25) The increase in cash flow generated as a result of a firm’s tax-deductible depreciation

expense is called the: A) aftertax depreciation savings. B) depreciable basis. C) depreciation tax shield. D) operating cash flow. E) aftertax salvage value.

26) Assume a firm has no interest expense or extraordinary items. Given this, the operating cash

flow can be computed as: A) EBIT − Taxes. B) EBIT(1 − Tax rate) + Depreciation(Tax rate). C) (Sales − Costs)(1 − Tax rate). D) EBIT − Depreciation + Taxes. E) Net income + Depreciation.

27) The bottom-up approach to computing the operating cash flow applies only when: A) both the depreciation expense and the interest expense are equal to zero. B) the interest expense is equal to zero. C) the project is a cost-cutting project. D) no fixed assets are required for the project. E) taxes are ignored and the interest expense is equal to zero.

28) The top-down approach to computing the operating cash flow: A) ignores all noncash items. B) applies only if a project produces sales. C) can only be used if the entire cash flows of a firm are included. D) is equal to: Sales − Costs − Taxes + Depreciation. E) includes the interest expense related to a project.

29) For a profitable firm, an increase in A) payroll B) office rent C) building maintenance D) depreciation E) equipment rental

expense will increase operating cash flow.

30) The term “tax shield” refers to a reduction in taxes created by: A) a reduction in sales. B) an increase in interest expense. C) noncash expenses. D) a project’s incremental expenses. E) opportunity costs.

31) A project which is designed to improve the manufacturing efficiency of a firm but will

generate no additional sales revenue is referred to as a(n) A) sunk cost B) opportunity C) cost-cutting D) revenue-cutting E) revenue-generating

project.

32) The annual annuity stream of payments with the same present value as a project’s costs is

called the project’s cost. A) incremental B) sunk C) opportunity D) erosion E) equivalent annual

33) Gorch Moving is comparing machines to determine which one to purchase. The machines

sell for differing prices, have differing operating costs, differing machine lives, and will be replaced when worn out. These machines should be compared using: A) net present value only. B) both net present value and the internal rate of return. C) their equivalent annual costs. D) the depreciation tax shield approach. E) the replacement cost approach.

34) The pro forma income statement for a cost reduction project: A) will reflect a reduction in the sales of the firm. B) will generally reflect no incremental sales. C) has to be prepared reflecting the total sales and expenses of the entire firm. D) cannot be prepared due to the lack of any project related sales. E) will always reflect a negative project operating cash flow.

35) The equivalent annual cost method is most useful in determining: A) the annual operating cost of an idle machine that is currently owned by a firm. B) the tax shield benefits of depreciation given the purchase of new assets for a project. C) operating cash flows for cost-cutting projects of equal duration. D) which one of two machines to acquire given equal machine lives but unequal machine

costs. E) which one of two machines to purchase when the machines are mutually exclusive, have differing lives, and will be replaced.

36) Interest rates that have been adjusted for the effects of inflation are called _ A) real B) nominal C) effective D) stripped E) coupon

rates.

37) The increase in buying power you experience as a result of owning an investment is referred

to as the rate of return. A) inflated B) realized C) nominal D) real E) risk-free

38) Four years ago, Rojas purchased a parcel of land for $760,000 and then spent an additional

$120,000 to install access to water and electricity. The land was recently appraised at $825,000. Rojas now wants to build a restaurant on the site. The cost to build the restaurant is estimated at $1.4 million. What amount should be used as the initial cash outflow for this building project? A) $3,105,000 B) $2,225,000 C) $2,280,000 D) $1,400,000 E) $2,345,000

39) Colletto’s purchased a lot seven years ago at a cost of $412,000. At that time, the firm spent

$378,000 to build a small retail store on the site. The most recent appraisal on the property placed a value of $522,000 on the lot and building combined. Colletto’s now wants to tear down the store and replace it with an office building at an estimated cost of $3.1 million. What amount should be used as the initial cash outflow for the new project? A) $4,034,000 B) $4,412,000 C) $3,890,000 D) $3,622,000 E) $3,100,000

40) Mougia’s currently produces boat sails and is considering expanding its operations to include

awnings. The expansion would require the use of land the firm purchased three years ago at a cost of $142,000 that is currently valued at $137,500. The expansion could use some equipment that is currently sitting idle if $6,700 of modifications were made to it. The equipment originally cost $139,500 six years ago, has a current book value of $24,700, and a current market value of $39,000. Other capital purchases costing $780,000 will also be required. What is the amount of the initial cash outflow for this expansion project? A) $953,400 B) $962,300 C) $948,900 D) $927,800 E) $963,200

41) The Boat Works currently produces boat sails and is considering expanding its operations to

include awnings. The expansion would require the use of land the firm purchased three years ago at a cost of $197,000 that is currently valued at $209,500. The expansion could use some equipment that is currently sitting idle if $7,500 of modifications were made to it. The equipment originally cost $387,500 five years ago, has a current book value of $132,700, and a current market value of $139,000. Other capital purchases costing $520,000 will also be required. What is the value of the opportunity costs that should be included in the initial cash outflow for the expansion project? A) $425,000 B) $485,000 C) $329,700 D) $348,500 E) $537,200

42) Cush currently sells 14,800 pairs of shoes annually at an average price of $59 a pair. It is

considering adding a lower-priced line of shoes that will be priced at $39 a pair. The company estimates it can sell 6,000 pairs of the lower-priced shoes annually but will sell 3,500 less pairs of the higher-priced shoes each year by doing so. What annual sales revenue should be used when evaluating the addition of the lower-priced shoes? A) $27,500 B) $24,000 C) $31,300 D) $789,100 E) $900,700

43) Foamsoft currently sells 16,850 pairs of shoes annually at an average price of $79 a pair. It is

considering adding a new line of shoes that would sell for $49 a pair. The company estimates it can sell 5,000 pairs of the lower-priced shoes annually but will sell 1,250 less pairs of the higher-priced shoes each year by doing so. What is the estimated value of the annual erosion cost that should be charged to the lower-priced shoe project? A) $138,750 B) $146,250 C) $98,750 D) $52,000 E) $123,240

44) Camila purchased a house for $89,000, spent $56,000 upgrading it, and recently had it

appraised at $212,900. The house is being rented to a family for $1,200 per month, the maintenance expenses average $200 per month, and the property taxes are $4,800 per year. If she sells the house she will incur $20,000 in expenses. She is considering converting the house into professional office space. What opportunity cost, if any, should she assign to this property if she has been renting it for the past two years? A) $178,500 B) $120,000 C) $185,000 D) $192,900 E) $232,900

45) Cahill Motor Home Sales currently sells 110 Class A motor homes, 220 Class C motor

homes, and 280 pop-up trailers each year. They are considering adding a mid-range camper with expected annual sales of 300 units. However, if the new camper is added, Class A sales will decline to 85 units and the Class C camper sales will decline to 200 units. The sales of pop-ups will not be affected. Class A motor homes sell for an average of $140,000 each. Class C homes are priced at $59,500, and the pop-ups sell for $5,000 each. The new midrange camper will sell for $42,900. What is the annual erosion cost of adding the mid-range camper? A) $5,425,000 B) $4,690,000 C) $5,375,000 D) $6,315,000 E) $7,875,000

46) Challa Corporation just purchased $40,000 of fixed assets that are classified as 5-year

MACRS property. The MACRS rates are 20 percent, 32 percent, 19.2 percent, 11.52 percent, 11.52 percent, and 5.76 percent for Years 1 to 6, respectively. What is the amount of the depreciation expense for the fourth year if the firm applies the new bonus method of depreciation? A) $2,304 B) $7,680 C) $4,608 D) $0 E) $8,000

47) Estafania just purchased $67,600 of equipment that is classified as 5-year MACRS property.

The MACRS rates are 20 percent, 32 percent, 19.2 percent, 11.52 percent, 11.52 percent, and 5.76 percent for Years 1 to 6, respectively. What will be the book value of this equipment at the end of four years if she ignores bonus depreciation? A) $11,681.28 B) $18,280.20 C) $17,040.00 D) $19,468.80 E) $22,672.00

48) Exposures Photographic just purchased $945,000 of fixed assets that are classified as 5-year

MACRS property. The MACRS rates are .2000, .3200, .1920, .1152, .1152, and .0576 for Years 1 to 4, respectively. What will be the amount of the depreciation expense for Year 3? Ignore bonus depreciation. A) $139,955 B) $108,864 C) $165,281 D) $84,389 E) $181,440

49) The Galley purchased some 3-year MACRS property two years ago at a cost of $19,800. The

MACRS rates are 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent. The firm no longer uses this property so is selling it today at a price of $13,500. What is the amount of the aftertax profit on the sale? Assume the firm applies bonus depreciation and has a tax rate of 21 percent. A) $9,140.48 B) $10,665.00 C) $8,295.00 D) $7,187.78 E) $10,702.40

50) Three years ago, you purchased some 5-year MACRS equipment at a cost of $180,000. The

MACRS rates are 20 percent, 32 percent, 19.2 percent, 11.52 percent, 11.52 percent, and 5.76 percent for Years 1 to 6, respectively. You sold the equipment today for $89,500. Which of these statements is correct if your tax rate is 21 percent and you ignore bonus depreciation? A) The taxable amount of the sale is $51,840. B) The book value today is $86,400. C) The book value today is $148,896. D) The tax due on the sale is $7,908.60. E) The tax refund from the sale is $2,091.40.

51) Su Sweets purchased $145,000 of fixed assets two years ago that are classified as 5-year

MACRS property. The MACRS rates are 20 percent, 32 percent, 19.2 percent, 11.52 percent, 11.52 percent, and 5.76 percent for Years 1 to 6, respectively. The tax rate is 22 percent. If the assets are sold today for $91,500, what will be the aftertax cash flow from the sale? Ignore bonus depreciation. A) $20,130 B) $15,312 C) $31,900 D) $17,072 E) $86,682

52) If Rosinki Fabricators purchases $618,000 of new equipment, they can lower annual

operating costs by $265,000. The equipment will be depreciated straight-line to a zero book value over its 3-year life. Ignore bonus depreciation. At the end of the three years, the equipment will be sold for an estimated $60,000. The equipment will require the company to hold an extra $23,000 of inventory over the 3-year period. What is the NPV if the discount rate is 14 percent and the tax rate is 21 percent? A) −$2,646.00 B) −$7,014.54 C) −$12,593.78 D) $3,106.54 E) $6,884.40

53) Winslow Motors purchased $225,000 of MACRS 5-year property. The MACRS rates are 20

percent, 32 percent, 19.2 percent, 11.52 percent, 11.52 percent, and 5.76 percent for Years 1 to 6, respectively. The tax rate is 21 percent. If the firm sells the asset after four years for $10,000, what will be the aftertax cash flow from the sale if the firm applies bonus depreciation? A) $6,488.85 B) $8,880.20 C) $7,900.00 D) $7,770.40 E) $11,006.40

54) A project is expected to create operating cash flows of $26,500 a year for four years. The

fixed assets required for the project cost $62,000 and will be worthless at the end of the project. An additional $3,000 of net working capital will be required throughout the life of the project. What is the project's net present value if the required rate of return is 12 percent? A) $19,208.11 B) $14,028.18 C) $15,306.09 D) $17,396.31 E) $21,954.17

55) A project is expected to create operating cash flows of $73,000 per year for eight years. The

fixed assets required for the project cost $108,000. It will cost an estimated $60,000 after tax to dispose of the fixed assets at the end of the project. What is the project’s net present value if the required rate of return is 12.5 percent? A) −$487,774 B) $225,005 C) $333,005 D) $271,774 E) −$333,005

56) A project is expected to create operating cash flows of $42,000 per year for five years. The

fixed assets required for the project cost $98,000. It will cost an estimated $54,000 after tax to dispose of the fixed assets at the end of the project. What is the project’s net present value if the required rate of return is 13 percent? A) −$275,033 B) $118,415 C) $20,415 D) $79,033 E) $23,787

57) Assume a project will increase inventory by $61,000, accounts payable by $28,000, and

accounts receivable by $36,000. What is the initial net working capital requirement for this project? A) $53,000 B) $69,000 C) $59,000 D) $97,000 E) $125,000

58) Efron Supply is considering a project which will require additional inventory of $115,000,

will decrease accounts payable by $12,000, and will increase accounts receivable by $22,000. What is the initial net working capital requirement for this project? A) $149,000 B) $173,000 C) $125,000 D) $95,000 E) $81,000

59) Chen Sports needs to maintain 15 percent of its sales in net working capital. The firm is

considering a 3-year project which will increase sales from their current level of $110,000 to $125,000 the first year and to $135,000 per year for the following two years. When analyzing the project, what amount should be included for net working capital for the last year if the net working capital returns to its original level at that time? A) $20,250 B) $7,000 C) $13,200 D) $3,750 E) $17,400

60) Bloom Corporation needs to maintain 8 percent of its sales in net working capital. The firm is

considering a 5-year project which will increase sales from their current level of $110,000 to $146,000, $152,000, $158,000, $164,000, and $155,000 for Years 1 to 5 of the project, respectively. What amount should be included in the project analysis cash flows for net working capital for Year 3 of the project? A) −$12,640 B) −$480 C) $0 D) $480 E) $12,640

61) Hannigan Home Theater is expanding its product offerings which includes increasing the

floor inventory by $150,000, increasing accounts receivable by $35,000, and increasing its debt to suppliers by $75,000. The company will also spend $200,000 for a building contractor to expand the size of the showroom. What is the amount of the project's initial cash flow? A) −$240,000 B) −$310,000 C) −$160,000 D) −$295,000 E) −$175,000

62) Izquierdo, Incorporated, is considering a project with a life of 4 years that will produce

annual operating cash flows of $123,000. During the life of the project, inventory will increase by $8,500, accounts receivable will increase by $11,000, and accounts payable will increase by $4,200. The project requires the purchase of equipment at an initial cost of $310,000 that will be depreciated straight-line to a zero book value over the life of the project. Ignore bonus depreciation. The equipment will be salvaged at the end of the project creating an aftertax cash inflow of $36,000. At the end of the project, net working capital will return to its normal level. What is the net present value of this project given a required return of 14.1 percent? A) $67,577 B) $62,621 C) $56,680 D) $59,177 E) $97,636

63) Prasla Auto Detailing is evaluating a project with a life of 6 years that will produce annual

operating cash flows of $134,000. During the life of the project, inventory will be increase by $7,000, accounts receivable will increase by $11,000, and accounts payable will increase by $3,600. The project requires the purchase of equipment at an initial cost of $298,000 that will be depreciated straight-line to a zero book value over the life of the project. Ignore bonus depreciation. The equipment will be salvaged at the end of the project creating an aftertax cash inflow of $37,000. At the end of the project, net working capital will return to its normal level. What is the net present value of this project given a required return of 15.3 percent? A) $211,179 B) $208,391 C) $251,243 D) $212,527 E) $215,591

64) A project will produce an operating cash flow of $7,300 per year for three years. The initial

investment for fixed assets will be $11,600, which will be depreciated straight-line to zero over the asset's 4-year life. Ignore bonus depreciation. The project will require an initial $500 in net working capital plus an additional $500 every year with all net working capital levels restored to their original levels when the project ends. The fixed assets can be sold for an estimated $2,500 at the end of the project, the combined tax rate is 23 percent, and the required rate of return is 12 percent. What is the net present value of the project? A) $7,500.95 B) $9,896.87 C) $7,072.72 D) $6,353.41 E) $8,398.29

65) Assume a proposed project under consideration by the James River Company requires

$28,900 in fixed assets. The firm plans to ignore bonus depreciation and instead apply straight-line depreciation to zero over the asset’s 6-year life. An aftertax salvage value of $5,400 is expected. The project will produce an annual operating cash flow of $7,300 and will require net working capital of $500 initially plus an additional $500 in Year 3. Net working capital will be restored to its original level when the project ends at the end of Year 6. The tax rate is 21 percent and the required rate of return is 14 percent. What is the net present value of this project? A) $1,565.54 B) $1,196.87 C) $1,072.72 D) $1,337.75 E) $1,398.29

66) Loop Enterprises is considering a new project that will require $325,000 for fixed assets,

$160,000 for inventory, and $35,000 for accounts receivable. Short-term debt is expected to increase by $100,000. The project has a life of 5 years. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. Ignore bonus depreciation. At the end of the project, the fixed assets can be sold for 25 percent of their original cost and the net working capital will return to its original level. The project is expected to generate annual sales of $554,000 with costs of $430,000. The tax rate is 21 percent and the required rate of return is 15 percent. What is the net present value of this project? A) $32,026.45 B) $33,278.35 C) $34,138.25 D) $32,318.29 E) $36,202.48

67) Capable Systems is considering a project with a life of 4 years that will require $164,800 for

fixed assets and $42,400 for net working capital. The fixed assets will be depreciated using the Year 2018 bonus depreciation method. At the end of the project, the fixed assets can be sold for $37,500 cash and the net working capital will return to its original level. The project is expected to generate annual sales of $195,000 and costs of $117,500. The tax rate is 24 percent and the required rate of return is 13 percent. What is the project's net present value? A) $48,909.09 B) $46,482.43 C) $42,316.67 D) $56,500.00 E) $59,488.87

68) Reed Music is considering a project with a life of 3 years that will require $289,400 for fixed

assets, $36,700 for inventory, and $27,800 for accounts receivable. Short-term debt is expected to increase by $16,500. The fixed assets will be depreciated straight-line to a zero book value over 5 years. Ignore bonus depreciation. At the end of the project, the fixed assets can be sold for 20 percent of their original cost and the net working capital will return to its original level. The project is expected to generate annual sales of $275,000 and costs of $198,000. The tax rate is 21 percent and the required rate of return is 16 percent. What is the amount of the cash flow in the project’s final year? A) $208,433.33 B) $197,908.18 C) $191,019.60 D) $160,087.09 E) $181,250.24

69) Freely Travel is considering a project with a life of 5 years that will require the purchase of

$1.4 million in new 5-year MACRS equipment. The MACRS rates are 20 percent, 32 percent, 19.2 percent, 11.52 percent, 11.52 percent, and 5.76 percent for Years 1 to 6, respectively. Ignore bonus depreciation. The firm desires a minimum 14 percent rate of return and the tax rate is 22 percent. The equipment can be sold at the end of the project for an estimated $225,000. What is the amount of the aftertax salvage value? A) $187,600.00 B) $162,418.54 C) $195,322.15 D) $184,238.97 E) $193,240.80

70) Schroeder Electronics is considering a project which will require the purchase of $5.68

million in new equipment that will be depreciated straight-line to a zero book value over the 5-year life of the project. Ignore bonus depreciation. The firm requires a rate of return of 12 percent and the tax rate is 21 percent. What is the value of the depreciation tax shield in Year 5 of the project? A) $225,608 B) $228,406 C) $334,800 D) $238,560 E) $0

71) Woodard Pools is evaluating a project which will increase annual sales by $50,000 and costs

by $30,000. The project has an initial asset cost of $150,000 that will be depreciated straightline to a zero book value over the 10-year life of the project. Ignore bonus depreciation. The applicable tax rate is 25 percent. What is the annual operating cash flow for this project? A) $19,250 B) $15,500 C) $21,350 D) $17,900 E) $18,750

72) Velasco Land Company is considering a project which will require the purchase of $1.4

million in new 5-Year MACRS equipment. The MACRS rates are 20 percent, 32 percent, 19.2 percent, 11.52 percent, 11.52 percent, and 5.76 percent for Years 1 to 6, respectively. Ignore bonus depreciation. The firm desires a minimal 14 percent rate of return and has a combined tax rate of 25 percent. What is the value of the depreciation tax shield in Year 2 of the project? A) $107,500 B) $90,400 C) $89,600 D) $123,416 E) $112,000

73) Ventana Windows is looking at a project that will require $80,000 in fixed assets and another

$20,000 in net working capital. The project is expected to produce annual sales of $110,000 with associated costs of $70,000. The project has a life of 4 years. The company ignores bonus depreciation and instead uses straight-line depreciation to a zero book value over the life of the project. The tax rate is 21 percent. What is the annual operating cash flow for this project? A) $31,600 B) $43,200 C) $27,000 D) $35,800 E) $40,000

74) For the current year, Skate and Snow has sales of $760,000 and a profit margin of 5 percent.

The annual depreciation expense is $80,000. What is the amount of the annual operating cash flow if the company has no long-term debt? A) $34,000 B) $86,400 C) $118,000 D) $120,400 E) $123,900

75) Windows by Addie has annual sales of $760,000 and a profit margin of 8 percent. The annual

depreciation expense is $50,000. What is the amount of the annual operating cash flow if the company has no long-term debt? A) $50,000 B) $60,800 C) $110,800 D) $810,000 E) $930,000

76) For this year, Katrina’s Kennels has sales of $439,000, depreciation of $32,000, and net

working capital of $56,000. The firm has a tax rate of 23 percent and a profit margin of 6 percent. The firm has no interest expense. What is the amount of the operating cash flow? A) $49,384 B) $52,616 C) $54,980 D) $58,340 E) $114,340

77) For next year, Prakash Partners has projected sales of $375,000, costs of $146,000,

depreciation of $17,600, interest expense of $2,090, and taxes of $48,141. What is the amount of the projected operating cash flow? A) $180,859 B) $163,259 C) $178,769 D) $180,378 E) $176,811

78) For this year, Wilbert’s Cakes has costs of $187,400, depreciation of $32,700, interest

expense of $14,800, dividends paid of $5,600, taxes of $17,600, and an operating cash flow of $101,900. What is the sales amount? A) $264,200 B) $269,800 C) $306,900 D) $322,100 E) $324,200

79) Welcome Inn is considering a project that will produce sales of $16,000, increase cash

expenses by $10,000, increase taxes by $950, and increase depreciation by $1,500 for each year of the project’s 9-year life. What is the amount of the annual operating cash flow using the top-down approach? A) $3,550 B) $5,050 C) $6,100 D) $7,550 E) $4,550

80) Klain Running is considering a project that will not produce any sales but will decrease

annual cash expenses by $12,000. If the project is implemented, annual taxes will increase from $23,000 to $25,205, and depreciation will increase from $4,000 to $5,500 per year. What is the amount of the annual operating cash flow using the top-down approach? A) $5,025 B) $9,795 C) $5,500 D) $12,000 E) $14,205

81) Wilson Feeds is considering a project with a life of one year that will produce sales of $6,000

and increase cash expenses by $2,500. If the project is implemented, taxes will increase by $700. The additional depreciation expense will be $200 and interest expense will increase by $100. An initial cash outlay of $200 is required for net working capital. What is the amount of the operating cash flow using the top-down approach? A) $2,200 B) $1,500 C) $2,800 D) $3,500 E) $4,200

82) A project will increase annual sales by $60,000 and annual cash expenses by $51,000. The

project will cost $40,000 and will be depreciated using straight-line depreciation to a zero book value over the 4-year life of the project. Ignore bonus depreciation. The company has a marginal tax rate of 23 percent. What is the annual operating cash flow using the tax shield approach? A) $5,850 B) $8,650 C) $9,230 D) $9,770 E) $10,350

83) A new project with a life of four years will increase sales by $140,000 and cash expenses by

$95,000 annually. The project will cost $100,000 and will be depreciated using the bonus depreciation method. The company has a marginal tax rate of 21 percent. What is the value of the depreciation tax shield in Year 2? A) $0 B) $5,250 C) $2,625 D) $3,375 E) $6,500

84) Matty’s Place is considering the installation of a new computer system that will cut annual

operating costs by $12,000. The system will cost $42,000 to purchase and install. This system is expected to have a life of 5 years and will be depreciated to zero using straight-line depreciation. Ignore bonus depreciation. What is the amount of the earnings before interest and taxes for each year of this project if the tax rate is 21 percent? A) −$20,400 B) $5,400 C) $3,600 D) $12,000 E) $8,400

85) Patel & Reed is considering replacing the equipment it uses. The equipment would cost $1.4

million and lower manufacturing costs by an estimated $215,000 per year. The equipment will be depreciated over 8 years using straight-line depreciation to a book value of zero. Ignore bonus depreciation. The required rate of return is 13 percent and the tax rate is 21 percent. The equipment will be worthless after 8 years. What is the annual operating cash flow from this proposed project? A) $141,900 B) $206,600 C) $232,400 D) $160,000 E) $40,000

86) The initial cost of one customized machine is $25,000 with an annual operating cost of

$5,000, and a life of 6 years. The machine will be worthless and replaced at the end of its life. What is the equivalent annual cost of this machine if the required rate of return is 12 percent and we ignore taxes? A) $4,443 B) $11,081 C) $7,593 D) $6,081 E) $9,167

87) Jackson Products uses packing machines to prepare its products for shipping. One machine

costs $397,500 and lasts 5 years before it needs replaced. The machine will be worthless after the 5 years. The annual aftertax operating cost per machine is $38,400. What is the equivalent annual cost of one machine if the required rate of return is 16 percent? A) $148,556.67 B) $159,800.23 C) $156,004.12 D) $143,006.15 E) $154,224.08

88) Starboard is analyzing two machines to determine which one it should purchase. The

company requires a rate of return of 14.6 percent and uses straight-line depreciation to a zero book value over a machine’s life. Ignore bonus depreciation and taxes. Machine A has a cost of $318,000, annual operating costs of $8,700, and a life of 3 years. Machine B costs $247,000, has annual operating costs of $9,300, and a life of 2 years. Whichever machine is purchased will be replaced at the end of its useful life. Which machine should Starboard purchase and why? A) Machine A; because it will save the company about $13,406 per year B) Machine A; because it will save the company about $18,100 per year C) Machine B; because it will save the company about $16,510 per year D) Machine B; because it will save the company about $11,609 per year E) Machine A; because it costs $154,224.08

89) Water Resources is considering a new project that will require $118,000 of fixed assets and

net working capital of $16,000. The fixed assets will be depreciated on a straight-line basis to a zero salvage value over three years. Ignore bonus depreciation. This project is expected to produce an operating cash flow of $45,000 the first year with that amount decreasing by 5 percent annually for two years before the project is shut down. The fixed assets can be sold for $55,000 at the end of the project and all net working capital will be recovered. What is the net present value of this project at a discount rate of 11.5 percent and a tax rate of 23 percent? A) $3,209.17 B) $15,311.09 C) $12,136.54 D) −$3,770.30 E) −$5,456.32

90) You are working on a bid for a contract. Thus far, you have determined that you will need

$156,000 for fixed assets and another $32,000 for net working capital at Time 0. You have also determined that you can recover $68,400 aftertax for the combined fixed assets and net working capital at the end of the 4-year project. What operating cash flow will be required each year for the project to return 16 percent in nominal terms? A) $46,666.67 B) $48,929.74 C) $55,200.16 D) $53,686.06 E) $50,725.50

91) You plan to bid on a project with a life of 5 years that will require $68,000 of fixed assets.

These assets will be depreciated straight-line to zero over the project’s life. Ignore bonus depreciation. The relevant discount rate is 12.5 percent, the tax rate is 21 percent, there is no interest expense, net working capital is unaffected, and there is no salvage value. What is the minimal required amount of annual sales revenue given annual cash costs of $47,900? A) $74,515.75 B) $82,018.27 C) $57,202.19 D) $68,459.58 E) $52,311.89

92) Eduardo is working on a bid for a contract. Thus far, he has determined that he will need

$218,000 for fixed assets and another $41,000 for net working capital at Time 0. He has also determined that he can recover $79,900 after tax for the combined fixed assets and net working capital at the end of the 3-year project. What operating cash flow will be required each year for the project to return 14 percent in nominal terms? A) $116,079.42 B) $97,487.79 C) $110,220.48 D) $88,330.01 E) $113,360.69

93) In working on a bid project, you have determined that $318,000 of fixed assets are required.

These assets will be depreciated straight-line to zero over the 6-year life of the project. Ignore bonus depreciation. The discount rate is 18 percent, the tax rate is 21 percent, and there is no interest expense. In addition, the annual cash costs will be $198,200. After considering all the project’s other cash flows, you have determined that the required operating cash flow is $92,400. What is the required amount of annual sales revenue? A) $299,811.17 B) $302,006.64 C) $284,849.92 D) $301,073.42 E) $279,407.72

94) Table Equity invested in a project that returned 14.83 percent during a period when inflation

averaged 2.69 percent. What real rate of return did the firm earn on its project? A) 12.41% B) 11.03% C) 12.99% D) 11.82% E) 11.29%

95) Mickles Real Estate earns 10.25 percent on its current investments after adjusting for

inflation. Inflation is expected to average 2.8 percent annually over the next 5 years. What discount rate should the firm assign to a project assuming the project has a life of 5 years and the same level of risk as the firm’s current operations? A) 12.96% B) 13.05% C) 13.14% D) 13.34% E) 12.87%

96) Duong Corporation has a new project with projected real cash flows of $12,200, $14,600,

and $16,300 for Years 1 to 3, respectively. The nominal discount rate is 15.96 percent and the inflation rate is 4 percent. What is the net present value of the project if the initial cost is $25,000? A) $9,711.64 B) $8,946.48 C) $9,508.70 D) $9,444.15 E) $9,248.74

97) Should financing costs be included as an incremental cash flow in capital budgeting analysis?

98) Explain the underlying assumptions that are being made when a project's total investment in

net working capital is recouped when the project ends.

99) This chapter introduced three new methods for calculating project operating cash flow

(OCF). Under what circumstances is each method appropriate?

100)

When is it appropriate to use the equivalent annual cost (EAC) methodology, and how do you make a decision using it?

101)

Explain the use of real and nominal discount rates in discounting cash flows. Which is used more often and why?

Answer Key Test name: Chapter 6(1) 1) A 2) C 3) D 4) E 5) B 6) C 7) D 8) B 9) A 10) D 11) C 12) C 13) A 14) C 15) D 16) D 17) A 18) E 19) D 20) C 21) E 22) B 23) D 24) A 25) C 26) E 27) B 28) A 29) D 30) C 31) C 32) E 33) C 34) B 35) E 36) A 37) D

38) B 39) D 40) E 41) D 42) A 43) C 44) D 45) B 46) D 47) A 48) E 49) B 50) D 51) E 52) B 53) C 54) D 55) B 56) C 57) B 58) A 59) D 60) B 61) B 62) B 63) D 64) A 65) A 66) B 67) B 68) C 69) E 70) D 71) E 72) E 73) D 74) C 75) C 76) D 77) A

78) C 79) B 80) B 81) C 82) C 83) A 84) C 85) B 86) B 87) B 88) A 89) C 90) D 91) D 92) D 93) D 94) D 95) D 96) D 97) Essay 98) Essay 99) Essay 100) Essay 101) Essay

Student name: 1) Shelton Company purchased a parcel of land six years ago for $876,500. At that time, the

firm invested $148,000 in grading the site so that it would be usable. Since the firm wasn't ready to use the site itself at that time, it decided to lease the land for $55,500 a year. The company is now considering building a warehouse on the site as the rental lease is expiring. The current value of the land is $928,000. What value should be included in the initial cost of the warehouse project for the use of this land? A) $1,076,000 B) $928,000 C) $876,500 D) $0 E) $1,024,500

2) You own a house that you rent for $1,425 per month. The maintenance expenses on the

house average $265 per month. The house cost $232,000 when you purchased it 4 years ago. A recent appraisal on the house valued it at $254,000. If you sell the house you will incur $20,320 in real estate fees. The annual property taxes are $3,150. You are deciding whether to sell the house or convert it for your own use as a professional office. What value should you place on this house when analyzing the option of using it as a professional office? A) $254,000 B) $233,680 C) $228,840 D) $0 E) $232,000

3) Bubbly Waters currently sells 420 Class A spas, 570 Class C spas, and 320 deluxe model

spas each year. The firm is considering adding a mid-class spa and expects that if it does, it can sell 495 units per year. However, if the new spa is added, Class A sales are expected to decline to 285 units while the Class C sales are expected to increase to 595. The sales of the deluxe model will not be affected. Class A spas sell for an average of $14,300 each. Class C spas are priced at $7,200 and the deluxe models sell for $18,200 each. The new mid-range spa will sell for $9,200. What annual sales figure should you use in your analysis? A) $1,750,500 B) $6,304,500 C) $6,664,500 D) $4,554,000 E) $2,803,500

4) McCanless Company recently purchased an asset for $2,150,000 that will be used in a 3-year

project. The asset is in the 3-year MACRS class. The depreciation percentage each year is 33.33 percent, 44.45 percent, 14.81 percent, and 7.41 percent, respectively. What is the amount of depreciation in Year 2? A) $159,315 B) $716,667 C) $955,675 D) $318,415 E) $716,595

5) A company purchased an asset for $2,950,000 that will be used in a 3-year project. The asset

is in the 3-year MACRS class. The depreciation percentage each year is 33.33 percent, 44.45 percent, and 14.81 percent, respectively. What is the book value of the equipment at the end of the project? A) $218,595 B) $0 C) $655,490 D) $1,966,765 E) $2,731,405

6) A company is evaluating a new 4-year project. The equipment necessary for the project will

cost $3,200,000 and can be sold for $685,000 at the end of the project. The asset is in the 5year MACRS class. The depreciation percentage each year is 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, and 11.52 percent, respectively. The company's tax rate is 34 percent. What is the aftertax salvage value of the equipment? A) $729,894 B) $452,100 C) $640,106 D) $685,000 E) $514,769

7) Brummitt Corporation, is evaluating a new 4-year project. The equipment necessary for the

project will cost $3,050,000 and can be sold for $323,000 at the end of the project. The asset is in the 5-year MACRS class. The depreciation percentage each year is 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, and 11.52 percent, respectively. The company's tax rate is 35 percent. What is the aftertax salvage value of the equipment? A) $394,414 B) $251,586 C) $323,000 D) $209,950 E) $271,438

8) Power Manufacturing has equipment that it purchased 4 years ago for $2,600,000. The

equipment was used for a project that was intended to last for 6 years and was being depreciated over the life of the project. However, due to low demand, the project is being shut down. The equipment was depreciated using the straight-line method and can be sold for $410,000 today. The company's tax rate is 34 percent. What is the aftertax salvage value of the equipment? A) $487,633 B) $565,267 C) $549,400 D) $410,000 E) $254,733

9) A project is expected to generate annual revenues of $132,900, with variable costs of

$80,500, and fixed costs of $21,000. The annual depreciation is $4,800 and the tax rate is 40 percent. What is the annual operating cash flow? A) $54,320 B) $20,760 C) $75,320 D) $36,200 E) $31,400

10) Bennett Company has a potential new project that is expected to generate annual revenues of

$256,700, with variable costs of $141,600, and fixed costs of $59,500. To finance the new project, the company will need to issue new debt that will have an annual interest expense of $21,500. The annual depreciation is $24,000 and the tax rate is 34 percent. What is the annual operating cash flow? A) $79,600 B) $174,612 C) $44,856 D) $42,260 E) $123,260

11) Bi-Lo Traders is considering a project that will produce sales of $41,350 and have costs of

$23,900. Taxes will be $4,200 and the depreciation expense will be $2,425. An initial cash outlay of $1,950 is required for net working capital. What is the project's operating cash flow? A) $15,675 B) $10,825 C) $8,875 D) $13,250 E) $11,300

12) You have calculated the pro forma net income for a new project to be $46,410. The

incremental taxes are $23,380 and incremental depreciation is $17,440. What is the operating cash flow? A) $69,790 B) $63,850 C) $46,410 D) $28,970 E) $87,230

13) Rock Haven has a proposed project that will generate sales of 1,830 units annually at a

selling price of $30 each. The fixed costs are $16,900 and the variable costs per unit are $9.15. The project requires $32,800 of fixed assets that will be depreciated on a straight-line basis to a zero book value over the 4-year life of the project. The salvage value of the fixed assets is $8,500 and the tax rate is 40 percent. What is the operating cash flow? A) $16,033 B) $19,969 C) $25,873 D) $9,473 E) $11,782

14) A gym owner is considering opening a location on the other side of town. The new facility

will cost $1.46 million and will be depreciated on a straight-line basis over a 20-year period. The new gym is expected to generate $557,000 in annual sales. Variable costs are 50 percent of sales, the annual fixed costs are $90,100, and the tax rate is 40 percent. What is the operating cash flow? A) $309,340 B) $142,240 C) $217,600 D) $186,040 E) $104,560

15) A cost-cutting project will decrease costs by $64,100 a year. The annual depreciation will be

$14,250 and the tax rate is 34 percent. What is the operating cash flow for this project? A) $47,151 B) $16,949 C) $37,461 D) $26,639 E) $42,306

16) The Lumber Yard is considering adding a new product line that is expected to increase

annual sales by $322,000 and expenses by $220,000. The project will require $129,000 in fixed assets that will be depreciated using the straight-line method to a zero book value over the 7-year life of the project. The company has a marginal tax rate of 34 percent. What is the depreciation tax shield? A) $6,266 B) $15,640 C) $12,467 D) $14,190 E) $34,680

17) Seeing Red has a new project that will require fixed assets of $895,000, which will be

depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, and 11.52 percent, respectively. The company has a tax rate of 35 percent. What is the depreciation tax shield for Year 3? A) $52,208 B) $62,650 C) $100,240 D) $36,086 E) $60,144

18) Pear Orchards is evaluating a new project that will require equipment of $241,000. The

equipment will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, and 11.52 percent, respectively. The company plans to shut down the project after 4 years. At that time, the equipment could be sold for $61,900. However, the company plans to keep the equipment for a different project in another state. The tax rate is 35 percent. What aftertax salvage value should the company use when evaluating the current project? A) $0 B) $61,900 C) $41,645 D) $68,989 E) $54,811

19) A 4-year project has an annual operating cash flow of $58,500. At the beginning of the

project, $4,950 in net working capital was required, which will be recovered at the end of the project. The firm also spent $23,800 on equipment to start the project. This equipment will have a book value of $5,220 at the end of the project, but can be sold for $6,090. The tax rate is 40 percent. What is the Year 4 cash flow? A) $69,192 B) $59,292 C) $25,697 D) $69,888 E) $67,104

20) Burke's Corner currently sells blue jeans and T-shirts. Management is considering adding

fleece tops to its inventory to provide a cooler weather option. The tops would sell for $50 each with expected sales of 4,450 tops annually. By adding the fleece tops, management feels the firm will sell an additional 300 pairs of jeans at $62 a pair and 435 fewer T-shirts at $23 each. The variable cost per unit is $33 on the jeans, $13 on the T-shirts, and $28 on the fleece tops. With the new item, the depreciation expense is $30,000 a year and the fixed costs are $77,500 annually. The tax rate is 35 percent. What is the project's operating cash flow? A) $15,278 B) $19,163 C) $20,933 D) $26,588 E) $32,243

21) Go Fly A Kite is considering making and selling custom kites in two sizes. The small kites

would be priced at $10.90 and the large kites would be $23.90. The variable cost per unit is $5.25 and $11.50, respectively. Jill, the owner, feels that she can sell 2,800 of the small kites and 1,760 of the large kites each year. The fixed costs would be $2,120 a year and the depreciation expense is $1,100. The tax rate is 35 percent. What is the annual operating cash flow? A) $12,818 B) $25,848 C) $23,091 D) $23,476 E) $24,854

22) A project will reduce costs by $42,400 but increase depreciation by $20,900. What is the

operating cash flow if the tax rate is 40 percent? A) $29,500 B) $33,800 C) $25,320 D) $37,980 E) $25,440

23) A project has annual depreciation of $22,300, costs of $97,100, and sales of $142,500. The

applicable tax rate is 35 percent. What is the operating cash flow? A) $44,005 B) $29,510 C) $37,315 D) $100,430 E) $23,695

24) King Nothing is evaluating a new 6-year project that will have annual sales of $455,000 and

costs of $311,000. The project will require fixed assets of $555,000, which will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, 11.52 percent, and 5.76 percent, respectively. The company has a tax rate of 35 percent. What is the operating cash flow for Year 3? A) $87,696 B) $130,896 C) $125,975 D) $115,978 E) $162,864

25) A company is considering a new 6-year project that will have annual sales of $192,000 and

costs of $118,000. The project will require fixed assets of $237,000, which will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, 11.52 percent, and 5.76 percent, respectively. The company has a tax rate of 35 percent. What is the operating cash flow for Year 2? A) $74,644 B) $61,925 C) $57,656 D) $52,444 E) $64,026

26) Bad Company has a new 4-year project that will have annual sales of 7,900 units. The price

per unit is $19.40 and the variable cost per unit is $7.15. The project will require fixed assets of $89,000, which will be depreciated on a 3-year MACRS schedule. The annual depreciation percentages are 33.33 percent, 44.45 percent, 14.81 percent, and 7.41 percent, respectively. Fixed costs are $29,000 per year and the tax rate is 35 percent. What is the operating cash flow for Year 3? A) $55,035 B) $28,335 C) $48,667 D) $51,841 E) $67,517

27) A project with a life of 8 years is expected to provide annual sales of $480,000 and costs of

$349,000. The project will require an investment in equipment of $820,000, which will be depreciated on a straight-line method over the life of the project. You feel that both sales and costs are accurate to +/-15 percent. The tax rate is 40 percent. What is the annual operating cash flow for the best-case scenario? A) $194,210 B) $44,990 C) $143,140 D) $168,675 E) $153,210

28) A 7-year project is expected to provide annual sales of $201,000 with costs of $95,000. The

equipment necessary for the project will cost $335,000 and will be depreciated on a straightline method over the life of the project. You feel that both sales and costs are accurate to +/10 percent. The tax rate is 40 percent. What is the annual operating cash flow for the worstcase scenario? A) $49,703 B) $45,840 C) $73,383 D) $64,983 E) $100,503

29) A 7-year project is expected to generate annual sales of 10,200 units at a price of $89 per unit

and a variable cost of $60 per unit. The equipment necessary for the project will cost $421,000 and will be depreciated on a straight-line basis over the life of the project. Fixed costs are $255,000 per year and the tax rate is 35 percent. How sensitive is the operating cash flow to a $1 change in the per unit sales price? A) $5,431 B) $6,630 C) $5,967 D) $5,163 E) $4,895

30) Sun Brite has a new pair of sunglasses it is evaluating. The company expects to sell 7,400

pairs of sunglasses at a price of $169 each and a variable cost of $121 each. The equipment necessary for the project will cost $385,000 and will be depreciated on a straight-line basis over the 7-year life of the project. Fixed costs are $350,000 per year and the tax rate is 35 percent. How sensitive is the operating cash flow to a $1 increase in variable costs per pairs of sunglasses? A) $4,810 B) −$4,810 C) −$4,329 D) $4,329 E) −$5,344

31) Bruno's Lunch Counter is expanding and expects operating cash flows of $24,900 a year for

4 years as a result. This expansion requires $55,000 in new fixed assets. These assets will be worthless at the end of the project. In addition, the project requires $3,200 of net working capital throughout the life of the project. What is the net present value of this expansion project at a required rate of return of 10 percent? A) $23,930 B) $27,775 C) $22,915 D) $25,924 E) $29,319

32) Jasper Metals is considering installing a new molding machine which is expected to produce

operating cash flows of $62,000 per year for 7 years. At the beginning of the project, inventory will decrease by $21,600, accounts receivables will increase by $23,800, and accounts payable will increase by $17,100. At the end of the project, net working capital will return to the level it was prior to undertaking the new project. The initial cost of the molding machine is $270,000. The equipment will be depreciated straight-line to a zero book value over the life of the project. The equipment will be salvaged at the end of the project creating an aftertax cash flow of $62,000. What is the net present value of this project given a required return of 10.7 percent? A) $75,147 B) $63,030 C) $60,289 D) $63,424 E) $71,736

33) Gateway Communications is considering a project with an initial fixed assets cost of $1.63

million that will be depreciated straight-line to a zero book value over the 10-year life of the project. At the end of the project the equipment will be sold for an estimated $233,000. The project will not change sales but will reduce operating costs by $384,000 per year. The tax rate is 40 percent and the required return is 10.8 percent. The project will require $48,500 in net working capital, which will be recouped when the project ends. What is the project's NPV? A) $138,291 B) $175,685 C) $144,577 D) $188,803 E) $182,712

34) Cori's Dog House is considering the installation of a new computerized pressure cooker for

hot dogs. The cooker will increase sales by $8,500 per year and will cut annual operating costs by $12,800. The system will cost $44,700 to purchase and install. This system is expected to have a 4-year life and will be depreciated to zero using straight-line depreciation and have no salvage value. The tax rate is 34 percent and the required return is 10.3 percent. What is the NPV of purchasing the pressure cooker? A) −$23,796 B) $22,802 C) −$9,926 D) $11,540 E) $1,336

35) The Bruin's Den Outdoor Gear is considering a new 6-year project to produce a new tent line.

The equipment necessary would cost $1.23 million and be depreciated using straight-line depreciation to a book value of zero. At the end of the project, the equipment can be sold for 10 percent of its initial cost. The company believes that it can sell 22,000 tents per year at a price of $61 and variable costs of $22 per tent. The fixed costs will be $365,000 per year. The project will require an initial investment in net working capital of $181,000 that will be recovered at the end of the project. The required rate of return is 10.4 percent and the tax rate is 35 percent. What is the NPV? A) $421,421 B) $502,453 C) $849,993 D) $585,723 E) $367,374

36) Lakeside Winery is considering expanding its winemaking operations. The expansion will

require new equipment costing $693,000 that would be depreciated on a straight-line basis to zero over the 5-year life of the project. The equipment will have a market value of $190,000 at the end of the project. The project requires $60,000 initially for net working capital, which will be recovered at the end of the project. The operating cash flow will be $164,500 a year. What is the net present value of this project if the relevant discount rate is 10 percent and the tax rate is 35 percent? A) –$16,508 B) −$13,929 C) −$18,343 D) −$15,477 E) −$19,753

37) Cirice Corporation is considering opening a branch in another state. The operating cash flow

will be $147,600 a year. The project will require new equipment costing $547,000 that would be depreciated on a straight-line basis to zero over the 6-year life of the project. The equipment will have a market value of $147,000 at the end of the project. The project requires an initial investment of $33,500 in net working capital, which will be recovered at the end of the project. The tax rate is 40 percent. What is the project's IRR? A) 16.80% B) 15.97% C) 18.17% D) 18.13% E) 14.53%

38) Outdoor Sports is considering adding a putt putt golf course to its facility. The course would

cost $175,000, would be depreciated on a straight-line basis over its 5-year life, and would have a zero salvage value. The sales would be $88,000 a year, with variable costs of $27,800 and fixed costs of $12,400. In addition, the firm anticipates an additional $18,500 in revenue from its existing facilities if the putt putt course is added. The project will require $3,000 of net working capital, which is recoverable at the end of the project. What is the net present value of this project at a discount rate of 10 percent and a tax rate of 35 percent? A) $33,664 B) $36,664 C) $34,801 D) $73,467 E) $11,920

39) Delia Landscaping is considering a new 4-year project. The necessary fixed assets will cost

$203,000 and be depreciated on a 3-year MACRS and have no salvage value. The MACRS percentages each year are 33.33 percent, 44.45 percent, 14.81 percent, and 7.41 percent, respectively. The project will have annual sales of $140,000, variable costs of $37,900, and fixed costs of $13,050. The project will also require net working capital of $3,650 that will be returned at the end of the project. The company has a tax rate of 40 percent and the project's required return is 11 percent. What is the net present value of this project? A) $29,198 B) $22,456 C) $27,951 D) $24,498 E) $26,225

Answer Key Test name: Chapter 6(2) 1) B 2) B 3) E 4) C 5) A 6) C 7) A 8) B 9) B 10) C 11) D 12) B 13) A 14) B 15) A 16) A 17) E 18) E 19) A 20) D 21) D 22) B 23) C 24) B 25) A 26) C 27) A 28) D 29) B 30) B 31) C 32) B 33) C 34) D 35) A 36) D 37) A

38) A 39) C

Chapter 7: 1) A

analysis evaluates the impact on net present value when only one input variable

is changed. A) forecasting B) scenario C) sensitivity D) simulation E) break-even

2) A

analysis evaluates the relationship between sales volume and accounting

profitability. A) forecasting B) scenario C) sensitivity D) simulation E) break-even

3) Variable costs: A) change in direct relationship to the quantity of output produced. B) are constant in the short-run regardless of the quantity of output produced. C) are equal to the change in the fixed assets required to change the level of output. D) are subtracted from fixed costs to compute the contribution margin. E) are added to fixed costs on a per-unit basis to compute the contribution margin.

4) Fixed costs: A) change as the quantity of output produced changes. B) are constant over the short-run regardless of the quantity of output produced. C) reflect the change in a variable when one more unit of output is produced. D) are subtracted from sales to compute the contribution margin. E) can be ignored in scenario analysis since they are constant over the life of a project.

5) At the break-even point, a project’s net income equals exactly zero. A) operational B) leveraged C) accounting D) cash E) financial

6) At the break-even point, a project’s net present value equals exactly zero. A) operational B) leveraged C) accounting D) cash E) financial

7) Conducting scenario analysis helps managers see the: A) impact of an individual variable on the outcome of a project. B) expected range of outcomes from a proposed project. C) maximum range of outcomes that can occur over the course of a proposed project. D) various decision points of a specific project. E) consequences of changing a firm’s market share for a specific product.

8) Sensitivity analysis is primarily designed to determine the: A) range of possible outcomes given the expected ranges for every variable. B) degree to which the net present value reacts to changes in a single variable. C) net present value given the best and the worst possible expected situations. D) degree to which a project relies on financial leverage. E) best mix of fixed and variable costs for each project.

9) As the degree of sensitivity of a project to a single variable rises, the: A) lower the forecasting risk of the project. B) smaller the range of possible outcomes given a pre-defined range of values for the

input. C) more attention management should place on accurately forecasting that variable. D) lower the maximum potential value of the project. E) lower the maximum potential loss of the project.

10) Sensitivity analysis is conducted by: A) holding all variables at their base level and changing the required rate of return. B) changing the value of two variables to determine their interdependency. C) changing the value of a single variable and computing the resulting change in the

project’s NPV. D) assigning either the best or the worst possible value to every variable and comparing the results to the base case. E) reviewing a project after implementation to determine how the actual results are comparing to the predicted results.

11) Conducting

analysis will shed light on whether the inaccuracy of the variable cost estimate for a project will have a significant effect on the project’s net present value. A) leverage B) scenario C) break-even D) sensitivity E) cash flow

12) Of the following choices, which one is most likely a variable cost? A) Office rent B) Property taxes C) Property insurance D) Machinist wages E) Management salaries

13) Which one of the following statements is correct? A) At the accounting break-even level, the pretax profit is equal to the aftertax profit. B) The contribution margin is equal to sales minus fixed costs. C) Taxes are considered when computing the accounting break-even point but not the

financial break-even point. D) The larger the contribution margin, the higher the financial break-even point. E) The accounting break-even point is higher than the financial break-even point for the same project.

14) All else constant, as a project’s variable cost per unit increases, the: A) contribution margin decreases. B) sensitivity to fixed costs decreases. C) project's net present value increases. D) accounting break-even point decreases. E) net profit increases.

15) The accounting profit break-even point is unaffected by a firm’s: A) contribution margin. B) depreciation method. C) tax rate. D) fixed costs. E) variable cost per unit.

16) All else equal, the contribution margin must increase as: A) both the sales price and variable cost per unit increase. B) the fixed cost per unit declines. C) the variable cost per unit declines. D) sales price per unit declines. E) the sales price minus the fixed cost per unit increases.

17) Which one of the following statements is correct? A) An increase in the initial fixed assets required by a project will increase the

accounting profit break-even point. B) If a firm needs to lower a project’s break-even points, it should lower the project’s revenue estimate. C) The NPV is zero at the accounting break-even point. D) An increase in the tax rate will increase the accounting break-even point. E) Depreciating project assets more rapidly will decrease the accounting break-even point.

18) A false sense of security can overcome a decision-maker when the net present value method

is applied properly but the positive NPV results are accepted without question. Sensitivity and scenario analysis aid in the process by: A) providing assurance that the most appropriate discount rate is being applied. B) ensuring all estimated values are accurate. C) ensuring the NPV value was calculated correctly. D) providing information on a number of potential outcomes. E) guaranteeing the NPV will be achieved.

19) Sensitivity analysis: A) provides the tradeoff between fixed and variable costs. B) provides an estimate of the most profitable situation that is reasonably expected. C) can be conducted on any input value used in the computation of a project’s NPV. D) cannot evaluate a change in NPV related to a project’s initial investment. E) should never be conducted if the base-case scenario results in a negative NPV.

20) Sensitivity analysis: A) is more difficult to conduct than simulation analysis. B) provides its user with the rate of return that corresponds to the project’s IRR. C) is affected primarily by the interrelationships between project variables. D) indicates which variable(s) need(s) to be most closely monitored. E) provides limited information and therefore is rarely used in practice.

21) Fixed costs of production are: A) directly related to labor costs. B) measured as costs per unit of time. C) ignored in project analysis. D) dependent on the amount of goods or services produced. E) irrelevant when conducting sensitivity analysis.

22) The contribution margin: A) is dependent upon achieving a minimal level of output. B) increases as the level of output decreases. C) decreases as the level of output decreases. D) has a major effect on the financial break-even point. E) changes indirectly to a firm’s tax rate changes.

23) In the financial value break-even method, the EAC is used to: A) determine the salvage value of the initial fixed asset investment. B) allocate depreciation over the life of the project. C) allocate the initial investment at its opportunity cost over the life of the project. D) determine the contribution margin to fixed costs ratio. E) allocate the opportunity and erosion costs over the life of the project.

24) The financial break-even method is superior to the accounting break-even method because

the financial break-even method: A) is more complicated to calculate. B) includes the economic opportunity costs of the investment. C) is equivalent to sensitivity analysis. D) covers the fixed costs of production, which the accounting break-even does not. E) provides an economic profit over and above the required rate of return.

25) All else constant, the accounting break-even level of sales will decrease when the: A) fixed costs increase. B) depreciation expense decreases. C) contribution margin decreases. D) variable costs per unit increase. E) selling price per unit decreases.

26) At the , a project produces a rate of return equal to the required return. A) point of zero profit B) internal break-even point C) accounting break-even point D) financial break-even point E) income break-even point

27) When a project is operating at its accounting break-even point, the: A) project is just recovering the cost of the initial investment. B) aftertax profit is equal to the initial investment. C) project just pays back on a discounted basis. D) project’s IRR is equal to zero. E) contribution margin is equal to zero.

28) Break-even analysis: A) based on accounting profits is preferable to the financial break-even method. B) identifies the optimal maximum level of output for any given level of fixed assets. C) ignores both taxes and interest when computing the financial break-even point. D) provides a means of determining the minimum number of units that need to be sold to

prevent a financial loss. E) identifies the optimal sales price for any new product.

29) The approach that further attempts to model real world uncertainty by analyzing projects the

way one might analyze gambling strategies is called: A) the gambler’s approach. B) the blackjack approach. C) Monte Carlo simulation. D) scenario analysis. E) sensitivity analysis.

30) If you want the most detailed information possible about the potential outcome of a critical

project you should conduct: A) operating analysis. B) simulation analysis. C) financial analysis. D) decision tree analysis. E) sensitivity analysis.

31) Simulation analysis is based on assigning a and analyzing the results. A) narrow range of values to a single variable B) narrow range of values to multiple variables simultaneously C) wide range of values to a single variable D) wide range of values to multiple variables simultaneously E) single value to each of the variables

32) An analysis of what happens to the estimate of a project’s net present value when you

examine a vast number of different likely economic situations is called A) forecasting B) scenario C) sensitivity D) simulation E) break-even

analysis.

33) Of the following methods, the one that is most dependent upon the use of a computer is

analysis. A) scenario B) financial break-even C) sensitivity D) accounting break-even E) simulation

34) Monte Carlo simulation is: A) the method of analysis most widely used by executives. B) a very simple formula. C) more complex than sensitivity or scenario analysis. D) the oldest capital budgeting technique. E) most commonly applied to small, short-term projects.

35) Management has decided to accept a new project but has yet to decide when the project

should commence. Which type of analysis would be most helpful at this time? A) Expansion analysis B) Timing option analysis C) Scenario analysis D) Sensitivity analysis E) Simulation analysis

36) The investment timing decision relates to: A) how long the cash flows last once a project is implemented. B) the preferred starting date of a new project. C) how frequently the cash flows of a project occur. D) how many times a project can be expanded. E) how long a project should operate before an abandonment decision can be

implemented.

37) The option to wait: A) increases in value as the project’s sensitivity to new technology increases. B) C) D) E)

is independent of the project’s discount rate. is valueless when a project is profitable given immediate implementation. decreases the net present value of a project. may have value even if a new project currently has a negative net present value.

38) Last month, a firm launched a new product. Demand has been better than expected and is

expected to continue over the long-term. Given this situation, management should consider the option to: A) suspend. B) expand. C) abandon. D) contract. E) withdraw.

39) Including the option to expand in a project analysis will tend to: A) extend the duration of a project but not affect the project’s net present value. B) C) D) E)

increase the cash flows of a project but decrease the project’s net present value. increase the net present value of a project. decrease the net present value of a project. have no effect on either a project’s cash flows or its net present value.

40) The potential decision to abandon a project has value as an option because: A) abandonment can occur at one specific point in the future. B) costs can be contained before bankrupting the firm. C) management is locked into a negative outcome. D) future demand may exceed expectations. E) the project may be worth more if its commencement is delayed.

41) When utilizing a decision tree to make a decision, an analyst must: A) start at the most distant point in time and work backward to Time 0. B) begin at Time 0 and work toward the most distant point in time. C) start at the top of the tree and work vertically downward to the very bottom. D) start at the middle of the tree and work both upward and downward simultaneously. E) concentrate only on the limbs with the highest probability of occurrence levels.

42) Assume an analyst is utilizing a decision tree. The NPV employed to make the decision to

commence the testing for a project is dependent on: A) only the cash flows related to the actual test. B) the path with the highest probability of occurrence. C) all the project’s cash flows and probabilities over the project’s entire life. D) only the cash flows and probabilities of the most successful path. E) the cash flows and probabilities for the first year of the project’s life.

43) In a decision tree, caution should be used in the analysis because: A) later stage decisions are probably riskier than earlier stages. B) negative NPVs should never occur. C) all real options must be included in the basic tree. D) failure and its probability should be ignored because they are irrelevant. E) early stage decisions are probably riskier than later stages.

44) Adept Company is analyzing a proposed project with annual sales of 5,200 units, ± 6 percent;

variable costs per unit of $11, ± 3 percent; fixed costs of $17,500 per year, ± 3 percent; and a sales price of $22 per unit, ± 2 percent. The annual depreciation expense is $4,200. What is the annual sales revenue under the optimistic scenario? A) $105,385 B) $116,688 C) $127,474 D) $123,689 E) $109,408

45) A proposed project has estimated sales of 3,300 units per year, ± 4 percent; a sales price of

$23 per unit, ± 1 percent; variable costs per unit of $12.60, ± 2 percent; annual fixed costs of $16,200; and annual depreciation of $3,100. What is the contribution margin under the expected scenario? A) $5.49 B) $4.55 C) $18.09 D) $10.40 E) $9.46

46) Pugh Cabinetry expects annual sales of 2,400 units, ± 3 percent, of a new product at a price

of $59 per unit, ± 2 percent. The expected variable cost per unit is $27.20, ± 2 percent, annual fixed costs are $32,500, and depreciation is $4,400 per year. What is the total annual expense per unit under the pessimistic scenario? Ignore taxes. A) $44.55 B) $41.70 C) $43.59 D) $40.02 E) $42.51

47) Guerrero Corporation has compiled these estimates for a new 1-year project: sales of 1,650

units, ± 5 percent; sales price of $17 per unit, ± 1 percent; variable costs per unit of $7.49, ± 3 percent; fixed costs of $3,800, ± 1 percent; and depreciation of $2,200. The company bases its sensitivity analysis on the expected scenario. If the company conducts a sensitivity analysis at a sales price of $16.25, what will be the earnings before interest and taxes? A) $8,265 B) $8,454 C) $8,530 D) $8,709 E) $8,510

48) A project has estimated sales of 2,600 units at $15.40 per unit; variable costs per unit of

$6.79, ± 3 percent; annual fixed costs of $17,500, ± 3 percent; and depreciation of $2,850 per year. The company bases its sensitivity analysis on the expected scenario. If a sensitivity analysis is conducted using a variable cost of $7, what will be the total annual variable costs? A) $18,746 B) $18,200 C) $16,625 D) $17,654 E) $21,185

49) A new project has estimated annual sales of 12,000 units, ± 3 percent; variable costs per unit

of $11.24, ± 2 percent; annual fixed costs of $38,290, ± 2 percent; and a sales price of $19.65 per unit, ± 4 percent. The annual depreciation is $21,400 and the tax rate is 21 percent. What are the annual earnings before interest and taxes under the optimistic scenario? A) $52,694.40 B) $64,854.40 C) $57,516.89 D) $54,048.91 E) $61,940.08

50) The variable cost per unit for a proposed project is $8.48 and the annual fixed costs are

$27,400. These costs can vary by ± 5 percent. Annual depreciation is $13,290 and the tax rate is 21 percent. The sale price is $13.29 per unit, ± 2 percent. If the firm bases its sensitivity analysis on the expected outcome, what will be the operating cash flow for a sensitivity analysis of 9,200 units? A) $14,066.02 B) $16,103.98 C) $22,078.40 D) $11,554.50 E) $18,385.60

51) The projections for a new one-year project show sales of 8,500 units, ± 5 percent; variable

costs per unit of $28.62, ± 3 percent; and fixed costs of $164,000, ± 3 percent. Depreciation is $62,000 and the tax rate is 23 percent. The sale price is $55 per unit, ± 2 percent. The company bases its sensitivity analysis on the expected scenario. What is the operating cash flow for a sensitivity analysis using total fixed costs of $170,000? A) $62,406.67 B) $58,219.90 C) $61,311.07 D) $56,017.10 E) $52,048.80

52) A project has a projected sales price of $99 per unit, variable costs per unit of $58, annual

fixed costs of $238,000, and annual depreciation of $139,000. The tax rate is 22 percent. What is the contribution margin for an analysis using sales units of 12,800? A) $27.06 B) $38.97 C) $22.41 D) $41.00 E) $42.64

53) The Akana Company expects to sell 3,000 units, ± 15 percent, of a new product. The variable

cost per unit is $8, ± 5 percent, and the annual fixed costs are $12,500, ± 5 percent. The annual depreciation expense is $4,000 and the sale price is $18 per unit, ± 2 percent. The project requires $24,000 of fixed assets which will be worthless when the project ends in six years. Also required is $6,500 of net working capital for the life of the project. The tax rate is 21 percent and the required rate of return is 12 percent. What is the net present value of the pessimistic scenario? A) $12,979.40 B) $14,008.16 C) $13,810.29 D) $10,146.18 E) $8,308.15

54) A new 5-year project has expected sales of 3,400 units, ± 8 percent; variable costs per unit of

$22, ± 2 percent; annual fixed costs of $47,500, ± 2 percent; annual depreciation of $33,000; and a sale price of $45 per unit, ± 3 percent. The project initially requires $165,000 of fixed assets and $42,000 of net working capital. At the end of the project, the net working capital will be recouped and the fixed assets will produce an aftertax cash inflow of $35,000. The tax rate is 21 percent and the discount rate is 14 percent. What is the net present value of the optimistic scenario? A) −$28,026.15 B) −$28,799.24 C) −$22,584.68 D) $21,202.98 E) $18,566.01

55) Aspect Resources expects to sell 3,000 units, ± 15 percent, of a new product. The variable

cost per unit is $8, ± 5 percent; annual fixed costs are $12,500, ± 5 percent; annual depreciation is $4,000; and the sale price is $18 per unit, ± 2 percent. What is the amount of the fixed cost per unit under the pessimistic scenario? A) $4.17 B) $4.66 C) $5.15 D) $5.35 E) $6.02

56) A project has these estimated values: sales quantity of 4,600 units ± 2 percent; variable cost

per unit of $17, ± 3 percent; annual fixed costs of $46,900, ± 1 percent; annual depreciation of $17,300; and a sales price of $39 per unit, ± 10 percent. The company bases its sensitivity analysis on the expected scenario. What will be the operating cash flow for a sensitivity analysis based on a sales price of $35 per unit and a tax rate of 21 percent? A) $27,319 B) $32,400 C) $31,994 D) $26,700 E) $23,508

57) Advance Electronics is analyzing a project with anticipated annual sales of 3,620 units, ± 5

percent; a sales price of $24, ± 2 percent; variable costs per unit of $14.60, ± 4 percent; and annual fixed costs of $12,900, ± 1 percent. What will be the annual total variable costs given a sensitivity analysis using a variable cost of $16 per unit? A) $53,470 B) $54,900 C) $55,500 D) $57,920 E) $61,050

58) A firm is reviewing a project with a labor cost of $18.90 per unit, raw materials cost of

$21.63 per unit, and fixed costs of $8,000 per month. Sales are projected at 7,200 units total for the 3-year life of the project. What are the total variable costs per year? A) $106,300 B) $99,300 C) $97,272 D) $103,300 E) $109,300

59) A project with a life of one year has earnings before interest and taxes of $5,750, fixed costs

of $50,000, a selling price of $13 per unit, and a sales quantity of 11,500 units. Depreciation is $7,500. What is the variable cost per unit? A) $6.75 B) $7.00 C) $7.25 D) $7.50 E) $7.75

60) At a production level of 5,600 units, a project has total costs of $89,000 and a variable cost

per unit of $11.20. What is the amount of the total fixed costs? A) $24,126 B) $26,280 C) $27,090 D) $27,820 E) $28,626

61) A project has a contribution margin of $2.16 per unit. If the sales price per unit is $11 and the

fixed costs are $24,700, what is the amount of total costs at a production level of 6,000 units? Ignore depreciation. A) $65,165 B) $81,080 C) $57,460 D) $68,221 E) $77,740

62) A project at Asgedom Mills has annual fixed costs of $5,000, sales of $13.39 per yard, and

variable costs of $6.00 per yard. If annual depreciation is $896, what is the accounting breakeven point? A) 798 yards B) 1,230 yards C) 555 yards D) 487 yards E) 1,308 yards

63) Sanchez Machine is considering a project with total sales of $17,500, total variable costs of

$9,800, total fixed costs of $3,500, and estimated production of 400 units. The depreciation expense is $2,400 annually. What is the contribution margin per unit? A) $4.50 B) $10.50 C) $14.14 D) $19.09 E) $19.25

64) Assume a project has projected annual depreciation of $878, annual fixed costs of $3,200,

and a variable cost per unit of $5.61. The sales price per unit is expected to be $13.39. What is the accounting break-even level of production? A) 787 units B) 524 units C) 298 units D) 320 units E) 859 units

65) The accounting break-even production quantity for a project with a life of one year is 35,173

units. The fixed costs are $318,290 and the contribution margin is $13.27. What is the projected depreciation expense? A) $142,734 B) $148,456 C) $110,025 D) $113,053 E) $122,082

66) The accounting break-even production quantity for a project is 5,799 units. The fixed costs

are $92,640, the depreciation is $36,210, and the sales price per unit is $48.29. What is the variable cost per unit? A) $31.18 B) $27.04 C) $26.07 D) $32.81 E) $33.04

67) A project with a life of one year has an accounting break-even point of 2,962 units. The fixed

costs are $46,308 and the depreciation expense is $22,147. The projected variable cost per unit is $23.10. What is the projected sales price? A) $48.07 B) $42.96 C) $41.20 D) $46.21 E) $45.40

68) A proposed 12-month project has fixed costs of $3,600, depreciation expense of $1,500, and

a sales quantity of 1,300 units. What is the contribution margin if the projected level of sales is the accounting break-even point? A) $3.92 B) $4.14 C) $4.50 D) $4.80 E) $5.00

69) A proposed 1-year project has a contribution margin of $5, fixed costs of $12,000, variable

costs per unit of $12, depreciation of $30,000, an EAC of $41,185, and a tax rate of 21 percent. What is the financial break-even point in units? A) 12,458 B) 9,489 C) 11,232 D) 10,603 E) 9,617

70) The Mini-Max Company has a prospective 5-year project with an initial cost of $318,900,

annual fixed costs of $45,200, variable costs per unit of $16.78, and a sales price of $29.95. The discount rate is 13 percent and the tax rate is 24 percent. The firm uses straight-line depreciation over a project’s life for all fixed assets. What is the accounting break-even point in units per year? A) 7,850 B) 8,275 C) 10,315 D) 11,304 E) 11,429

71) The Highlight Company is reviewing a proposed 7-year project with an initial cost of

$687,400. The annual fixed costs are $92,800, the variable cost per unit is $49.79, and the sales price per unit is $89. The tax rate is 21 percent and the discount rate is 12 percent. All assets are depreciated straight-line over the life of the project. What is the accounting breakeven point in units per year? (Round up to the nearest whole unit.) A) 6,518 B) 3,069 C) 5,475 D) 6,103 E) 4,872

72) A project requires an initial fixed asset investment of $3,500,000, has annual fixed costs of

$500,000, a sales price of $44,000 per unit, variables costs of $15,000 per unit, a discount rate of 20 percent, and straight-line depreciation over the project’s 5-year life. The assets will be worthless at the end of the project. The income tax rate is 21 percent. What is the financial break-even point? A) 58 units B) 41 units C) 44 units D) 53 units E) 62 units

73) The Quorum Company has a prospective 5-year project that requires initial fixed assets

costing $2,600,000, annual fixed costs of $515,000, variable costs per unit of $18,000, a sales price per unit of $44,000, a discount rate of 20 percent, and a tax rate of 21 percent. What is the financial break-even point? A) 53 units B) 57 units C) 44 units D) 50 units E) 33 units

74) Northern Woods is considering two methods of production for a new product. The first

method will require fixed assets costing $450,000 that will be depreciated straight-line to zero over the product’s 3-year life. Annual fixed costs are $316,000 and variable costs per unit are $8.64. The second method will require fixed assets costing $790,000, annual fixed costs of $211,000, and variable costs per unit of $6.57. The firm expects to sell 46,000 units per year at $20 per unit. The discount rate is 16 percent and the tax rate is 21 percent. Should the product be produced and if so, which method of production should be implemented and why? A) Yes; Method A; because A has the lower initial cost B) Yes; Method A; because it will break-even on a financial basis with fewer annual sales C) Yes; Method B; because it has lower annual costs D) Yes; Method B; because B has a financial break-even quantity that is less than the expected sales units E) No; Neither method of production will financially break-even within the expected life of the project.

75) An investment has an initial cash outflow of $210,000 for fixed assets that will be

depreciated straight-line to zero over the 4-year life of the project. The sales price is $19.95 per unit, annual fixed costs are $237,000, the variable costs per unit are $8.87, and the tax rate is 23 percent. At what annual sales quantity will the investment break even on an accounting basis? (Round up to the nearest whole unit.) A) 32,088 units B) 29,889 units C) 24,092 units D) 30,135 units E) 26,129 units

76) An investment has an initial cash outflow of $210,000 for fixed assets that will be

depreciated straight-line to zero over 4 years, which is the life of the project. The sales price is set at $19.95 per unit, the annual fixed costs are $237,000, and the variable cost per unit is $8.87. The tax rate is 22 percent and the discount rate is 11 percent. At what sales quantity per year will the investment break even on a financial basis? A) 29,787 units B) 29,143 units C) 27,886 units D) 28,096 units E) 30,308 units

77) Quarter Market has determined that a new project has expected fixed costs of $132,378, a

contribution margin of $36.20, and a tax rate of 21 percent. The investment has an initial cost of $548,000 that will be depreciated straight-line to zero over the 5-year life of the project. What is the expected financial break-even point in units per year if the discount rate is 15 percent? (Round up to the nearest whole unit.) A) 8,569 B) 9,046 C) 9,331 D) 9,849 E) 9,615

78) Larson Woodworking is considering a project with a sales price of $11, variable cost per unit

of $8.50, and annual fixed costs of $134,500. The tax rate is 23 percent and the discount rate is 14 percent. The project requires $224,000 of fixed assets that will be worthless at the end of the 4-year project. What is the financial break-even point in units per year if the firm uses straight line depreciation? A) 88,808 B) 92,480 C) 93,057 D) 93,750 E) 87,046

79) A project has a contribution margin of $15, projected fixed costs of $120,000, variable costs

per unit of $12, annual depreciation of $61,000, and a projected financial break-even point of 13,601.20 units. The tax rate is 21 percent, the discount rate is 12 percent, and the project life is 3 years. What is the equivalent annual cost? A) $81,110 B) $76,192 C) $84,207 D) $72,549 E) $76,667

80) Club Corporation is analyzing a project with anticipated sales of 12,000 units, ± 4 percent;

variable costs per unit of $7, ± 6 percent; and annual fixed costs of $36,000, ± 6 percent. Annual depreciation is $29,600 and the tax rate is 21 percent. The sale price is $14.99 per unit, ± 1 percent. What is the operating cash flow under the optimistic scenario? A) $63,876 B) $54,309 C) $56,208 D) $59,311 E) $64,499

81) A project has been assigned a discount rate of 12 percent. If the project starts immediately, it

will have an initial cost of $480 and cash inflows of $350 per year for three years. If the start is delayed one year, the initial cost will rise to $520 and the cash flows will increase to $385 per year for three years. What is the value of the option to wait? A) $.70 B) $1.08 C) $1.67 D) $2.20 E) $.20

82) Marguerite is reviewing a project with projected sales of 1,400 units per year, a cash flow of

$39 per unit, and project life of 3 years. The initial cost of the project is $94,000 and the discount rate is 14 percent. She has the option to abandon the project after one year at which time she feels she could sell the project for $63,000. At what quantity of annual sales should she be willing to abandon the project after the first year? A) 899 units B) 981 units C) 967 units D) 1,199 units E) 1,006 units

83) Wilson’s Antiques is considering a project with an initial cost today of $10,000. The project

has a life of 2 years with cash inflows of $6,500 per year. Should the firm decide to wait one year to commence this project, the initial cost will increase by 5 percent, and the cash inflows will increase to $7,500 per year. What is the value of the option to wait at a discount rate of 10 percent? A) $1,006.76 B) $1,235.54 C) $1,509.28 D) $1,606.76 E) $1,735.54

84) Jones & Jones is considering a project with a life of 5 years, an initial cost of $120,000, and a

discount rate of 12 percent. The firm expects to sell 2,100 units per year at a cash flow per unit of $20. The firm will have the option to abandon this project after three years at which time it could sell the project for $50,000. At what level of sales should the firm be willing to abandon this project at the end of the third year? A) 420 units B) 1,041 units C) 1,479 units D) 1,618 units E) 2,500 units

85) Brewster’s is considering a project with a life of 5 years and an initial cost of $120,000. The

discount rate for the project is 12 percent. The firm expects to sell 2,100 units per year at a net cash flow per unit of $20. The firm will have the option to abandon this project after three years at which time it could sell the project for $50,000. The firm is interested in knowing how the project will perform if the sales forecasts for Years 4 and 5 of the project are revised such that there is a 50 percent chance the sales will be either 1,400 or 2,500 units per year. What is the net present value of this project given these revised sales forecasts? A) $23,617 B) $23,719 C) $25,002 D) $26,877 E) $28,745

86) Stage 2 of a decision tree shows that if a project is successful, the payoff will be $53,000

with a 2/3 chance of occurrence. There is also the 1/3 chance of a −$24,000 payoff. The cost of getting to Stage 2 (1 year out) is $24,000. The cost of capital is 15 percent. What is the NPV of the project at Stage 1? A) −$349.16 B) −$231.88 C) $108.17 D) $133.33 E) $147.59

87) The Quick-Start Company has the following pattern of potential cash flows for a new project.

If the company has a discount rate of 16 percent, what is the Time 1 net present value? A) $50,807,953 B) $48,326,218 C) $52,009,107 D) $47,362,515 E) $45,887,056

88) The Quick-Start Company has the following pattern of potential cash flows for a new project.

If the company has a discount rate of 17 percent, should it test the product? Why or why not? A) Yes; NPV = −$48,632,106 B) Yes; NPV = $21,565,903 C) No; NPV = −$2,308,410 D) No; NPV = $36,515,028 E) Yes; NPV = $3,462,911

89) What is the benefit of scenario analysis if it does not produce a definitive accept or reject

decision for a proposed project?

90) Consider the following statement by a project analyst: "I analyzed my project using scenarios

for the optimistic, expected, and pessimistic cases. I computed break-evens and conducted sensitivity and simulation analysis. I computed NPV, IRR, the profitability index, and payback. In the end, I have over a hundred different estimates and am more confused than ever. I would have been better off just sticking with my first estimate and going by my gut instinct." Critique this statement.

91) Explain the primary benefit of sensitivity analysis and explain why that benefit cannot be

realized by conducting scenario analysis.

92) The market value of an investment project should be viewed as the sum of the standard NPV

and the value of the managerial options. Identify three common project options available to management, when each might be employed, and how each of those options would influence a project’s value.

93) Discuss some potential shortcomings of the standard decision tree analysis.

94) Other than quantifying the potential NPV of a project, what other benefits do decision trees

offer to managers?

Answer Key Test name: Chapter 7 1) C 2) E 3) A 4) B 5) C 6) E 7) B 8) B 9) C 10) C 11) D 12) D 13) A 14) A 15) C 16) C 17) A 18) D 19) C 20) D 21) B 22) D 23) C 24) B 25) B 26) D 27) A 28) D 29) C 30) B 31) D 32) D 33) E 34) C 35) B 36) B 37) E

38) B 39) C 40) B 41) A 42) C 43) E 44) D 45) D 46) C 47) B 48) B 49) C 50) B 51) D 52) D 53) D 54) C 55) C 56) C 57) D 58) C 59) D 60) B 61) E 62) A 63) E 64) B 65) B 66) C 67) D 68) A 69) C 70) B 71) E 72) E 73) B 74) D 75) E 76) C 77) A

78) E 79) B 80) A 81) A 82) B 83) A 84) C 85) E 86) B 87) A 88) B 89) Essay 90) Essay 91) Essay 92) Essay 93) Essay 94) Essay

Chapter 8: 1) A

bond makes no coupon payments and is initially priced at a deep discount. A) Treasury B) municipal C) floating-rate D) junk E) zero coupon

2) The stated interest payment, in dollars, made on a bond each period is called the bond’s: A) coupon. B) face value. C) maturity. D) yield to maturity. E) coupon rate.

3) A bond’s principal amount, which is repaid at the end of the loan term, is called the: A) coupon. B) face value. C) maturity. D) yield to maturity. E) coupon rate.

4) The principal amount of a bond must be repaid on the bond’s A) coupon B) face value C) maturity D) yield to maturity E) issue

date.

5) The rate of return required by investors in the market for owning a bond is called the: A) coupon. B) face value. C) maturity. D) yield to maturity. E) coupon rate.

6) The A) B) C) D) E)

is the annual interest amount paid by a bond divided by the bond’s face value. coupon face value maturity yield to maturity coupon rate

7) A

bond has a face value of $1,000 and a market price of $1,000. A) par value B) discount C) premium D) zero coupon E) floating rate

8) A

bond has a face value of $1,000 and a market price of less than $1,000. A) par value B) discount C) premium D) zero coupon E) floating rate

9) A bond with a coupon rate of 6 percent that pays interest semiannually and is priced at par

will have a market price of A) $1,006; $60 B) $1,060; $30 C) $1,060; $60 D) $1,000; $30 E) $1,000; $60

and interest payments in the amount of

each.

10) All else constant, a bond will sell at

when the yield to maturity is

the coupon

rate. A) B) C) D) E)

a premium; greater than a premium; equal to at par; greater than at par; less than a discount; greater than

11) All else constant, a coupon bond that is selling at a premium must have: A) a coupon rate that is equal to the yield to maturity. B) a market price that is less than par value. C) semiannual interest payments. D) a yield to maturity that is less than the coupon rate. E) a coupon rate that is less than the yield to maturity.

12) The market price of a bond increases when the: A) face value decreases. B) coupon rate decreases. C) discount rate decreases. D) par value decreases. E) coupon is paid annually rather than semiannually.

13) Aspen leaf is preparing a bond offering with a coupon rate of 5.5 percent. The bonds will be

repaid in 10 years. The company plans to issue the bonds at par value and pay interest annually. Which one of the following statements is correct? Assume a face value of $1,000. A) The bonds will pay 19 interest payments and one principal payment. B) The bonds will initially sell at a discount. C) At maturity, the bonds will pay a final payment of $1,027.50. D) The bonds will pay twenty equal coupon payments. E) At issuance, the bond's yield to maturity is 5.5 percent.

14) A par value bond offers a coupon rate of 7 percent with semiannual interest payments. The

effective annual rate provided by these bonds must be: A) equal to 3.5 percent. B) greater than 3.5 percent but less than 4 percent. C) equal to 7 percent. D) greater than 7 percent but less than 8 percent. E) equal to 14 percent.

15) Gloria purchased one 20-year bond at par value when it was initially issued. This bond has a

coupon rate of 6 percent and matures 11 years from now. If the current market rate for this type and quality of bond is 6.4 percent, then Gloria should expect: A) the bond issuer to increase the amount of all future interest payments. B) the yield to maturity to remain constant due to the fixed coupon rate. C) to realize a capital loss if she sold the bond at today’s market price. D) today’s market price to exceed the face value of the bond. E) the current yield today to be less than 6 percent.

16) Interest rate risk

as the time to maturity decreases and

as the coupon rate

decreases. A) decreases; increases B) decreases; decreases C) increases; increases D) increases; decreases E) increases; is unaffected

17) A zero coupon bond: A) is sold at a large premium. B) has a price equal to the future value of the face amount given a positive rate of return. C) can only be issued by the U.S. Treasury. D) has less interest rate risk than a comparable coupon bond. E) has a market price that is computed using semiannual compounding of interest.

18) Which one of these bonds is the most interest-rate sensitive? A) 5-year zero coupon bond B) 10-year zero coupon bond C) 5-year, 6 percent, annual coupon bond D) 10-year, 6 percent, semiannual coupon bond E) 10-year, 6 percent, annual coupon bond

19) The yield to maturity: A) that is expected will be realized any time a bond is sold. B) will exceed the coupon rate when the bond is selling at a premium. C) equals the current yield for all annual coupon bonds. D) can only be realized if a bond is purchased on the issue date at par value. E) equals both the current yield and the coupon rate for par value bonds.

20) If a bond’s yield to maturity is less than its coupon rate, the bond will sell at a

, and

increases in market interest rates will: A) discount; decrease this discount. B) discount; increase this discount. C) premium; decrease this premium. D) premium; increase this premium. E) premium; not affect this premium.

21) The longest term bonds ever issued had an initial maturity date of: A) 25 years. B) 50 years. C) 100 years. D) 1,000 years. E) never as the bonds are perpetual.

22) All else held constant, interest rate risk will increase when the time to maturity: A) decreases or the coupon rate increases. B) decreases or the coupon rate decreases. C) increases or the coupon rate increases. D) increases or the coupon rate decreases. E) decreases and the coupon rate equals zero.

23) Which one of these combinations of bond ratings represents a crossover situation? A) BBB; Baa B) BB; Ba C) Ba; B D) Baa; BB E) B; CCC

24) The interest paid on any municipal bond is: A) free of default risk. B) subject to default risk and is exempt from state income taxation. C) free of both default risk and federal income taxation. D) exempt from federal income taxation and may or may not be exempt from state

taxation. E) taxable at the federal level and tax exempt at the state and local level.

25) The interest rate for a tax-exempt bond that equates to the rate paid on a taxable bond is

computed as: A) Taxable rate/(1 − T*). * B) Tax-exempt rate × (1 − T ). C) Taxable rate − (1 + T*). * D) Taxable rate × (1 − T ). E) Tax-exempt rate/(1 + T*).

26) Bond dealers report all of their trading information using the system known as: A) SEC-Bond. B) Nasdaq. C) FED trades. D) FINRA. E) TRACE.

27)

Most of the trading in bonds is conducted: A) in person on the floor of the NYSE. B) by dealers located in Chicago. C) by brokers on various trading floors. D) electronically. E) on the trading floor in Washington, DC.

28) Which entity provides a daily snapshot of bond prices for the most active issues? A) Federal Reserve Bank B) US Treasury Department C) SEC D) FINRA E) NYSE

29) The dirty price of a bond is defined as the: A) market price minus any taxes due on the accrued interest. B) market price minus the accrued interest. C) clean price minus the accrued interest. D) quoted price plus the accrued interest. E) clean price minus any taxes due on the accrued interest.

30) A newspaper listing of bond prices has an “Asked yield” column. This yield is based on the

asked price and represents the: A) yield to maturity. B) difference between the current yield and the yield to maturity. C) difference between the bond’s yield and the yield of a comparable Treasury issue. D) coupon rate. E) current yield.

31) A bond is listed in a newspaper at a bid of 103.2922. This quote should be interpreted to

mean: A) the bond will pay semiannual interest payments of $103.2922 per $1,000 of face

value. B) you can sell that bond at a price equal to 103.2922 percent of face value. C) the bond will pay annual interest payments of $103.2922 per $1,000 of face value. D) you can buy that bond at a price equal to 103.2922 percent of face value. E) the bond dealer is willing to sell that bond for a price equal to 103.2922 percent of par.

32) The total price you pay to purchase a premium bond is referred to as the: A) dirty price or the full price. B) clean price or the invoice price. C) invoice price or the par value. D) dirty price or the par value. E) clean price or the par value.

33) The profit that is earned on a bond trade by a bond dealer is called the: A) asked price. B) spread. C) bid price. D) accrued interest. E) quote value.

34) The Fisher formula is expressed as

where R is the nominal rate, r is the real rate, and h

is the inflation rate. A) r = Rh B) R = rh C) 1 + h = (1 + r)/(1 + R) D) 1 + R = (1 + r)/(1 + h) E) 1 + R = (1 + r)(1 + h)

35) An increase in the rate of inflation will: A) increase both the real and the nominal rate of interest. B) decrease both the real and the nominal rate of interest. C) increase the nominal interest rate while lowering the real interest rate. D) increase the real interest rate but not affect the nominal interest rate. E) increase the nominal interest rate but will not affect the real interest rate.

36) To increase your purchasing power when investing in a bond: A) you must purchase that bond at a discount. B) the nominal rate of return on that bond must be less than the inflation rate. C) you should purchase a premium bond. D) the nominal rate of return must equal or exceed the rate of inflation. E) you must earn a positive real rate of return on that bond.

37) The promised coupon payments on a U.S. TIPS bond are specified in: A) euros. B) Canadian dollars. C) nominal terms. D) inflated terms. E) real terms.

38) The monthly returns on U.S. Treasury bills over the past 50 years have: A) exceeded inflation for all periods. B) provided consistently positive monthly rates of return for investors. C) ranged between zero and five percent on an annualized basis. D) always been positive on a real basis. E) sometimes been less than the monthly rate of inflation.

39) The relationship between nominal rates, real rates, and inflation is known as the: A) Miller and Modigliani theorem. B) Fisher effect. C) Gordon growth model. D) term structure of interest rates. E) interest rate risk premium.

40) The relationship between nominal interest rates on default-free, pure discount securities and

the time to maturity is called the: A) liquidity effect. B) Fisher effect. C) term structure of interest rates. D) inflation premium. E) interest rate risk premium.

41) The

premium is that portion of a nominal interest rate or bond yield that represents compensation for expected future loss in purchasing power. A) default risk B) taxability C) liquidity D) inflation E) interest rate risk

42) The

premium is that portion of the bond yield that represents compensation for potential difficulties that might be encountered should the bondholder wish to sell the bond prior to maturity. A) default risk B) taxability C) inflation D) liquidity E) interest rate risk

43) The term structure of interest rates reflects the: A) real rate of interest. B) real rate of interest plus the inflation premium. C) nominal interest rate plus the interest rate risk premium. D) pure time value of money. E) real rate, inflation premium, interest rate risk premium, and the liquidity premium.

44) An upward-sloping term structure of interest rates indicates that: A) longer-term rates are higher than shorter-term rates. B) investors should expect interest rates to decline in the future. C) short- and intermediate-term rates are real rates while long-term rates are nominal

rates. D) the Fed is expected to decrease rates in the near term. E) the larger the investment in dollars, the higher the interest rate paid.

45) The term structure of interest rates: A) plots interest rates against bond ratings. B) is just another name for the yield curve. C) ignores interest rate risk premiums while the Treasury yield curve includes those

premiums. D) ignores both inflation and interest rate risk premiums. E) is based on pure discount bonds while the Treasury yield curve is based on coupon bond yields.

46) The term structure of interest rates: A) must be upward-sloping. B) can be humped in the middle. C) is downward-sloping when inflation is expected to rise. D) obtains its slope from the real rate of return. E) generally has the same degree of steepness each year.

47) Which of the following items is included in the return on a municipal bond but excluded

from the return on a U.S. Treasury bond? A) Inflation premium and liquidity premium B) Taxability premium and interest rate risk premium C) Default risk premium and interest rate risk premium D) Inflation premium and default risk premium E) Liquidity premium and default risk premium

48) Consider a bond with an annual coupon rate of 7 percent that pays semiannual interest and

matures in ten years. The market rate of return on bonds of this risk is currently 3.5 percent. What is the current value of a $1,000 face value bond? A) $1,291.08 B) $1,159.27 C) $1,293.18 D) $629.21 E) $1000.00

49) What is the value of a 20-year, zero-coupon bond with a face value of $1,000 when the

market required rate of return is 9.6 percent, compounded semiannually? A) $153.30 B) $192.40 C) $195.26 D) $168.31 E) $172.19

50) Chang, Incorporated, issued bonds with an annual coupon rate of 5 percent. Coupons are paid

semiannually. The bonds mature in 12 years and have a $1,000 face value. The bonds are currently selling at par. What is the yield to maturity? A) 2.97% B) 3.97% C) 4.17% D) 5.00% E) 2.50%

51) A corporate bond has a coupon of 7.5 percent and pays interest annually. The face value is

$1,000 and the current market price is $1,108.15. The bond matures in 14 years. What is the yield to maturity? A) 6.31% B) 7.82% C) 8.00% D) 8.04% E) 8.12%

52) Otto Enterprises has a bond issue outstanding with an annual coupon rate of 6 percent that

matures in 9 years. The bond is currently priced at $1,046.92 and has a par value of $1,000. Interest is paid semiannually. What is the yield to maturity? A) 5.34% B) 4.83% C) 2.67% D) 2.77% E) 5.54%

53) Franco, Incorporated, offers a bond with an annual coupon rate of 4.5 percent, semiannual

payments, and a yield to maturity of 6.5 percent. The bond matures in 10 years. What is the market price of a $1,000 face value bond? A) $531.71 B) $854.61 C) $856.22 D) $915.78 E) $707.32

54) Morris has an outstanding bond with a coupon rate of 5.5 percent that matures in 12 years.

The bond pays interest semiannually. What is the market price of one $1,000 face value bond if the yield to maturity is 7.13 percent? A) $934.59 B) $880.86 C) $870.01 D) $905.92 E) $947.87

55) Lancaster offers a bond with annual payments and a coupon rate of 5 percent. The yield to

maturity is 5.62 percent and the maturity date is 9 years away. What is the market price of one $1,000 face value bond? A) $942.66 B) $868.67 C) $869.67 D) $957.12 E) $1,009.59

56) The Wright Corporation offers a bond with a current market price of $1,029.75, a coupon

rate of 8 percent, and a yield to maturity of 7.52 percent. The face value is $1,000. Interest is paid semiannually. How many years is it until this bond matures? A) 8.5 years B) 8.0 years C) 9.0 years D) 17 years E) 16 years

57) Vo Restaurant Group has a semiannual, 5 percent coupon bond with a current market price of

$988.52. The bond has a par value of $1,000 and a yield to maturity of 5.68 percent. How many years is it until this bond matures? A) 1.5 years B) 1.8 years C) 2.1 years D) 2.2 years E) 1.6 years

58) A firm offers a zero coupon bond with a face value of $1,000 that matures in 10 years. What

is the current market price if the yield to maturity is 7.6 percent, given semiannual compounding? A) $474.30 B) $473.26 C) $835.56 D) $919.12 E) $1,088.00

59) Gray Corporation offers a $1,000 face value, zero coupon bond with a yield to maturity of

11.3 percent, given annual compounding. The bond matures in 16 years. What is the current price? A) $178.78 B) $180.33 C) $188.36 D) $190.09 E) $192.18

60) The zero coupon bonds of Moore Medical have a market price of $394.47, a face value of

$1,000, and a yield to maturity of 6.87 percent based on semiannual compounding. How many years is it until this bond matures? A) 11.08 years B) 10.49 years C) 13.77 years D) 12.64 years E) 15.42 years

61) A $1,000 face value coupon bond will pay 5 percent interest annually for 12 years. What is

the percentage change in the price of this bond if the market yield rises to 6 percent from the current level of 5.5 percent? A) −5.28% B) −4.26% C) −2.38% D) 1.13% E) 4.13%

62) Andrew’s has 5-year, 8 percent annual coupon bonds outstanding with a par value of $1,000.

Boyega’s has 10-year, 8 percent annual coupon bonds outstanding with a par value of $1,000. Both bonds currently have a yield to maturity of 8 percent. Which one of the following statements is correct if the market rate decreases to 7 percent? A) Both bonds will decrease in value by 4.10 percent. B) Andrew’s bond will increase in value by $52.10. C) Boyega’s bond will increase in value by 4.61 percent. D) Andrew’s bond will increase in value by $41. E) Boyega’s bond will increase in value by 6.87 percent.

63) A zero coupon bond with a face value of $1,000 is issued with an initial price of $430.84

based on semiannual compounding. The bond matures in 20 years. What is the implicit interest, in dollars, for the first year of the bond’s life? A) $19.08 B) $22.56 C) $18.53 D) $21.47 E) $25.25

64) Khanijow’s wants to raise $12.4 million to expand its business. To accomplish this, it plans

to sell 25-year, $1,000 face value, zero-coupon bonds. The bonds will be priced to yield 6.5 percent, with semiannual compounding. What is the minimum number of bonds the firm must sell to raise the $12.4 million it needs? A) 59,864 B) 52,667 C) 61,366 D) 60,107 E) 60,435

65) Jackson’s has $1,000 face value, zero-coupon bonds outstanding that mature in 13.5 years.

What is the current value of one of these bonds if the market rate of interest is 7.6 percent? Assume semiannual compounding. A) $365.32 B) $401.12 C) $360.49 D) $378.17 E) $384.07

66) A 15-year corporate bond with a face value of $1,000 matures in 5 years and has an annual

coupon rate of 4.5 percent. The current price of the bond is $1,069.14 and interest is paid semiannually. What is the yield to maturity? A) 1.66% B) 1.50% C) 1.94% D) 3.89% E) 3.00%

67) A bond has a coupon rate of 8.2 percent, a $1,000 par value, matures in 11.5 years, has a

yield to maturity of 7.67 percent, and pays interest annually. What is the current yield? A) 7.89% B) 8.21% C) 8.43% D) 7.67% E) 8.52%

68) A 15-year bond has a coupon rate of 4.5 percent, a $1,000 par value, matures in 7 years, has a

price of $1,105.50, and pays interest semiannually. What is the current yield? A) 1.41% B) 1.79% C) 2.04% D) 4.07% E) 2.83%

69) A 15-year bond has a coupon rate of 4 percent, a $1,000 par value, matures in 4 years, has a

price of $1,085.30, and pays interest semiannually. What is the current yield? A) 1.84% B) 3.69% C) 1.78% D) 0.89% E) 1.64%

70) Paulina owns a corporate bond with a yield to maturity of 7.45 percent. She is in the 12

percent tax bracket. What is her equivalent rate of return on a municipal bond? Ignore state taxes. A) 6.17% B) 5.89% C) 6.56% D) 8.26% E) 8.47%

71) Currently, you own a municipal bond with a yield to maturity of 4.86 percent. If you are in

the 24 percent tax bracket, what is your equivalent corporate tax rate? Ignore state taxes. A) 7.17% B) 6.61% C) 6.39% D) 6.59% E) 6.82%

72) A corporate bond has a coupon rate of 6 percent, a $1,000 face value, and matures two years

from today. The corporation is in a serious financial situation and has announced that no future annual interest payments will be paid and that only 50 percent of the face value will be repaid but that payment will be delayed by one year. What is the current value of this bond to a bondholder with a required rate of return of 14 percent? A) $374.31 B) $358.40 C) $299.02 D) $337.49 E) $325.08

73) A corporate bond has a coupon rate of 5.5 percent, a $1,000 face value, and matures three

years from today. The corporation is in a serious financial situation and has announced that no future annual interest payments will be paid and that the probability the entire face value will be repaid is only 75 percent. If the entire face value cannot be paid, then 60 percent of the face value will be repaid. All payments will be made three years from now. What is the current value of this bond at a discount rate of 15 percent? A) $591.76 B) $603.10 C) $611.90 D) $617.48 E) $622.04

74) Nicholas is buying a $1,000 face value bond at a quoted price of 99.486. The bond carries a

coupon rate of 5.6 percent, with interest paid semiannually. The next interest payment is four months from today. What is the clean price of this bond? A) $994.86 B) $1,004.19 C) $1,013.53 D) $987.21 E) $1,005.73

75) Zaila is buying a $1,000 face value bond at a quoted price of 101.364. The bond carries a

coupon rate of 7.75 percent, with interest paid semiannually. The next interest payment is two months from today. What is the dirty price of this bond? A) $1,039.47 B) $1,042.15 C) $1,056.02 D) $1,028.18 E) $1,026.56

76) Nihal just purchased a $1,000 face value bond at an invoice price of $1,288.16. The bond has

a coupon rate of 6.2 percent, semiannual interest payments, and the next interest payment occurs one month from today. Of the amount paid for the bond, what was the dollar amount of the accrued interest? A) $25.83 B) $5.17 C) $31.00 D) $27.39 E) $6.20

77) A corporate bond is currently quoted at 101.633. What is the market price of a bond with a

$1,000 face value? A) $1,000.28 B) $1,002.77 C) $1,016.33 D) $1,102.77 E) $1,276.70

78) The 5-year bond of Bulgarelli Corporation has a bid quote of 131.2891 and an asked quote of

131.3470. Assume you purchase one of these bonds with a face value of $5,000 and a coupon rate of 7.4 percent, paid semiannually. The next interest payment will be paid two months from today. What will be your invoice price for this purchase? A) $7,220.01 B) $6,690.68 C) $6,809.47 D) $7,001.32 E) $6,549.30

79) Last year, a bond yielded a nominal return of 6.06 percent while inflation averaged 1.82

percent. What was the real rate of return? A) 9.60% B) 4.16% C) 7.99% D) 5.77% E) 9.66%

80) A $1,000 par value bond carries an annual coupon rate of 6.65 percent and has a yield to

maturity of 6.98 percent. The inflation rate is 1.28 percent. What is the bond's real rate of return? A) 8.02% B) 4.03% C) 5.63% D) 8.35% E) 5.30%

81) If a bond provides a real rate of return of 2.89 percent at a time when inflation is 3.21

percent, what is the nominal rate of return on the bond? A) 6.10% B) 6.13% C) 6.16% D) 6.19% E) 6.22%

82) The nominal rate of return on a bond is 7.28 percent while the real rate is 3.09 percent. What

is the rate of inflation? A) 4.06% B) 4.28% C) 4.09% D) 4.13% E) 4.17%

83) Ivan wants to earn a real return of 3.4 percent on any bond he acquires. The inflation rate is

2.8 percent. He has determined that a particular bond he is considering should have an interest rate risk premium of .27 percent, a liquidity premium of .08 percent, and a taxability premium of 1.69 percent. What nominal rate of return is Stu demanding from this particular bond? A) 8.34% B) 7.19% C) 8.40% D) 7.38% E) 8.74%

84) Define what is meant by interest rate risk. Also, assume the manager of a $100 million

portfolio of corporate bonds predicts interest rates will rise in the near future. What adjustments should be made to the portfolio assuming the market has not already adjusted for this prediction?

85) Why do corporations issue 100-year bonds, knowing that interest rate risk is highest for very

long-term bonds? How does the interest rate risk affect the issuer?

86) Normally, the Treasury yield curve is upward-sloping. Explain the conditions required for a

downward-sloping yield curve to exist.

87) Explain liquidity risk, default risk, and taxability risk. How does each of these risks affect the

yield of a bond?

88) Should investors be indifferent between two bonds which have equal market yields to

maturity as long as the bonds have the same bond rating? Can you think of any real-world factors which might make a given investor prefer one of these bonds over the other?

Answer Key Test name: Chapter 8(1) 1) E 2) A 3) B 4) C 5) D 6) E 7) A 8) B 9) D 10) E 11) D 12) C 13) E 14) D 15) C 16) A 17) E 18) B 19) E 20) C 21) E 22) D 23) D 24) D 25) D 26) E 27) D 28) D 29) D 30) A 31) B 32) A 33) B 34) E 35) E 36) E 37) E

38) E 39) B 40) C 41) D 42) D 43) D 44) A 45) E 46) B 47) E 48) C 49) A 50) D 51) A 52) A 53) B 54) C 55) D 56) A 57) B 58) A 59) B 60) C 61) B 62) D 63) C 64) C 65) A 66) E 67) A 68) D 69) B 70) C 71) C 72) D 73) A 74) A 75) A 76) A 77) C

78) B 79) B 80) C 81) D 82) A 83) A 84) Essay 85) Essay 86) Essay 87) Essay 88) Essay

Student name: 1) An investment had a nominal return of 11.4 percent last year. The inflation rate was 3.8

percent. What was the real return on the investment? A) 7.32% B) 15.63% C) 6.82% D) 11.23% E) 8.14%

2) An investment had a nominal return of 10.3 percent last year. If the real return on the

investment was only 5.7 percent, what was the inflation rate for the year? A) 10.38% B) 4.84% C) 16.59% D) 4.17% E) 4.35%

3) The inflation rate over the past year was 2.3 percent. If an investment had a real return of 7.5

percent, what was the nominal return on the investment? A) 9.97% B) 5.08% C) 10.53% D) 4.84% E) 11.08%

4) A bond that pays interest annually yields a rate of return of 6.00 percent. The inflation rate

for the same period is 2 percent. What is the real rate of return on this bond? A) 2.00% B) 1.04% C) 3.92% D) 3.00% E) 8.00%

5) Gugenheim, Incorporated, has a bond outstanding with a coupon rate of 6.5 percent and

annual payments. The yield to maturity is 7.7 percent and the bond matures in 21 years. What is the market price if the bond has a par value of $2,000? A) $1,758.97 B) $1,756.65 C) $1,752.09 D) $1,789.03 E) $1,753.96

6) Whatever, Incorporated, has a bond outstanding with a coupon rate of 5.64 percent and

semiannual payments. The yield to maturity is 6.1 percent and the bond matures in 15 years. What is the market price if the bond has a par value of $1,000? A) $957.94 B) $955.61 C) $956.68 D) $974.31 E) $955.21

7) Lincoln Park Company has a bond outstanding with a coupon rate of 5.92 percent and

semiannual payments. The yield to maturity is 4.9 percent and the bond matures in 21 years. What is the market price if the bond has a par value of $2,000? A) $2,265.69 B) $2,272.16 C) $2,269.18 D) $2,311.00 E) $2,263.87

8) Harpeth Valley Water District has a bond outstanding with a coupon rate of 4.43 percent and

semiannual payments. The bond matures in 17 years, with a yield to maturity of 3.83 percent, and a par value of $5,000. What is the market price of the bond? A) $5,380.57 B) $5,372.30 C) $5,387.65 D) $5,479.75 E) $5,369.83

9) Kasey Corporation has a bond outstanding with a coupon rate of 5.94 percent and semiannual

payments. The bond has a yield to maturity of 5.1 percent, a par value of $2,000, and matures in 20 years. What is the quoted price of the bond? A) 110.77 B) 2,209.10 C) 112.66 D) 110.45 E) 2,430.01

10) Footsteps Company has a bond outstanding with a coupon rate of 5.7 percent and annual

payments. The bond currently sells for $927.87, matures in 13 years, and has a par value of $1,000. What is the YTM of the bond? A) 5.70% B) 6.54% C) 5.89% D) 5.45% E) 6.14%

11) Broke Benjamin Company has a bond outstanding that makes semiannual payments with a

coupon rate of 5.9 percent. The bond sells for $968.49 and matures in 23 years. The par value is $1,000. What is the YTM of the bond? A) 4.62% B) 5.85% C) 3.08% D) 5.54% E) 6.16%

12) Crossfade Corporation has a bond with a par value of $2,000 that sells for $1,956.84. The

bond has a coupon rate of 6.84 percent and matures in 24 years. If the bond makes semiannual coupon payments, what is the YTM of the bond? A) 3.51% B) 7.03% C) 6.68% D) 5.27% E) 6.32%

13) There is a bond that has a quoted price of 102.285 and a par value of $2,000. The coupon rate

is 6.78 percent and the bond matures in 22 years. If the bond makes semiannual coupon payments, what is the YTM of the bond? A) 5.92% B) 3.29% C) 4.94% D) 3.24% E) 6.58%

14) A bond has a par value of $1,000, a current yield of 6.75 percent, and semiannual coupon

payments. The bond is quoted at 99.22. What is the amount of each coupon payment? A) $33.75 B) $66.97 C) $67.50 D) $37.67 E) $33.49

15) A bond has a par value of $1,000, a current yield of 7.01 percent, and semiannual coupon

payments. The bond is quoted at 96.09. What is the coupon rate of the bond? A) 7.58% B) 7.01% C) 6.74% D) 13.47% E) 14.02%

16) A 12-year, semiannual coupon bond sells for $951.07. The bond has a par value of $1,000

and a yield to maturity of 6.48 percent. What is the bond's coupon rate? A) 4.42% B) 5.89% C) 5.59% D) 2.94% E) 5.30%

17) AB Builders, Incorporated, has 24-year bonds outstanding with a par value of $2,000 and a

quoted price of 98.145. The bonds pay interest semiannually and have a yield to maturity of 6.86 percent. What is the coupon rate? A) 6.70% B) 13.40% C) 10.05% D) 6.03% E) 6.37%

18) A bond that pays interest semiannually has a price of $1,055.02 and a semiannual coupon

payment of $27.25. If the par value is $1,000, what is the current yield? A) 2.73% B) 5.45% C) 2.58% D) 4.91% E) 5.17%

19) Sweet Sue Foods has bonds outstanding with a coupon rate of 5.47 percent paid

semiannually and sell for $1,923.74. The bonds have a par value of $2,000 and 17 years to maturity. What is the current yield for these bonds? A) 6.16% B) 5.47% C) 5.69% D) 2.84% E) 5.40%

20) A bond that pays interest semiannually has a coupon rate of 5.08 percent and a current yield

of 5.37 percent. The par value is $1,000. What is the bond's price? A) $930.23 B) $973.00 C) $1,057.09 D) $1,024.83 E) $946.00

21) A bond with 16 years to maturity and a semiannual coupon rate of 5.02 percent has a current

yield of 5.35 percent. The bond's par value is $2,000. What is the bond's price? A) $1,845.36 B) $2,033.02 C) $1,876.64 D) $2,131.47 E) $1,938.32

22) A municipal bond has a coupon rate of 6.13 percent and a YTM of 5.73 percent. If an

investor has a marginal tax rate of 35 percent, what is the equivalent pretax yield on a taxable bond? A) 3.72% B) 9.43% C) 8.82% D) 6.40% E) 3.98%

23) A taxable bond has a coupon rate of 6.10 percent and a YTM of 5.71 percent. If an investor

has a marginal tax rate of 30 percent, what is the equivalent aftertax yield? A) 6.21% B) 4.00% C) 4.27% D) 8.71% E) 8.16%

24) A municipal bond has a YTM of 4.71 percent while the YTM of a comparable taxable bond

is 7.54 percent. What is the tax rate that will make an investor indifferent between the municipal bond and the taxable bond? A) 41.29% B) 50.69% C) 48.81% D) 60.08% E) 37.53%

25) Navarro, Incorporated, plans to issue new zero coupon bonds with a par value of $1,000 to

fund a new project. The bonds will have a YTM of 6.09 percent and mature in 15 years. If we assume semiannual compounding, at what price will the bonds sell? A) $393.07 B) $396.46 C) $411.99 D) $406.62 E) $390.36

26) There are zero coupon bonds outstanding that have a YTM of 6.03 percent and mature in 18

years. The bonds have a par value of $10,000. If we assume semiannual compounding, what is the price of the bonds? A) $3,317.87 B) $3,432.28 C) $3,485.64 D) $3,346.48 E) $3,294.99

27) There is a zero coupon bond that sells for $437.81 and has a par value of $1,000. If the bond

has 12 years to maturity, what is the yield to maturity? Assume semiannual compounding. A) 6.83% B) 6.77% C) 6.72% D) 7.13% E) 7.00%

28) There is a zero coupon bond that sells for $4,432.06 and has a par value of $10,000. If the

bond has 23 years to maturity, what is the yield to maturity? Assume semiannual compounding. A) 3.43% B) 3.48% C) 3.60% D) 3.57% E) 3.45%

29) You purchase a zero coupon bond with 23 years to maturity and a yield to maturity of 5.37

percent. The bond has a par value of $1,000. What is the implicit interest for the first year? Assume semiannual compounding. A) $15.44 B) $15.68 C) $16.09 D) $14.08 E) $15.55

30) An investor purchases a zero coupon bond with 23 years to maturity at a price of $298.56.

The bond has a par value of $1,000. What is the implicit interest for the first year? Assume semiannual compounding. A) $15.57 B) $14.10 C) $16.11 D) $15.34 E) $16.51

31) You purchase a bond with an invoice price of $1,065. The bond has a coupon rate of 5.81

percent, it makes semiannual payments, and there are 2 months to the next coupon payment. The par value is $1,000. What is the clean price of the bond? A) $1,094.05 B) $1,084.37 C) $1,045.63 D) $1,035.95 E) $1,055.32

32) The bond has a coupon rate of 5.99 percent, it makes semiannual payments, and there are 4

months to the next coupon payment. A clean price of $965 and the par value is $1,000. What is the invoice price? A) $945.03 B) $935.05 C) $955.02 D) $994.95 E) $974.98

33) A bond with a coupon rate of 5.36 percent and semiannual coupon payments matures in 17

years. The YTM is 6.52 percent. What is the effective annual yield? A) 6.63% B) 5.43% C) 6.89% D) 6.52% E) 5.36%

34) There is a bond that has a quoted price of 106.875 and a par value of $2,000. The coupon rate

is 6.93 percent and the bond matures in 23 years. If the bond makes semiannual coupon payments, what is the effective annual interest rate? A) 3.04% B) 6.36% C) 6.46% D) 5.81% E) 3.18%

35) Setrakian Industries needs to raise $78.7 million to fund a new project. The company will sell

bonds that have a coupon rate of 5.84 percent paid semiannually and that mature in 20 years. The bonds will be sold at an initial YTM of 6.55 percent and have a par value of $2,000. How many bonds must be sold to raise the necessary funds? (Round your intermediate calculations to two decimal places and final answer to the nearest whole number.) A) 53,379 bonds B) 42,703 bonds C) 78,700 bonds D) 130,815 bonds E) 39,350 bonds

36) Whipple Corporation just issued 290,000 bonds with a coupon rate of 6.08 percent paid

semiannually that mature in 15 years. The bonds have a YTM of 6.52 percent and have a par value of $2,000. How much money was raised from the sale of the bonds? (Round your intermediate calculations to two decimal places and final answer to the nearest whole dollar amount.) A) $518.76 million B) $580.00 million C) $533.58 million D) $555.81 million E) $1,067.16 million

37) A bond with a par value of $5,000 is quoted at 98.013. What is the dollar price of the bond? A) $4,900.65 B) $4,853.98 C) $4,872.65 D) $4,809.95 E) $4,933.32

38) A bond with a current yield of 5.87 percent is quoted at 93.157. What is the coupon rate of

the bond:? A) 5.47% B) 5.83% C) 5.10% D) 5.38% E) 5.19%

Answer Key Test name: Chapter 8(2) 1) A 2) E 3) A 4) C 5) E 6) E 7) A 8) B 9) D 10) B 11) E 12) B 13) E 14) E 15) C 16) B 17) A 18) E 19) C 20) E 21) C 22) C 23) B 24) E 25) D 26) B 27) E 28) D 29) C 30) C 31) C 32) E 33) A 34) C 35) B 36) D 37) A

38) A

Chapter 9: 1) Of the following choices, which one applies to the dividend growth model of stock

valuation? A) The dividend must be for the same time period as the stock price. B) The growth rate must be less than the discount rate. C) The rate of growth must be positive. D) The model cannot be applied if the growth rate is zero. E) The dividend amount must be constant over time.

2) A stock can be valued by using the

formula if the stock pays a constant annual

dividend. A) fixed coupon bond present value B) present value of an annuity due C) payout ratio D) present value of an ordinary annuity E) perpetuity present value

3) In the formula, P3 = Dx/(R − g), the dividend is for period: A) two. B) five. C) four. D) three. E) one.

4) The differential growth model of stock valuation: A) makes allowance for one change in the discount rate. B) uses DT + 1 as the dividend amount throughout the formula. C) requires g2 to be less than the discount rate. D) assumes the second growth rate will be zero. E) assumes the first growth rate will be zero.

5) The constant dividend growth model: A) is more complex than the differential growth model. B) requires the growth period be limited to a set number of years. C) is never used because firms rarely attempt to maintain steady dividend growth. D) can be used to compute a stock price at any point in time. E) most applies to stocks with differential growth rates.

6) The underlying assumption of the dividend growth model is that a stock is worth: A) the same amount to every investor regardless of their desired rate of return. B) the present value of the future income that the stock is expected to generate. C) an amount computed as the next annual dividend divided by the market rate of return. D) the same amount as any other stock that pays the same current dividend and has the

same required rate of return. E) an amount computed as the next annual dividend divided by the required rate of return.

7) Assume you are using the dividend growth model to value stocks. If you expect the market

rate of return to increase for all equity securities, then you should also expect the: A) market values of all stocks to increase. B) market values of all stocks to remain constant as the dividend growth will offset the increase in the market rate. C) market values of all stocks to decrease. D) stocks that do not pay dividends to decrease in price while the dividend-paying stocks maintain a constant price. E) dividend growth rates to increase to offset this change.

8) Ollivette is a relatively new firm and is in a period of rapid development. The company plans

on retaining all of its earnings for the next four years. Five years from now, the company projects paying an annual dividend of $.33 per share and then increasing that amount by 2 percent annually thereafter. To value this stock as of today, you would first determine the value of the stock years from today, and then determine today’s value. A) 4 B) 5 C) 6 D) 7 E) 8

9) Singh Sport Training currently pays no dividends. The company is anticipating annual

dividends of $.03, $.07, $.12, and $.25 over the next 4 years, respectively. After that, the company anticipates increasing the dividend by 2.5 percent per year. To value this stock as of today, an analyst would most likely first determine the value of: A) P1. B) P3. C) P4. D) P5. E) P6.

10) The

equals the annual dividend amount to be paid next year, divided by the current

stock price. A) yield to maturity B) total yield C) dividend yield D) capital gains yield E) earnings yield

11) The

yield is the rate at which a stock’s price is expected to appreciate or

depreciate. A) current B) total C) dividend D) capital gains E) earnings

12) For a firm with a constant payout ratio, the dividend growth rate can be estimated as: A) Payout ratio × Return on equity. B) Return on assets × Retention ratio. C) Return on equity × (1 + Retention ratio). D) Payout ratio × Return on assets. E) Return on retained earnings × Retention ratio.

13) The A) B) C) D) E)

equals the total return on a stock. dividend yield minus the capital gains yield dividend growth rate minus the dividend yield dividend yield plus the dividend growth rate growth rate of the dividends dividend divided by the sum of the dividend yield and capital gains yield

14) A stock’s PE ratio is primarily affected by which one of the following sets of three factors? A) Accounting practices, opportunities, the market rate of return B) Dividend yield, capital gains yield, opportunities C) Market rate of return, risk, opportunities D) Accounting practices, market rate of return, risk E) Risk, opportunities, accounting practices

15) Of the following choices, which one generally has the greatest impact on a firm’s PE ratio? A) Required rate of return B) Current dividends C) Future opportunities D) The overall risk level of the current firm E) Depreciation method used by the firm

16) The closing price of a stock is quoted at 32.08, with a PE of 21 and a net change of .36.

Based on this information, which one of the following statements is correct? A) The closing price on the previous day was $.36 higher than today’s closing price. B) A dealer will buy the stock at $32.08 and sell it at $32.44 per share. C) The current earnings per share equal $32.08/21 + $.36. D) The current stock price is equivalent to 21 years of the firm’s current earnings per share. E) The earnings per share have increased by $.36 this year.

17) A forward PE is generally based on the projected: A) average earnings for the next five years. B) average earnings for the next three years. C) earnings for the upcoming quarter. D) earnings for the next year. E) stock price in one year.

18) Enterprise value equals the: A) combined market value of debt and equity minus excess cash. B) market value of equity minus the market value of debt plus excess cash. C) market value of debt plus the book value of equity minus excess cash. D) combined market value of debt and equity. E) combined book value of debt and equity minus excess cash.

19) One advantage of the EV/EBITDA ratio over the PE ratio is the: A) inclusion of depreciation charges. B) increased reliance on leverage. C) averaging of annual sales. D) inclusion of all the firm’s cash reserves. E) lessened impact of leverage on the ratio.

20) When calculating a firm’s enterprise value, what portion of the firm’s cash should be

included, in order to remain in the enterprise value? A) Only the amount needed to run the business B) None of the cash should be included C) Somewhere between 25 and 50 percent, at the analyst’s discretion D) Only the amount necessary to maintain a constant EV/EBITDA ratio E) The average cash balance over the past three years

21) The free cash flow model of valuation is most helpful for firms that: A) have similar investment opportunities as other firms in their industry. B) pay steady dividends and have excess cash. C) are financially sound and thus pay constant, high dividends. D) do not pay dividends, but do have external financing needs. E) are projected to grow at a constant, steady pace while increasing their dividends.

22) If the issuer of a stock receives the proceeds from the sale of that stock, then the sale: A) had to have occurred on the floor of an exchange. B) was a secondary market transaction. C) was transacted on the NYSE. D) was conducted in the primary market. E) had to have been a limit order.

23) Of the following statements, which one is correct? A) Investors earn a return called a spread. B) Dealers pay a fee, called the spread, to brokers. C) Investors sell securities at the ask price. D) Dealers buy securities at the bid price. E) Brokers maintain an inventory of securities.

24) Supplemental liquidity providers (SLPs): A) act as floor brokers. B) only represent stock purchasers. C) seek the best price for their customers. D) do not operate on the floor of a stock exchange. E) have been replaced by designated market makers.

25) A stop order to sell at $32 will be executed: A) at a price of $32 at the end of the day on which the order was placed. B) at $32 following the first trade with a price below $32. C) as a market order once a trade occurs at a price of $32 or less. D) immediately at a price of $32. E) as a market order once a trade occurs at a price of $32 or higher.

26) A limit order to buy: A) guarantees the quantity purchased but not the price. B) guarantees both the purchase price and the order fulfillment. C) is executed only if the purchase price is less than the limit amount. D) guarantees the purchase price but not the order execution. E) will be executed either at the limit price or at the end-of-day price.

27) A day order to sell at a limit of $46 will be: A) executed at the next available price once a trade occurs at the limit price. B) cancelled at the end of the day if not executed. C) executed only if the purchase price is less than the limit amount. D) executed at the end-of-day price if $46 has not been obtained. E) transferred to a market order on the following day if not executed at the limit price.

28) Nasdaq: A) has a single trading floor located in Chicago, Illinois. B) has multiple trading floors. C) is a designated market maker system. D) has a multiple market maker system. E) is closed to all electronic communications networks (ECNs).

29) You recently contacted a brokerage firm and purchased 100 shares of stock. The brokerage

firm acquired the shares for you by making a deal with a floor broker who represented one of the stock issuer’s shareholders. Given this, you know your purchase: A) was conducted in the secondary market. B) occurred over-the-counter. C) was for shares of a stock listed on Nasdaq. D) occurred on an ECN. E) involved the issuance of new shares.

30) Inside quotes on a stock are: A) the prices available only to corporate insiders. B) prices obtained only on the actual floor of an exchange. C) prices available only to stock market employees. D) the lowest asked quote and the highest bid quote. E) prices paid that lie between yesterday’s closing price and today’s closing price.

31) Teahna’s announced that its next annual dividend will be $1.80 per share and all future

dividends will increase by 4 percent annually. What is the maximum amount you should pay to purchase a share of this stock if you require a rate of return of 11 percent? A) $26.74 B) $28.54 C) $17.02 D) $25.71 E) $16.36

32) How much are you willing to pay for one share of stock if the company just paid an annual

dividend of $2.57, the dividends increase by 4.8 percent annually, and you require a rate of return of 17.6 percent? A) $23.61 B) $15.30 C) $21.04 D) $14.60 E) $20.08

33) Akinnibo sun Motors recently paid a per share dividend of $1.97. Dividends are expected to

increase by 2.8 percent annually. What is one share of this stock worth today if the appropriate discount rate is 17 percent? A) $13.87 B) $14.26 C) $11.59 D) $13.87 E) $16.23

34) The stock of Sharkey Enterprises typically provides an average rate of return of 12.4 percent.

The firm’s next annual dividend is projected at $.89 with future increases of 2.1 percent per year. What price should you pay for this stock if you are satisfied with the firm’s average rate of return? A) $8.64 B) $7.18 C) $8.82 D) $9.71 E) $7.73

35) Moreno Corporation common stock pays a constant annual dividend of $4.50 per share.

What is the value of this stock at a discount rate of 14.2 percent? A) $36.19 B) $61.67 C) $54.00 D) $45.00 E) $31.69

36) Williams Builders is expected to pay annual dividends of $1.40, $1.75, and $2.00 per share

over the next three years, respectively. After that, the dividend is expected to remain constant. What is the current value per share at a discount rate of 14 percent? A) $12.22 B) $13.57 C) $13.08 D) $12.82 E) $13.39

37) Jafferali, Incorporated, common stock sells for $21 per share and pays an annual dividend

that increases by 5 percent each year. The rate of return on this stock is 9 percent. What is the amount of the last dividend paid? A) $.77 B) $.80 C) $.84 D) $.87 E) $.88

38) The common stock of Energy Saver pays an annual dividend that is expected to increase by 4

percent annually. The stock commands a market rate of return of 12 percent and sells for $58.25 per share. What is the expected amount of the next dividend to be paid? A) $4.87 B) $5.02 C) $5.10 D) $4.66 E) $4.33

39) The Reading Company has adopted a policy of increasing the annual dividend on its common

stock at a constant rate of 3 percent annually. The last dividend it paid (T = 0) was $.90 per share. What will be the company’s dividend six years from now? A) $.90 B) $.93 C) $1.04 D) $1.07 E) $1.11

40) You have decided to purchase shares of Sohne, Incorporated, but expect to earn a 15.4

percent rate of return to compensate for the perceived risk of such ownership. What is the maximum price you should pay per share if the company pays a constant $5.25 annual dividend per share? A) $52.50 B) $63.00 C) $39.34 D) $72.70 E) $34.09

41) Dasgupta common stock sells for $23.43 per share at a market rate of return of 11.65 percent.

The company just paid its annual dividend of $1.20. What is the dividend growth rate? A) 5.87% B) 6.43% C) 5.91% D) 6.07% E) 6.21%

42) Kalamarides Enterprises will pay an annual dividend of $2.08 per share on its common stock

next year. The firm just paid a dividend of $2.00 per share and adheres to a constant rate of growth dividend policy. What will one share of S&P common stock be worth ten years from now if the applicable discount rate is 8 percent? A) $71.16 B) $74.01 C) $76.97 D) $80.05 E) $83.25

43) The Merriweather Company just announced that it will pay a dividend next year of $1.50.

The company will then increase its dividend by 15 percent per year for three years after which it will maintain a constant 5 percent dividend growth rate. What is one share worth today at a required rate of return of 11 percent? A) $29.40 B) $45.63 C) $32.00 D) $28.57 E) $34.90

44) Patel & Valdez is planning on increasing its annual dividend by 20 percent next year and

then decreasing the growth rate to a constant 5 percent per year. The company just paid its annual dividend in the amount of $1 per share. What is the current value of a share if the required rate of return is 14 percent? A) $13.28 B) $13.42 C) $13.33 D) $13.19 E) $13.24

45) Mesa Homes just paid a per share annual dividend of $1.50. The company is planning on

paying $1.62, $1.68, $1.75, and $1.80 per share over the next four years, respectively. After that, the dividend will be a constant $2.00 per share per year. What is the market price of this stock if the market rate of return is 15 percent? A) $6.00 B) $8.49 C) $12.48 D) $11.57 E) $9.09

46) Choi Citrus is going to pay annual dividends of $.35, $.50, and $.80 per share over the next

three years, respectively. After that, the dividend will be $1.25 per share indefinitely. What is this stock worth today at a discount rate of 13.45 percent? A) $6.20 B) $9.48 C) $10.88 D) $7.61 E) $5.06

47) Duran Logistics announced its next annual dividend will be $.40 per share. The following

dividends will be $.60, and $.75 per share annually for the following two years, respectively. After that, dividends are projected to increase by 3.5 percent per year. How much is one share of this stock worth at a rate of return of 12 percent? A) $8.45 B) $6.84 C) $7.87 D) $8.06 E) $7.03

48) Fong Medical Equipment recently paid $1.10 as its annual dividend. Future dividends are

projected at $1.06, $1.02, and $1.00 over the next three years, respectively. After that, the dividend is expected to decrease by 2 percent annually. What is one share of this stock worth at a rate of return of 17 percent? A) $5.62 B) $5.50 C) $5.21 D) $5.33 E) $5.98

49) Davey Mortorsport just paid a dividend of $1.03 per share. The company announced today

that it expects to pay $.90 per share next year and a final liquidating dividend of $18.44 in two years. What is one share of this stock worth today if the required rate of return is 16 percent? A) $14.94 B) $14.48 C) $13.23 D) $13.44 E) $13.60

50) A company plans to pay an annual dividend of $.30 per share for two years commencing two

years from today. After that time, a constant $1 per share annual dividend is planned indefinitely. Given a required return of 14 percent, what is the current value of this stock? A) $4.82 B) $5.25 C) $5.39 D) $5.46 E) $5.58

51) Rangel Corporation paid an annual dividend of $2.50 last year. The company has announced

plans to lower the dividend by $.50 per year. Once the dividend amount becomes zero, the company will cease all dividends permanently. The required rate of return is 14.5 percent. What is one share of this stock worth? A) $3.85 B) $3.48 C) $4.87 D) $4.13 E) $4.39

52) Wholesome Foods paid its first annual dividend yesterday in the amount of $.28 per share.

The company plans to double each annual dividend payment for the next three years. After that time, it plans to pay a constant $2.25 per share indefinitely. What is one share of this stock worth today if the market rate of return on similar securities is 11.5 percent? A) $19.41 B) $18.40 C) $17.46 D) $16.93 E) $17.13

53) Garnet Aviation just paid its annual dividend of $.60 per share. The projected dividends for

the next five years are $.30, $.50, $.75, $1.00, and $1.20, respectively. After that time, the dividends will be held constant at $1.40 per share. What is this stock worth today at a discount rate of 14 percent? A) $7.56 B) $10.60 C) $8.02 D) $9.28 E) $9.43

54) Plateau, Incorporated, pays a dividend of $2.00 per share every other year with the last

payment having just been paid. Five years from now, the company is repurchasing all of the outstanding shares at a price of $50 per share. What is the current value of one share at a discount rate of 12 percent? A) $34.03 B) $31.24 C) $33.78 D) $27.89 E) $34.99

55) Yesterday, Railway Tours paid its annual dividend of $1.20 per share. The company has been

reducing the dividends by 10 percent each year. What is the value of this stock at a discount rate of 13 percent? A) $4.70 B) $3.71 C) $8.31 D) $36.00 E) $27.00

56) Acorn Equity will reduce its annual dividend by 10 percent per year for the next two years.

After that, it will maintain a constant dividend of $.70 per share. The company just paid a dividend of $1.80 per share. What is the value of this stock if the required rate of return is 13 percent? A) $6.99 B) $6.79 C) $8.22 D) $8.87 E) $7.62

57) What would be the maximum an investor should pay for the common stock of a firm that has

no growth opportunities but pays a dividend of $3.55 per year? The required rate of return is 17 percent. A) $24.43 B) $49.84 C) $20.88 D) $35.50 E) $42.60

58) O’Connor Corporation will pay an annual dividend of $1.00 next year. The dividend will

increase by 12 percent per year for the following two years before growing at 4 percent indefinitely thereafter. If the required rate of return is 10 percent, what is the stock's current value? A) $13.38 B) $14.05 C) $19.11 D) $9.80 E) $10.38

59) A company just paid an annual dividend of $.40 per share and plans to increase the dividend

by 7 percent per year for the next 6 years and then increase it by 4 percent annually thereafter. What is the value of this stock at the end of Year 6 if the discount rate is 11 percent? A) $10.63 B) $8.92 C) $9.68 D) $10.21 E) $9.37

60) Richards Retailers just paid an annual dividend of $1.20 and increases its dividend by 2.5

percent annually. You would like to purchase 100 shares of stock in this firm but realize that you will not have the funds to do so for another three years. If you desire a rate of return of 10 percent, how much should you expect to pay for 100 shares when you can afford to buy this stock? Ignore trading costs. A) $1,640 B) $1,681 C) $1,723 D) $1,766 E) $1,810

61) Longshire just paid $1.50 as its annual dividend and increases its dividend by 2.5 percent

each year. What will Longshire's stock price be in ten years at a discount rate of 12.25 percent? A) $19.46 B) $22.08 C) $20.19 D) $19.70 E) $21.50

62) Windle’s has a policy of increasing its annual dividend by 1.75 percent each year. How much

will one share be worth five years from now if the required rate of return is 15 percent and the next dividend will be $3.40? A) $28.48 B) $27.99 C) $34.84 D) $28.60 E) $32.78

63) A stock pays a constant annual dividend and sells for $31.11 per share. If the dividend yield

of this stock is 9 percent, what is the dividend amount? A) $1.40 B) $1.80 C) $2.20 D) $2.40 E) $2.80

64) The common stock of Jacey Home Store sells for $38.42 per share. The stock is expected to

pay an annual dividend of $1.80 next year and increase that amount by 4 percent annually thereafter. What is the market rate of return on this stock? A) 9.04% B) 9.13% C) 8.69% D) 9.22% E) 8.36%

65) Hernandez Diving just paid an annual dividend of $2.20 and announced that all future

dividends would be $2.25 per share indefinitely. What is your required rate of return if you are willing to pay $15.25 per share for this stock? A) 14.75% B) 16.07% C) 13.88% D) 13.67% E) 14.50%

66) Cadar Security recently paid an annual dividend of $6.60 on its common stock. This dividend

increases by 3 percent per year. What is the market rate of return if the stock is selling for $42.21 per share? A) 16.40% B) 15.57% C) 18.64% D) 19.11% E) 15.64%

67) Javelina Corporation just announced its next annual dividend will be $3.43 per share and all

future dividends will increase by 3.8 percent annually. What is the market rate of return if this stock is currently selling for $44.73 per share? A) 11.47% B) 7.38% C) 7.96% D) 11.76% E) 11.04%

68) Shares of Ramirez Corporation offer an expected total return of 12 percent. The dividend is

increasing at a constant 3.25 percent per year. What is the value of the next dividend if the stock is selling at $28 per share? A) $2.50 B) $2.45 C) $2.78 D) $2.34 E) $2.10

69) A stock had a total return of 19.25 percent last year. The dividend amount was $.65 per share

which equated to a dividend yield of 3.1 percent. What is the dividend growth rate? A) 22.35% B) 19.23% C) 19.90% D) 18.60% E) 16.15%

70) The Marcus Company had net earnings of $127,000 this past year of which $46,200 was paid

out in dividends. The company's equity was $1,587,500. Lory has 200,000 shares outstanding with a current market price of $11.63 per share. Both the number of shares and the dividend payout ratio are constant. What is the required rate of return if the growth rate is 5.6 percent? A) 8.42% B) 6.67% C) 7.70% D) 7.39% E) 8.24%

71) The stock of Manca Development sells for $32.37 per share. The firm just paid an annual

dividend of $5.85 per share and has a long-established record of increasing its dividend by a constant 2.4 percent annually. What is the market rate of return on this stock? A) 20.47% B) 20.91% C) 18.07% D) 18.51% E) 14.86%

72) Schweitz has a fixed dividend payout ratio of 40 percent, current net income of $5,200, total

assets of $56,400, and total equity of $21,600. Given this information, what estimate would you use as the dividend growth rate if the last dividend paid was $.464 per share? A) 9.63% B) 3.69% C) 12.84% D) 8.61% E) 14.44%

73) The dividend yield on Estrella common stock is 5.2 percent. The company just paid a $2.10

dividend. The rumor is that the dividend will be $2.30 next year. The dividend growth rate is expected to remain constant at the current level. What is the required rate of return on Estrella’s stock? A) 14.72% B) 12.31% C) 18.29% D) 20.01% E) 24.21%

74) Triangle Supply has a return on equity of 11.6 percent, a profit margin of 6.2 percent, and a

payout ratio of 35 percent. What is the firm's growth rate? A) 13.74% B) 7.54% C) 11.09% D) 8.77% E) 9.71%

75) Arrington stock is currently valued at $28.40 per share. The firm had earnings per share of

$1.86 last year and projects earnings of $2.09 per share for next year. What is the trailing twelve month price-earnings ratio? A) 13.59 B) 14.38 C) 12.84 D) 16.67 E) 15.27

76) The stock of Ravenn’s Nest is currently valued at $32.70 per share. The firm had earnings per

share of $1.88 last year and projects earnings of $2.10 per share for next year. What is the forward price-earnings ratio? A) 15.57 B) 14.38 C) 17.39 D) 16.43 E) 15.06

77) Outbound Trading has annual revenue of $387,000 with costs of $216,400. Depreciation is

$48,900 and the tax rate is 21 percent. The firm has debt outstanding with a market value of $182,000 along with 9,500 shares of stock that is selling at $67 per share. The firm has $48,000 of cash of which $29,500 is needed to run the business. What is the firm's EV/EBITDA ratio? A) 5.57 B) 4.69 C) 3.39 D) 3.93 E) 6.20

78) Alcala Imports has annual revenue of $506,000 with costs of $369,400. Depreciation is

$64,900 and the tax rate is 21 percent. The firm has debt outstanding with a market value of $240,000 along with 7,500 shares of stock that is valued at $87 per share. The firm has $51,200 of cash, all of which is needed to run the business. What is the firm’s EV/EBITDA ratio? A) 6.37 B) 6.53 C) 5.39 D) 6.15 E) 6.28

79) Gardner Hospitals has total revenue of $418,300, earnings before interest and taxes of

$102,600, depreciation of $59,200, and a tax rate of 21 percent. The firm is all-equity financed with 15,000 shares outstanding at a book value of $38.03 per share and a price-tobook ratio of 3.2. What is the firm's EV/EBITDA ratio if the firm has excess cash of $49,300? A) 9.67 B) 11.28 C) 8.39 D) 9.15 E) 10.98

80) Hedge Corporation is expected to have annual free cash flow of $62,000, $65,400, and

$68,900 for the next three years, respectively. After that, the free cash flow is expected to increase at a constant rate of 2 percent per year. At a discount rate of 14.5 percent, what is the present value of this firm? A) $469,118 B) $603,509 C) $577,088 D) $524,467 E) $497,364

81) Nighthawk Theaters has 15,000 shares of stock outstanding and projected annual free cash

flows of $48,200, $57,900, $71,300, and $72,500 for the next four years, respectively. After that, the cash flows are expected to increase at a constant annual rate of 1.6 percent. What is the current value per share of stock at a discount rate of 15.4 percent? A) $31.57 B) $29.06 C) $28.99 D) $26.14 E) $34.08

82) A number of publicly traded firms pay no dividends yet investors are willing to buy shares in

these firms. How is this possible? Does this violate our basic principle of stock valuation? Explain.

83) What are the components of the required rate of return on a share of stock? Briefly explain

each component.

84) Explain whether it is easier to find the required return on a publicly traded stock or a publicly

traded bond, and explain why.

85) What is the difference between the EV/EBITDA ratio and the PE ratio?

86) Explain the differences between a market order, a limit order, and a stop order.

Answer Key Test name: Chapter 9(1) 1) B 2) E 3) C 4) C 5) D 6) B 7) C 8) A 9) C 10) C 11) D 12) E 13) C 14) E 15) C 16) D 17) D 18) A 19) E 20) A 21) D 22) D 23) D 24) D 25) C 26) D 27) B 28) D 29) A 30) D 31) D 32) C 33) B 34) A 35) E 36) B 37) B

38) D 39) D 40) E 41) E 42) C 43) C 44) C 45) C 46) D 47) C 48) B 49) B 50) B 51) A 52) E 53) A 54) B 55) A 56) B 57) C 58) C 59) B 60) D 61) C 62) B 63) E 64) C 65) A 66) D 67) A 68) B 69) E 70) C 71) B 72) E 73) A 74) B 75) E 76) A 77) B

78) B 79) E 80) D 81) A 82) Essay 83) Essay 84) Essay 85) Essay 86) Essay

Student name: 1) You want a seat on the board of directors of Four Keys, Incorporated. The company has

290,000 shares of stock outstanding and the stock sells for $49 per share. There are currently 5 seats up for election. The company uses straight voting. How many shares do you need to guarantee that you will be elected to the board? A) 96,668 shares B) 48,334 shares C) 145,001 shares D) 58,000 shares E) 130,501 shares

2) You want a seat on the board of directors of Red Cow, Incorporated. The company has

310,000 shares of stock outstanding and the stock sells for $55 per share. There are currently 3 seats up for election. The company uses straight voting. How much will it cost you to guarantee that you will be elected to the board? A) $5,683,333 B) $6,393,805 C) $8,525,055 D) $7,672,550 E) $4,262,555

3) You want a seat on the board of directors of Four Keys, Incorporated. The company has

235,000 shares of stock outstanding and the stock sells for $60 per share. There are currently 5 seats up for election. If the company uses cumulative voting, how many shares do you need to guarantee that you will be elected to the board? A) 78,334 shares B) 39,168 shares C) 47,000 shares D) 117,501 shares E) 35,251 shares

4) You want a seat on the board of directors of Zeph, Incorporated. The company has 210,000

shares of stock outstanding and the stock sells for $75 per share. There are currently 3 seats up for election. If the company uses cumulative voting, how much will it cost you to guarantee that you will be elected to the board? A) $5,880,000 B) $8,820,084 C) $6,615,084 D) $3,969,076 E) $3,937,575

5) Michael's, Incorporated, just paid $2.00 to its shareholders as the annual dividend.

Simultaneously, the company announced that future dividends will be increasing by 4.4 percent. If you require a rate of return of 8.6 percent, how much are you willing to pay today to purchase one share of the company's stock? A) $51.71 B) $16.06 C) $49.71 D) $24.28 E) $24.86

6) Stoneheart Group is expected to pay a dividend of $2.93 next year. The company's dividend

growth rate is expected to be 4.3 percent indefinitely and investors require a return of 10.5 percent on the company's stock. What is the stock price? A) $49.29 B) $47.26 C) $44.90 D) $27.90 E) $42.53

7) You are considering purchasing stock in Canyon Echo. You feel the company will increase

its dividend at 4.4 percent indefinitely. The company just paid a dividend of $3.47 and you feel that the required return on the stock is 11.2 percent. What is the price per share of the company's stock? A) $53.27 B) $47.95 C) $50.61 D) $30.98 E) $51.03

8) Symon's Suppers Company has announced that it will pay a dividend of $4.41 per share one

year from today. Additionally, the company expects to increase its dividend by 4.1 percent annually. The required return on the company's stock is 11.5 percent. What is the current share price? A) $56.61 B) $62.04 C) $55.83 D) $59.59 E) $38.35

9) A stock currently sells for $39. The dividend yield is 2.8 percent and the dividend growth

rate is 4.1 percent. What is the amount of the dividend that was just paid? A) $.92 B) $1.09 C) $1.05 D) $.98 E) $1.00

10) A stock currently sells for $49. The dividend yield is 3.4 percent and the dividend growth

rate is 4.7 percent. What is the amount of the dividend to be paid in one year? A) $1.67 B) $1.51 C) $1.55 D) $1.59 E) $1.39

11) A stock is expected to maintain a constant dividend growth rate of 4.2 percent indefinitely. If

the stock has a dividend yield of 5.5 percent, what is the required return on the stock? A) 8.7% B) 9.1% C) 9.7% D) 8.1% E) 9.2%

12) A stock just paid a dividend of $5.45 and is expected to maintain a constant dividend growth

rate of 4.5 percent indefinitely. If the current stock price is $79, what is the required return on the stock? A) 10.93% B) 10.83% C) 11.71% D) 11.40% E) 9.97%

13) CDB stock is currently priced at $67. The company will pay a dividend of $4.97 next year

and investors require a return of 11.3 percent on similar stocks. What is the dividend growth rate on this stock? A) 3.88% B) 3.62% C) 3.69% D) 6.49% E) 7.42%

14) Kindzi Company has preferred stock outstanding that is expected to pay an annual dividend

of $4.88 every year in perpetuity. If the required return is 4.69 percent, what is the current stock price? A) $99.39 B) $104.05 C) $97.11 D) $93.65 E) $108.93

15) Voltanis Corporation has preferred stock outstanding that will pay an annual dividend of

$3.51 every year in perpetuity. If the stock currently sells for $96.61 per share, what is the required return? A) 4.15% B) 2.75% C) 3.27% D) 3.63% E) 3.40%

16) Stana, Incorporated, has preferred stock outstanding that sells for $99.81 per share. If the

required return is 3.93 percent, what is the annual dividend? A) $3.67 B) $3.53 C) $4.08 D) $3.77 E) $3.92

17)

McKerley Corporation has preferred stock outstanding that will pay an annual dividend of $6.55 per share with the first dividend exactly 15 years from today. If the required return is 4.17 percent, what is the current price of the stock? A) $81.70 B) $88.66 C) $85.11 D) $150.79 E) $157.07

18) Asonia Company will pay a dividend of $3.90, $8.05, $10.90, and $12.65 per share for each

of the next four years, respectively. The company will then close its doors. If investors require a return of 11 percent on the company's stock, what is the stock price? A) $26.35 B) $31.52 C) $29.27 D) $38.83 E) $33.25

19) Knightmare, Incorporated, will pay a dividend of $4.75, $8.85, and $12.05 per share for each

of the next three years, respectively. The company will then close its doors. Investors require a return of 8.9 percent on the company's stock. What is the current stock price? A) $27.25 B) $24.23 C) $21.15 D) $26.09 E) $30.94

20) Leslie's Unique Clothing Stores offers a common stock that pays an annual dividend of $2.70

a share. The company has promised to maintain a constant dividend. How much are you willing to pay for one share of this stock if you want to earn a return of 12.70 percent on your equity investments? A) $34.29 B) $21.26 C) $10.00 D) $4.70 E) $15.40

21) The common stock of Eddie's Engines, Incorporated, sells for $44.78 a share. The stock is

expected to pay a dividend of $3.20 per share next year. Eddie's has established a pattern of increasing their dividends by 5.3 percent annually and expects to continue doing so. What is the market rate of return on this stock? A) 13.99% B) 7.15% C) 6.35% D) 12.45% E) 15.04%

22) Shares of common stock of the Samson Company offer an expected total return of 20.00

percent. The dividend is increasing at a constant 6.80 percent per year. The dividend yield must be: A) 2.94% B) 6.80% C) 13.20% D) 26.80% E) 20.00%

23) Weisbro and Sons common stock sells for $23 a share and pays an annual dividend that

increases by 4.5 percent annually. The market rate of return on this stock is 10.2 percent. What is the amount of the last dividend paid by Weisbro and Sons? A) $1.37 B) $1.25 C) $2.24 D) $.99 E) $1.21

24) The Bell Weather Company is a new firm in a rapidly growing industry. The company is

planning on increasing its annual dividend by 19 percent a year for the next 4 years and then decreasing the growth rate to 3 percent per year. The company just paid its annual dividend in the amount of $3.30 per share. What is the current value of one share of this stock if the required rate of return is 8.80 percent? A) $100.47 B) $103.77 C) $83.87 D) $120.82 E) $117.52

25) NU YU announced today that it will begin paying annual dividends. The first dividend will

be paid next year in the amount of $.49 a share. The following dividends will be $.54, $.69, and $.99 a share annually for the following three years, respectively. After that, dividends are projected to increase by 3.4 percent per year. How much are you willing to pay today to buy one share of this stock if your desired rate of return is 15 percent? A) $9.31 B) $9.12 C) $8.82 D) $1.73 E) $6.90

26) The Red Bud Company pays a constant dividend of $1.70 a share. The company announced

today that it will continue to do this for another 2 years after which time they will discontinue paying dividends permanently. What is one share of this stock worth today if the required rate of return is 7.3 percent? A) $3.06 B) $1.89 C) $3.40 D) $1.82 E) $4.76

27) Railway Cabooses just paid its annual dividend of $1.70 per share. The company has been

reducing the dividends by 11.3 percent each year. How much are you willing to pay today to purchase stock in this company if your required rate of return is 12 percent? A) $15.04 B) $6.47 C) $8.73 D) $6.98 E) $8.12

28) Keidis Industries will pay a dividend of $4.65, $5.75, and $6.95 per share for each of the next

three years, respectively. In four years, you believe that the company will be acquired for $64.00 per share. The return on similar stocks is 10.2 percent. What is the current stock price? A) $72.66 B) $55.56 C) $57.54 D) $59.84 E) $62.89

29) Braxton's Cleaning Company stock is selling for $30.00 per share based on a required return

of 9.5 percent. What is the the next annual dividend if the growth rate in dividends is expected to be 3.2 percent indefinitely? A) $2.07 B) $1.89 C) $1.83 D) $1.95 E) $1.73

30) The stock in Up-Towne Movers is selling for $46.60 per share. Investors have a required

return of 9.2 percent and expect the dividends to grow at 4.4 percent indefinitely. What was the dividend the company just paid? A) $2.15 B) $1.96 C) $2.16 D) $2.24 E) $2.44

31) Santa Klaus Toys just paid a dividend of $3.30 per share. The required return is 9.6 percent

and the perpetual dividend growth rate is 4.2 percent. What price should this stock sell for five years from today? A) $61.11 B) $81.51 C) $78.22 D) $72.04 E) $75.07

32) This morning you purchased a stock that just paid an annual dividend of $3.30 per share. You

require a return of 9.6 percent and the dividend will increase at an annual growth rate of 4.2 percent. If you sell this stock in three years, what will your capital gain be? A) $10.93 B) $2.67 C) $6.28 D) $4.20 E) $8.37

33) The common stock of Sweet Treats is selling for $50.60 per share. The company is expected

to have an annual dividend increase of 3.7 percent indefinitely and pay a dividend of $3.85 in one year. What is the total return on this stock? A) 12.75% B) 11.59% C) 12.75% D) 12.03% E) 11.31%

34) Brickhouse is expected to pay a dividend of $2.45 and $2.18 over the next two years,

respectively. After that, the company is expected to increase its annual dividend at 2.5 percent. What is the stock price today if the required return is 9.9 percent? A) $29.03 B) $27.23 C) $31.13 D) $33.21 E) $25.00

35) Red Sun Rising just paid a dividend of $2.16 per share. The company said that it will

increase the dividend by 30 percent and 25 percent over the next two years, respectively. After that, the company is expected to increase its annual dividend at 3.6 percent. If the required return is 10.6 percent, what is the stock price today? A) $45.01 B) $47.88 C) $25.00 D) $42.47 E) $46.44

36) General Importers announced that it will pay a dividend of $4.10 per share one year from

today. After that, the company expects a slowdown in its business and will not pay a dividend for the next 6 years. Then, 8 years from today, the company will begin paying an annual dividend of $2.20 forever. The required return is 12.3 percent. What is the price of the stock today? A) $3.65 B) $10.72 C) $17.89 D) $11.59 E) $12.57

37) New Gadgets, Incorporated, currently pays no dividend but is expected to pay its first annual

dividend of $5.45 per share exactly 6 years from today. After that, the dividends are expected to grow at 3.6 percent forever. If the required return is 12.4 percent, what is the price of the stock today? A) $61.93 B) $30.71 C) $51.89 D) $34.52 E) $40.27

38) For the past six years, the stock price of Slippery Rock Mining has been increasing at a rate

of 6.6 percent per year. Currently, the stock is selling for $73 per share and has a required return of 9.1 percent. What is the dividend yield? A) 5.8% B) 6.6% C) 5.4% D) 7.3% E) 2.5%

39) Graphical Designs is offering 20-20 preferred stock. The stock will pay an annual dividend

of $20 with the first dividend payment occurring 20 years from today. The required return on this stock is 5.10 percent. What is the price of the stock today? A) $141.49 B) $145.01 C) $152.41 D) $392.16 E) $137.98

40) Mariota Corporation just paid a dividend of $3.40 per share on its stock. The dividend

growth rate is expected to be 4.1 forever and investors require a return of 11.8 percent on this stock. What will the stock price be in 10 years? A) $22.52 B) $65.99 C) $61.45 D) $68.70 E) $44.83

41) Sankey Company has earnings per share of $3.75. The benchmark PE is 18.3 times. What

stock price would you consider appropriate? A) $22.05 B) $68.63 C) $48.80 D) $58.71 E) $46.85

42) Flex Company just paid total dividends of $600,000 and reported additions to retained

earnings of $1,800,000. The company has 525,000 shares of stock outstanding and a benchmark PE of 15.4 times. What stock price would you consider appropriate? A) $17.60 B) $70.40 C) $52.80 D) $66.88 E) $63.36

43) Gnomes R Us just paid a dividend of $1.85 per share. The company has a dividend payout

ratio of 45 percent. If the PE ratio is 16.4 times, what is the stock price? A) $13.65 B) $67.42 C) $55.16 D) $30.34 E) $61.29

44) Ghost Riders Company has an EPS of $1.45 that is expected to grow at 6.5 percent per year.

If the PE ratio is 17.15 times, what is the projected stock price in 4 years? A) $30.04 B) $34.07 C) $28.39 D) $33.03 E) $31.99

45) Fowler is expected to pay a dividend of $1.87 one year from today and $2.02 two years from

today. The company has a dividend payout ratio of 30 percent and the PE ratio is 19.25 times. If the required return on the company's stock is 12.2 percent, what is the current stock price? A) $102.96 B) $47.40 C) $106.23 D) $110.48 E) $32.56

46) The Ronnie Company has sales per share of $25.73. If the PS ratio is 1.82 times, what is the

stock price? A) $14.15 B) $49.90 C) $46.83 D) $13.59 E) $40.93

47) Blitz Corporation had total sales of $3,170,000 last year and has 110,000 shares of stock

outstanding. The benchmark PS is 1.68 times. What stock price would you consider appropriate? A) $43.57 B) $48.41 C) $45.19 D) $38.73 E) $17.15

48) Silky Smooth has an EPS of $3.14 per share and a profit margin of 7 percent. If the PS ratio

is 1.77 times, what is the stock price? A) $89.32 B) $92.63 C) $21.98 D) $86.01 E) $79.40

49) Rise Above This has sales per share of $19.91 that is expected to grow at 4.2 percent per

year. The PS ratio is 1.63 times. What is the projected stock price in 5 years? A) $40.70 B) $36.22 C) $41.54 D) $38.26 E) $39.87

50) Erna Company is expected to pay a dividend of $2.75 one year from today and $2.90 two

years from today. The company's sales in two years are expected to be $16,300,000. The company has a PS ratio of 1.93 times, and 530,000 shares outstanding. If the required return on the company's stock is 12.1 percent, what is the current stock price? A) $4.76 B) $47.23 C) $54.08 D) $6.91 E) $52.00

Answer Key Test name: Chapter 9(2) 1) C 2) C 3) B 4) E 5) C 6) B 7) A 8) D 9) C 10) A 11) C 12) C 13) A 14) B 15) D 16) E 17) B 18) A 19) C 20) B 21) D 22) C 23) B 24) A 25) E 26) A 27) B 28) C 29) B 30) A 31) C 32) E 33) E 34) A 35) B 36) D 37) D

38) E 39) C 40) D 41) B 42) B 43) B 44) E 45) C 46) C 47) B 48) E 49) E 50) E

Chapter 10: 1) The stock of Ramba Moving sold for $53 per share at the beginning of the year. During the

year, the company paid a dividend of $2.50 per share and then ended the year with a stock price of $51.75. The change in the stock price is best described as a: A) capital gain. B) positive total dollar return. C) capital loss. D) negative total dollar return. E) negative dividend yield.

2) For any given stock, the capital gains yield plus the dividend yield equals the: A) variance of returns. B) geometric return. C) average period return. D) current yield. E) total return.

3) The portfolio of small-company common stocks measured by Ibbotson, et al. is best

described as the stocks of the firms that: A) represent the smallest twenty percent of the companies listed on the NYSE. B) have gone public within the past five years. C) are too small to be listed on the NYSE. D) are included in the S&P 500 index. E) trade publicly for $5 per share or less.

4) Based on the period from 1926 through 2020,

have tended to outperform other

securities over the long-term. A) U.S. Treasury bills B) large-company stocks C) long-term corporate bonds D) small-company stocks E) long-term government bonds

5) During the period from 1926 through 2020, U.S. Treasury bills produced annual rates of

return that: A) ranged from −1 percent to +15 percent. B) ranged from −1 percent to +5 percent. C) were negative only during the Great Depression. D) have always been positive. E) never exceeded 6 percent.

6) Another term that refers to the average rate of return is the: A) variance. B) standard deviation. C) real return. D) mean. E) histogram.

7) Which one of the following types of securities produced the lowest real rate of annual return,

on average, for the period from 1926 through 2020? A) U.S. Treasury bills B) Long-term government bonds C) Small-company stocks D) Large-company stocks E) Long-term corporate bonds

8) On average, for the period from 1926 through 2020: A) the real rate of return on U.S. Treasury bills has been negative. B) small-company stocks underperformed large-company stocks. C) long-term government bonds produced higher returns than long-term corporate bonds. D) the excess return on long-term corporate bonds exceeded the excess return on long-

term government bonds. E) the excess return on large-company stocks exceeded the excess return on smallcompany stocks.

9) Over the period from 1926 through 2020, the annual rate of return on

was more

volatile than the annual rate of return on . A) large-company stocks; small-company stocks B) U.S. Treasury bills; small-company stocks C) U.S. Treasury bills; long-term government bonds D) long-term corporate bonds; small-company stocks E) large-company stocks; long-term corporate bonds

10) Which one of the following is a correct ranking of securities based on their volatility during

the period from 1926 to 2020? Rank from highest to lowest volatility. A) Large-company stocks, intermediate-term government bonds, long-term government bonds B) Small-company stocks, long-term corporate bonds, large-company stocks C) Long-term government bonds, long-term corporate bonds, small-company stocks D) Small-company stocks, large-company stocks, long-term corporate bonds E) Long-term corporate bonds, large-company stocks, U.S. Treasury bills

11) During the period from 1926 to 2020, small-company stocks had an average annual return of

approximately A) 8 B) 14 C) 12 D) 16 E) 10

percent.

12) During the period from 1926 to 2020, the average annual rate of inflation was approximately

percent. A) 5 B) 2 C) 1 D) 4 E) 3

13) The average annual return on long-term corporate bonds during the period from 1926 to 2020

was

percent. A) 3.8 B) 5.2 C) 6.5 D) 7.9 E) 8.4

14) The average annual return on small-company stocks was about

percentage points greater than the average annual return on large-company stocks during the period from 1926 to 2020. A) 7 B) 6 C) 5 D) 4 E) 3

15) The average annual estimated real return on U.S. Treasury bills during the period from 1926

to 2020 was A) .4 B) 1.6 C) 2.2 D) 3.1 E) 3.8

percent.

16) The excess return is computed by the average return for the investment. A) subtracting the inflation rate from B) adding the inflation rate to C) subtracting the average return on the U.S. Treasury bill from D) adding the average return on the U.S. Treasury bill to E) subtracting the average return on long-term government bonds from

17) Which one of the following statements concerning the excess return is correct? A) The greater the volatility of returns, the greater the expected excess return. B) The lower the volatility of returns, the greater the expected excess return. C) The lower the average rate of return, the greater the excess return. D) The excess return is not correlated to the average rate of return. E) The excess return is not affected by the volatility of returns.

18) Which one of the following statements concerning the standard deviation is correct? A) The standard deviation is a measure of total return. B) The higher the standard deviation, the higher the expected return. C) The standard deviation varies in direct relation to increases in dividend yield. D) The higher the standard deviation, the lower the risk. E) The lower the standard deviation, the less certain the rate of return in any one given

year.

19) The standard deviation of small-company stocks: A) had an average value of about 20 percent for the period 1926 to 2020. B) is roughly equivalent to the standard deviation on stocks of all sizes. C) is about ten times as large as the standard deviation of U.S. Treasury bills. D) is less than the standard deviation on large-company stocks. E) produces a narrow normal distribution curve.

20) Capital market history shows us that a correct ordering of the average return by asset class,

from lowest to highest, is: A) corporate bonds, U.S. Treasury bills, small-company stocks, large-company stocks. B) U.S. Treasury bills, small-company stocks, large-company stocks, government bonds. C) government bonds, U.S. Treasury bills, large-company stocks, small-company stocks. D) U.S. Treasury bills, government bonds, large-company stocks, small-company stocks. E) U.S. Treasury bills, long-term government bonds, intermediate-term government bonds, small-company stock.

21) The average squared difference between the actual return and the average return is called the: A) volatility return. B) variance. C) standard deviation. D) risk premium. E) excess return.

22) The standard deviation for a set of stock returns can be calculated as the: A) positive square root of the average return. B) average squared difference between the actual return and the average return. C) positive square root of the variance. D) average return divided by N minus one, where N is the number of returns. E) variance squared.

23) A symmetric, bell-shaped frequency distribution that is completely defined by its mean and

standard deviation is the A) gamma B) Poisson C) bimodal D) normal E) uniform

24)

distribution.

The variance of returns is computed by dividing the sum of the: A) squared deviations by the number of returns minus one. B) average returns by the number of returns minus one. C) average returns by the number of returns plus one. D) squared deviations by the average rate of return. E) squared deviations by the number of returns plus one.

25) The Sharpe ratio is computed as the average: A) equity risk premium divided by the standard deviation. B) squared deviation divided by the average excess return. C) excess return divided by the variance of the returns. D) equity risk premium divided by the variance. E) squared deviation divided by the (Number of returns − 1).

26) The average compound return earned per year over a multi-year period is called the

average return. A) arithmetic B) standard C) variant D) geometric E) real

27) The return earned in an average year over a multi-year period is called the

average

return. A) B) C) D) E)

arithmetic standard variant geometric real

28) Of the following countries, which one had the highest historical equity risk premium for the

period 1900-2010? A) Germany B) Ireland C) Switzerland D) Spain E) Norway

29) Which country had the highest Sharpe ratio based on historical equity risk premiums and

standard deviations of returns for the period 1900-2010? A) Italy B) Australia C) United States D) Germany E) Norway

30) When estimating the future equity risk premium, it is important to include assumptions about

the: A) B) C) D)

historical distribution of returns on derivative securities only. future risk environment only. amount of risk aversion of future investors only. historical distribution of returns on derivative securities and the future risk environment. E) future risk environment and the amount of risk aversion of future investors.

31) From November 2007 through January 2009, the S&P 500 index lost approximately what

percent of its value? A) 37 B) 51 C) 53 D) 33 E) 45

32) In 2008, which country experienced a decline in its stock market value in excess of 90

percent? A) India B) Russia C) China D) United States E) Iceland

33) In 2008, which asset class had the highest rate of return in the U.S.? A) Small-company stocks B) Long-term U.S. Treasury bonds C) Large-company stocks D) U.S. Treasury bills E) High-quality long-term corporate bonds

34) One year ago, you purchased 100 shares of stock for $39.46 per share. The stock paid

quarterly dividends of $1.50 per share. Today, the stock is worth $28.70 per share. What is the total dollar return per share to date from this investment? A) −$76.00 B) −$4.76 C) −$6.00 D) −$14.76 E) −$16.76

35) Six months ago, you purchased 100 shares of stock at a price of $43.89 per share. The stock

paid a quarterly dividend of $.10 per share. Today, you sold all your shares for $45.13 per share. What is the total amount of your capital gains on this investment? A) $1.24 B) $1.64 C) $40.00 D) $124.00 E) $164.00

36) A year ago, you purchased 300 shares of stock at a price of $49.03 per share. The stock paid

an annual dividend of $.10 per share. Today, you sold all your shares for $58.14 per share. What is your total dollar return on this investment? A) $2,755 B) $2,733 C) $2,703 D) $2,763 E) $3,006

37) One year ago, you purchased 100 shares of stock at a price of $24.36 per share. During the

last year, you received quarterly dividends of $.80 per share. Today, the stock price is $34.48. What is the dividend yield? A) 13.14% B) 29.35% C) 3.28% D) 9.28% E) 41.54%

38) The stock of Cain & Campos is currently selling for $28 per share. The stock has a dividend

yield of 2.6 percent. How much dividend income will you receive per year if you purchase 500 shares of this stock? A) $130 B) $364 C) $424 D) $280 E) $728

39) One year ago, you purchased a stock at a price of $32 per share. Today, you sold the stock

and realized a total return of 14.62 percent. Your capital gain was $3.48 per share. What was your dividend yield on this stock? A) 2.25% B) 3.75% C) 3.35% D) 2.85% E) 4.35%

40) You just sold 500 shares of Alcove stock at a price of $29.40 per share. Last year you paid

$33.44 per share to buy this stock. You received dividends totaling $.95 per share. What is your capital gains yield on this investment? A) −13.7% B) 11.4% C) 2.8% D) −.7% E) −12.1%

41) You purchased 300 shares of Deltona stock for $43.90 per share. You have received a total of

$630 in dividends and $14,620 in proceeds from selling the shares. What is your capital gains yield on this stock? A) 6.23% B) 11.01% C) 17.68% D) 9.55% E) 15.79%

42) Today, you sold 300 shares of Workbench stock and realized a total return of 12.5 percent.

You purchased the shares one year ago at a price of $27.43 per share. You have received a total of $192 in dividends. What is your capital gains yield on this investment? A) 14.80% B) 9.39% C) 6.67% D) 10.17% E) 11.67%

43) Six months ago, you purchased 1,200 shares of Talisman stock for $21.20 per share and have

received total dividend payments of $.60 per share. Today, you sold all your shares for $22.20 per share. What is your total dollar return on this investment? A) $720 B) $1,200 C) $1,440 D) $1,920 E) $3,840

44) One year ago, you purchased 100 shares of Acreage stock at a price of $28.68 per share. The

company pays quarterly dividends of $1.50 per share. Today, you sold all your shares for $29.42 per share. What is your total percentage return on this investment? A) 23.5% B) 5.2% C) 22.9% D) 20.4% E) 20.9%

45) You bought 360 shares of stock at a total cost of $7,754.40. You received a total of $403.20

in dividends and sold your shares for $19.98 per share. What was your total rate of return? A) 3.67% B) −2.04% C) −1.29% D) 7.24% E) 5.38%

46) You bought 600 shares of stock at $24.20 each. At the end of the year, you received a total of

$720 in dividends, and your stock was worth a total of $15,678. What was your total dollar capital gain and total dollar return? A) $1,878; $2,598 B) $1,878; $1,158 C) $1,158; $1,878 D) $1,158; $2,598 E) $2,598; $1,878

47) Roller Mills shares are currently selling for $27.38 each. You bought 200 shares one year ago

at $26.59 and received dividend payments of $1.27 per share. What was your percentage capital gain for the year? A) 7.75% B) 2.97% C) −2.89% D) 3.21% E) 7.52%

48) One year ago, you purchased 300 shares of Midwya stock at a price of $22.05 per share,

received $460 in dividends over the year, and today sold all your shares for $29.32 per share. What was your dividend yield? A) 5.23% B) 5.87% C) 6.95% D) 1.92% E) 2.48%

49) You purchased 300 shares of stock at a price of $37.23 per share. Over the last year, you

have received total dividend income of $351. What is the capital gains yield if your total return is 11.47 percent? A) 8.33% B) 7.26% C) 9.39% D) 9.50% E) 7.67%

50) The stock of Cylinder Systems is currently selling for $59.48 per share. The stock has an

expected growth rate of 4.22 percent and an expected total return for the next year of 9.87 percent. How much dividend income should you expect to receive next year if you purchase 800 shares of this stock today? A) $2,309.20 B) $2,008.04 C) $2,688.50 D) $2,380.15 E) $2,001.10

51) A stock had annual returns of 7.63 percent, 9.28 percent, −3.11 percent, and 15.09 percent for

the past four years, respectively. What is the real arithmetic average rate of return for this period if inflation averaged 2.3 percent? A) 4.15% B) 5.24% C) 4.81% D) 5.02% E) 5.36%

52) Three years ago, you purchased a stock at a price of $33.48. The stock paid annual dividends

of $.60 per share. Today, the stock is worth $35.20 per share. What is your holding period return? A) 10.51% B) 10.03% C) 6.93% D) 5.14% E) 6.59%

53) Two years ago, you purchased 100 shares of stock in Nature Core at a price of $43.26 per

share. The stock pays an annual dividend of $.10 per share. Today, you sold all your shares for $46.71 per share. What is your holding period return? A) 8.24% B) 7.81% C) 7.97% D) 8.44% E) 8.90%

54) A stock had annual returns of 11.6 percent, 9.3 percent, −22.8 percent, and 34.6 percent

during the last four-year period. What is his arithmetic mean return on this investment? A) 7.94% B) 19.58% C) 14.62% D) 11.47% E) 8.18%

55) Assume that over the last several decades, the total annual returns on large-company

common stocks averaged 12.1 percent, small-company stocks averaged 16.5 percent, longterm government bonds averaged 6 percent, and U.S. T-bills averaged 3.4 percent. What was the average excess return earned by long-term government bonds, and small-company stocks respectively? A) 4.4%; 2.6% B) 1.8%; 13.3% C) 2.6%; 13.1% D) 2.6%; 4.4% E) 1.9%; 5.1% F) 4.4%; 2.6%

56) You invested in long-term corporate bonds and earned 6.8 percent. During that same time

period, large-company stocks returned 12.6 percent, long-term government bonds returned 6.4 percent, U.S. Treasury bills returned 4.2 percent, and inflation averaged 3.8 percent. What excess return did you earn? A) 2.6% B) 2.3% C) 1.3% D) .4% E) 3.0%

57) You have a sampling of returns for the Malta Stock Fund. The returns are 7.25 percent, 5.63

percent, 12.56 percent, and 1.08 percent. What is the mean and variance of this sampling? A) 6.57%; .00287 B) 6.63%; .00225 C) 6.65%; .00215 D) 6.63%; .00287 E) 6.63%; .00215

58) A stock had returns of 5 percent, −17 percent, and 11 percent during the past three years,

respectively. What is the standard deviation of these returns? A) 14.74% B) 12.04% C) 45.94% D) 5.63% E) 2.17%

59) A stock has an expected rate of return of 8.3 percent and a standard deviation of 6.4 percent.

Which one of the following best describes the probability that this stock will lose more than 4.50 percent in any one given year? A) Less than 2.5 percent B) Less than 1.0 percent C) Less than 1.5 percent D) Less than .5 percent E) Less than 5 percent

60) A stock had annual returns of 3 percent, 18 percent, and −24 percent over a three-year period.

Based on this information, what is the 68 percent probability range for any one given year? A) −40.53% to 38.53% B) −20.28% to 22.28% C) −20.28% to 20.28% D) −22.28% to 20.28% E) −43.56% to 41.56%

61) A stock had annual returns of 8 percent, 14 percent, and 2 percent for the past three years.

Based on these returns, what is the probability that this stock will return more than 26 percent in any one given year? A) 2.5% B) 1.0% C) .5% D) 5.0% E) 16.0%

62) A stock had returns of 16 percent, 4 percent, −22 percent, 15 percent, and −2 percent for the

past five years. What is the variance of these returns? A) .01997 B) .02037 C) .02402 D) .01869 E) .02340

63) A stock had returns of 8 percent, 39 percent, 11 percent, and −24 percent for the past four

years. Which one of the following best describes the probability that this stock will not lose more than 43 percent in any one given year? A) 92.5% B) 95.0% C) 97.5% D) 84.0% E) 99.5%

64) Over the past four years, a stock produced returns of 14 percent, 22 percent, 6 percent, and

−19 percent. What is the approximate probability that an investor in this stock will not lose more than 30 percent nor earn more than 41 percent in any one given year? A) 84% B) 95% C) 68% D) 5% E) 34%

65) The returns on a portfolio during the last three years were 4 percent, −15 percent, and 12.5

percent. What is the standard deviation of these returns? A) 11.50% B) 14.08% C) 38.74% D) 4.75% E) 1.98%

66) Suppose you own a risky asset with an expected return of 12.6 percent and a standard

deviation of 18.2 percent. If the returns are normally distributed, the most accurate probability that the stock will return more than 50 percent in any one given year is best described as less than: A) .025 percent. B) .05 percent. C) 2.5 percent. D) .01 percent. E) 1.25 percent.

67) The return pattern on your favorite stock has been 5.39 percent, 8.26 percent, −12.04 percent,

and 14.27 percent over the last four years. What are the average arithmetic and geometric rates of return? A) 3.45%; 3.21% B) 3.97%; 3.48% C) 3.88%; 3.64% D) 3.92%; 3.56% E) 3.51%; 3.26%

68) What are the arithmetic and geometric average returns (answer in that order) for a stock with

annual returns of 4 percent, 9 percent, −6 percent, and 18 percent? A) 5.89%; 6.25% B) 6.25%; 5.89% C) 6.25%; 8.33% D) 8.33%; 5.89% E) 8.33%; 8.33%

69) What are the arithmetic and geometric (answer in that order) average returns for a stock with

annual returns of 9.4 percent, 8.2 percent, −7.3 percent, 4.1 percent, and 9.5 percent? A) 5.61%; 4.58% B) 5.61%; 4.78% C) 4.78%; 4.58% D) 4.58%; 5.61% E) 4.58%; 4.78%

70) A stock had returns of 3.5 percent, −24 percent, 12 percent, and 30.2 percent over the past

five years. What is the geometric average return for this time period? A) 17.4% B) 5.4% C) 17.0% D) 3.5% E) 4.3%

71) A stock was priced at $23.08, $24.15, $23.99, and $24.26 at end of Years 1 to 4, respectively.

The annual dividend is constant at $.20 per share. What is the geometric average return on this stock? A) 3.27% B) 2.52% C) 2.56% D) 2.48% E) 2.54%

72) Assume a stock had an historical equity risk premium of 5.49 percent and a standard

deviation of 11.46 percent over the past two decades. What is the 95.4 percent range for the equity risk premium? A) −.18% to 9.26% B) −.57% to 15.09% C) .41% to 20.03% D) −.36% to 10.62% E) 1.08% to 22.49%

73) Assume you are comparing two stocks that are identical in every way except that one stock

pays dividends and the other does not. How would you expect this difference to affect the annual performance of the dividend-paying stock as compared to the non-dividend-paying stock?

74) What does the historical record reveal about the relationship between the returns on U.S.

Treasury bills and the rate of inflation as measured by the consumer price index? Is this relationship what investors would tend to expect? Why or why not?

75) Based on historical market performance, what can we conclude about the relationship

between return and risk?

76) What are the lessons learned from capital market history? What evidence is there to suggest

these lessons are correct?

77) Suppose you have $30,000 invested in the stock market and your banker comes to you and

tries to get you to move that money into the bank's certificates of deposit (CDs). He explains that the CDs are 100 percent government insured and that you are taking unnecessary risks by being in the stock market. How would you respond?

Answer Key Test name: Chapter 10(1) 1) C 2) E 3) A 4) D 5) A 6) D 7) A 8) D 9) E 10) D 11) D 12) E 13) C 14) D 15) A 16) C 17) A 18) B 19) C 20) D 21) B 22) C 23) D 24) A 25) A 26) D 27) A 28) A 29) B 30) E 31) E 32) E 33) B 34) B 35) D 36) D 37) A

38) B 39) B 40) E 41) B 42) D 43) D 44) A 45) B 46) C 47) B 48) C 49) A 50) C 51) C 52) A 53) D 54) E 55) C 56) A 57) B 58) A 59) A 60) D 61) C 62) C 63) C 64) B 65) B 66) C 67) B 68) B 69) C 70) D 71) B 72) D 73) Essay 74) Essay 75) Essay 76) Essay 77) Essay

Student name: 1) You purchased 300 shares of stock at a price of $39.12 per share. Over the last year, you

have received total dividend income of $330. What is the dividend yield? A) 8.4% B) 25.3% C) 1.1% D) 9.3% E) 2.8%

2) Six months ago, you purchased 1,600 shares of ABC stock for $22.99 a share. You have

received dividend payments equal to $.80 a share. Today, you sold all of your shares for $25.27 a share. What is your total dollar return on this investment? A) $9,856 B) $3,648 C) $1,280 D) $4,928 E) $4,560

3) Last year, you purchased a stock at a price of $60.00 a share. Over the course of the year, you

received $1.60 per share in dividends and inflation averaged 2.1 percent. Today, you sold your shares for $64.50 a share. What is your approximate real rate of return on this investment? A) 9.6% B) 8.1% C) 12.3% D) 5.4% E) 10.2%

4) What are the arithmetic and geometric average returns for a stock with annual returns of 7

percent, 9 percent, −2 percent, and 16 percent? A) 8.38%; 7.50% B) 7.50%; 8.38% C) 7.50%; 7.31% D) 7.31%; 7.50% E) 8.38%; 7.31%

5) You own a stock that had returns of 10.96 percent, −15.62 percent, 20.08 percent, and 18.82

percent over the past four years. What was the arithmetic average return for this stock? A) 9.27% B) 8.90% C) 8.56% D) 7.51% E) 8.03%

6) You own a stock that had returns of 10.75 percent, −16.16 percent, 20.24 percent, 24.31

percent, and 7.39 percent over the past five years. What was the arithmetic average return for this stock? A) 9.68% B) 8.81% C) 8.31% D) 10.08% E) 9.31%

7) You own a stock that had returns of 11.39 percent, −7.68 percent, 24.62 percent, and 16.83

percent over the past four years. What was the geometric average return for this stock? A) 10.62% B) 9.91% C) 11.29% D) 11.74% E) 12.23%

8) A stock had returns of 8.97 percent, −14.35 percent, 19.15 percent, 24.80 percent, and 6.70

percent over the past five years. What was the geometric average return for this stock? A) 8.61% B) 8.17% C) 9.05% D) 9.42% E) 9.81%

9) A bond had a price of $946.72 at the beginning of the year and a price of $983.73 at the end

of the year. The bond's par value is $1,000 and its coupon rate is 6.1 percent. What was the percentage return on the bond for the year? A) 9.06% B) 3.76% C) 10.35% D) 6.20% E) 11.04%

10) A bond par value is $1,000 and the coupon rate is 6.1 percent. The bond price was $946.72 at

the beginning of the year and $983.73 at the end of the year. The inflation rate for the year was 3.1 percent. What was the bond's real return for the year? A) 7.03% B) 6.20% C) 7.50% D) 10.35% E) 6.16%

11) You purchased a stock at a price of $41.44. The stock paid a dividend of $1.51 per share and

the stock price at the end of the year is $46.99. What is the capital gains yield? A) 11.81% B) 13.39% C) 17.04% D) 3.64% E) 11.22%

12) You purchased a stock at a price of $48.01. The stock paid a dividend of $1.87 per share and

the stock price at the end of the year is $54.01. What was the dividend yield? A) 12.50% B) 3.90% C) 4.67% D) 16.39% E) 4.28%

13) You purchased a stock at a price of $60.66. The stock paid a dividend of $2.27 per share and

the stock price at the end of the year was $68.36. What was the total return for the year? A) 3.74% B) 14.58% C) 15.51% D) 12.69% E) 16.44%

14) You purchased a stock at a price of $62.48. The stock paid a dividend of $1.71 per share and

the stock price at the end of the year is $55.90. What are your capital gains on this investment? A) −$6.15 B) −$6.58 C) −$4.87 D) −$1.71 E) −$5.73

15) Three months ago, you purchased a stock for $74.60. The stock is currently priced at $81.34.

What is the EAR on your investment? A) 45.10% B) 33.13% C) 36.14% D) 41.34% E) 9.03%

16) Seven months ago, you purchased 580 shares of Mitchum Trading for $70.53 per share. The

stock pays a quarterly dividend of $.39 per share and is currently priced at $71.71. What is the total dividend income you received? A) $226.20 B) $452.40 C) $510.40 D) $568.40 E) $684.40

17) One year ago, you purchased 430 shares of Titan Wood Products for $67.82 per share. The

stock has paid dividends of $.76 per share over the past year and is currently priced at $72.92. What is your total dollar return on your investment? A) $2,356.40 B) $2,519.80 C) $2,603.79 D) $2,193.00 E) $1,259.90

18) You purchased 490 shares of Barden Enterprises stock for $54.50 per share at the beginning

of the year. The stock is currently priced at $56.55 per share. What is your dividend yield if you received total dividends of $776 over the year? A) 1.45% B) 2.91% C) 2.57% D) 3.00% E) 2.80%

19) You own 370 shares of Maslyn Tours stock that sells for $53.41 per share. If the stock has a

dividend yield of 2.5 percent, how much do you expect to receive next year in dividend income from this investment? A) $510.51 B) $481.18 C) $548.94 D) $494.04 E) $524.92

20) One year ago, you purchased a stock at a price of $62.09 per share. Today, you sold your

stock at a loss of 18.79 percent. Your capital loss was $13.05 per share. What was the dividend yield on this stock? A) 2.30% B) 17.03% C) 2.48% D) 18.58% E) 2.23%

21) One year ago, you purchased a stock at a price of $55.78 per share. Today, you sold your

stock at a loss of 18.71 percent. Your capital loss was $12.80 per share. What was the total dividends per share paid on this stock over the year? A) $4.24 B) $2.36 C) $3.88 D) $2.63 E) $2.15

22) You purchased GARP stock one year ago at a price of $63.03 per share. Today, you sold

your stock and earned a total return of 18.15 percent. The stock paid dividends of $2.28 per share over the year. What was the capital gains yield on your investment? A) 16.94% B) 18.15% C) 14.53% D) 16.15% E) 13.21%

23) You purchased Butterfly Wing Corporation stock exactly one year ago at a price of $79.98

per share. Over the past year, the stock paid dividends of $3.40 per share. Today, you sold your stock and earned a total return of 16.72 percent. What was the price at which you sold the stock? A) $98.02 B) $99.58 C) $95.69 D) $89.95 E) $93.35

24) Last year, you purchased 680 shares of Forever, Incorporated, stock at a price of $49.18 per

share. You received $1,020 in dividends and a total of $39,814 when you sold the stock. What was the capital gains yield on this stock? A) 19.05% B) 17.59% C) 16.33% D) 3.05% E) 18.10%

25) You purchased 1,550 shares of Barrett Golf Corporation stock at a price of $36.75 per share.

While you owned the stock, you received dividends totaling $.73 per share. Today, you sold your stock at a price of $40.70 per share. What was your total dollar return on the investment? A) $5,816 B) $6,971 C) $7,254 D) $6,123 E) $6,688

26) You purchased 1,150 shares of stock in Natural Chicken Wings, Incorporated, at a price of

$43.46 per share. Since you purchased the stock, you have received dividends of $1.01 per share. Today, you sold your stock at a price of $46.71 per share. What was your total percentage return on this investment? A) 8.64% B) 9.80% C) 10.46% D) 11.15% E) 7.48%

27) You purchased 1,550 shares of stock in Natural Chicken Wings, Incorporated, at a price of

$43.70 per share. Since you purchased the stock, you have received dividends of $1.17 per share. Today, you sold your stock at a price of $47.88 per share. What was your total percentage return on this investment? A) 12.24% B) 13.93% C) 10.90% D) 13.06% E) 9.57%

28) You purchased shares of stock one year ago at a price of $64.90 per share. During the year,

you received dividend payments of $2.23 and sold the stock for $72.02 per share. If the inflation rate during the year was 2.99 percent, what was your real return? A) 17.83% B) 7.75% C) 9.75% D) 11.09% E) 14.46%

29) An asset has an average return of 10.03 percent and a standard deviation of 18.96 percent.

What range of returns should you expect to see with a 68 percent probability? A) −46.85% to 66.91% B) −8.93% to 11.13% C) −27.89% to 47.95% D) −18.41% to 38.47% E) −8.93% to 28.99%

30) An asset has an average return of 11.15 percent and a standard deviation of 21.26 percent.

What range of returns should you expect to see with a 95 percent probability? A) −10.11% to 32.41% B) −52.63% to 74.93% C) −31.37% to 53.67% D) −20.74% to 43.04% E) −10.11% to 12.19%

31) What range of returns should you expect to see with a 99.7 percent probability on an asset

that has an average return of 11.15 percent and a standard deviation of 24.79 percent? A) −38.43% to 60.73% B) −63.22% to 85.52% C) −13.64% to 8.66% D) −13.64% to 35.94% E) −26.04% to 48.34%

32) An asset has an average return of 10.79 percent and a standard deviation of 22.71 percent.

What is the most you should expect to lose in any given year with a probability of 16 percent? A) −34.63% B) −23.28% C) −57.34% D) −33.50% E) −11.92%

33) An asset has an average return of 10.31 percent and a standard deviation of 22.65 percent.

What is the most you should expect to lose in any given year with a probability of 2.5 percent? A) −23.67% B) −34.99% C) −12.34% D) −57.64% E) −55.61%

34) An asset has an average return of 10.73 percent and a standard deviation of 22.68 percent.

What is the most you should expect to earn in any given year with a probability of 16 percent? A) 57.31% B) 33.41% C) 34.63% D) 11.95% E) 23.29%

35) An asset has an average return of 10.73 percent and a standard deviation of 23.28 percent.

What is the most you should expect to earn in any given year with a probability of 2.5 percent? A) 80.57% B) 57.29% C) 68.93% D) 45.65% E) 34.01%

36) A stock had returns of 16.11 percent, 23.82 percent, −11.53 percent, and 9.58 percent over

four of the past five years. The arithmetic average return over the five years was 13.16 percent. What was the stock return for the missing year? A) 4.76% B) 27.82% C) 22.26% D) 14.66% E) 25.04%

37) A stock had the following year-end prices and dividends: Year Price Dividend 0 $ 60.19 — 1 71.68 $ 1.26 2 62.74 1.57 3 72.84 1.61

What was the arithmetic average return for the stock? A) 16.71% B) 9.86% C) 8.86% D) 16.62% E) 12.32%

38) A stock had returns of 17.78 percent, −5.10 percent, and 20.33 percent for the past three

years. What is the variance of the returns? A) .01569 B) .00839 C) .14004 D) .01961 E) .02615

39) A stock had returns of 17.93 percent, −5.19 percent, 20.42 percent, and 8.63 percent for the

past four years. What is the variance of the returns? A) .01792 B) .01344 C) .01613 D) .00621 E) .11594

40) A stock had returns of 14.87 percent, 19.53 percent, −17.41 percent, 12.61 percent, and 27.24

percent for the past five years. What is the variance of the returns? A) .00390 B) .03868 C) .17033 D) .03482 E) .02901

41) A stock had returns of 18.43 percent, −7.67 percent, and 24.02 percent for the past three

years. What is the standard deviation of the returns? A) 9.89% B) 28.61% C) 16.92% D) 13.40% E) 2.86%

42) A stock had returns of 16.55 percent, −10.28 percent, 21.40 percent, and 13.31 percent for the

past four years. What is the standard deviation of the returns? A) 1.98% B) 14.08% C) 11.27% D) 12.67% E) 19.83%

43) A stock had returns of 19.02 percent, 22.72 percent, −16.16 percent, 9.44 percent, and 28.51

percent for the past five years. What is the standard deviation of the returns? A) 30.85% B) 21.95% C) 14.05% D) 17.56% E) 3.08%

44) Over a certain period, large-company stocks had an average return of 12.14 percent, the

average risk-free rate was 2.49 percent, and small-company stocks averaged 17.09 percent. What was the risk premium on small-company stocks for this period? A) 4.95% B) 11.68% C) 9.65% D) 19.58% E) 14.60%

45) If the risk premium on the stock market was 7.14 percent and the risk-free rate was 2.66

percent, what is the stock market return? A) 7.84% B) 7.14% C) 10.69% D) 9.80% E) 4.48%

Answer Key Test name: Chapter 10(2) 1) E 2) D 3) B 4) C 5) C 6) E 7) A 8) B 9) C 10) A 11) B 12) B 13) E 14) B 15) D 16) B 17) B 18) B 19) D 20) E 21) B 22) C 23) D 24) A 25) C 26) B 27) A 28) D 29) E 30) C 31) B 32) E 33) B 34) B 35) B 36) B 37) B

38) D 39) B 40) E 41) C 42) B 43) D 44) E 45) D

Chapter 11: 1) The A) B) C) D) E)

measures the interrelationship between two securities. covariance duration coefficient standard deviation alpha coefficient variance

2) You are considering purchasing a particular stock, which has an expected return of 12

percent if the economy booms, 8 percent if the economy is normal, and 3 percent if the economy goes into a recessionary period. The overall expected rate of return on this stock will: A) be equal to one-half of 8 percent if there is a 50 percent chance of an economic boom. B) vary inversely with the growth of the economy. C) increase as the probability of a recession increases. D) be independent of the probability of each economic state occurring. E) increase as the probability of a boom economy increases.

3) Which one of the following statements is correct concerning the expected rate of return on an

individual stock given various states of the economy? A) The expected return is a geometric average where the probabilities of the economic states are used as the exponential powers. B) The expected return is an arithmetic average of the individual returns for each state of the economy. C) The expected return is a weighted average where the probabilities of the economic states are used as the weights. D) The expected return is equal to the summation of the values computed by dividing the expected return for each economic state by the probability of the state. E) As long as the total probabilities of the economic states equal 100 percent, then the expected return on the stock is a geometric average of the expected returns for each economic state.

4) The expected return on a stock that is computed using economic probabilities is: A) guaranteed to equal the actual average return on the stock for the next five years. B) guaranteed to be the minimal rate of return on the stock over the next two years. C) guaranteed to equal the actual return for the immediate twelve month period. D) a mathematical expectation and not an actual anticipated outcome. E) the actual return you will receive.

5) The correlation between Stocks A and B is computed as the: A) covariance between A and B divided by the standard deviation of A times the

standard deviation of B. B) standard deviation of A divided by the standard deviation of B. C) standard deviation of AB divided by the covariance between A and B. D) variance of A plus the variance of B divided by the covariance of AB. E) square root of the covariance of AB.

6) On a single graph, you plotted the monthly returns for two securities for the past five years.

You observed that the returns of each of the two securities generally rose and fell together at the same time, and to the same degree. This indicates the securities have: A) no correlation with each other. B) a weak negative correlation. C) a strong negative correlation. D) a strong positive correlation. E) a weak positive correlation.

7) Assume the covariance of Stock Alpha with Stock Beta is .32. Accordingly, what is the

covariance of Stock Beta with Stock Alpha? A) .68 B) .32 C) −.32 D) −.68 E) −.1024

8) You own a portfolio of two risky securities. Combining the two securities produced no

diversification benefit. Accordingly, you would be most justified in concluding that the returns of the two securities: A) are too low for their level of risk. B) move perfectly opposite one another. C) are too large to offset one another. D) move perfectly in sync with one another. E) are completely unrelated to one another.

9) The range of possible correlations between two securities is defined as: A) 0 to +1. B) 0 to −1. C) ≧ 0. D) ≦ 1. E) +1 to −1.

10) If the correlation between two stocks is −1, the returns on the stocks: A) generally move in the same direction. B) move perfectly opposite one another. C) are unrelated to one another. D) have standard deviations of equal size but opposite signs. E) totally offset each other producing a rate of return of zero.

11) Which of the following values are squared values? A) Variance, correlation, and covariance B) Variance and beta C) Covariance and variance D) Correlation, beta, variance E) Covariance and correlation

12) The symbol A) α

represents the correlation coefficient.

B) ρ C) β D) c E) є

13) Which one of the following conditions must exist if the standard deviation of a portfolio

composed of two securities is less than the weighted average of the standard deviations of the individual securities held within that portfolio? A) β < 1 B) Rm > 1 C) ρ < 1 D) β = 0 E) ρ > 1

14) When computing the expected return on a portfolio of stocks, the portfolio weights are based

on the: A) B) C) D) E)

number of shares owned in each stock. price per share of each stock. market value of the total shares held in each stock. original amount invested in each stock. cost per share of each stock held.

15) The expected return on a portfolio is calculated as a(n)

average of the expected returns

on the individual securities held in the portfolio. A) arithmetic B) weighted C) compounded D) geometric E) median

16) The expected return on a portfolio: A) can be greater than the expected return on the best performing security in the

portfolio. B) can be less than the expected return on the worst performing security in the portfolio. C) is independent of the performance of the overall economy. D) is limited by the returns on the individual securities within the portfolio. E) is an arithmetic average of the returns of the individual securities when the weights of those securities are unequal.

17) If a stock portfolio is well diversified, then the portfolio variance: A) will equal the variance of the most volatile stock in the portfolio. B) may be less than the variance of the least risky stock in the portfolio. C) must be equal to or greater than the variance of the least risky stock in the portfolio. D) will be a weighted average of the variances of the individual securities in the

portfolio. E) will be an arithmetic average of the variances of the individual securities in the portfolio.

18) Of the following statements regarding the standard deviation of a portfolio, which one is

correct? A) The greater the diversification of a portfolio, the greater the standard deviation of that portfolio. B) The standard deviation of a portfolio can often be lowered by changing the weights of the securities in the portfolio. C) Standard deviation is used to determine the amount of risk premium that should apply to a portfolio. D) The standard deviation of a portfolio is equal to the geometric average standard deviation of the individual securities held within that portfolio. E) The standard deviation of a portfolio is equal to a weighted average of the standard deviations of the individual securities held within the portfolio.

19) The standard deviation of a portfolio will tend to increase when: A) a risky asset in the portfolio is replaced with U.S. Treasury bills. B) one of two stocks related to the airline industry is replaced with a third stock that is

unrelated to the airline industry. C) the portfolio concentration in a single cyclical industry increases. D) the weights of the various diverse securities become more evenly distributed. E) short-term bonds are replaced with Treasury Bills.

20) The A) B) C) D) E)

has the lowest possible level of risk among all portfolios in an opportunity set. efficient frontier minimum variance portfolio upper tail of the efficient set tangency portfolio optimal covariance portfolio

21) You are comparing five separate portfolios, each of which contains two stocks of varied

characteristics. Of the following choices, which characteristic is most indicative of a diversified portfolio? A) The standard deviation of the portfolio equals the weighted average standard deviation of the two securities. B) The correlation between the two securities is equal to zero. C) The covariance of the two securities is equal to one. D) There is a highly positive covariance between the two securities. E) The correlation between the two securities is negative.

22) An efficient set of portfolios is composed of: A) a complete opportunity set. B) the portion of the opportunity set located below the minimum variance portfolio. C) only the minimum variance portfolio. D) the dominant portion of the opportunity set. E) only the maximum return portfolio.

23) Assume you are looking at an opportunity set representing many securities. Where would the

minimum variance portfolio be located in relation to this set? A) At the lowest point of the set B) In the exact center of the set C) At the far-right point of the set D) At the far-left point of the set E) At the highest point of the set

24) The variance of a portfolio composed of many securities is primarily dependent upon the: A) variances of the securities held within the portfolio. B) beta of the portfolio. C) portfolio's correlation with the market. D) covariance between the overall portfolio and the market. E) covariances between the individual securities.

25) Risk that affects a large number of assets, each to a greater or lesser degree, is called

risk. A) B) C) D) E)

idiosyncratic diversifiable systematic asset-specific total

26) As we add more diverse securities to a portfolio, the A) total and systematic B) systematic and unsystematic C) total and unsystematic D) unsystematic E) systematic

risks of the portfolio will decrease.

27) The measure called beta associates most closely with: A) idiosyncratic risk. B) the risk-free return. C) systematic risk. D) unexpected risk. E) unsystematic risk.

28) Which one of the following is the best example of systematic risk? A) The price of lumber declines sharply B) The machinery operators at a firm go on strike C) Inflation increases consumer prices D) A storm causes a power outage in a city E) People become health aware and avoid fast food restaurants

29) Unsystematic risk: A) can be effectively eliminated through portfolio diversification. B) is compensated for by the risk premium. C) is measured by beta. D) cannot be avoided if you wish to participate in the financial markets. E) is related to the overall economy.

30) Standard deviation measures risk while beta measures A) total; systematic B) nondiversifiable; diversifiable C) unsystematic; total D) unsystematic; systematic E) total; unsystematic

risk.

31) One example of a nondiversifiable risk is the sudden: A) resignation of a well-respected president of a firm. B) outbreak of a global virus. C) resignation of a key employee of a major manufacturer. D) replacement of a firm's workforce with robots. E) closing of a business due to a lack of sales.

32) Which one of the following is an example of unsystematic risk? A) The inflation rate increases unexpectedly B) The federal government lowers income taxes C) An oil tanker runs aground and spills its cargo D) Interest rates decline by .5 percent E) A country's GDP rises by .5 percent more than anticipated

33) The primary purpose of portfolio diversification is to: A) increase returns and risks. B) eliminate all risks. C) eliminate asset-specific risk. D) eliminate systematic risk. E) lower both returns and risks.

34) Which one of the following would indicate a portfolio is being effectively diversified? A) An increase in the portfolio beta B) A decrease in the portfolio beta C) An increase in the portfolio rate of return D) An increase in the portfolio standard deviation E) A decrease in the portfolio standard deviation

35) A) B) C) D) E)

risk affects at most a small number of assets. Portfolio Nondiversifiable Market Unsystematic Total

36) The principle of diversification tells us that: A) concentrating an investment in two or three large stocks will eliminate all your risk. B) concentrating an investment in three companies all within the same industry will

greatly reduce your overall risk. C) spreading an investment across five diverse companies will not lower your overall risk. D) spreading an investment across many diverse assets will eliminate all the risk. E) spreading an investment across many diverse assets will eliminate idiosyncratic risk.

37) The separation principle states that an investor will: A) choose between any efficient portfolio and a riskless asset to generate the desired

expected return. B) choose a portfolio from the efficient set based on individual risk tolerance. C) never choose to invest in a riskless asset due to the low expected rate of return. D) combine a riskless asset with the tangency portfolio based on their risk tolerance level. E) combine a riskless asset with the minimum variance portfolio based on their risk tolerance level.

38) The combination of the efficient set of portfolios with a riskless lending and borrowing rate

results in the: A) capital market line which shows that all investors will only invest in the riskless asset. B) capital market line which shows that all investors will invest in a combination of the riskless asset and the tangency portfolio. C) security market line which shows that all investors will invest in the minimum variance portfolio. D) security market line which shows that all investors will invest only in the riskless asset. E) characteristic line which shows that all investors will invest in the same combination of securities.

39) The capital market line: A) and the characteristic line are two terms describing the same function. B) intersects the feasible set at its midpoint. C) has a vertical intercept at the risk-free rate of return. D) has a horizontal intercept at the market beta. E) lies tangent to the opportunity set at its minimum point.

40) Of the following choices, which one best describes the steps outlined by the separation

principle? A) Determine the beta that best fits an investor's risk tolerance level and then determine which assets can be combined to create a portfolio that matches that beta B) Determine the tangency point between the risk-free rate and the efficient set of risky assets and then determine how to combine the tangency point portfolio with risk-free assets to match the investor's risk tolerance level C) Determine the appropriate beta for an individual investor and then determine the most efficient set of risky assets that falls below that beta level D) From a pool of assets determine which pairs of assets have the lowest covariances and then determine how to combine these pairs into a portfolio that matches the investor's preferred beta E) Determine an investor's risk tolerance level and then determine which portfolio rate of return best fits that level of risk tolerance

41) The amount of systematic risk present in a particular risky asset, relative to the systematic

risk present in an average risky asset, is called the particular asset's: A) beta coefficient. B) reward-to-risk ratio. C) total risk. D) diversifiable risk. E) Treynor index.

42) The characteristic line graphically depicts the relationship between the: A) beta of a security and the return on the security. B) arithmetic average beta of the securities in a portfolio and the weighted average beta

of those securities. C) return on a security and the return on the market. D) beta of a security and the return on the market. E) beta of a security and the corresponding beta of the market.

43) The beta of a security is calculated by dividing the: A) covariance of the security return with the market return by the variance of the market. B) correlation of the security return with the market return by the variance of the market. C) variance of the market by the covariance of the security return with the market return. D) variance of the market return by the correlation of the security return with the market

return. E) covariance of the security return with the market return by the correlation of the security and market returns.

44) The systematic risk of the market is measured by a: A) beta of 1.0. B) beta of zero. C) standard deviation of 1.0. D) standard deviation of zero. E) variance of 1.0.

45) A stock with a beta of zero would be expected to have a rate of return equal to: A) the risk-free rate. B) the market rate of return. C) the prime rate. D) the market risk premium. E) zero.

46) The excess return earned by an asset that has a beta of 1.0 over that earned by a risk-free

asset is referred to as the: A) market rate of return. B) market risk premium. C) systematic return. D) total return. E) real rate of return.

47) The intercept point of the security market line is the rate of return which corresponds to: A) the risk-free rate of return. B) the market rate of return. C) a value of zero. D) a value of 1.0. E) the beta of the market.

48) A stock with an actual return that lies above the security market line has: A) more systematic risk than the overall market. B) more risk than warranted based on the realized rate of return. C) earned a higher return than expected for the level of risk assumed. D) less systematic risk than the overall market. E) earned the return expected for the level of risk assumed.

49) The market risk premium is computed by: A) adding the risk-free rate of return to the inflation rate. B) adding the risk-free rate of return to the market rate of return. C) subtracting the risk-free rate of return from the inflation rate. D) subtracting the risk-free rate of return from the market rate of return. E) multiplying the risk-free rate of return by the market beta.

50) The risk premium for an individual security is computed by: A) multiplying the security's beta by the market risk premium. B) multiplying the security's beta by the risk-free rate of return. C) adding the risk-free rate to the security's expected return. D) dividing the market risk premium by the quantity (1 + β). E) dividing the market risk premium by the beta of the security.

51) A security that is fairly priced will have a return that plots A) below B) on or below C) on D) on or above E) above

the security market line.

52) The slope of the security market line is the: A) reward-to-risk ratio. B) portfolio weight. C) beta coefficient. D) risk-free interest rate. E) market risk premium.

53) According to the CAPM, the expected return on a security is: A) negatively and non-linearly related to the security's beta. B) negatively and linearly related to the security's beta. C) positively and linearly related to the security's variance. D) positively and non-linearly related to the security's beta. E) positively and linearly related to the security's beta.

54) You recently purchased a stock that is expected to earn 12.6 percent in a booming economy,

8.9 percent in a normal economy, and lose 5.2 percent in a recessionary economy. Each economic state is equally likely to occur. What is your expected rate of return on this stock? A) 6.47% B) 8.90% C) 5.43% D) 7.65% E) 7.01%

55) Reed owns a stock that is expected to earn 8.7 percent in a booming economy, 9.2 percent in

a normal economy, and 12.6 percent in a recessionary economy. Each economic state is equally likely to occur. What is the expected rate of return on this stock? A) 10.38% B) 11.90% C) 10.17% D) 9.98% E) 11.01%

56) Dovetail stock is expected to lose 5.0 percent in a booming economy, earn 12.5 percent in a

normal economy, and earn 2.0 percent in a recession. The probability of a boom is 14 percent while the probability of a normal economy is 57 percent. What is the expected rate of return on this stock? A) −2.89% B) 7.01% C) 3.17% D) 8.41% E) −4.41%

57) Stock A is expected to return 12 percent in a normal economy and lose 7 percent in a

recession. Stock B is expected to return 8 percent in a normal economy and 2 percent in a recession. The probability of the economy being normal is 80 percent and the probability of a recession is 20 percent. What is the covariance of these two securities? A) .001824 B) .004115 C) .003280 D) .003876 E) .003915

58) Stock A is expected to return 14 percent in a normal economy and lose 21 percent in a

recession. Stock B is expected to return 11 percent in a normal economy and 5 percent in a recession. The probability of the economy being normal is 75 percent and being recessionary is 25 percent. What is the covariance of these two securities? A) .007006 B) .006563 C) .005180 D) .007309 E) .006274

59) Stock A has a variance of .1493 while Stock B’s variance is .0717. The covariance of the

returns for these two stocks is −.0476. What is the correlation coefficient? A) −.4601 B) −.4466 C) −.2249 D) −.5053 E) −.0046

60) You are comparing Stock A to Stock B. Stock A will return 9 percent in a boom and 4

percent in a recession. Stock B will return 15 percent in a boom and lose 6 percent in a recession. The probability of a boom is 60 percent while the chance of a recession is 40 percent. Given this information, which one of these two stocks should you prefer and why? A) Stock A; because it has a higher expected return and appears to be more risky than Stock B B) Stock A; because it has a higher expected return and appears to be less risky than Stock B C) Stock A; because it has a slightly lower expected return but appears to be significantly less risky than Stock B D) Stock B; because it has a higher expected return and appears to be just slightly more risky than Stock A E) Stock B; because it has a higher expected return and appears to be less risky than Stock A

61) Ohtani stock is expected to return 11.5 percent if the economy booms and only 3.0 percent if

the economy goes into a recessionary period. The probability of a boom is 32 percent while the probability of a recession is 68 percent. What is the standard deviation of the returns on the stock? A) 2.39% B) 3.97% C) 15.72% D) 6.39% E) 5.72%

62) The rate of return on the common stock of Snider Oil is expected to be 14 percent in a boom

economy, 8 percent in a normal economy, and only 2 percent in a recessionary economy. The probabilities of these economic states are 20 percent for a boom, 70 percent for a normal economy, and 10 percent for a recession. What is the variance of the returns? A) .001044 B) .001280 C) .001863 D) .002001 E) .002471

63) Kali's Ski Resort stock is quite cyclical. In a boom economy, the stock is expected to return

30 percent in comparison to 12 percent in a normal economy and a negative 20 percent in a recessionary period. The probability of a recession is 15 percent while it is 30 percent for a booming economy. The remainder of the time, the economy will be at normal levels. What is the standard deviation of the returns? A) 10.05% B) 12.60% C) 15.83% D) 17.46% E) 25.04%

64) The probability of the economy booming is 8 percent, while it is 70 percent for being normal,

and 22 percent for being recessionary. A stock is expected to return 18.3 percent in a boom, 7.4 percent in a normal economy, and lose 6.4 percent in a recession. What is the standard deviation of the returns? A) 8.61% B) 6.72% C) 6.94% D) 7.32% E) 6.84%

65) The variance of Stock A is .0036, the variance of the market is .0059, and the covariance

between the two is .0026. What is the correlation coefficient? A) .8776 B) .1224 C) .5010 D) .5642 E) .4918

66) Stock A has an expected return of 17.8 percent, and Stock B has an expected return of 9.6

percent. However, the risk of Stock A as measured by its variance is 3 times that of Stock B. If the two stocks are combined equally in a portfolio, what would be the portfolio's expected return? A) 13.37% B) 13.70% C) 15.75% D) 12.41% E) 14.55%

67) A portfolio is entirely invested into Selvedge stock, which is expected to return 16.4 percent,

and Border bonds, which are expected to return 8.6 percent. The stock comprises 48 percent of the portfolio. What is the expected return on the portfolio? A) 13.64% B) 14.36% C) 12.34% D) 14.22% E) 11.69%

68) A portfolio has 45 percent of its funds invested in Alpha stock and 55 percent invested in

Beta stock. Alpha has a standard deviation of 6 percent. Beta has a standard deviation of 12 percent. The securities have a coefficient of correlation of .62. What is the portfolio variance? A) .006946 B) .007295 C) .007157 D) .008104 E) .007506

69) A portfolio has 38 percent of its funds invested in Stock A and 62 percent invested in Stock

B. Stock A has an expected return of 8.47 percent and a standard deviation of 7.12 percent. Stock B has an expected return of 13.45 percent and a standard deviation of 16.22 percent. The securities have a coefficient of correlation of .89. What are the portfolio rate of return and variance values? A) 11.56% ; .015688 B) 11.09% ; .124031 C) 10.87% ; .014308 D) 11.56% ; .127620 E) 10.87% ; .127620

70) A portfolio consists of Stocks A and B and has an expected return of 11.6 percent. Stock A

has an expected return of 17.8 percent while Stock B is expected to return 8.4 percent. What is the portfolio weight of Stock A? A) 29.87% B) 61.98% C) 32.58% D) 34.04% E) 67.42%

71) A portfolio is composed of 100 shares of Stock A valued at $22 each, 600 shares of Stock B

valued at $17 each, 400 shares of Stock C valued at $46 each, and 200 shares of Stock D valued at $38 each. What is the portfolio weight of Stock C? A) 46.87% B) 48.09% C) 42.33% D) 45.27% E) 47.92%

72) The probability the economy will boom is 20 percent, while it is 70 percent for a normal

economy, and 10 percent for a recession. Stock A will return 18 percent in a boom, 11 percent in a normal economy, and lose 10 percent in a recession. Stock B will return 9 percent in boom, 7 percent in a normal economy, and 4 percent in a recession. Stock C will return 6 percent in a boom, 9 percent in a normal economy, and 13 percent in a recession. What is the expected return on a portfolio which is invested 20 percent in Stock A, 50 percent in Stock B, and 30 percent in Stock C? A) 7.40% B) 8.25% C) 8.33% D) 9.45% E) 9.50%

73) A portfolio consists of three stocks. There are 2,000 shares of Stock A valued at $14.91

share, 2,800 shares of Stock B valued at $71.90 per share, and 1,200 shares of Stock C priced at $31.95 per share. Stock A is expected to lose 5.0 percent, while Stocks B, and C are expected to earn 14 percent and 5.5 percent, respectively. What is the expected return on this portfolio? A) 18.46% B) 5.97% C) 11.79% D) 4.83% E) 10.69%

74) Stock A is expected to return 12.4 percent while the return on Stock B is expected to be 8.6

percent. You have $10,000 to invest in these two stocks. How much should you invest in Stock B if you desire a combined return from the two stocks of 11 percent? A) $3,511 B) $4,209 C) $3,684 D) $2,907 E) $3,415

75) Stock A is expected to return 12 percent in a boom and 6 percent in a normal economy. Stock

B is expected to return 20 percent in a boom and 4 percent in a normal economy. There is a probability of 40 percent that the economy will boom; otherwise, it will be normal. What is the portfolio variance if 30 percent of the portfolio is invested in Stock A and 70 percent is invested in Stock B? A) .002220 B) .004056 C) .006224 D) .008080 E) .098000

76) The probability the economy will boom is 15 percent; otherwise, it will be normal. Stock A

should return 15 percent in a boom and 8 percent in a normal economy. Stock B should return 9 percent in a boom and 6 percent otherwise. What is the variance of a portfolio consisting of $3,500 in Stock A and $6,500 in Stock B? A) .000209 B) .000247 C) .002098 D) .037026 E) .073600

77) There is a probability of 25 percent that the economy will boom; otherwise, it will be normal.

Stock A is expected to return 18 percent in a boom and 9 percent otherwise. Stock B is expected to return 9 percent in a boom and 5 percent otherwise. What is the standard deviation of a portfolio that is invested 40 percent in Stock A and 60 percent in Stock B? A) .7% B) 1.4% C) 2.6% D) 6.8% E) 8.1%

78) Stock A is expected to return 12 percent in a boom, 9 percent in a normal economy, and 2

percent in a recession. Stock B is expected to return 4 percent in a boom, 6 percent in a normal economy, and 9 percent in a recession. The probability of a boom is 10 percent while the probability of a recession is 25 percent. What is the standard deviation of a portfolio which is composed of $4,500 of Stock A and $3,000 of Stock B? A) 1.4% B) 1.9% C) 2.6% D) 5.7% E) 7.2%

79) The probability the economy will boom is 10 percent while the probability of a recession is

20 percent. Stock A is expected to return 15 percent in a boom, 9 percent in a normal economy, and lose 14 percent in a recession. Stock B should return 10 percent in a boom, 6 percent in a normal economy, and 2 percent in a recession. Stock C is expected to return 5 percent in a boom, 7 percent in a normal economy, and 8 percent in a recession. What is the standard deviation of a portfolio invested 20 percent in Stock A, 30 percent in Stock B, and 50 percent in Stock C? A) .6% B) .9% C) 1.8% D) 2.2% E) 4.9%

80) Wei has decided to invest $5,800 in a portfolio with an expected return of 11.7 percent and

invest $4,130 in a risk-free asset that he expects to return 1.7 percent. What rate of return is he expecting on this portfolio? A) 8.01% B) 7.49% C) 7.54% D) 6.33% E) 7.36%

81) Noel has decided to invest $6,800 in a risky asset that has an expected return of 11.3 percent

and a standard deviation of 21.2 percent. He will also invest $3,200 in a risk-free asset with an expected return of 4.2 percent. The market risk premium is 7.1 percent. What is the standard deviation of his portfolio? A) 3.30% B) 11.94% C) 6.87% D) 9.25% E) 14.42%

82) You would like to combine a risky stock with a beta of 1.87 with U.S. Treasury bills in such

a way that the risk level of the portfolio is equivalent to the risk level of the overall market. What percentage of the portfolio should be invested in the risky stock? A) 54.15% B) 53.48% C) 55.09% D) 52.91% E) 54.67%

83) Stock A has an expected return of 12 percent and a variance of .0203. The market has an

expected return of 11 percent and a variance of .0093. What is the beta of Stock A if the covariance of Stock A with the market is .0137? A) .68 B) .76 C) 1.55 D) 1.47 E) 1.32

84) Stock A has a beta of 1.2, Stock B's beta is 1.46, and Stock C's beta is .72. If you invest

$2,000 in Stock A, $3,000 in Stock B, and $5,000 in Stock C, what will be the beta of your portfolio? A) 1.008 B) 1.014 C) 1.038 D) 1.067 E) 1.127

85) Your portfolio is composed of 30 percent of Stock X, 50 percent of Stock Y, and 20 percent

of Stock Z. Stock X has a beta of .64, Stock Y has a beta of 1.48, and Stock Z has a beta of 1.04. What is the portfolio beta? A) 1.01 B) 1.05 C) 1.09 D) 1.14 E) 1.18

86) Your portfolio is composed of 800 shares of Stock X, 3,500 shares of Stock Y, and 1,400

shares of Stock Z. Stock X has a beta of .25 and a price of $13.77 per share. Stock Y has a beta of .93 and a price of $60.07 per share. Stock Z has a beta of 2.01 and a price of $29.25 per share. What is the portfolio beta? A) 1.07 B) 1.10 C) 2.07 D) 1.06 E) 1.05

87) Your portfolio is composed of 500 shares of Stock X, 2,500 shares of Stock Y, and 2,800

shares of Stock Z. Stock X has a beta of .45 and a price of $12.30 per share. Stock Y has a beta of .85 and a price of $57.47 per share. Stock Z has a beta of 1.95 and a price of $33.00 per share. What is the portfolio beta? A) 1.26 B) 2.05 C) 1.35 D) 1.24 E) 1.08

88) Your portfolio has a beta of 1.18 and consists of 15 percent U.S. Treasury bills, 30 percent

Stock A, and 55 percent Stock B. Stock A has a risk level equivalent to that of the overall market. What is the beta of Stock B? A) .55 B) 1.10 C) 1.24 D) 1.40 E) 1.60

89) You would like to combine a highly risky stock with a beta of 2.6 with U.S. Treasury bills in

such a way that the risk level of the portfolio is equivalent to the risk level of the overall market. What percentage of the portfolio should be invested in Treasury bills? A) 57.91% B) 61.54% C) 50.00% D) 38.46% E) 42.09%

90) The market has an expected rate of return of 6.5 percent. The long-term government bond is

expected to yield 4.5 percent and the U.S. Treasury bill is expected to yield 1.8 percent. The inflation rate is 3.1 percent. What is the market risk premium? A) 8.3% B) 3.4% C) 4.7% D) 9.6% E) 2.0%

91) The risk-free rate of return is 1.9 percent and the market risk premium is 6.6 percent. What is

the expected rate of return on a stock with a beta of 1.16? A) 9.17% B) 9.56% C) 9.24% D) 7.35% E) 7.59%

92) The common stock of Grimm Companys has an expected return of 14.48 percent. The return

on the market is 11.6 percent and the risk-free rate of return is 3.42 percent. What is the beta of this stock? A) .95 B) 1.49 C) 1.31 D) 1.42 E) 1.35

93) The stock of Foreman’s has a beta of 1.38 and an expected return of 16.26 percent. The risk-

free rate of return is 3.42 percent. What is the expected return on the market? A) 7.60% B) 8.04% C) 9.30% D) 12.72% E) 12.16%

94) The expected return on Garza Company stock is 14.08 percent while the expected return on

the market is 11.5 percent. The beta of Garza is 1.26. What is the risk-free rate of return? A) .41% B) 2.01% C) .69% D) 1.58% E) 1.62%

95) The stock of Fritsch Engineering has a beta of 1.2. The risk-free rate of return is 1.7 percent

and the expected market return is 8.6 percent. What is the expected rate of return? A) 7.45% B) 8.60% C) 2.53% D) 9.98% E) 9.10%

96) Stock A has a beta of .68 and an expected return of 8.1 percent. Stock B has a beta of 1.42

and an expected return of 13.9 percent. Stock C has beta of 1.23 and an expected return of 12.4 percent. Stock E has a beta of 1.31 and an expected return of 12.6 percent. Stock E has a beta of .94 and an expected return of 9.8 percent. Which one of these stocks is the most accurately priced if the risk-free rate of return is 2.5 percent and the market risk premium is 8 percent? A) Stock A B) Stock B C) Stock C D) Stock D E) Stock E

97) Stock A has a beta of .69 and an expected return of 9.27 percent. Stock B has a beta of 1.13

and an expected return of 11.88 percent. Stock C has a beta of 1.48 and an expected return of 15.31 percent. Stock D has a beta of .71 and an expected return of 8.79 percent. Lastly, Stock E has a beta of 1.45 and an expected return of 14.04 percent. Which one of these stocks is most accurately priced if the risk-free rate of return is 3.6 percent and the market rate of return is 10.8 percent? A) Stock A B) Stock B C) Stock C D) Stock D E) Stock E

98) A portfolio contains two securities and has a beta of 1.08. The first security comprises 54

percent of the portfolio and has a beta of 1.27. What is the beta of the second security? A) .79 B) .86 C) .62 D) .82 E) .93

99) You have a $1,250 portfolio which is invested in Stocks A and B plus a risk-free asset. $350

is invested in Stock A which has a beta of 1.36 and Stock B has a beta of .84. How much needs to be invested in Stock B if you want a portfolio beta of .95? A) $803 B) $951 C) $782 D) $847 E) $791

100)

Stock M has a beta of 1.2. The market risk premium is 7.8 percent and the risk-free rate is 3.6 percent. Assume you compile a portfolio equally invested in Stock M, Stock N, and a risk-free security; the portfolio has a beta equal to the overall market. What is the expected return on the portfolio? A) 11.2% B) 10.8% C) 10.4% D) 11.4% E) 11.7%

101)

Clarity Homes stock has a beta of 1.46. The risk-free rate of return is 3.07 percent and the market rate of return is 11.81 percent. What is the amount of the risk premium on the stock? A) 8.09% B) 12.76% C) 9.59% D) 10.25% E) 17.24%

102)

You want to design a portfolio that has a beta of zero. Stock A has a beta of 1.69 and Stock B's beta is also greater than 1. You are willing to include both stocks as well as a riskfree security in your portfolio. If your portfolio will have a combined value of $5,000, how much should you invest in Stock B? A) $2,630 B) $0 C) $2,959 D) $3,008 E) $1,487

103)

You desire a portfolio beta of 1.1. Currently, your portfolio consists of $100 invested in Stock A with a beta of 1.4 and $300 in Stock B with a beta of .6. You have another $400 to invest and want to divide it between Stock C with a beta of 1.6 and a risk-free asset. How much should you invest in the risk-free asset to obtain your desired beta? A) $50 B) $100 C) $125 D) $350 E) $300

104)

Madison Consulting stock has a beta of 1.23. The risk-free rate of return is 2.86 percent and the market rate of return is 11.47 percent. What is the amount of the risk premium on the stock? A) 9.47% B) 12.60% C) 11.54% D) 10.59% E) 12.30%

105)

You want to compile a portfolio valued at $1,000 which will be invested in Stocks A and B plus a risk-free asset. Stock A has a beta of 1.2 and Stock B has a beta of .7. If you invest $300 in Stock A and want a portfolio beta of .9, how much should you invest in Stock B? A) $700.00 B) $268.40 C) $300.00 D) $771.43 E) $608.15

106)

Draw a graph that represents an opportunity set for a two-asset combination. Indicate four points on the graph as follows: (1) the minimum variance portfolio, (2) point (A) which represents the best return to risk combination, (3) point (B) which provides the same return but with more risk than point (A) and, (4) point (C) which has the same risk but a lower return than point (A). Lastly, indicate the efficient frontier.

107)

Why are some risks diversifiable and some nondiversifiable? Give an example of each.

108)

We routinely assume that investors are risk-averse return-seekers; i.e., they like returns and dislike risk. If so, why do we contend that only systematic risk and not total risk is important?

109)

Explain in words what beta is and why it is an important tool of security valuation.

110)

According to the CAPM, the expected return on a risky asset depends on three components. Describe each component, and explain its role in determining expected return.

111)

Draw the SML and plot Asset C such that it has less risk than the market but plots above the SML, and Asset D such that it has more risk than the market and plots below the SML. (Be sure to indicate where the market portfolio is on your graph.) Explain how assets like C or D can plot as they do and explain why such pricing cannot persist in a market that is in equilibrium.

Answer Key Test name: Chapter 11(1) 1) A 2) E 3) C 4) D 5) A 6) D 7) B 8) D 9) E 10) B 11) C 12) B 13) C 14) C 15) B 16) D 17) B 18) B 19) C 20) B 21) E 22) D 23) D 24) E 25) C 26) C 27) C 28) C 29) A 30) A 31) B 32) C 33) C 34) E 35) D 36) E 37) D

38) B 39) C 40) B 41) A 42) C 43) A 44) A 45) A 46) B 47) A 48) C 49) D 50) A 51) C 52) E 53) E 54) C 55) C 56) B 57) A 58) B 59) A 60) B 61) B 62) A 63) C 64) E 65) D 66) B 67) C 68) B 69) A 70) D 71) E 72) B 73) E 74) C 75) B 76) B 77) C

78) A 79) D 80) C 81) E 82) B 83) D 84) C 85) D 86) A 87) A 88) E 89) B 90) C 91) B 92) E 93) D 94) D 95) D 96) B 97) E 98) B 99) D 100) 101) 102) 103) 104) 105) 106) 107) 108) 109) 110) 111)

D B B A D D Essay Essay Essay Essay Essay Essay

Student name: 1) A portfolio consists of 190 shares of Stock C that sells for $35 and 155 shares of Stock D that

sells for $40. What is the portfolio weight of Stock C? A) .4825 B) .5822 C) .5606 D) .5175 E) .4136

2) You own the following portfolio of stocks. What is the portfolio weight of Stock C? Stock A B C D A) B) C) D) E)

Number of Shares 120 800 450 260

Price per Share $ 37 $ 33 $ 57 $ 56

.0625 .3610 .3716 .2049 .5650

3) You own 380 shares of Stock X at a price of $33 per share, 250 shares of Stock Y at a price

of $56 per share, and 315 shares of Stock Z at a price of $79 per share. What is the portfolio weight of Stock Y? A) .4839 B) .3063 C) .2722 D) .4148 E) .2439

4) You have a portfolio of two stocks that has a total value of $29,000. The portfolio is 41

percent invested in Stock J. If you own 190 shares of Stock K, what is Stock K's share price? A) $82.55 B) $84.05 C) $90.05 D) $80.05 E) $85.96

5) A portfolio consists of $16,200 in Stock M and $25,900 invested in Stock N. The expected

return on these stocks is 9.40 percent and 13.10 percent, respectively. What is the expected return on the portfolio? A) 11.25% B) 9.92% C) 10.82% D) 11.68% E) 12.39%

6) You have a portfolio that is 32 percent invested in Stock R, 14 percent invested in Stock S,

with the remainder in Stock T. The expected return on these stocks is 8.3 percent, 9.7 percent, and 12.0 percent, respectively. What is the expected return on the portfolio? A) 10.25% B) 10.00% C) 9.17% D) 11.02% E) 10.49%

7) You have gathered the following information on your investments. What is the expected

return on the portfolio? Stock F G H A) B) C) D) E)

Number of Shares Price per Share 220 $ 31 270 $ 17 210 $ 43

Expected Return 12.96% 9.60% 10.32%

11.04% 12.48% 12.00% 11.52% 10.96%

8) You have $17,600 to invest and would like to create a portfolio with an expected return of

11.1 percent. You can invest in Stock K with an expected return of 10.1 percent and Stock L with an expected return of 13.7 percent. How much will you invest in Stock K? A) $11,651.85 B) $6,518.52 C) $4,888.89 D) $12,711.11 E) $4,277.78

9) You recently purchased a stock that is expected to earn 10 percent in a booming economy, 4

percent in a normal economy, and lose 4 percent in a recessionary economy. There is 15 percent probability of a boom, 70 percent chance of a normal economy, and 15 percent chance of a recession. What is your expected rate of return on this stock? A) 3.33% B) 3.70% C) 10.00% D) 1.85% E) 4.67%

10) Based on the following information, what is the expected return? State of Economy Probability of State of Economy Recession .24 Normal .45 Boom .31 A) B) C) D) E)

Rate of Return if State Occurs −9.20% 10.70% 21.40%

8.44% 7.63% 13.66% 11.45% 9.24%

11) There is 6 percent probability of recession, 19 percent probability of a poor economy, 49

percent probability of a normal economy, and 26 percent probability of a boom. A stock has returns of −20.6 percent, 4.2 percent, 12 percent and 27.7 percent in these states of the economy, respectively. What is the stock's expected return? A) 5.83% B) 15.12% C) 11.59% D) 13.88% E) 12.64%

12) If the economy booms, RTF, Incorporated, stock is expected to return 11 percent. If the

economy goes into a recessionary period, then RTF is expected to only return 3 percent. The probability of a boom is 73 percent while the probability of a recession is 27 percent. What is the variance of the returns on RTF, Inc., stock? A) .035517 B) .044200 C) .000580 D) .001261 E) .000921

13) Based on the following information, what is the variance? State of Economy Probability of State of Economy Recession .29 Normal .32 Boom .39 A) B) C) D) E)

Rate of Return if State Occurs −10.50% 12.00% 23.00%

.08764 .13748 .02835 .03780 .01890

14) A stock will have a loss of 11.4 percent in a bad economy, a return of 11.2 percent in a

normal economy, and a return of 25.1 percent in a hot economy. There is 30 percent probability of a bad economy, 33 percent probability of a normal economy, and 37 percent probability of a hot economy. What is the variance of the stock's returns? A) .14901 B) .02220 C) .04441 D) .03331 E) .01665

15) If the economy booms, Meyer&Company stock will have a return of 20.8 percent. If the

economy goes into a recession, the stock will have a loss of 13.1 percent. The probability of a boom is 63 percent while the probability of a recession is 37 percent. What is the standard deviation of the returns on the stock? A) 14.61% B) 16.37% C) 12.43% D) 9.29% E) 13.56%

16) Based on the following information, what is the standard deviation of returns? State of Economy Recession Normal Boom A) B) C) D) E)

Probability of State of Economy .27 .30 .43

Rate of Return if State Occurs −.107 .122 .232

19.15% 19.69% 27.86% 13.84% 25.53%

17) A stock will have a loss of 14.2 percent in a recession, a return of 12.9 percent in a normal

economy, and a return of 27.6 percent in a boom. There is 27 percent probability of a recession, 30 percent probability of normal economy, and 43 percent probability of boom. What is the standard deviation of the stock's returns? A) 15.62% B) 12.78% C) 29.02% D) 14.60% E) 17.04%

18) You have a portfolio that is invested 16 percent in Stock A, 36 percent in Stock B, and 48

percent in Stock C. The betas of the stocks are .61, 1.16, and 1.45, respectively. What is the beta of the portfolio? A) .95 B) 1.07 C) 1.14 D) 1.36 E) 1.21

19) You have a portfolio that is invested 14 percent in Stock R, 50 percent in Stock S, and the

remainder in Stock T. The beta of Stock R is .81, and the beta of Stock S is 1.36. The beta of your portfolio is 1.30. What is the beta of the Stock T? A) 1.58 B) 1.21 C) 1.41 D) 1.09 E) 1.30

20) You have a portfolio that is equally invested in Stock F with a beta of 1.11, Stock G with a

beta of 1.48, and the market. What is the beta of your portfolio? A) 1.44 B) 1.30 C) 1.20 D) 1.15 E) .86

21) You have a portfolio that is equally invested in Stock F with a beta of 1.11, Stock G with a

beta of 1.48, and the risk-free asset. What is the beta of your portfolio? A) 1.33 B) .99 C) .86 D) .93 E) 1.20

22) You own a portfolio that has a total value of $210,000 and it is invested in Stock D with a

beta of .87 and Stock E with a beta of 1.38. The beta of your portfolio is equal to the market beta. What is the dollar amount of your investment in Stock D? A) $156,470.59 B) $40,147.28 C) $53,529.41 D) $46,838.24 E) $26,765.14

23) What is the beta of a portfolio comprised of the following securities? Stock A B C A) B) C) D) E)

Amount Invested $ 5,500 $ 6,500 $ 9,000

Security Beta 1.74 1.85 1.00

1.000 1.740 1.530 1.457 1.850

24) Your portfolio has a beta of 1.66. The portfolio consists of 17 percent U.S. Treasury bills, 24

percent Stock A, and 59 percent Stock B. Stock A has a risk level equivalent to that of the overall market. What is the beta of Stock B? A) 2.36 B) .42 C) 2.41 D) .88 E) 6.92

25) You own a portfolio that has a total value of $175,000 and a beta of 1.37. You have another

$76,000 to invest and you would like the beta of your portfolio to decrease to 1.30. What does the beta of the new investment have to be in order to accomplish this? A) .996 B) 1.139 C) 1.197 D) 1.254 E) 1.335

26) The risk-free rate is 2.6 percent and the market expected return is 12.3 percent. What is the

expected return of a stock that has a beta of .90? A) 11.33% B) 12.50% C) 13.67% D) 10.07% E) 14.81%

27) The risk-free rate of return is 4.2 percent and the market risk premium is 14 percent. What is

the expected rate of return on a stock with a beta of 1.5? A) 25.20% B) 20.30% C) 12.60% D) 10.15% E) 21.00%

28) The common stock of Flavorful Teas has an expected return of 16.15 percent. The return on

the market is 13 percent and the risk-free rate of return is 2.5 percent. What is the beta of this stock? A) .77 B) 1.30 C) .65 D) 5.50 E) 1.17

29) The stock of Big Joe's has a beta of 1.38 and an expected return of 12.00 percent. The risk-

free rate of return is 4.5 percent. What is the expected return on the market? A) 5.79% B) 9.93% C) 7.50% D) 13.71% E) 8.55%

30) The expected return on HiLo stock is 14.50 percent while the expected return on the market

is 13.2 percent. The beta of HiLo is 1.15. What is the risk-free rate of return? A) 5.68% B) 4.53% C) 2.27% D) 2.25% E) 1.30%

31) Which one of the following stocks is correctly priced if the risk-free rate of return is 2.8

percent and the market risk premium is 7.3 percent? Stock A B C D E A) B) C) D) E)

Beta .73 1.44 1.25 1.40 .80

Expected Return 7.73% 12.43 12.50 11.59 8.64

Stock D Stock C Stock A Stock E Stock B

32) A stock has a beta of .86 and an expected return of 8.45 percent. If the risk-free rate is 2.2

percent, what is the stock's reward-to-risk ratio? A) 7.27% B) 6.36% C) 9.83% D) 6.71% E) 8.55%

33) A stock has a beta of .87 and a reward-to-risk ratio of 6.49 percent. If the risk-free rate is 2.3

percent, what is the stock's expected return? A) 4.82% B) 7.64% C) 6.95% D) 7.95% E) 7.34%

34) A stock has a beta of 1.15 and an expected return of 10.27 percent. If the stock's reward-to-

risk ratio is 6.56 percent, what is the risk-free rate? A) 2.52% B) 2.39% C) 1.39% D) 2.62% E) 2.73%

35) A stock has an expected return of 11.41 percent and its reward-to-risk ratio is 7.3 percent. If

the risk-free rate is 2.85 percent, what is the stock's beta? A) 1.17 B) 1.08 C) 1.36 D) 1.56 E) 1.31

36) A stock has an expected return of 10.86 percent. Based on the following information, what is

the stock's return in a boom state of the economy? State of Economy Recession Normal Boom A) B) C) D) E)

Probability of State of Economy .21 .24 .55

Rate of Return if State Occurs −11.3% 12.8% ?

16.17% 20.15% 19.31% 17.32% 18.47%

37) You have a portfolio worth $51,000 that has an expected return of 12.8 percent. The portfolio

has $16,400 invested in Stock O, $24,200 invested in Stock P, with the remainder in Stock Q. The expected return on Stock O is 17.6 percent and the expected return on Stock P is 10.8 percent. What is the expected return on Stock Q? A) 11.53% B) 10.78% C) 13.73% D) 12.80% E) 9.88%

38) You decide to invest in a portfolio consisting of 25 percent Stock A, 25 percent Stock B, and

the remainder in Stock C. Based on the following information, what is the expected return of your portfolio? State of Economy

Probability of State of Economy

Recession Normal Boom

.23 .43 .34

Return if State Occurs Stock A Stock B Stock C -14.0% 10.2% 23.8%

-1.5% 6.1% 13.4%

-20.4% 14.7% 29.3%

A) 11.60% B) 9.81% C) 10.70% D) 12.65% E) 10.26%

39) You decide to invest in a portfolio consisting of 27 percent Stock A, 38 percent Stock B, and

the remainder in Stock C. Based on the following information, what is the variance of your portfolio? State of Economy

Probability of State of Economy

Recession Normal Boom

.105 .647 .248

A) B) C) D) E)

Return if State Occurs Stock A Stock B Stock C −9.20% 8.50% 21.37%

−2.60% 10.48% 24.75%

−11.60% 16.00% 29.45%

.01130 .00946 .00837 .00879 .00778

40) You decide to invest in a portfolio consisting of 11 percent Stock X, 53 percent Stock Y, and

the remainder in Stock Z. Based on the following information, what is the standard deviation of your portfolio? State of Economy

Normal Boom A) B) C) D) E)

Probability of State of Economy

.76 .24

Return if State Occurs

Stock X 10.70% 18.00%

Stock Y 4.10% 26.00%

Stock Z 13.10% 17.50%

8.72% 7.47% 2.68% 5.98% 3.57%

Answer Key Test name: Chapter 11(2) 1) D 2) B 3) C 4) C 5) D 6) E 7) A 8) D 9) B 10) E 11) E 12) D 13) E 14) B 15) B 16) D 17) E 18) E 19) C 20) C 21) C 22) A 23) D 24) C 25) B 26) A 27) A 28) B 29) B 30) B 31) D 32) A 33) D 34) E 35) A 36) E 37) E

38) B 39) C 40) D

Chapter 12: 1) As read from left to right, the three variables in the equation R = E(R) + U indicate: A) average return, expected return, and unexpected return. B) required return, expected return, and unbiased return. C) actual return, expected return, and unexpected return. D) required return, expected return, and unbiased risk. E) required return, expected return, and unsystematic risk.

2) The two components of the unexpected return on a security are: A) market risk and systematic risk. B) systematic risk and unsystematic risk. C) idiosyncratic risk and unsystematic risk. D) expected return and market risk. E) expected return and idiosyncratic risk.

3) If a stock tends to rise in value in response to news that inflation is exceeding expectations,

the stock has a: A) zero inflation beta. B) positive inflation beta. C) beta that exactly matches the market beta. D) negative inflation beta. E) beta equal to the risk-free beta.

4) As used in the market model, the symbol “ε” represents: A) unsystematic risk. B) beta. C) systematic risk. D) a stock’s response to systematic risk. E) the expected change in GNP.

5) The symbol “FI” is best defined as the: A) indicated GNP value. B) first and primary source of unexpected returns. C) initial expected rate of return. D) actual inflation rate minus the expected inflation rate. E) surprise change in interest rates.

6) If an announcement by a firm causes the price of that firm's stock to suddenly change, that

price change was most likely be driven by: A) the expected part of the announcement. B) market inefficiency. C) the unexpected part of the announcement. D) systematic risk. E) expectations of a revised announcement in the near term.

7) Lausanne Corporation manufactures and sells cosmetics. Horizons, Incorporated, arranges

global adventure tours for individuals and groups. If Lausanne develops a new product and its stock rises in value by 3 percent as a result, this will most likely have effect on Horizon’s stock price because the discovery would be classified as a(n) risk. A) no; systematic B) no; unsystematic C) a large; systematic D) a large; unsystematic E) an indeterminate; market

8) Assume a security has a GNP beta of 1.3. Accordingly, the security's total rate of return will: A) increase by 1.3 percent for every 1 percent decrease in GNP. B) increase by 1.3 percent every time the GNP increases by 1.3 percent. C) change by 1.3 times the percentage amount of any unexpected change in GNP. D) change by the unexpected percentage change in GNP divided by 1.3. E) increase by 1.3 percent whenever the GNP increases by 1.3 percent.

9) If the expected rate of GNP growth was 4 percent and the actual rate was .3 percent higher

than the expectation, the total return on a stock would change by model. A) 4.3βGNP B) .3βGNP C) −.3βGNP D) −4.3βGNP E) 4βGNP

based on a multifactor

10) A three-factor model of a security’s return would most likely include factors such as: A) tax rates, inflation, and profit margin. B) PE ratio, price-to-book ratio, and firm size. C) firm size, inflation, and GNP. D) inflation, GNP, and interest rates. E) GNP, interest rates, and PE ratios.

11) A beta coefficient reflects the response of a security's return to: A) the risk-free rate. B) an unsystematic risk. C) a systematic risk. D) the market rate of return. E) idiosyncratic risk.

12) Based on a multifactor model, systematic risk arises from: A) a common factor, F. B) negative betas. C) the lack of market liquidity. D) the variable, ε. E) a positive covariance between securities.

13) In a portfolio of risky assets, the portfolio's response to any factor, Fi, can be determined by: A) multiplying the portfolio weighted average βi by the factor Fi. B) C) D) E)

computing the portfolio weighted average Fi. multiplying the CAPM beta times the factor. summing the weighted random errors. dividing the percentage change in the factor, Fi, by the total number of factors affecting the portfolio.

14) Based on a multifactor model, portfolio diversification minimizes which one of the

following? A) Weighted average β B) Weighted average of (β × F) C) F D) Weighted average of ε E) Weighted average of E(R)

15) Assume a well-diversified portfolio has a beta of zero in a one-factor model. A security held

inside that portfolio will have an actual return: A) of zero. B) closely equal to the market risk premium. C) closely equal to the expected return. D) that is positive and less than the risk-free rate. E) that is less than the risk-free rate and can be negative.

16) Assume a security has no unsystematic risk. Given this, the excess return on that security will

be the highest if the factor, F, A) increases in value; high B) increases in value; low C) remains constant; zero D) decreases in value; high E) decreases in value; low

and the beta for that factor is

17) Which type of risk is unaffected by portfolio diversification? A) Unsystematic risk B) Idiosyncratic risk C) Total risk D) Systematic risk E) All types of risk are affected by portfolio diversification.

18) Assume a portfolio is composed of three different stocks. If a large number of diverse

securities are added to the portfolio, then the: A) weighted average expected return goes to zero. B) weighted average of the factor betas goes to zero. C) weighted average of the unsystematic risk goes to zero. D) return of the portfolio must equal the market rate of return. E) return of the portfolio will equal the risk-free rate.

19) Which one of the following statements is true? A) A well-diversified portfolio has negligible systematic risk. B) A well-diversified portfolio has negligible unsystematic risk. C) An individual security has negligible systematic risk. D) An individual security has negligible unsystematic risk. E) Both a well-diversified portfolio and an individual security have negligible

unsystematic risk.

20) If an investor plans to add a stock to a well-diversified portfolio, the investor should first

consider the risks of that additional stock. A) expected total B) historical total C) systematic D) idiosyncratic E) firm-specific

21) Consider the security market line (SML) under the one-factor model. Assume Point C lies on

the SML but an investor would prefer a point that also lies on the SML but is lower and to the left of Point C. How can this investor obtain that point for their portfolio? A) Replace the lower beta stocks in the portfolio with higher beta stocks B) Sell a portion of the portfolio and use the proceeds to purchase undervalued stocks C) Sell the higher beta stocks in the portfolio and replace them with undervalued stocks D) Replace the portfolio with undervalued stocks and risk-free assets E) Replace the portfolio with a combination of a higher beta portfolio that lies on the SML and risk-free assets

22)

The slope of the security market line equals the: A) risk-premium for an individual security. B) risk-free rate of return. C) market rate of return. D) total return per unit of beta. E) market risk premium.

23) The single-factor model generally uses A) arbitrage fees B) GNP C) the inflation rate D) the market risk premium E) the risk-free return

as the single factor.

24) Assuming the single-factor model applies, the factor beta for the market portfolio is: A) zero. B) one. C) the average of the risk-free beta and the beta for the highest risk security in the

portfolio. D) impossible to calculate without collecting sample data. E) irrelevant to the model.

25) Assume the single-factor model is applied to a security that has a negative factor beta. The

security will: A) always have a positive rate of return. B) have an expected return greater than the risk-free rate. C) have an actual return that equals the risk-free rate. D) have an expected return equal to the market rate of return. E) have an actual rate of return that can be positive, negative, or zero.

26) Estimating the rate of return for any portfolio lying on the security market line requires

which of the following? A) Market rate of return and the portfolio beta B) Market rate of return, market beta, and the risk-free rate C) Risk-free rate, factor beta, and the industry beta D) Factor beta and the market risk premium E) Portfolio beta, the risk-free rate, and the market risk premium

27) The acronym APT stands for: A) arbitrage pricing techniques. B) absolute profit theory. C) arbitrage pricing theory. D) asset pricing theory. E) assured price techniques.

28) A factor, as used in APT, is a variable that: A) represents a nondiversifiable risk. B) affects the returns of risky assets in an unsystematic fashion. C) correlates the returns of a risky asset with those of a risk-free asset. D) measures the response of a specific asset to a systematic risk. E) represents a firm-specific risk.

29) A criticism of the CAPM is that it: A) ignores the rate of return on the market portfolio. B) ignores the risk-free rate. C) requires a single measure of systematic risk. D) utilizes too many factors. E) contradicts the single-factor APT model.

30) The general purpose of identifying multiple factors in the APT model is to: A) identify the top three factors that have the largest impact on the market rate of return. B) identify and eliminate all systematic risks from a portfolio. C) identify the quantity of each factor that is needed to reduce a portfolio's risk, as

measured by beta, to a level equal to that of the overall market. D) reduce the unsystematic risk to a level where the unsystematic risk of one security is unrelated to the unsystematic risk of any other security. E) reduce the slope of the security market line, thereby reducing portfolio risk.

31) If you were to consider the CAPM as a one-factor model, then the factor would be the: A) rate of inflation. B) market risk premium. C) GNP. D) risk-free rate. E) individual beta of each security or portfolio.

32) Which one of the following statements is true? A) Both APT and CAPM argue that expected excess return must be proportional to the

beta(s). B) APT and CAPM are the only quantitative approaches to measure expected returns in risky assets. C) The factors to be used in the APT are easier to identify than the factor used in the CAPM. D) CAPM provides the means for a more-detailed estimate of a security's expected return than does APT. E) CAPM assigns a beta of 1 to the market while APT assigns the market a beta of zero.

33) Parametric or empirical models rely: A) on security betas explaining systematic factor relationships. B) on finding regularities and relations in past market data. C) on security returns always being located on the capital market line. D) solely on factors within the security’s issuing firm’s realm of control. E) primarily on financial market models and theories.

34) When using the empirical approach, rather than a risk-based model, to compute an expected

rate of return on a security, the beta values are replaced with: A) the ratio of the market rate of return to the risk-free rate. B) a singular value equal to the market-to-book value of the firm. C) the firm's various attributes. D) the ratio of the firm's historical average return to the risk-free rate. E) the average standard deviation of the security's historical returns.

35) A growth-stock portfolio is probably best characterized as having a: A) high PE ratio relative to the overall market. B) lower risk premium than the overall market. C) low level of systematic risk and a high level of unsystematic risk. D) low PE ratio relative to the overall market. E) lower beta than the overall market.

36) When selecting a benchmark, it is important to match the security or portfolio that will be

evaluated to securities: A) that have an opposing style. B) that have identical factor betas for all factors in the pricing model being utilized. C) that closely mimic the overall market. D) with the same PE ratios. E) of similar style that are available for purchase.

37) The Fama-French three-factor model seems to support the notion that higher returns can best

be earned over time on: A) large, growth stocks. B) large, value stocks. C) small, value stocks. D) small, growth stocks. E) the overall stock market.

38) The systematic response coefficient for productivity, βp, would produce an unexpected

change in any security return of (βP × ) if the expected rate of productivity was 1.25 percent and the actual rate was 2.46 percent. A) −1.21 percent B) 1.21 percent C) 2.46 percent D) −2.46 percent E) 1.25 percent

39) The stock of Osaka Corporation has an expected return of 8.2 percent and betas of: βGNP =

1.23; βI = .97; and βEx = 1.08. This expectation is based on a three-factor model with expected values of: GNP growth of −1 percent; inflation of 2.4 percent; and export growth of 3.5 percent. However, actual growth in these factors turns out to be .55 percent, 1.8 percent, and 2.6 percent, respectively. Assuming there was no unexpected news related specifically to the stock, what was the stock's total rate of return? A) 8.04% B) 8.55% C) 8.47% D) 7.85% E) 8.85%

40) The stock of Giannis Sports has an expected return of 7.8 percent and betas of: βGNP = 1.06;

βI = 1.01; and βEx = .52. This expectation is based on a three-factor model with expected values of: GNP growth of 2.6 percent; inflation of 3.1 percent; and export growth of 1.4 percent. However, actual growth in these factors turns out to be 3.1 percent, 2.6 percent, and .2 percent, respectively. Calculate the stock's total return if the company unexpectedly announces that an important patent filing has been granted sooner than expected and will earn the company 5 percent more in return, (i.e., from 10 percent up to 15 percent). A) 16.02% B) 12.20% C) 11.55% D) 10.90% E) 11.02%

41) The stock of Quintanilla, Incorporated, has an expected return of 12.6 percent and betas of:

βGNP = 1.52; βI = 1.06; and βEx = 1.28. This expectation is based on a three-factor model with expected values of: GNP growth of 3.2 percent; inflation of 2.9 percent; and export growth of 2.2 percent. However, actual growth in these factors turns out to be 3.6 percent, 3.2 percent, and 2.5 percent, respectively. Calculate the stock's total return if the company unexpectedly announces they had an industrial accident and the operating facilities will close down temporarily which will reduce the return by 7 percent (from 10 percent down to 3 percent). A) −4.05% B) 6.91% C) 3.57% D) 7.42% E) −1.85%

42) Assume you have identified three important systematic risk factors: exports, inflation, and

industrial production. At the beginning of the year, a stock’s return is estimated at 10.3 percent and the growth in the three factors is estimated at −.5 percent, 2.8 percent, and 3.6 percent, respectively. The factor betas are: βEX = 1.8, βI = .7, and βIP = 1. What would be the stock’s total return if the actual growth in each of the factors was equal to the expected growth and no unexpected news occurred? A) 4.7 percent B) 5.9 percent C) 10.3 percent D) 14.96 percent E) 8.7 percent

43) The systematic response coefficient for productivity, βp, would produce an unexpected

change in any security return of [βP × and the actual rate was 2.2 percent. A) .4 percent B) −.4 percent C) 2.2 percent D) −2.2 percent E) 1.8 percent

] if the expected rate of productivity was 1.8 percent

44) Assume the single-factor APT model applies, and that 50 percent of the funds in a portfolio

are invested in a risky security and 50 percent in a risk-free asset. The risky security has a beta of 1.6. The portfolio has a factor beta of: A) 0. B) .8. C) .9. D) 1. E) 1.6.

45) Assume the single-factor model applies and that 70 percent of the funds in a portfolio are

invested in a risky security and the remainder in the risk-free asset. The risky security has a beta of 1.4. The portfolio has a beta of: A) 1.40. B) .98. C) .70. D) .49. E) 1.00.

46) Assume a one-factor model where the factor is associated with the overall market. Suppose

McTavish common stock has a factor beta of .8, the risk-free rate is 3.2 percent, and the expected market rate of return is 11.2 percent. What is the expected return for the stock? A) 10.25% B) 6.40% C) 7.20% D) 9.60% E) 12.16%

47) Suppose Itzel’s common stock has a return of 12.87 percent, the risk-free rate is 2.65 percent,

the market return is 13.46 percent, and there is currently no unsystematic influence affecting Itzel’s return. Given a one-factor APT model, what is the factor beta? A) .896 B) .945 C) 1.003 D) .962 E) .979

48) Suppose a sizeable, fully diversified portfolio has an F1 beta of .9, an F2 beta of 1.4, and an

expected return of 11.6 percent. If F1 turns out to be 1.1 percent and F2 is −.8 percent, what will be the actual rate of return based on a two-factor arbitrage pricing model? A) 12.05% B) 11.47% C) 11.72% D) 12.32% E) 12.58%

49) Suppose Reflective Corporation's common stock has an actual return of 12.34 percent

compared to its expected return of 12.6 percent. The risk-free rate was expected to be 4.3 percent, which it was. The beta of Fi is .9 and the beta of FGNP is 1.1. If inflation unexpectedly increased by 1.4 percent, what was the unexpected change in GNP? A) 2.02% B) 1.38% C) −.82% D) −1.38% E) −2.02%

50) In a multifactor model, explain what a factor represents and the role that beta plays in

relation to factors. How do factors and betas affect the actual return?

51) Verbally describe a graph that illustrates the one-factor model.

52) Explain the conceptual differences in the theoretical development of the CAPM and the APT.

53) Explain the concept of a benchmark and why benchmarks provide value when evaluating the

performance of a security or portfolio.

Answer Key Test name: Chapter 12 1) C 2) B 3) B 4) A 5) D 6) C 7) B 8) C 9) B 10) D 11) C 12) A 13) A 14) D 15) C 16) A 17) D 18) C 19) B 20) C 21) E 22) E 23) D 24) B 25) E 26) E 27) C 28) A 29) C 30) D 31) B 32) A 33) B 34) C 35) A 36) E 37) C

38) B 39) B 40) B 41) B 42) C 43) A 44) B 45) B 46) D 47) B 48) B 49) D 50) Essay 51) Essay 52) Essay 53) Essay

Chapter 13: 1) To determine the appropriate cost of capital to employ when computing the present value of

a project, an analyst should use the rate that is earned on: A) the overall market portfolio. B) the sponsoring firm’s return on assets. C) a financial asset of comparable risk. D) a riskless asset with a similar life span. E) the sponsoring firm’s return on equity.

2) When using the CAPM to estimate the cost of equity capital, the expected excess market

return equals the: A) return on the stock minus the risk-free rate. B) return on the market minus the risk-free rate. C) beta times the market risk premium. D) beta times the risk-free rate. E) market rate of return.

3) If a firm issues new stock to fund a project, the firm should expect the issuance to: A) have no effect on the previous shareholders. B) create costless benefits for the firm. C) cause any potential gains to the firm from the project to be lost. D) affect future dividends but not the appreciation realized by previous shareholders. E) dilute the capital gains that would have been earned by the previous shareholders.

4) An all-equity firm is evaluating a capital project that has the same level of risk as the firm.

The project should be accepted if its: A) internal rate of return exceeds the firm’s cost of equity capital. B) expected rate of return exceeds the market rate of return. C) anticipated rate of return exceeds the firm’s return on assets. D) internal rate of return is positive given this level of risk. E) expected rate of return exceeds the risk-free rate.

5) With respect to the CAPM, which one of the following statements is correct? A) The CAPM is the only available method for determining an appropriate discount rate

for a proposed project. B) The market rate of return is most commonly based on the forecasted return on the market for the next 5-year period. C) CAPM is used quite frequently by firms in their capital budgeting processes. D) The expected return on the 30-year U.S. Treasury bond is the most commonly used as the risk-free rate of return. E) An increase in the risk-free rate combined with a beta greater than 1.0 increases the discount rate computed using the CAPM.

6) When estimating the cost of equity using the DDM, the factor that is the most apt to add error

to this estimate is the: A) value of the last dividend. B) firm’s tax rate. C) historical beta. D) dividend growth rate. E) current stock price.

7) With respect to beta, which one of the following statements is correct? A) Firm betas have less error than industry betas. B) Firms should always rely on their own beta rather than their industry’s beta. C) Beta is unaffected by a firm’s capital structure. D) The sample size used to compute beta may be too small to yield a reliable result. E) Firm betas rarely vary over time.

8) The beta of a security is calculated as: (

of a security’s return with the return on the

market portfolio/ ). A) Variance; Covariance of the market return B) Covariance; Variance of the market return C) Covariance; Standard deviation of the market return D) Variance; Covariance of the security return E) Covariance; Variance of the security return

9) Assume you plotted the monthly returns for both a stock and the S&P 500. Using regression

analysis, the straight line through these points that is developed by the analysis is referred to as the which has a slope of and an intercept of . A) security market line; alpha; gamma B) characteristic line; beta; alpha C) characteristic line; alpha; beta D) security market line; beta; gamma E) characteristic line; gamma; alpha

10) Companies will generally have a beta if their: A) low; stock price is relatively low. B) high; sales are highly dependent on the market cycle. C) high; sales are growing at a steady rate of increase. D) high; sales are high compared to other firms in their industry. E) low; production costs are primarily fixed in nature.

11) Assume a firm increases its use of both operating leverage and financial leverage.

Accordingly, an analyst should expect the firm’s: A) asset beta to exceed its equity beta. B) beta of debt to exceed 1.0. C) beta to remain constant as the increased operating leverage will offset the increased financial leverage. D) equity beta to increase. E) debt beta to exceed its equity beta.

12) The beta of debt is commonly considered to be: A) equal to the market beta. B) one-half of the equity beta. C) equal to the asset beta. D) zero. E) one.

13) If two firms are equivalent in all other respects, an analyst should expect the beta of the

levered firm’s common stock to be A) roughly equivalent to B) significantly less than C) slightly less than D) greater than E) equal to

the beta of the unlevered firm’s the common stock.

14) The beta of a firm is most likely to be high under which of the following conditions? A) High cyclical business activity and low operating leverage B) High cyclical business activity and high operating leverage C) Low cyclical business activity and low financial leverage D) Low cyclical business activity and low operating leverage E) Low financial leverage and low operating leverage

15) A firm with cyclical earnings is characterized by: A) revenue patterns that vary with the business cycle. B) high levels of debt in its capital structure. C) high fixed costs. D) high costs per unit. E) low contribution margins.

16) A firm with high operating leverage has: A) low fixed costs in its production process. B) high variable costs in its production process. C) high fixed costs in its production process. D) high total costs per unit. E) low total costs per unit.

17) Wyatt Materials is equivalent to other firms in its industry in all ways but one: Wyatt has

much lower fixed costs than its peers. Accordingly, an analyst should expect Wyatt to have: A) a lower beta than its industry. B) the same beta as the industry but a lower beta than the other firms in the industry. C) a higher beta than its industry. D) a higher beta than the industry and all the firms within that industry. E) the same beta as the industry but a higher beta than the other firms in the industry.

18) The use of leverage: A) increases both the asset and the equity betas. B) decreases both the asset and the equity betas. C) decreases the equity beta and increases the asset beta. D) increases the equity beta but does not affect the asset beta. E) decreases the equity beta but does not affect the asset beta.

19) An industry is likely to have a low beta if the: A) stream of revenues within that industry is less volatile than the market. B) economy is in a recessionary period. C) market for its goods is highly affected by the market cycle. D) number of firms within the industry is fairly constant. E) industry tends to use a lot of debt financing.

20) For a levered firm the equity beta is the asset beta. A) greater than B) less than C) equal to D) sometimes greater than and sometimes less than E) unrelated to

21) The CAPM has an advantage over the DDM because the CAPM: A) explicitly adjusts for risk. B) applies to firms that pay dividends. C) has no measurement risk. D) specifically considers a firm’s rate of growth. E) ignores changes in the overall market over time.

22) Which one of the following options is a correct means of calculating an expected rate of

growth? A) ROA × Dividend payout ratio B) ROE × Profit margin C) ROA × Retention ratio D) ROA × Profit margin E) ROE × Retention ratio

23) Yu and De Leon is evaluating a project that has a different level of risk than the overall firm.

This project should be evaluated: A) using the market beta. B) using the overall firm’s beta. C) using a beta commensurate with the project’s risks. D) at the market rate of return. E) at the T-bill rate of return.

24) The discount rate applied to an individual project should be based on the: A) sources of funding for that project. B) risks associated with the project’s cash flows. C) sponsoring firm’s average level of risk. D) expertise of the project’s managers. E) size and duration of the project’s life.

25) If a firm applies its overall firm beta to projects with varying levels of risk, the firm will tend

to: A) B) C) D) E)

reject the riskiest projects. accept all low-risk projects. accept only projects of equal risk to its current operations. remain at its current level of overall risk. become riskier over time.

26) Tedjo, Incorporated, is considering a project that is markedly different from its current

operations. An analyst at Tedjo has located the beta of a firm that is a good example of a pure play for this new project. Although it is a good fit, why might Tedjo assign a higher beta to the project than the beta of the pure play? A) Tedjo should assign a project beta that is based on the average of Tedjo and the pure play firm’s betas. B) The expected project revenues may be less cyclical than those of the pure play firm. C) Tedjo may use less debt in its operations than does the pure play firm. D) The pure play firm has more experience in the new area than Tedjo does. E) The project may incur flotation costs so a higher beta is warranted to offset the additional cost.

27) The cost of preferred stock: A) should be adjusted for taxes when computing WACC. B) is ignored by all firms when computing WACC. C) is generally calculated using the overall firm’s beta. D) is equal to the stock’s dividend yield. E) is set equal to the pretax cost of debt since it is a fixed income security.

28) Baumgartner’s already has debt outstanding but will issue new debt in order to expand. The

best estimate of the pretax cost of the new debt is the A) original yield to maturity B) current yield to maturity C) embedded cost D) current yield E) coupon rate

of the already outstanding debt.

29) As of 2018, U.S. tax law limits the tax deduction for interest payments to 30 percent of: A) EBIT. B) EBT. C) net income. D) net revenue. E) the total interest paid.

30) When computing WACC, an analyst should use the: A) pretax cost of debt because most corporations pay taxes at the same tax rate. B) pretax cost of debt because it is the actual rate the firm is paying its bondholders. C) current yield because it is based on the current market price of debt. D) aftertax cost of debt because interest is partially, if not fully, tax deductible. E) pretax yield to maturity because it considers the current market price of debt.

31) When computing the weighted average cost of capital, which of the following items must be

adjusted for taxes? A) Cost of equity B) Cost of preferred stock C) Both the cost of equity and the cost of preferred stock D) The costs of debt and preferred stock E) Cost of debt

32) All else held constant, which one of the following actions is most likely to increase the

WACC of a levered firm? A) An increase in the weight of debt B) A decrease in a firm’s equity beta C) A decrease in the dividend growth rate D) A decrease in the tax rate E) An increase in the risk-free rate when the equity beta exceeds 1.0

33) The weighted average cost of capital for a firm is the: A) discount rate that the firm should apply to all the projects it undertakes. B) overall rate that the firm must earn on its existing assets to maintain the value of its

stock. C) rate the firm should expect to pay on its next bond issue. D) maximum rate that the firm should require on any projects it undertakes. E) rate of return that the firm’s preferred stockholders should expect to earn over the long term.

34) A firm’s WACC can be correctly used to discount the expected future cash flows of a new

project when that project will: A) have the same level of risk as the firm’s current operations. B) be financed solely with new debt and internal equity. C) be managed by the firm’s current managers. D) be financed based on the firm’s current debt-equity ratio. E) be financed solely with internal equity.

35) When valuing a firm financed with debt and equity, the individual cash flows should be

discounted using: A) the market rate of return. B) the average of the DDM and CAPM costs of equity. C) (1 + WACC)T. D) (1 + CAPM)T. E) (r − g).

36) The terminal value of a firm is also commonly referred to as the: A) final value. B) cash value. C) non-constant value. D) estimated value. E) horizon value.

37) A firm’s net cash flow is calculated as: A) EBIT − Taxes + Depreciation − Capital spending − Increases in net working capital. B) EBIT + Taxes + Depreciation − Capital spending − Increases in net working capital. C) EBIT − Taxes − Depreciation − Capital spending + Increases in net working capital. D) EBIT − Taxes + Depreciation + Capital spending − Increases in net working capital. E) EBIT + Taxes + Depreciation − Capital spending + Increases in net working capital.

38) Assume a levered firm will raise new capital to fund a project. To account for the flotation

costs appropriately, the firm should: A) subtract the pretax flotation cost from the project’s NPV. B) deduct the amount of the flotation cost from the cash flows for Year 1 of the project. C) add the percentage of the flotation cost to the WACC when discounting the cash flows. D) divide the amount of project capital needed by (1 − weighted average flotation cost). E) increase the target weights of both debt and equity to account for the flotation percentage.

39) When calculating the weighted average flotation cost, the weights should be based on the: A) mix of debt and equity that will be used to finance the specific project. B) firm’s target capital structure. C) percentages of internal and external financing that will be used for the project. D) firm’s current mix of debt and equity. E) average amounts of external capital raised during the past twelve months.

40) The flotation cost of internal equity is: A) assumed to be zero. B) assumed to be the same as the cost of external equity. C) assigned a cost equal to the aftertax cost of equity. D) assumed to be the same as the firm’s return on equity. E) assigned a cost equal to the risk-free rate.

41) Quintero Logistics is an all-equity firm. The beta is 1.16, the expected market return is 10.7

percent, and the risk-free rate is 1.6 percent. What is the expected rate of return on Quintero’s stock? A) 2.66% B) 10.70% C) 12.16% D) 11.14% E) 9.44%

42) What is the cost of equity for a firm that has a beta of 1.22 if the risk-free rate of return is 1.4

percent and the expected market return is 6.6 percent? A) 6.60% B) 7.74% C) 8.27% D) 7.60% E) 2.03%

43) Lancaster recently paid its annual dividend of $4.20 per share. At that time, the firm

announced that all future dividends will be increased by 5.5 percent annually. What is the firm’s cost of equity if the stock is currently selling for $51.75 per share? A) 13.62% B) 8.11% C) 8.55% D) 14.06% E) 4.95%

44) West Corporation is expected to pay an annual dividend of $1.50 per share one year from

now with future increases of 7.5 percent annually. The stock currently sells for $53.25 per share. What is the cost of equity? A) 10.32% B) 12.38% C) 10.53% D) 13.02% E) 12.81%

45) The cost of equity for Chang Corporation is 8.4 percent and the debt-equity ratio is .6. The

expected return on the market is 10.4 percent and the risk-free rate is 3.8 percent. Using the common assumption for the debt beta, what is the asset beta? A) .70 B) .44 C) .62 D) .67 E) .59

46) Clark, Incorporated has an asset beta of .57, the risk-free rate is 4.3 percent, and the market

risk premium is 7.7 percent. What is the equity beta if the firm has a debt-equity ratio of .56? A) .46 B) .89 C) .74 D) .37 E) .32

47) Dylan & Lee is an all-equity firm with a beta of .88. What will the firm’s equity beta be if the

firm switches to a debt-equity ratio of .23? A) .80 B) 1.23 C) .20 D) 1.19 E) 1.08

48) A firm has an equity beta of 1.2, the risk-free rate is 3.4 percent, the market return is 15.7

percent, and the pretax cost of debt is 9.4 percent. The debt-equity ratio is .47. If you apply the common beta assumptions, what is the firm’s asset beta? A) .82 B) .61 C) .67 D) .58 E) .73

49) The cost of equity of Caro Corporation is 9.4 percent, the expected return on the market is

13.6 percent, and the risk-free rate is 3.8 percent. What is the firm’s debt-equity ratio if its asset beta is .36? Assume there is no preferred stock. A) .52 B) .59 C) .82 D) .77 E) .63

50) Regan Transport stock is selling for $42.39 per share, has an ROE of 14.3 percent, and a

dividend payout ratio of 35 percent. The next expected dividend is $1.62 per share. What is the cost of equity for this firm? A) 12.86% B) 13.12% C) 13.47% D) 12.52% E) 13.70%

51) Arnel and Company just paid its annual dividend of $1.48 per share. Analysts expect the

stock price to increase by 2.1 percent annually and value the stock at $14.65 per share currently. What is the cost of equity for this firm? A) 12.41% B) 13.32% C) 12.20% D) 13.87% E) 14.06%

52) Lavan Systems is an all-equity firm with a beta of 1.32. The firm is considering a new project

that entails less risk than its current operations and thus management feels that the firm’s beta should be lowered by .18 when assigning a discount rate to this project. The market rate of return is 9.4 percent and the risk-free rate is 2.8 percent. What discount rate should be assigned to this project? A) 11.46% B) 11.21% C) 10.87% D) 6.49% E) 10.32%

53) Alpha, Incorporated, has an overall cost of capital of 11.6 percent and a beta of 1.31. The

firm is contemplating a new project that is unrelated to the firm’s current operations. Omega Corporation is a firm that operates similarly to the new project and Omega has a cost of capital of 10.7 percent. Alpha knows that it will be less efficient than Omega and thus feels that an adjustment of +1 percentage point should be added to the project’s discount rate to allow for this inefficiency. What discount rate should be assigned to the new project? A) 10.7% B) 11.3% C) 11.7% D) 11.6% E) 12.6%

54) Monitor pays an annual dividend of $3.80 on its preferred stock. What is the cost of preferred

if the stock currently sells for $42.70 per share and the tax rate is 21 percent? A) 7.94% B) 11.87% C) 6.68% D) 9.39% E) 8.90%

55) Counterweight Company has debt outstanding with a coupon rate of 4.5 percent and a yield

to maturity of 7.5 percent. What is the aftertax cost of debt if the tax rate is 22 percent? Assume all interest is tax deductible. A) 7.02% B) 3.51% C) 5.85% D) 2.93% E) 11.70%

56) Tiara Events has an aftertax cost of debt of 5.1 percent at its current tax rate of 34 percent.

What will its aftertax cost of debt be if the tax rate drops to 21 percent? Assume all interest is tax deductible. A) 6.10% B) 5.92% C) 6.17% D) 4.03% E) 4.47%

57) Harvey Machinery has 80 bonds outstanding that are selling at their par value of $1,000 each.

Bonds with similar characteristics are yielding a pretax 8.6 percent. The firm also has 4,000 shares of common stock outstanding. The stock has a beta of 1.1 and sells for $40 per share. The U.S. T-bill is yielding 4 percent, the market risk premium is 8 percent, and the firm’s tax rate is 21 percent. What is the firm’s weighted average cost of capital assuming its earnings are sufficient to classify all interest as a tax-deductible expense? A) 10.10% B) 11.39% C) 10.80% D) 10.65% E) 11.40%

58) Zachary Confections has a yield to maturity on its debt of 7.8 percent, a cost of equity of 12.4

percent, and a cost of preferred stock of 8 percent. The firm has 105 shares of common stock outstanding at a market price of $22 per share. There are 25 shares of preferred stock outstanding at a market price of $45 per share. The bond issue has a total face value of $1,500 and sells at 98 percent of face value. If the tax rate is 21 percent, what is the weighted average cost of capital assuming all interest is tax deductible? A) 9.68% B) 8.54% C) 8.69% D) 9.52% E) 9.45%

59) Jahzeel’s wants to have a weighted average cost of capital of 9.5 percent. The firm has an

aftertax cost of debt of 6.5 percent and a cost of equity of 12.75 percent. What debt-equity ratio is needed for the firm to achieve its targeted weighted average cost of capital? A) .84 B) .92 C) 1.08 D) .76 E) .67

60) Brick and Mortar has 200 shares of common stock outstanding at a market price of $37 per

share. The firm recently paid an annual dividend in the amount of $1.20 per share and has a dividend growth rate of 4 percent. The firm also has 5 bonds outstanding with a face value of $1,000 per bond that are selling at 99 percent of par. The bonds have a coupon rate of 6 percent and a yield to maturity of 6.7 percent. All interest is tax deductible. If the tax rate is 21 percent, what is the weighted average cost of capital? A) 5.93% B) 6.87% C) 6.37% D) 6.54% E) 7.08%

61) The common stock of Plank Communications has a beta of 1.37, the risk-free rate is 3.4

percent, and the market risk premium is 8.2 percent. The yield to maturity on the firm’s bonds is 7.6 percent and the debt-equity ratio is .45. What is the WACC if the tax rate is 23 percent and all interest is tax deductible? A) 14.07% B) 10.94% C) 12.60% D) 10.59% E) 11.91%

62) Edelman’s net cash flows for the next three years are projected at $72,000, $78,000, and

$84,000, respectively. After that, the cash flows are expected to increase by 3.2 percent annually. The aftertax cost of debt is 6.2 percent and the cost of equity is 11.4 percent. What is the value of the firm if it is financed with 40 percent debt and 60 percent equity? A) $1,215,650 B) $1,328,141 C) $1,461,439 D) $1,575,941 E) $1,279,623

63) The expected net cash flows of Vincent Homes for the next three years are $42,000, $49,000,

and $64,000, respectively. After three years, the growth rate of the cash flows will be a constant 2 percent annually. The WACC is 8 percent. What is the present value of the terminal value? A) $881,822 B) $863,689 C) $959,259 D) $910,444 E) $828,406

64) Skyler Audio has developed an improved version of its most popular product. To get this

improvement to the market will cost $48 million but the project will return an additional $13.5 million for 5 years in net cash flows. The firm’s debt-equity ratio is .25, the cost of equity is 13 percent, the pretax cost of debt is 9 percent, and the tax rate is 21 percent. All interest is tax deductible. What is the net present value of this proposed project? A) $906,411 B) $902,459 C) $879,838 D) $884,318 E) $889,760

65) Zander Systems has 25,000 shares of common stock outstanding with a beta of 1.4, a market

price of $32 per share, and a dividend yield of 5.7 percent. Dividends increase by 4.2 percent annually. The firm also has $450,000 of debt outstanding that is selling at 102 percent of par that has a yield to maturity of 6.8 percent. The tax rate is 21 percent and all interest is tax deductible. The firm is considering a project that has the same risk level as the firm’s current operations, an initial cost of $328,000, and cash inflows of $52,500, $155,000, and $225,000 for Years 1 to 3, respectively. What is the NPV of the project? A) $28,515 B) $31,492 C) $36,511 D) $27,006 E) $30,157

66) Alpha Corporation is considering acquiring Omega, Incorporated, and has compiled the

following information about Omega: Year EBIT Capital spending Increases in net working capital Depreciation

1 $ 318,000 46,500 5,500 34,000

2 $ 364,000 28,000 6,500 32,100

3 $ 392,000 36,200 1,200 28,700

The applicable tax rate is 21 percent and the terminal value of Omega as of Year 3 is $2.5 million. What is the NPV of this acquisition if the discount rate is 7.1 percent and the acquisition cost is $2.25 million? A) $538,316 B) $509,482 C) $499,003 D) $506,048 E) $496,399

67) Andrews has a current debt-equity ratio of .52 and a target debt-equity ratio of .45. The cost

of floating equity is 9.5 percent and the flotation cost of debt is 6.6 percent. What should the firm use as its weighted average flotation cost? A) 8.01% B) 8.51% C) 8.33% D) 7.76% E) 8.60%

68) Jillian Retail can issue equity at a flotation cost of 8.76 percent and debt at 5.93 percent. The

firm currently has a debt-equity ratio of .37 but prefers a ratio of .35. What should this firm use as its weighted average flotation cost? A) 8.26% B) 8.03% C) 8.34% D) 8.37% E) 8.00%

69) Explain a) the factors that determine a security’s beta and b) how asset beta relates to equity

beta.

70) The Neptune Company offers network communications systems to computer users. The

company is planning a major investment expansion but is unsure of the cost of equity capital as it has no publicly-traded equity. Your assignment is to determine an appropriate equity cost. List and explain the steps you will need to take to complete this assignment.

71) World Corporation has traditionally employed a firm-wide discount rate for capital budgeting

purposes. However, its two divisions, publishing and entertainment, have different degrees of risk given by βP = 1.1, βE = 1.8, while the beta for the overall firm is 1.3. The publishing division has proposed three projects with the following internal rates of return: P1 = 13.2 percent; P2 = 12.4 percent; and P3 = 9.8 percent. The entertainment division has presented their three projects: E1 = 16.4 percent; E2 = 17.8 percent; and E3 = 14.7 percent. The risk-free rate is 4 percent and the market risk premium is 8 percent. Identify which projects will be accepted if the firm applies its overall beta to all projects. Then identify which projects will be accepted if the division betas are properly applied.

72) On-line Text Company has four new text publishing products that it is considering. The

projects are of equal risk with a beta of 1.6. The risk-free rate is 4.2 percent and the market rate is expected to be 12.3 percent. The projects and their expected internal rates of return are: W = 14.4 percent; X = 18 percent, Y = 16.4 percent; and Z = 17.2 percent. Which projects should be accepted? Justify your acceptance decision.

Answer Key Test name: Chapter 13(1) 1) C 2) B 3) E 4) A 5) C 6) D 7) D 8) B 9) B 10) B 11) D 12) D 13) D 14) B 15) A 16) C 17) A 18) D 19) A 20) A 21) A 22) E 23) C 24) B 25) E 26) D 27) D 28) B 29) A 30) D 31) E 32) D 33) B 34) A 35) C 36) E 37) A

38) D 39) B 40) A 41) C 42) B 43) D 44) A 45) B 46) B 47) E 48) A 49) B 50) B 51) A 52) E 53) C 54) E 55) C 56) A 57) C 58) D 59) C 60) D 61) E 62) E 63) B 64) C 65) E 66) E 67) E 68) B 69) Essay 70) Essay 71) Essay 72) Essay

Student name: 1) Judy's Boutique just paid an annual dividend of $3.55 on its common stock. The firm

increases its dividend by 3.55 percent annually. What is the company's cost of equity if the current stock price is $43.24 per share? A) 12.05% B) 11.11% C) 12.47% D) 11.76% E) 11.43%

2) Countess Corporation is expected to pay an annual dividend of $4.27 on its common stock in

one year. The current stock price is $70.99 per share. The company announced that it will increase its dividend by 3.45 percent annually. What is the company's cost of equity? A) 10.04% B) 9.20% C) 8.94% D) 9.46% E) 9.67%

3) The stock in Bowie Enterprises has a beta of 1.22. The expected return on the market is 11.40

percent and the risk-free rate is 2.90 percent. What is the required return on the company's stock? A) 12.90% B) 15.04% C) 16.81% D) 12.53% E) 13.27%

4) Smathers Corporation stock has a beta of 1.13. The market risk premium is 8.00 percent and

the risk-free rate is 3.30 percent annually. What is the company's cost of equity? A) 12.34% B) 8.37% C) 8.13% D) 8.61% E) 10.48%

5) Rossdale Company stock currently sells for $72.43 per share and has a beta of 1.20. The

market risk premium is 7.30 percent and the risk-free rate is 2.98 percent annually. The company just paid a dividend of $4.21 per share, which it has pledged to increase at an annual rate of 3.65 percent indefinitely. What is your best estimate of the company's cost of equity? A) 11.53% B) 9.85% C) 9.44% D) 8.16% E) 10.71%

6) Bethesda Water has an issue of preferred stock outstanding with a coupon rate of 4.80

percent that sells for $92.78 per share. If the par value is $100, what is the cost of the company's preferred stock? A) 4.96% B) 4.80% C) 5.17% D) 4.88% E) 5.60%

7) Too Young, Incorporated, has a bond outstanding with a coupon rate of 6.5 percent and

semiannual payments. The bond currently sells for $1,933 and matures in 19 years. The par value is $2,000. What is the company's pretax cost of debt? A) 6.95% B) 3.37% C) 7.38% D) 7.14% E) 6.82%

8) Galvatron Metals has a bond outstanding with a coupon rate of 6.5 percent and semiannual

payments. The bond currently sells for $1,905 and matures in 15 years. The par value is $2,000 and the company's tax rate is 40 percent. What is the company's aftertax cost of debt? A) 4.21% B) 3.51% C) 4.46% D) 3.89% E) 3.27%

9) Mojo Mining has a bond outstanding that sells for $2,138 and matures in 16 years. The bond

pays semiannual coupons and has a coupon rate of 6.82 percent. The par value is $2,000. If the company's tax rate is 39 percent, what is the aftertax cost of debt? A) 4.08% B) 5.89% C) 3.55% D) 6.31% E) 3.74%

10) Great Lakes Packing has two bond issues outstanding. The first issue has a coupon rate of

3.76 percent, a par value of $2,000 per bond, matures in 3 years, has a total face value of $4.9 million, and is quoted at 108 percent of face value. The second issue has a coupon rate of 6.53 percent, a par value of $1,000 per bond, matures in 17 years, has a total face value of $9.2 million, and is quoted at 105 percent of face value. Both bonds pay interest semiannually. The company's tax rate is 35 percent. What is the firm's weighted average aftertax cost of debt? A) 2.55% B) 2.78% C) 4.28% D) 2.31% E) 3.53%

11) Kim's Bridal Shoppe has 12,300 shares of common stock outstanding at a price of $57 per

share. It also has 320 shares of preferred stock outstanding at a price of $89 per share. There are 390 bonds outstanding that have a coupon rate of 7.6 percent paid semiannually. The bonds mature in 38 years, have a face value of $2,000, and sell at 112.5 percent of par. What is the capital structure weight of the common stock? A) .4964 B) .4363 C) .5460 D) .3981 E) .4644

12) Further From Center has 10,600 shares of common stock outstanding at a price of $40 per

share. It also has 235 shares of preferred stock outstanding at a price of $91 per share. There are 560 bonds outstanding that have a coupon rate of 5.9 percent paid semiannually. The bonds mature in 21 years, have a face value of $1,000, and sell at 95 percent of par. What is the capital structure weight of the preferred stock? A) .5443 B) .4338 C) .0672 D) .0986 E) .0219

13) Here I Sit Sofas has 7,400 shares of common stock outstanding at a price of $97 per share.

There are 720 bonds that mature in 33 years with a coupon rate of 7.1 percent paid semiannually. The bonds have a par value of $2,000 each and sell at 110 percent of par. The company also has 6,300 shares of preferred stock outstanding at a price of $50 per share. What is the capital structure weight of the debt? A) .2743 B) .7257 C) .6506 D) .6820 E) .6053

14) Saint Nick Enterprises has 19,900 shares of common stock outstanding at a price of $81 per

share. The company has two bond issues outstanding. The first issue has 10 years to maturity, a par value of $2,000 per bond, and sells for 97.5 percent of par. The second issue matures in 24 years, has a par value of $1,000 per bond, and sells for 94.5 percent of par. The total face value of the first issue is $370,000, while the total face value of the second issue is $470,000. What is the capital structure weight of debt? A) .3783 B) .1838 C) .4048 D) .3052 E) .3330

15) Bermuda Cruises issues only common stock and coupon bonds. The firm has a debt equity

ratio of 1.37. The cost of equity is 13.3 percent and the pretax cost of debt is 7.5 percent. What is the capital structure weight of the firm's equity if the firm's tax rate is 40 percent? A) .4219 B) .4937 C) .3941 D) .5781 E) .4672

16) The Two Dollar Store has a cost of equity of 10.9 percent, the YTM on the company's bonds

is 5.5 percent, and the tax rate is 39 percent. If the company's debt–equity ratio is .44, what is the weighted average cost of capital? A) 7.54% B) 8.59% C) 8.22% D) 5.66% E) 9.17%

17) Wentworth's Five and Dime Store has a cost of equity of 11.2 percent. The company has an

aftertax cost of debt of 4.8 percent, and the tax rate is 39 percent. If the company's debt– equity ratio is .72, what is the weighted average cost of capital? A) 7.30% B) 6.39% C) 6.69% D) 7.74% E) 8.52%

18) Kountry Kitchen has a cost of equity of 11.4 percent, a pretax cost of debt of 6 percent, and

the tax rate is 35 percent. If the company's WACC is 8.83 percent, what is its debt–equity ratio? A) 1.92 B) 1.49 C) .52 D) .34 E) .65

19) Take It All Away has a cost of equity of 10.93 percent, a pretax cost of debt of 5.48 percent,

and a tax rate of 39 percent. The company's capital structure consists of 73 percent debt on a book value basis, but debt is 39 percent of the company's value on a market value basis. What is the company's WACC? A) 7.97% B) 11.81% C) 9.39% D) 8.80% E) 7.20%

20) Upton Umbrellas has a cost of equity of 10.8 percent, the YTM on the company's bonds is

6.3 percent, and the tax rate is 35 percent. The company's bonds sell for 103.6 percent of par. The debt has a book value of $420,000 and total assets have a book value of $956,000. If the market-to-book ratio is 2.86 times, what is the company's WACC? A) 7.92% B) 5.58% C) 7.80% D) 8.90% E) 9.32%

21) Skolits Corporation has a cost of equity of 11.6 percent and an aftertax cost of debt of 4.38

percent. The company's balance sheet lists long-term debt of $330,000 and equity of $590,000. The company's bonds sell for 96.3 percent of par and market-to-book ratio is 2.74 times. If the company's tax rate is 40 percent, what is the WACC? A) 9.57% B) 9.01% C) 10.41% D) 11.06% E) 10.13%

22) Western Electric has 29,500 shares of common stock outstanding at a price per share of $74

and a rate of return of 13.25 percent. The firm has 7,050 shares of 7.30 percent preferred stock outstanding at a price of $92.50 per share. The preferred stock has a par value of $100. The outstanding debt has a total face value of $389,000 and currently sells for 108.5 percent of face. The yield to maturity on the debt is 7.93 percent. What is the firm's weighted average cost of capital if the tax rate is 39 percent? A) 10.28% B) 11.49% C) 11.09% D) 10.50% E) 10.70%

23) Charlotte's Crochet Shoppe has 10,400 shares of common stock outstanding at a price per

share of $62 and a rate of return of 11.09 percent. The company also has 310 bonds outstanding, with a par value of $1,000 per bond. The pretax cost of debt is 5.87 percent and the bonds sell for 93.3 percent of par. What is the firm's WACC if the tax rate is 39 percent? A) 8.46% B) 8.76% C) 9.89% D) 8.30% E) 9.47%

24) Piedmont Hotels is an all-equity company. Its stock has a beta of 1.21. The market risk

premium is 6.8 percent and the risk-free rate is 2.6 percent. The company is considering a project that it considers riskier than its current operations so it wants to apply an adjustment of 1.8 percent to the project's discount rate. What should the firm set as the required rate of return for the project? A) 7.68% B) 9.48% C) 12.63% D) 9.03% E) 10.83%

25) The required return on the stock of Moe's Pizza is 11.6 percent and aftertax required return

on the company's debt is 3.64 percent. The company's market value capital structure consists of 77 percent equity. The company is considering a new project that is less risky than current operations and it feels the risk adjustment factor is minus 2.7 percent. The tax rate is 35 percent. What is the required return for the new project? A) 12.18% B) 6.78% C) 12.47% D) 7.07% E) 9.77%

26) Alpha Industries is considering a project with an initial cost of $8.3 million. The project will

produce cash inflows of $1.73 million per year for 7 years. The project has the same risk as the firm. The firm has a pretax cost of debt of 5.70 percent and a cost of equity of 11.33 percent. The debt–equity ratio is .63 and the tax rate is 35 percent. What is the net present value of the project? A) $613,870 B) $362,201 C) $531,234 D) $590,259 E) $505,937

27) Dyrdek Enterprises has equity with a market value of $10.7 million and the market value of

debt is $3.50 million. The company is evaluating a new project that has more risk than the firm. As a result, the company will apply a risk adjustment factor of 1.5 percent. The new project will cost $2.18 million today and provide annual cash flows of $571,000 for the next 6 years. The company's cost of equity is 11.03 percent and the pretax cost of debt is 4.87 percent. The tax rate is 39 percent. What is the project's NPV? A) $234,824 B) $378,137 C) $267,736 D) $496,618 E) $233,551

28) Based on market values, Gubler's Gym has an equity multiplier of 1.52 times. Shareholders

require a return of 11.15 percent on the company's stock and a pretax return of 4.90 percent on the company's debt. The company is evaluating a new project that has the same risk as the company itself. The project will generate annual aftertax cash flows of $289,000 per year for 9 years. The tax rate is 39 percent. What is the most the company would be willing to spend today on the project? A) $2,050,380 B) $1,682,313 C) $1,626,236 D) $1,778,775 E) $1,731,793

Answer Key Test name: Chapter 13(2) 1) A 2) D 3) E 4) A 5) E 6) C 7) E 8) A 9) E 10) B 11) B 12) E 13) E 14) E 15) A 16) B 17) E 18) C 19) A 20) E 21) C 22) C 23) B 24) C 25) D 26) D 27) C 28) D

Chapter 14: 1) Which one of the following choices is the best means of creating a valuable financing

opportunity? A) Reduce a tax subsidy B) Fool investors in an efficient market C) Create a new security to meet the needs of an unsatisfied clientele D) Issue new securities in a market niche of satisfied clientele E) Create new securities to minimize tax benefits

2) In an efficient capital market: A) brokerage commissions are zero. B) taxes are irrelevant. C) securities always offer a positive NPV. D) all investments earn the market rate of return. E) security prices reflect all available information.

3) According to the , capital markets such as the NYSE are fairly priced. A) efficient market hypothesis (EMH) B) law of one price (LOP) C) open markets theorem (OMT) D) laissez-faire axiom E) monopoly pricing theorem (MPT)

4) Andrei Shleifer argues that any one of the following conditions will create market efficiency: A) arbitrage, independent deviations from rationality, and rationality. B) competition, arbitrage, and rational investors. C) rational investors, dependent deviations from rationality, and competition. D) wide public access to information, rational investors, and arbitrage. E) professional investors, easy access to information, rational independent investors.

5) Individuals who constantly monitor financial markets in pursuit of mispriced securities: A) tend to make substantial profits on a daily basis. B) tend to make the markets more efficient. C) are never able to find a security that is temporarily mispriced. D) are always quite successful using only well-known public information as their basis

of evaluation. E) are always quite successful using only historical price information as their basis of evaluation.

6) Market efficiency requires: A) arbitrage conducted by irrational investors. B) the absence of arbitrage. C) speculation by amateur investors. D) all investors to be rational. E) countervailing irrationalities.

7) Which of the following actions would be indicative of inefficient markets? A) Overreaction and reversion B) Delayed response C) Immediate and accurate response D) Overreaction with reversion and delayed response E) Immediate and accurate response with a zero NPV

8) Arbitrage involves the simultaneous purchase: A) of one security and the corporate repurchase of another similar security. B) of two substitute securities, and their subsequent sale within the hour. C) of two or more similar securities. D) and sale of the same security. E) and sale of different, but substitute, securities.

9) If markets are

form efficient, market prices reflect all forms of available

information. A) open B) strong C) semistrong D) weak E) stable

10) The hypothesis that market prices reflect all publicly available information is called

form efficiency. A) open B) strong C) semistrong D) weak E) stable

11)

form market efficiency is the only form that asks whether past market returns are useful in predicting future market returns. A) Open B) Strong C) Semistrong D) Weak E) Stable

12) In an efficient market, the price of a security will: A) always rise immediately upon the release of new information with no further price

adjustments related to that information. B) react to new information over a two-day period after which time no further price adjustments related to that information will occur. C) rise sharply when new information is first released and then decline to a new stable level by the following day. D) react immediately to any new information that affects the value of the issuing firm. E) be slow to react for the first few hours after new information is released allowing time for that information to be reviewed and analyzed.

13) If the financial markets are efficient, investors should expect their investments in those

markets to: A) earn extraordinary returns on a routine basis. B) generally have positive net present values. C) generally have zero net present values. D) produce arbitrage opportunities on a routine basis. E) produce negative returns on a routine basis.

14) Which one of the following statements is correct concerning market efficiency? A) Markets tend to be more efficient when the frequency of price changes diminishes. B) If a market is efficient, arbitrage opportunities should be common. C) In an efficient market, some market participants will have an advantage over others. D) A firm will generally receive a fair price when it sells newly issued shares of stock. E) New information will gradually be reflected in a stock’s price to avoid spooking

investors.

15) Financial markets fluctuate daily because they: A) are inefficient. B) are slowly reacting to new information. C) are continually reacting to new information. D) offer tremendous arbitrage opportunities. E) only reflect historical information.

16) Insider trading does not offer any advantages if the financial markets are: A) weak form efficient. B) semiweak form efficient. C) semistrong form efficient. D) strong form efficient. E) inefficient.

17) According to theory, studying historical prices in order to identify mispriced stocks will: A) only work if the market is at least weak form efficient. B) work as long as the market is less than strong form efficient. C) work only in a strong form efficient market. D) not work in any market regardless of the level of efficiency. E) not work if the market is at least weak form efficient.

18) If you excel in analyzing the future outlook of firms based on past performance, you would

prefer that the financial markets be less than advantage in the marketplace. A) weak B) semiweak C) semistrong D) strong E) perfect

_ form efficient so that you can have an

19) An acquaintance works in the finance office of the Bernal Company. He frequently boasts

about earning profits by trading Bernal stock based on information he overhears in the office but which is not known to the general public. Given this information, you would tend to argue that the financial markets are at best form efficient. A) weak B) semiweak C) semistrong D) strong E) perfect

20) The U.S. Securities and Exchange Commission periodically charges individuals with insider

trading and claims those individuals have made unfair profits. Based on this fact, you would tend to argue that the financial markets are at best form efficient. A) weak B) semiweak C) semistrong D) strong E) perfect

21) An investor discovers that for a certain group of stocks, large positive price changes are

always followed by large negative price changes. This finding is a violation of the of the efficient market hypothesis. A) moderate B) semistrong C) strong D) weak E) historical

form

22) If a stock price follows a random walk, the price today is said to be equal to the prior period

price plus the expected return for the period with any remaining difference from the actual return considered to be: A) a predictable amount based on the past prices. B) due to new information related to the stock. C) related to the security’s risk. D) related to the risk-free rate. E) an overall market abnormality.

23) A fully efficient market will eliminate which one of the following? A) Cyclical patterns B) Daily price fluctuations C) Unexpected price declines D) All abnormal profits except those related to insider trading E) Price increases over any period of time in excess of six months

24) If a market is strong form efficient then: A) company insiders are the only investors capable of earning an abnormal profit. B) abnormal profits are obtainable by any and all investors. C) technical analysts who study past market performance have a market advantage. D) all investments should have positive NPVs. E) company insiders have no advantage over public investors.

25) An investor discovers that predictions about weather patterns published years in advance in

the Farmer’s Almanac are amazingly accurate. In fact, these predictions enable the investor to predict the health of the farm economy and therefore certain security prices. This finding is a violation of the: A) moderate form of the efficient market hypothesis. B) semistrong form of the efficient market hypothesis. C) strong form of the efficient market hypothesis. D) weak form of the efficient market hypothesis. E) efficient market hypothesis at all levels.

26) An investor discovers that stock prices change drastically as a result of certain economic

events. This finding is an indication that the: A) moderate form of the efficient market hypothesis does not hold. B) semistrong form of the efficient market hypothesis does not hold. C) strong form of the efficient market hypothesis does not hold. D) weak form of the efficient market hypothesis does not hold. E) market is efficient.

27) The market price of a stock tends to fluctuate throughout every trading day. This fluctuation

is: A) inconsistent with the semistrong form of the efficient market hypothesis because

prices should be stable. B) inconsistent with the weak form of the efficient market hypothesis because all past information should already be included in the price. C) consistent with the semistrong form of the efficient market hypothesis because daily prices should adjust as new information becomes available. D) consistent with the strong form of market efficiency because prices are controlled by insiders. E) a strong indicator that abnormal profits can be realized.

28) Suppose firms with unexpectedly high earnings earn abnormally high returns for several

months after the earnings announcement. This would be evidence of: A) efficient markets in the weak form. B) inefficient markets in the weak form. C) efficient markets in the semistrong form. D) inefficient markets in the semistrong form. E) inefficient markets in the strong form.

29) Consider the following statement: “If the securities market is efficient, an investor need only

throw darts at the stock pages to pick securities and be just as well off as they would be with a professionally-developed portfolio.” This statement is: A) true because there would be no significant difference in risk and return. B) true because in an efficient stock market all portfolios earn the market rate of return. C) false because professionals guarantee higher returns given the same level of risk. D) false because investors may not hold a desirable risk-return combination. E) false because the markets are controlled by the institutional investors.

30) Serial correlation: A) measures the relationship between the current return on a security with that of a

second security. B) involves multiple securities within the same industry. C) indicates a tendency for continuation when the correlation is positive. D) indicates a tendency toward reversal when the correlation coefficient is zero. E) supports weak form efficiency when the correlation coefficient is near zero.

31) Event studies attempt to determine: A) the influence of information released to the market on stock prices in days

surrounding the information’s release. B) if the market is at least weak form efficient. C) whether the market is semistrong or strong form efficient. D) the correlation between the returns on two diverse securities. E) the optimal time to release new information to the public.

32) The abnormal return in an event study is described as the: A) total return earned on a security on the day of an announcement. B) daily return on a security minus the daily return on the overall market. C) average return on a security for the 7-day period surrounding an announcement. D) average return on a security for the 7-day period surrounding an announcement minus

the average return on the security for the past year. E) daily return on a security on the announcement date minus the risk-free rate of return.

33) Assume the price of a stock rises upon the announcement that the firm’s chief executive

officer (CEO) unexpectedly resigned. This market reaction is most indicative of the: A) uncertainty of the firm’s future existence. B) random nature of stock price movements. C) expected management turmoil that is anticipated. D) underperformance of that CEO. E) sadness of hearing the news.

34) Studies of the performance of professionally managed mutual funds find that these funds: A) all have a tendency to consistently outperform the overall market. B) perform in a manner consistent with semistrong form efficiency. C) all have a tendency to underperform the market consistently year after year. D) perform in a manner that definitely refutes both strong and semistrong form

efficiency. E) indicate that stock prices consistently adhere to a daily continuation pattern.

35) Which one of the following statements is true? A) Highly positive serial correlations are indicators of market efficiency. B) Abnormal returns limited to the announcement date are indicators of market

inefficiency. C) Market studies indicate that stock markets are only weak form efficient. D) Studies seem to indicate stock markets are semistrong but not strong form efficient. E) Mutual funds provide little, if any, benefit to investors.

36) Event studies of dividend omissions indicate that: A) this type of announcement generally has no effect on abnormal returns. B) the cumulative abnormal return remains constant when this type of announcement is

made. C) stock returns are positively, and efficiently, impacted when dividend omission announcements are made. D) this type of an event is incorporated into stock prices slowly over a 10-day period. E) the cumulative abnormal return declines on the day prior to and the day of the announcement.

37) Which one of the following actions is an example of financially irrational behavior? A) An investor selling stock to realize a profit B) Increasing the amount you are willing to pay for a stock following a positive

announcement C) Buying a mutual fund to benefit from diversification D) Casino gambling E) A firm issuing new shares when their managers feel the stock is overpriced

38) An overconfident investor will tend to: A) trade primarily in securities from their local area. B) trade less frequently than an average investor. C) underperform due to excess trading. D) suffer from the disposition effect. E) underestimate their ability to pick a winning stock.

39) The disposition effect refers to: A) the underreaction of investors to bad news. B) selling any security that creates a tax liability. C) the hesitancy to sell a security of any firm with which you are affiliated. D) the urge to sell all your securities when market values decline. E) selling your winners while holding your losers.

40) Which term best applies to the situation where an investor cares less about losing $1 of his

profits than he does about losing $1 of his original investment? A) Casino impact B) Snakebite effect C) Familiarity D) Home bias E) House money effect

41) Drawing conclusions from too small of a sample describes the behavioral characteristic of: A) conservatism. B) familiarity. C) representativeness. D) overconfidence. E) underreaction.

42) Psychologists generally agree that irrational traits such as those related to behavioral finance

are generally: A) temporary and limited to a small sector of the population. B) pervasive across individuals. C) offset within the overall population. D) cyclical in nature. E) unique to a few individuals.

43) One reason why the efficient capital market hypothesis may not hold in reality is that: A) risk has been eliminated from the process of arbitrage. B) most investors appear in studies to be rational. C) arbitrage appears to be fully effective. D) irrationality may be related across individuals. E) irrationalities cancel out across investors.

44) Stock market events in 1929, 1987, and 2008 are most apt to be used as examples in support

of which one of these theories? A) Blanket theory B) Advanced markets theory C) Value theory D) Bubble theory E) Behavioral theory

45) Who is credited with saying “Markets can stay irrational longer than you can stay solvent?” A) G.C. Biddle B) Warren Buffett C) R.S. Kaplan D) John Maynard Keynes E) Jay Ritter

46) The Kolasinski and Li study of earnings surprises showed that: A) prices tend to overreact and then properly adjust the following day. B) prices tend to be unaffected by these types of announcements. C) prices tend to adjust rapidly and efficiently to these announcements. D) prices adjust slowly to earnings announcements. E) earnings surprises tend to be predicted such that prices adjust prior to the

announcement.

47) The studies conducted by Fama and French show that: A) value stocks have higher average returns than growth stocks around the world. B) growth stocks have higher average returns than value stocks around the world. C) value stocks outperform in the U.S. while growth stocks outperform elsewhere. D) growth stocks outperform in the U.S. while value stocks outperform elsewhere. E) value and growth stocks perform relatively the same over longer periods of time.

48) Critics of behavioral finance use which one of these as an argument for market efficiency? A) Research papers supporting market efficiency tend to end up “in the file drawer”. B) Underreactions fail to exist in actual studies. C) The overall community of financial economists firmly decided the markets are

efficient. D) Overreactions offset underreactions in almost every market study conducted to date. E) Conservatism has been found to be absent in studies under actual market conditions.

49) If financial markets are efficient, then attempting to accurately predict interest rates is: A) an endeavor best left to corporate executives. B) a relatively easy and accurate exercise. C) a waste of time. D) relatively easy to do if you have a general understanding of finance and economics. E) a little tricky but wise managers tend to succeed at it on an ongoing basis.

50) In the three years prior to a forced departure of a top manager, stock prices, adjusted for

market performance, on average: A) decline about 20 percent. B) decline about 40 percent. C) decline about 60 percent. D) remain stable. E) increase about 20 percent.

51) Ritter’s study of SEO’s suggests that: A) managers appear to be able to successfully time SEO issues when the stock is

overpriced. B) managers can only successfully time SEO issuance by pure chance. C) managers tend to be incorrect in their market assessment of the market movement of their firm’s stock price. D) returns on SEO-issuing firms are statistically the same as those of style-matched nonissuers for the five years following issuance. E) firms are better at timing IPOs than they are at timing SEOs.

52) In examining the issue of whether the choice of accounting methods affects stock prices,

studies have found that: A) accounting depreciation methods can significantly affect stock prices. B) switching depreciation methods can significantly affect stock prices. C) accounting changes that increase accounting earnings also increase stock prices. D) accounting changes can affect stock prices if the company were either to withhold information or provide incorrect information. E) accounting reporting has little, if any effect, ever on stock prices.

53) Empirical evidence suggests that: A) prices may not reflect their true underlying value. B) financial managers lack any ability to correctly time stock repurchases. C) managers may profitably speculate in foreign currency. D) managers cannot boost stock prices by changing their accounting methods. E) wise accounting choices can impact a firm’s stock price.

54) Assume today is an earnings announcement day for a firm. For the day, the firm’s return was

.8 percent, while the risk-free daily rate was .01 percent and the market rate of return was 1.1 percent. The firm’s industrial class returned 1.2 percent on average, for the day. What was the firm's abnormal return for the day? A) .8% B) .79% C) −.3% D) −.4% E) −.39%

55) Explain why in an efficient market all investments have an expected NPV of zero.

56) Suppose your cousin invests in the stock market and doubles her money in a single year

while the market, on average, earned a return of only 15 percent. Is your cousin’s performance a violation of market efficiency?

57) Why should a financial decision maker such as a corporate treasurer or CFO be concerned

with market efficiency?

58) Define the three forms of market efficiency.

59) Explain the risk that often accompanies the behavioral concept of familiarity.

Answer Key Test name: Chapter 14 1) C 2) E 3) A 4) A 5) B 6) E 7) D 8) E 9) B 10) C 11) D 12) D 13) C 14) D 15) C 16) D 17) E 18) A 19) C 20) C 21) D 22) B 23) A 24) E 25) B 26) E 27) C 28) D 29) D 30) E 31) A 32) B 33) D 34) B 35) D 36) E 37) D

38) C 39) E 40) E 41) C 42) B 43) D 44) D 45) D 46) D 47) A 48) A 49) C 50) B 51) A 52) D 53) D 54) C 55) Essay 56) Essay 57) Essay 58) Essay 59) Essay

Chapter 15: 1) Ultimately, it is the who has (have) control over a corporation. A) bondholders B) classified board C) shareholders D) board of directors E) chief executive officer

2) A classified board is one which has: A) representation from various classes of stock. B) terms that expire at different times. C) both employee and non-employee directors. D) directors elected solely by one class of shareholders. E) directors that have been assigned differing numbers of votes per seat.

3) Preferred stock dividends: A) become a debt of the firm if unpaid. B) can be deferred indefinitely. C) are paid only if common stock dividends are also paid. D) have priority over debt interest payments but not over common stock dividends. E) are a tax-deductible business expense.

4) Why might a firm prefer to issue cumulative preferred stock rather than? A) If there is no current taxable income, preferred stock dividends are automatically

voided. B) Preferred stock has no voting rights but debt does. C) Preferred dividends provide a tax shield but debt does not. D) Corporate investors can receive a tax break on dividends received. E) Dividend payments are tax deductible, interest on debt is not.

5) Of the following statements about preferred stock, which one is correct? A) Unlike dividends paid on common stock, dividends paid on preferred stock are a tax-

deductible expense. B) Dividends on preferred stock payable during the next twelve months are considered to be a corporate liability. C) If preferred dividends are non-cumulative, then preferred dividends not paid in a particular year will be carried forward to the next year. D) There is no significant difference in the voting rights granted to preferred and common shareholders. E) Preferred stock usually has a stated liquidating value of $100 per share.

6) A

grants authority to someone other than the shareholder to vote shares of stock. A) power-of-share authorization B) proxy C) share authority grant (SAG) D) restricted conveyance E) general right of execution

7) Assume a firm has issued cumulative preferred stock but has not paid any of the dividends.

This situation may result in: A) preferred dividend arrearages that can be eliminated only after all common dividends are paid. B) increased taxes based on the amount of the dividend arrearage. C) the permanent forfeiture of all unpaid past dividends but the resumption of future dividends. D) the issuer being forced into repaying all preferred shareholders the stated value of their shares. E) voting rights being granted to preferred shareholders.

8) Alpha owns 15 percent of Omega Corporation. What tax benefit does ALPHA derive from

this situation? A) Alpha receives no tax benefit but Omega is taxed on only 30 percent of its net income. B) Alpha is able to treat any Omega dividends it receives as interest income. C) Fifty percent of the dividends paid by Omega to Alpha is exempt from income taxes. D) Alpha can exclude 30 percent of any Omega dividends received from its taxable income. E) All dividend income Alpha receives from Omega is tax-exempt.

9) Assume you own 1,000 shares of stock in a firm for which four directors’ seats are up for

election. If you have been granted a total of 4,000 votes to cast in a single election, then the firm uses voting. A) cumulative B) absolute priority C) sequential D) straight E) market share

10) Assume you own 1,000 shares of stock in a firm for which four directors’ seats are up for

election. If you can cast 1,000 votes in each of the four elections, then the firm uses voting. A) cumulative B) absolute priority C) sequential D) straight E) market share

11) A

is when a group other than the current management team solicits the authority to vote shares as part of an effort to replace the current management team. A) proxy fight B) stockholder derivative action C) tender offer D) vote of confidence E) seniority turnover

12) Shareholders obtain the right when they are granted preemptive rights. A) to elect members to the board of directors B) to share proportionally in regular and liquidating dividends C) of first refusal for their proportionate percentage of new shares offered D) to receive dividends prior to any preferred shareholders E) to resell their shares to the issuer at any time at a predetermined price

13) Why might a firm issue different classes of stock? In order to: A) allow a certain group to maintain ownership control while reducing that group’s

equity position. B) reduce the firm’s dividend obligation. C) fool investors. D) extract perquisites from one class of shareholders without the other class of shareholders knowing. E) distinguish the time periods in which the various shares were issued.

14) Taking control of a corporation would be hardest to do if the corporation uses: A) cumulative voting with annual elections for each seat. B) cumulative voting with an annual board. C) straight voting with a staggered board. D) cumulative voting with a staggered board. E) straight voting with annual elections for each seat.

15) Shareholders are not generally granted the: A) right to elect individuals to the board of directors. B) right to purchase shares of any new stock issue. C) right to receive proportional dividends. D) right to vote to approve or reject a merger offer. E) first right to liquidation proceeds.

16) Which one of the following statements is true? A) Bondholders are generally granted voting rights equal to those of common

shareholders. B) Payments of both interest and dividends are tax deductible as business expenses. C) Unpaid common stock dividends can force a firm into liquidation. D) Debt increases the possibility of financial distress. E) Debt holders have a residual claim on a firm’s assets.

17) Unsecured corporate debt is commonly referred to as: A) an indenture. B) a debenture. C) deferred debt. D) protected debt. E) collateralized debt.

18)

grant the issuer the right to extinguish the debt prior to maturity. A) Put bonds B) Debentures C) Callable bonds D) Subordinated bonds E) Covenant bonds

19) The A) B) C) D) E)

is the written agreement between a corporation and its bondholders. collateral agreement note indenture conveyance legal understanding

20) Ideally, corporations try to create securities that have the tax benefits: A) of equity but the bankruptcy benefits of debt. B) and bankruptcy benefits of debt. C) and bankruptcy benefits of equity. D) of debt and the equity benefits of dividends. E) of debt but the bankruptcy benefits of equity.

21) If an issuer retires a debt issue before its maturity, the amount paid to do so is called the: A) amortized payoff. B) call price. C) sinking fund amount. D) the discount. E) par or face amount.

22) A subordinated debt: A) has a higher priority status than secured creditors. B) is secondary to equity. C) must give preference to the secured creditors in the event of default. D) has been issued because the company is in default. E) is treated as an equity security.

23) The written agreement between a corporation and its bondholders might contain a prohibition

against paying dividends in excess of current earnings. This prohibition is an example of a(n): A) maintenance of security provision. B) collateral restriction. C) affirmative indenture. D) negative covenant. E) put provision.

24) Which one of these is not included in the indenture? A) Bond seniority B) Registered owner C) Protective covenant D) Call provision E) Repayment arrangements

25) If a bond issue is callable, the call price generally is: A) less than par value. B) variable based on the market rate of interest. C) equal to par value. D) constant over the life of the debt. E) set so it decreases as the bond approaches maturity.

26) Historically in the U.S., corporate bonds have generally been issued with a par value of: A) $100. B) $5,000. C) $500. D) $10,000. E) $1,000.

27) A blanket mortgage is securitized by: A) the sinking fund. B) the borrower’s inventory. C) all the borrower’s real property. D) the good faith and credit of the borrower. E) the borrower’s inventories and accounts receivables.

28) Sinking fund arrangements are least likely to include which one of the following

requirements? A) A deferred provision for the first few years B) A one-time repayment of the entire principal and interest at maturity C) A balloon payment D) Equal payments of principal over the life of the bond E) Sufficient payments over the bonds’ life to retire the entire bond issue

29) If a bond has a make-whole call provision, the: A) call premium can be either positive or negative. B) bond’s market price will always equal its face value. C) bondholder will receive the face value amount plus interest if the bond is called. D) bondholder will receive the face value amount minus any interest paid to date if the

bond is called. E) call price will increase as interest rates decrease.

30)

Which one of the following statements is a positive covenant? A) The firm must maintain a current ratio of 1.2 or better. B) The firm will not issue any debt with higher seniority. C) The firm cannot be acquired in a friendly takeover. D) No dividend increases will be allowed. E) The market debt-equity ratio cannot exceed .60.

31) Which one of the following statements applies to floating-rate bonds? A) Bondholders can generally redeem their bonds at par at any time. B) Coupon payments are variable while the par value is fixed. C) Interest adjustments are accrued and paid on the maturity date. D) Coupon payments are fixed but the par value is variable. E) Bondholders frequently are granted a put provision at the current market price.

32) Which type of bond grants the bondholder the right to force the bond’s issuer to repay the

bond at a stated price given that a certain situation(s) occurs? A) Put bond B) Cat bond C) NoNo bond D) Income bond E) Warrant bond

33) Bonds with attached warrants are frequently issued: A) with very low coupons. B) at a greatly discounted price. C) with an attached share of preferred stock. D) with a share purchase price set equal to the market price at time of share purchase. E) with an attached share of common stock.

34) A(n)

bond pays coupon payments only if it can do so from the income earned by

the firm. A) interest-only bond B) sustainability bond C) floater bond D) LIBOR-based bond E) income bond

35) Which type of bond is a city or state most likely to use as a means of offsetting its cost of

damages caused by a hurricane? A) Convertible bond B) Sustainability bond C) Cat bond D) Put bond E) CoCo bond

36) Which set of circumstances would best ensure that the price of a bond with attached warrants

will increase given no change in the bond’s credit quality or terms? A) An increase in both the market rate of interest and the underlying stock price B) A decrease in the market rate of interest and an increase in the underlying stock price C) An increase in the market rate of interest and a decrease in the underlying stock price D) A decrease in both the market rate of interest and the underlying stock price E) A decrease in the market rate of interest with no change in the underlying stock price

37) A revolving bank line of credit: A) generally requires the borrower to borrow the entire credit line amount at some point

in time. B) generally involves a fee charged to the borrower on the unused portion of the revolver. C) may only be offered for periods of one year or less. D) generally is free of charge until money is actually borrowed. E) allows the borrower to determine the amount of credit to be granted.

38) Which one of these statements correctly applies to either a leveraged or an unleveraged

syndicated loan? A) The loan will always be rated as investment grade. B) The loan may not be publicly traded. C) The loan arranger is not involved with the actual lending. D) Each bank that participates negotiates the terms for its portion of the overall loan. E) Each bank has its own loan agreement with the borrowers.

39) Which of the following characteristics does not apply to Eurobonds? A) Commonly traded from London B) Always denominated in euros C) Always denominated in a single currency D) Generally denominated in the issuer’s home currency E) Issued in multiple countries

40) Bulldog bonds are associated with: A) Spain. B) Great Britain. C) France. D) Germany. E) Morocco.

41) Rembrandt bonds are associated with: A) the Netherlands. B) Switzerland. C) Germany. D) Belgium. E) Austria and Hungary.

42) The term financial deficit is defined as the: A) loss realized on bonds that are sold for less than their purchase price. B) amount needed to fund all interest payments on currently outstanding debt. C) total amount of cash flow required from all sources to meet the needs of the uses of

cash. D) amount of cash flow that must be funded internally. E) uses of cash flow minus the cash flow available from internal sources.

43) What is the predominant source of financing for positive NPV projects by U.S. nonfinancial

corporations? A) Preferred stock B) Internally generated funds C) Common stock D) Publicly issued debt E) Privately issued debt

44) Recently, U.S. nonfinancial corporations have been: A) net repurchasers of stock. B) issuing new shares of stock in record numbers. C) primarily relying on external debt. D) paying off external debt at a record pace. E) net issuers of stock.

45) Since 1975, U.S. nonfinancial corporations have tended to have debt-equity ratios that are: A) steadily rising due to the low interest rate environment. B) less than 1.0. C) averaging in the .8 to .9 range. D) relatively stable over time. E) relatively unaffected by stock market movements.

46) Financial economists prefer to use market values rather than book values when measuring

debt ratios because market values are: A) more stable than book values. B) a better reflection of current information. C) net of taxes. D) used by Standard & Poor’s to measure credit worthiness. E) most commonly required by bond covenants.

47) There are three seats on the board of directors of MMT, Incorporated, up for election. The

firm has 175,000 shares of stock outstanding and uses cumulative voting. Each share is granted one vote per open seat. You currently own 10,000 shares that have a market value of $23 each. How much must you spend, if anything, to acquire sufficient shares to guarantee your election to the board? Assume no one else votes for you. A) $1,111,690 B) $776,273 C) $830,814 D) $1,006,273 E) $688,230

48) There are five seats on the board of directors of Serbone Equity that are up for election. The

firm has 320,400 shares of stock outstanding and uses straight voting. Each share is granted one vote for each open seat. How many shares must you control if you want to guarantee your election to the board and no one else votes for you? A) 53,334 B) 64,000 C) 160,200 D) 160,201 E) 64,001

49) There are four seats on the board of directors of Heritch Global that up for election. The firm

has 160,000 shares of stock outstanding and uses cumulative voting. Each share is granted one vote per open seat. How many shares must you control if you want to guarantee your election to the board and assuming no one else votes for you? A) 40,000 B) 40,001 C) 36,001 D) 32,000 E) 32,001

50) Arevalos, Incorporated, has cumulative preferred stock outstanding that calls for quarterly

dividend payments of $2.25 per share. Unfortunately, the firm has not paid these preferred dividends for the past three quarters. What amount per share must be paid to the preferred shareholders this quarter if the firm also wants to pay a dividend on its common stock? A) $9.00 B) $6.75 C) $4.50 D) $11.25 E) $13.50

51) Analysts estimate that one year from today, a bond has a probability of 40 percent of being

priced at $950 and a probability of 60 percent of being priced at $1,050. The bond is also callable at any time at $1,010. What is the expected value of this bond in one year? A) $995 B) $980 C) $1,000 D) $1,010 E) $986

52) Analysts estimate that a bond has an equal probability of being priced at either $940 or

$1,050 one year from today. The bond is also callable at any time at $1,020. What is the expected value of this bond in one year? A) $995 B) $980 C) $1,000 D) $1,020 E) $940

53) Identify the general rights that are commonly granted to common stock shareholders.

54) Explain some of the means by which a select group of shareholders can retain control over a

corporation while still raising equity capital outside of their group.

55) Explain the main differences between debt and equity.

56) Identify three key duties of a bond trustee.

57) Bond issuers will call bonds when it is favorable for them to do so. The benefit the issuer

receives is a cost to the bondholders. Explain some of the ways in which bondholders are protected from calls.

Answer Key Test name: Chapter 15(1) 1) C 2) B 3) B 4) D 5) E 6) B 7) E 8) C 9) A 10) D 11) A 12) C 13) A 14) C 15) E 16) D 17) B 18) C 19) C 20) E 21) B 22) C 23) D 24) B 25) E 26) E 27) C 28) B 29) E 30) A 31) B 32) A 33) A 34) E 35) C 36) B 37) B

38) E 39) B 40) B 41) A 42) E 43) B 44) A 45) B 46) B 47) B 48) D 49) E 50) A 51) E 52) B 53) Essay 54) Essay 55) Essay 56) Essay 57) Essay

Student name: 1) You want a seat on the board of directors of Four Keys, Incorporated The company has

200,000 shares of stock outstanding and the stock sells for $69 per share. There are currently 5 seats up for election. The company uses straight voting. How many shares do you need to guarantee that you will be elected to the board? A) 40,000 shares B) 33,334 shares C) 100,001 shares D) 90,001 shares E) 66,668 shares

2) You want a seat on the board of directors of Red Cow, Incorporated The company has

310,000 shares of stock outstanding and the stock sells for $55 per share. There are currently 3 seats up for election. The company uses straight voting. How much will it cost you to guarantee that you will be elected to the board? A) $4,262,555 B) $7,672,550 C) $5,683,333 D) $6,393,805 E) $8,525,055

3) You want a seat on the board of directors of Four Keys, Incorporated The company has

220,000 shares of stock outstanding and the stock sells for $69 per share. There are currently 5 seats up for election. If the company uses cumulative voting, how many shares do you need to guarantee that you will be elected to the board? A) 110,001 shares B) 73,334 shares C) 33,001 shares D) 44,000 shares E) 36,668 shares

4) You want a seat on the board of directors of Zeph, Incorporated The company has 270,000

shares of stock outstanding and the stock sells for $73 per share. There are currently 3 seats up for election. If the company uses cumulative voting, how much will it cost you to guarantee that you will be elected to the board? A) $8,505,084 B) $4,927,573 C) $7,560,000 D) $5,103,076 E) $11,340,084

Answer Key Test name: Chapter 15(2) 1) 2) 3) 4)

C E E B

Chapter 16: 1) A firm’s is referred to as its capital structure. A) mix of current and fixed assets B) amount of capital invested in the firm C) typical amount of dividends it pays D) mix of debt and equity used to finance its assets E) amount of cash versus receivables

2) A general rule for managers to follow is to set the firm’s capital structure such that the firm’s: A) size is maximized. B) value is maximized. C) bondholders are secured. D) suppliers of raw materials are satisfied. E) dividend payout is maximized.

3) A manager should attempt to maximize the value of the firm by changing the capital

structure if and only if the value of the firm increases: A) as a result of the change. B) to the sole benefit of the managers. C) to the sole benefit of the debtholders. D) while also decreasing shareholder value. E) while holding stockholder value constant.

4) A firm should always select the capital structure that: A) produces the highest cost of capital. B) maximizes the value of the firm. C) minimizes taxes. D) maximizes current dividends. E) has no debt.

5) Zehra invested in Cameron Corporation stock when the firm was financed solely with equity.

The firm now has a debt-equity ratio of .4. To maintain her original level of leverage, Zehra must: A) borrow money and purchase additional shares of Cameron stock. B) maintain her current position in Cameron stock. C) sell some shares of Cameron stock and hold the proceeds in cash. D) sell some shares of Cameron stock and lend out the proceeds. E) sell 60 percent of her Cameron stock and invest the proceeds in risk-free securities.

6) In the absence of taxes, the capital structure chosen by a firm is irrelevant because of: A) taxes. B) the interest tax shield. C) the relationship between dividends and earnings per share. D) the effects of leverage on the cost of equity. E) homemade leverage.

7) According to MM Proposition I with no tax: A) business risk determines the return on assets. B) the cost of equity rises as leverage rises. C) it is completely irrelevant how a firm arranges its finances. D) a firm should borrow money to the point where the tax benefit from debt is equal to

the cost of the increased probability of financial distress. E) financial risk is determined by the debt-equity ratio.

8) According to the value of the levered firm equals the value of the unlevered firm. A) MM Proposition I with no tax B) MM Proposition II with no tax C) MM Proposition I with tax D) MM Proposition II with tax E) both MM Proposition I with tax and MM Proposition I without tax

9) The idea of homemade leverage is employed as an argument in support of: A) MM Proposition I with no tax. B) MM Proposition II with no tax. C) MM Proposition I with tax. D) MM Proposition II with tax. E) no MM Proposition.

10) A levered firm is a company that has: A) accounts payable as its only liability. B) some debt in its capital structure. C) an all-equity capital structure. D) a tax loss carry forward. E) taxable income.

11) The effects of financial leverage depend on the operating earnings of the company. Based on

this relationship, assume you graph the EPS and EBI for a firm, while ignoring taxes. Which one of these statements correctly states a relationship illustrated by the graph? A) Financial leverage decreases the slope of the EPS line. B) Below the break-even point unlevered structures have a lower EPS for every dollar of EBI than levered structures do. C) Above the break-even point the increase in EPS for unlevered structures is greater than that of levered structures for every dollar increase in EBI. D) Leverage only provides value above the break-even point. E) Above the break-even point, the unlevered structure is preferred.

12) MM Proposition I without taxes proposes that: A) the value of an unlevered firm exceeds that of a levered firm. B) there is one ideal capital structure for each firm. C) leverage does not affect the value of the firm. D) shareholder wealth is directly affected by the capital structure selected. E) the value of a levered firm exceeds that of an unlevered firm.

13) A key underlying assumption of MM Proposition I without taxes is that: A) financial leverage increases risk. B) individuals can borrow at lower rates than corporations. C) individuals and corporations borrow at the same rate. D) managers always act to maximize the value of the firm. E) corporations are all-equity financed.

14) In an EPS-EBI graphical relationship, the slope of the debt line is steeper than the equity line.

The debt line has a lower intercept because: A) more shares are outstanding for the same level of EBI. B) the break-even point is higher with debt. C) a fixed interest charge must be paid even at low earnings. D) the amount of interest per share has only a positive effect on the intercept. E) the break-even point is lower with debt.

15) When comparing levered versus unlevered capital structures, leverage works to increase EPS

for high levels of EBIT because interest payments on the debt: A) vary with EBIT levels. B) stay fixed, leaving less income to be distributed among fewer shares. C) stay fixed, leaving more income to be distributed among fewer shares. D) stay fixed, leaving less income to be distributed among more shares. E) stay fixed, leaving more income to be distributed among more shares.

16) The increase in risk to shareholders when financial leverage is added is best evidenced by: A) higher EPS as EBIT increases. B) a higher variability of EPS with partial debt financing than with all-equity financing. C) increased use of homemade leverage. D) the increase in taxes. E) decreasing earnings as EBIT increases.

17) The use of personal borrowing to change the overall amount of financial leverage to which

an individual is exposed is called: A) homemade leverage. B) dividend recapture. C) the weighted average cost of capital. D) private debt placement. E) personal offset.

18) The concept that the value of the firm is independent of its capital structure is called: A) the capital asset pricing model. B) MM Proposition I (no taxes). C) MM Proposition II (no taxes). D) the law of one price. E) the efficient markets hypothesis.

19) The unlevered cost of capital equals: A) the cost of capital for a firm with no equity in its capital structure. B) the cost of capital for a firm with no debt in its capital structure. C) the interest tax shield times pretax net income. D) the cost of preferred stock for an all-equity firm. E) the profit margin for a firm with some debt in its capital structure.

20) According to MM Proposition II with no taxes, the: A) return on assets is determined by financial risk. B) required return on equity is a linear function of the firm’s debt-equity ratio. C) cost of equity in inversely related to the firm’s debt-equity ratio. D) cost of debt must equal the cost of equity. E) required return on assets exceeds the weighted average cost of capital.

21) MM Proposition II with no taxes supports the argument that a firm’s: A) unlevered equity is risk-free. B) cost of equity is inversely related to the firm’s debt-equity level. C) cost of equity is unaffected by the firm’s unlevered cost of capital. D) WACC will exceed the unlevered firm’s cost of equity. E) WACC remains constant even if the firm changes its capital structure.

22) Because interest expense is tax deductible, levered firms can benefit from the: A) tax shield from debt. B) depreciable basis. C) financing umbrella. D) current yield. E) tax-loss carryback.

23) MM Proposition I without taxes does not hold when corporate taxes are introduced because: A) levered firms pay less in taxes than identical unlevered firms. B) bondholders require higher rates of return than stockholders do. C) earnings per share are no longer relevant with taxes. D) dividends become a tax shield. E) debt is more expensive than equity.

24) MM Proposition I with taxes supports the theory that: A) there is a positive linear relationship between the proportion of debt versus equity in a

levered firm and the firm's value. B) the value of a firm is inversely related to the amount of leverage used by the firm. C) the value of an unlevered firm is equal to the value of a levered firm plus the value of the interest tax shield. D) a firm’s cost of capital is the same regardless of the mix of debt and equity used by the firm. E) a firm’s weighted average cost of capital increases as the debt-equity ratio of the firm rises.

25) According to MM Proposition I with taxes: A) capital structure does not affect firm value. B) increasing the debt-equity ratio increases firm value. C) firm value is maximized when the firm is all-equity financed. D) the cost of equity rises as the debt-equity ratio increases. E) the unlevered cost of equity is equal to RWACC.

26) MM Proposition I with taxes demonstrates that the: A) optimal capital structure is the one that is totally financed with equity. B) capital structure of the firm does not matter because investors can use homemade

leverage. C) firm is better off with debt based on the weighted average cost of capital. D) presence of taxes causes debt to add value to a firm. E) cost of equity increases as the debt-equity ratio of a firm increases.

27) MM Proposition II with taxes: A) explains how a firm’s WACC increases with the use of financial leverage. B) reveals that the tax shield on debt causes an increase in the value of a firm. C) supports the argument that business risk is determined by the capital structure

employed by a firm. D) supports the argument that the cost of equity decreases as the debt-equity ratio increases. E) reaches the final conclusion that the capital structure decision is irrelevant to the value of a firm.

28) According to MM Proposition II: A) the capital structure of a firm is irrelevant to the value of the firm. B) the cost of levered equity depends solely on the return on debt, the debt-equity ratio,

and the tax rate. C) a firm’s cost of equity is a positive linear function of the firm's capital structure. D) the cost of equity is equivalent to the required return on the total assets of a levered firm. E) the cost of debt is inversely related to a firm’s debt-equity ratio.

29) The tax shield on debt has a value of zero when: A) the firm’s debt-equity ratio is exactly equal to 1. B) C) D) E)

the firm’s debt-equity ratio is exactly .5. the firm is unlevered. shareholders fully utilize homemade leverage. RS is less than R0.

30) The tax shield on debt is one reason why: A) the required rate of return on assets rises when debt is added to the capital structure. B) a firm’s unlevered value is less than its levered value. C) a firm’s net cost of debt is generally less than its cost of equity. D) the cost of debt is equal to the cost of equity for a levered firm. E) firms prefer equity financing over debt financing.

31) Cuellar’s has debt with a book value of $285,000 and a market value of $263,000. The firm’s

equity has a book value of $418,000 and a market value of $612,000. The tax rate is 21 percent and the cost of capital is 12.4 percent. What is the market value of this firm based on MM Proposition I without taxes? A) $703,000 B) $897,000 C) $875,000 D) $819,770 E) $837,150

32) Fowler Wellness is an all-equity firm with 360,000 shares of stock outstanding. The

company will borrow $1.8 million at 4.5 percent interest to repurchase 50,000 shares of the outstanding stock. Assume there are no taxes. What is the value of the firm? A) $8,960,000 B) $9,240,000 C) $12,500,000 D) $12,960,000 E) $11,550,000

33) Hidalgo Realty is an all-equity firm with 60,000 shares of stock outstanding. The company

will borrow $120,000 to buy out the 4,800 shares of one of its stockholders. Ignoring taxes, what is the total value of the firm today? A) $1,500,000 B) $1,960,000 C) $960,000 D) $1,380,000 E) $1,620,000

34) A 40 percent owner of Nguyen Medical Group is electing to retire. The other shareholders in

this closely held, all-equity firm have agreed that the firm will borrow $1.8 million to purchase the retiring owner’s 3,000 shares of stock. Ignoring taxes, what is the total value of this firm? A) $4.8 million B) $4.5 million C) $5.4 million D) $3.0 million E) $6.0 million

35) Assume an unlevered firm has total assets of $6,000, earnings before interest and taxes of

$600, and 500 shares of stock outstanding. Further assume the firm decides to change 40 percent of its capital structure to debt with an interest rate of 8 percent. Ignore taxes. What will be the amount of the change in the earnings per share as a result of this change in the capital structure? A) $.16 B) $.09 C) No change D) −$.09 E) −$.16

36) Assume an initial scenario where a levered firm has total assets of $8,000, earnings before

interest and taxes of $600, 400 shares of stock outstanding, a debt-equity ratio of .25, and a cost of debt of 7 percent. Now assume a second scenario where the firm changes to an allequity structure by issuing new shares to pay off debt while a shareholder holding 10 percent of the stock borrows funds at 7 percent and uses homemade leverage to offset the firm’s change in capital structure. Ignore taxes. What are the net earnings for this shareholder under the initial scenario? Under the second scenario? A) $90.00; $90.00 B) $90.00; $112.50 C) $48.80; $38.80 D) $48.80; $48.80 E) $45.00; $48.80

37) A firm has a debt-equity ratio of .52, a pretax cost of debt of 6.5 percent, and a required

return on assets of 12 percent. Ignoring taxes, what is the cost of equity? A) 14.36 percent B) 20.36 percent C) 14.86 percent D) 12.00 percent E) 12.86 percent

38) McCord has a levered cost of equity of 14.29 percent and a pretax cost of debt of 7.23

percent. The required return on the assets is 11 percent. What is the firm’s debt-equity ratio based on MM Proposition II with no taxes? A) .67 B) .87 C) .72 D) .75 E) .81

39) Max Iger Designs has a debt-equity ratio of .68. The firm's required return on assets is 11.7

percent and its levered cost of equity is 15.54 percent. What is the pretax cost of debt based on MM Proposition II with no taxes? A) 6.76 percent B) 6.39 percent C) 7.25 percent D) 6.05 percent E) 7.50 percent

40) A firm has zero debt in its capital structure and has an overall cost of capital of 10 percent.

The firm is considering a new capital structure with 60 percent debt at an interest rate of 8 percent. Assuming there are no taxes or other imperfections, what would be the cost of equity with the new capital structure? A) 9 percent B) 10 percent C) 13 percent D) 14 percent E) 11 percent

41) A firm has a debt-equity ratio of .48. Its cost of debt is 7 percent and its WACC is 10.8

percent. What is its cost of equity if there are no taxes or other imperfections? A) 10.97 percent B) 13.05 percent C) 12.62 percent D) 11.46 percent E) 13.67 percent

42) A firm has a debt-equity ratio of 1, a cost of equity of 16 percent, and a cost of debt of 8

percent. If there are no taxes or other imperfections, what is its unlevered cost of equity? A) 8 percent B) 10 percent C) 12 percent D) 14 percent E) 16 percent

43) A firm has a debt-equity ratio of .55 with a cost of debt of 6.7 percent. If it had no debt, its

cost of equity would be 14.5 percent. What is its levered cost of equity assuming there are no taxes or other imperfections? A) 18.96 percent B) 15.82 percent C) 17.94 percent D) 18.79 percent E) 13.67 percent

44) If a firm is unlevered and has a cost of equity capital of 13.7 percent, what would be the cost

of equity if its debt-equity ratio was revised to .4? The expected cost of debt is 7.4 percent and there are no taxes. A) 15.54 percent B) 15.67 percent C) 16.09 percent D) 16.22 percent E) 16.36 percent

45) Stewart Holding has $224,000 of debt outstanding that is selling at par and has a coupon rate

of 5.5 percent. If the tax rate is 21 percent, what is the present value of the tax shield on debt? A) $12,320 B) $9,733 C) $17,696 D) $47,040 E) $37,162

46) A firm has debt of $7,000, equity of $12,000, a cost of debt of 7 percent, a cost of equity of

14 percent, and a tax rate of 21 percent. What is the firm’s weighted average cost of capital? A) 8.45 percent B) 9.90 percent C) 10.88 percent D) 12.50 percent E) 11.27 percent

47) Daniels & Daniels has expected earnings before interest and taxes of $3,800, an unlevered

cost of capital of 15.4 percent, and a tax rate of 22 percent. The company also has $2,600 of debt with a coupon rate of 5.7 percent. The debt is selling at par value. What is the value of this firm? A) $15,585 B) $19,819 C) $12,115 D) $12,055 E) $17,700

48) Harbinger is currently an all-equity firm that has 22,000 shares of stock outstanding with a

market price of $27 per share. The current cost of equity is 12 percent and the tax rate is 23 percent. The firm is considering adding $225,000 of debt with a coupon rate of 6.25 percent to its capital structure. The debt will sell at par. What will be the levered value of the equity? A) $325,500 B) $420,750 C) $521,250 D) $472,750 E) $594,000

49) Awning Supply has expected earnings before interest and taxes of $17,100 forever, an

unlevered cost of capital of 12.4 percent, and debt with both a book and face value of $25,000. The debt has an annual 6.2 percent coupon. If the tax rate is 21 percent, what is the value of the firm? A) $91,016 B) $137,903 C) $114,194 D) $106,667 E) $146,403

50) Yuan Creative is an unlevered firm with an aftertax net income of $78,400. The unlevered

cost of capital is 11.4 percent and the tax rate is 23 percent. What is the value of this firm? A) $447,017 B) $581,818 C) $687,719 D) $613,309 E) $537,900

51) An unlevered firm has a cost of capital of 13.6 percent and earnings before interest and taxes

of $138,000. A levered firm with the same operations and assets has both a book value and a face value of debt of $520,000 with an annual coupon of 7 percent. The applicable tax rate is 21 percent. What is the value of the levered firm? A) $996,421 B) $907,679 C) $1,184,929 D) $910,818 E) $1,191,506

52) Agave Group has an unlevered cost of capital of 11.6 percent, a cost of debt of 7.9 percent,

and a tax rate of 23 percent. What is the target debt-equity ratio if the targeted levered cost of equity is 12.6 percent? A) .44 B) .39 C) .35 D) .56 E) .53

53) Trident Hotels has debt with both a face and a market value of $227,000. This debt has a

coupon rate of 7 percent and pays interest annually. The expected earnings before interest and taxes is $87,200, the tax rate is 21 percent, and the unlevered cost of capital is 12 percent. What is the firm’s cost of equity? A) 13.25 percent B) 13.89 percent C) 13.92 percent D) 14.27 percent E) 14.14 percent

54) Dressel Pools has an unlevered cost of capital of 10.3 percent, a tax rate of 21 percent, and

expected earnings before interest and taxes of $1,900. The company has $4,000 in bonds outstanding that have an annual coupon of 7 percent. If the bonds are selling at par, what is the cost of equity? A) 11.33 percent B) 9.34 percent C) 10.72 percent D) 9.99 percent E) 11.21 percent

55) Hossain Health has a levered cost of equity of 13.84 percent and an unlevered cost of capital

of 12.5 percent. The company has $5,000 in debt that is selling at par. The levered value of the firm is $14,600 and the tax rate is 25 percent. What is the pretax cost of debt? A) 7.92 percent B) 9.07 percent C) 8.16 percent D) 8.84 percent E) 9.00 percent

56) Reisboards has a cost of equity of 13.76 percent and a pretax cost of debt of 8.5 percent. The

debt-equity ratio is .60 and the tax rate is 21 percent. What is the unlevered cost of capital? A) 11.83 percent B) 12.07 percent C) 13.97 percent D) 14.08 percent E) 14.60 percent

57) An all-equity firm has a cost of capital of 12.8 percent and a tax rate of 23 percent. At the

firm’s target debt-equity ratio, the pretax cost of debt is 7.35 percent, and the cost of equity is 15.07 percent. What is the target debt-equity ratio? A) .67 B) .49 C) .51 D) .61 E) .54

58) Thompson Theaters has a debt-equity ratio of .60. The pretax cost of debt is 9 percent while

the unlevered cost of capital is 14 percent. What is the cost of equity if the tax rate is 23 percent? A) 7.52 percent B) 8.78 percent C) 16.31 percent D) 16.83 percent E) 17.30 percent

59) A firm has a bond issue outstanding with a par value of $450,000. The bonds have a coupon

rate of 6 percent, pay interest semiannually, and have a market price equal to 102 percent of par value. The firm’s tax rate is 21 percent. What is the amount of the annual tax shield on the debt? A) $5,783 B) $21,330 C) $94,500 D) $27,000 E) $5,670

60) Yelne Florist has 2,000 bonds outstanding with a face value of $1,000 each, a market value

of $1,060 each, and a coupon rate of 9 percent. The interest is paid semiannually. What is the amount of the annual tax shield on debt if the tax rate is 23 percent? A) $44,872 B) $460,000 C) $43,884 D) $41,400 E) $487,600

61) Denney Resort has $12,000 of debt outstanding that is selling at 101.2 percent of par, has a

coupon rate of 8 percent, and a current yield of 7.91 percent. The tax rate is 21 percent. What is the present value of the tax shield on debt? A) $3,188 B) $3,887 C) $2,520 D) $2,500 E) $2,550

62) A firm has debt of $5,000, equity of $16,000, a cost of debt of 8 percent, a cost of equity of

12 percent, and a tax rate of 21 percent. What is the firm’s weighted average cost of capital? A) 10.20 percent B) 9.94 percent C) 10.90 percent D) 10.65 percent E) 11.05 percent

63) A firm has zero debt and an overall cost of capital of 13.8 percent. The firm is considering a

new capital structure with 40 percent debt. The interest rate on the debt would be 7.2 percent and the corporate tax rate is 21 percent. What would be the cost of equity with the new capital structure? A) 16.90 percent B) 16.11 percent C) 17.28 percent D) 17.34 percent E) 17.59 percent

64) A firm has a debt-equity ratio of .64, a cost of equity of 13.04 percent, and a cost of debt of 8

percent. Assume the corporate tax rate is 25 percent. What would be the cost of equity if the firm were all-equity financed? A) 11.30 percent B) 11.41 percent C) 13.33 percent D) 12.42 percent E) 12.25 percent

65) A firm has an equity multiplier of 1.57, an unlevered cost of equity of 14 percent, a levered

cost of equity of 15.6 percent, and a tax rate of 21 percent. What is the cost of debt? A) 11.25 percent B) 10.50 percent C) 10.45 percent D) 11.00 percent E) 10.33 percent

66) Javed Medical Management has 5,000 bonds outstanding with a face value of $1,000 each

and a coupon rate of 7.65 percent. Interest is paid semiannually. What is the amount of the annual tax shield on debt if the tax rate is 23 percent? A) $157,650 B) $160,125 C) $1,062,500 D) $1,150,000 E) $87,975

67) Pineda Gallery is currently an all-equity firm with earnings before interest and taxes of

$338,000 and a cost of equity of 14.2 percent. Assume the tax rate is 22 percent. The firm is considering adding $400,000 of debt with a coupon rate of 7 percent to its capital structure. The debt will be sold at par value. What is the levered value of the equity? A) $1,987,408 B) $1,544,620 C) $2,038,519 D) $986,420 E) $1,944,620

68) Movsovitz has an all-equity value of $648,200, a cost of equity of 11.7 percent, and a tax rate

of 35 percent. Assume the firm’s capital structure changes to 30 percent debt followed by a lowering of the tax rate to 21 percent. What will be the change in the levered value of the firm due to the reduction in the tax rate? A) $16,020 B) $17,520 C) $29,169 D) −$27,224 E) −$17,520

69) Explain homemade leverage and why it matters.

70) Explain why the weighted average cost of capital is invariant to the firm’s debt-equity ratio in

the absence of corporate taxes.

71) Discuss MM Propositions I and II in a world without taxes. List the basic assumptions,

results, and intuition of the model.

72) In each of the theories of capital structure, the cost of equity rises as the amount of debt

increases. So why don’t financial managers use as little debt as possible to keep the cost of equity down? After all, isn’t the goal of the firm to maximize share value and doesn’t a lower discount rate applied to the firm’s cash flows increase the present value of those cash flows?

73) Based on MM Propositions, with and without taxes, how much time should a financial

manager spend analyzing the capital structure of his firm?

74) Discuss MM Propositions I and II in a world with taxes. List the basic assumptions, results,

and intuition of the model.

Answer Key Test name: Chapter 16(1) 1) D 2) B 3) A 4) B 5) D 6) E 7) C 8) A 9) A 10) B 11) D 12) C 13) C 14) C 15) C 16) B 17) A 18) B 19) B 20) B 21) E 22) A 23) A 24) A 25) B 26) D 27) B 28) C 29) C 30) C 31) C 32) D 33) A 34) B 35) A 36) D 37) C

38) B 39) D 40) C 41) C 42) C 43) D 44) D 45) D 46) C 47) B 48) B 49) C 50) C 51) D 52) C 53) D 54) E 55) B 56) B 57) E 58) C 59) E 60) D 61) C 62) D 63) C 64) B 65) C 66) E 67) B 68) D 69) Essay 70) Essay 71) Essay 72) Essay 73) Essay 74) Essay

Student name: 1) The Greenbriar is an all-equity firm with a total market value of $569,000 and 22,300 shares

of stock outstanding. Management is considering issuing $177,000 of debt at an interest rate of 10 percent and using the proceeds on a stock repurchase. Ignore taxes. How many shares will the firm repurchase if it issues the debt securities? A) 7,708 shares B) 56,900 shares C) 694 shares D) 8,408 shares E) 6,937 shares

2) Ornaments, Incorporated, is an all-equity firm with a total market value of $575,000 and

24,000 shares of stock outstanding. Management believes the earnings before interest and taxes (EBIT) will be $81,500 if the economy is normal. If there is a recession, EBIT will be 10 percent lower, and if there is a boom, EBIT will be 20 percent higher. The tax rate is 35 percent. What is the EPS in a recession? A) $1.99 B) $2.21 C) $2.65 D) $2.43 E) $1.77

3) Summer Tan, Incorporated, is an all-equity firm with a total market value of $586,000 and

39,500 shares of stock outstanding. Management believes the earnings before interest and taxes (EBIT) will be $83,700 if the economy is normal. If there is a recession, EBIT will be 15 percent lower, and if there is a boom, EBIT will be 25 percent higher. The tax rate is 40 percent. What is the EPS in a boom? A) $.95 B) $1.08 C) $1.27 D) $1.46 E) $1.59

4) Northern Wood Products is an all-equity firm with 21,500 shares of stock outstanding and a

total market value of $367,000. Based on its current capital structure, the firm is expected to have earnings before interest and taxes of $33,500 if the economy is normal, $20,000 if the economy is in a recession, and $47,000 if the economy booms. Ignore taxes. Management is considering issuing $92,500 of debt with an interest rate of 9 percent. If the firm issues the debt, the proceeds will be used to repurchase stock. What will the earnings per share be if the debt is issued and the economy is in a recession? A) $2.41 B) $1.57 C) $.73 D) $1.06 E) $.54

5) Southern Wind is an all-equity firm with 23,700 shares of stock outstanding and a total

market value of $369,000. Based on its current capital structure, the firm is expected to have earnings before interest and taxes of $34,500 if the economy is normal, $20,800 if the economy is in a recession, and $48,200 if the economy booms. Ignore taxes. Management is considering issuing $93,100 of debt with an interest rate of 7 percent. If the firm issues the debt, the proceeds will be used to repurchase stock. What will the earnings per share be if the debt is issued and the economy booms? A) $2.55 B) $1.58 C) $2.35 D) $2.72 E) $2.04

6) Cross Town Cookies is an all-equity firm with a total market value of $755,000. The firm has

46,000 shares of stock outstanding. Management is considering issuing $182,000 of debt at an interest rate of 8 percent and using the proceeds to repurchase shares. Before the debt issue, EBIT will be $68,000. What is the EPS if the debt is issued? Ignore taxes. A) $1.53 B) $.98 C) $1.77 D) $1.31 E) $1.66

7) Kelso Electric is an all-equity firm with 42,500 shares of stock outstanding. The company is

considering the issue of $290,000 in debt at an interest rate of 8 percent and using the proceeds to repurchase stock. Under the new capital structure, there would be 26,000 shares of stock outstanding. Ignore taxes. What is the break-even EBIT between the two plans? A) $36,558 B) $51,221 C) $41,127 D) $64,737 E) $59,758

8) Hotel Cortez is an all-equity firm that has 10,300 shares of stock outstanding at a market

price of $32 per share. The firm's management has decided to issue $62,000 worth of debt and use the funds to repurchase shares of the outstanding stock. The interest rate on the debt will be 6 percent. What is the break-even EBIT? A) $12 B) $16,951 C) $19,776 D) $13 E) $21,424

9) Simone's Sweets is an all-equity firm that has 10,300 shares of stock outstanding at a market

price of $24 per share. The firm's management has decided to issue $104,000 worth of debt at an interest rate of 6 percent. The funds will be used to repurchase shares of the outstanding stock. What are the earnings per share at the break-even EBIT? A) $3.42 B) $1.44 C) $1.73 D) $2.69 E) $2.49

10) Northwestern Lumber Products currently has 25,500 shares of stock outstanding. Patricia, the

financial manager, is considering issuing $183,000 of debt at an interest rate of 8.0 percent. Given this, how many shares of stock will be outstanding once the debt is issued if the breakeven level of EBIT between these two capital structure options is $81,000? Ignore taxes. A) 22,632.04 shares B) 20,891.11 shares C) 17,906.67 shares D) 19,846.56 shares E) 19,498.37 shares

11) Southwest Sands currently has 19,400 shares of stock outstanding. It is considering issuing

$89,000 of debt at an interest rate of 6.2 percent. The break-even level of EBIT between these two capital structure options is $61,000. How many shares of stock will be repurchased if the company undergoes the recapitalization? Ignore taxes. A) 1,378.85 shares B) 1,504.20 shares C) 1,754.90 shares D) 1,667.16 shares E) 1,901.15 shares

12) Northeast Lobster currently has 20,700 shares of stock outstanding. It is considering issuing

$232,000 of debt at an interest rate of 8.3 percent. The break-even level of EBIT between these two capital structure options is $165,000. For this to be true, what is the current stock price? Ignore taxes. A) $109.76 B) $96.04 C) $100.61 D) $91.23 E) $105.18

13) A firm is considering two different capital structures. The first option is an all-equity firm

with 40,500 shares of stock. The levered option is 27,800 shares of stock plus some debt. Ignoring taxes, the break-even EBIT between these two options is $54,800. How much money is the firm considering borrowing if the interest rate is 7.6 percent? A) $214,802 B) $226,108 C) $236,875 D) $258,409 E) $202,869

14) Room and Board is considering two capital structures that have a break-even EBIT of

$27,000. The all-equity capital structure would have 16,600 shares outstanding. The levered capital structure would have 12,250 shares of stock and $90,000 of debt. What is the interest rate on the debt? Ignore taxes. A) 8.24% B) 7.05% C) 7.47% D) 8.98% E) 7.86%

15) Taunton's is an all-equity firm that has 151,000 shares of stock outstanding. The CFO is

considering borrowing $233,000 at 7 percent interest to repurchase 20,000 shares. Ignoring taxes, what is the value of the firm? A) $1,842,919 B) $2,010,457 C) $1,759,150 D) $2,273,363 E) $2,165,108

16) Gulf Shores Inn is comparing two separate capital structures. The first structure consists of

295,000 shares of stock and no debt. The second structure consists of 246,000 shares of stock and $1.74 million of debt. What is the price per share of equity? A) $37.20 B) $43.70 C) $35.51 D) $45.89 E) $40.58

17) The Tree House has a pretax cost of debt of 6.3 percent and a return on assets of 10.8

percent. The debt–equity ratio is .54. Ignore taxes. What is the cost of equity? A) 13.89% B) 13.23% C) 14.43% D) 13.66% E) 8.37%

18) The Outlet Mall has a cost of equity of 13 percent, a pretax cost of debt of 6.6 percent, and a

return on assets of 11.5 percent. Ignore taxes. What is the debt–equity ratio? A) .37 B) 2.73 C) .40 D) .31 E) 3.27

19) Debbie's Cookies has a return on assets of 8.1 percent and a cost of equity of 12.5 percent.

What is the pretax cost of debt if the debt–equity ratio is .87? Ignore taxes. A) 3.21% B) 2.77% C) 3.38% D) 3.04% E) 3.52%

20) Brick House Cafe has a tax rate of 34 percent and paid total taxes of $52,400. The company

had an interest expense of $23,300. What was the value of the interest tax shield? A) $18,529 B) $7,922 C) $17,816 D) $8,642 E) $12,869

21) Rappaport Industries has 7,000 perpetual bonds outstanding selling for $2,000 each. The tax

rate is 35 percent. What is the present value of the interest tax shield? A) $352,800 B) $338,100 C) $4,410,000 D) $966,000 E) $4,900,000

22) Bassett Fruit Farm expects its EBIT to be $405,000 a year forever. Currently, the firm has no

debt. The cost of equity is 11.9 percent and the tax rate is 34 percent. The company is in the process of issuing $2 million worth of bonds at par that carry an annual coupon of 5.8 percent. What is the unlevered value of the firm? A) $2,495,798 B) $2,926,218 C) $2,246,218 D) $2,711,008 E) $2,021,597

23) Kline Construction is an all-equity firm that has projected perpetual EBIT of $292,000. The

current cost of equity is 11.6 percent and the tax rate is 35 percent. The company is in the process of issuing $908,000 worth of perpetual bonds with an annual coupon rate of 5.8 percent at par. What is the value of the levered firm? A) $1,954,007 B) $1,636,207 C) $1,472,586 D) $1,886,007 E) $1,818,008

24) Stevenson's Bakery is an all-equity firm that has projected perpetual EBIT of $171,000 per

year. The cost of equity is 12.3 percent and the tax rate is 34 percent. The firm can borrow perpetual debt at 6.7 percent. Currently, the firm is considering taking on debt equal to 81 percent of its unlevered value. What is the firm's levered value? A) $1,260,277 B) $917,561 C) $825,805 D) $1,170,257 E) $1,043,909

25) A firm has a cost of debt of 5.9 percent and a cost of equity of 10.7 percent. The debt–equity

ratio is .57. There are no taxes. What is the firm's weighted average cost of capital? A) 8.06% B) 8.96% C) 8.27% D) 9.43% E) 7.46%

Answer Key Test name: Chapter 16(2) 1) E 2) A 3) E 4) C 5) C 6) A 7) E 8) C 9) B 10) B 11) C 12) B 13) B 14) E 15) C 16) C 17) B 18) D 19) D 20) B 21) E 22) C 23) A 24) D 25) B

Chapter 17: 1) If a firm were to , the firm’s cash flows would decrease. A) decrease the use of leverage B) decrease costs C) increase sales due to an improved economy D) incur costs associated with bankruptcy E) decrease the interest rate paid on its debt

2) The

are the explicit costs, such as legal expenses, associated with corporate

default. A) debt flotation costs B) beta conversion costs C) direct costs of financial distress D) indirect bankruptcy costs E) unlevered costs of capital

3) According to White, Altman, and Weiss, the estimated direct cost of financial distress as a

percentage of the market value of a firm is: A) 3 percent. B) 5 percent. C) 8 percent. D) 1 percent. E) 10 percent.

4) Which one of the following is a direct, rather than an indirect, cost of financial distress? A) Key employee leaving for another job due to concerns over job security given the

company’s financial status B) Loss of a key supplier due to late payments to that supplier C) Fees paid to financial advisors related to bankruptcy matters D) Loss of customers due to concerns the company will close E) Money spent to send a mailing to customers dispelling any and all financial distress concerns about the company

5) The costs incurred because of conflicts of interest between stockholders and bondholders are

known as costs. A) trustee B) financial distress C) dealer D) agency E) underwriting

6) An indirect cost of bankruptcy is the effect that a potential bankruptcy has on the firm’s

decisions. The general result is that: A) the firm will rank all projects and select the project which results in the highest expected firm value. B) bondholders expropriate value from stockholders by selecting high-risk projects. C) stockholders expropriate value from bondholders by selecting high-risk projects. D) the firm will always select the lowest-risk project available. E) the firm will select only all-equity financed projects.

7) One of the indirect costs of bankruptcy is the incentive to underinvest. Such underinvestment

generally would result in: A) the firm selecting all projects with positive NPVs. B) the firm turning down positive NPV projects that would clearly be accepted if the firm were all-equity financed. C) bondholders contributing the full amount of any new investment, but both stockholders and bondholders sharing in the benefits of those investments. D) shareholders making decisions based on the best interests of the bondholders. E) the firm accepting more projects than it would if the probability of bankruptcy was ignored.

8) Which one of the following actions best exemplifies “milking the property”? A) A firm paying a premium to acquire a competitor B) A firm demanding a premium to be acquired without a proxy fight C) A firm with high financial distress paying additional dividends D) An all-equity firm repurchasing shares E) A firm with high financial distress using expected dividends to repay debt

9) Shareholders sometimes pursue selfish strategies when the firm experiences financial

distress. These actions generally result in: A) no action by debtholders since such strategies are shareholder concerns. B) agency costs to bondholders. C) investments with risks similar to those of the current firm. D) undertaking scale-enhancing projects. E) lower agency costs, as shareholders have more control over the firm’s assets.

10) Bondholders tend to offset the effects of selfish strategies implemented by shareholders by: A) restructuring their loans to provide additional time to the firm to make repayment. B) subordinating their bankruptcy position to the shareholders. C) agreeing to reduce the outstanding principal balances on their loans. D) agreeing to reduce the interest rate on existing loans. E) increasing the interest rate on monies loaned to the firm.

11) Covenants restricting additional borrowings primarily protect the: A) shareholders’ residual interests in the firm. B) debtholders from the added risk of dilution of their claims. C) debtholders from changes in market interest rates. D) managers by avoiding agency costs. E) shareholders from agency costs.

12) If a firm issues debt and includes protective covenants in the indenture, then the debt will

probably be issued at similar debt without the covenants. A) a variable interest rate rather than the fixed rate paid on B) a lower interest rate than C) a significantly higher interest rate than D) an interest rate equal to that of E) a slightly higher interest rate than

13) Which one of the following actions is most related to a positive covenant? A) Limiting the amount of the firm’s dividends B) Avoiding a merger while a debt remains unpaid C) Furnishing financial statements to the firm’s lenders D) Not issuing any additional long-term debt E) Not selling any major assets without lender approval

14) Suppose a potential bondholder requires that the indenture agreement include a limit on

dividend distributions by the bond’s issuer and also a restriction on the sale of the issuer’s assets. In this case, the bondholder is most likely concerned about: A) shareholder claims being diluted. B) shareholders claiming all of the residual profits of the firm. C) increasing interest rates. D) shareholders transferring the firm’s assets to themselves. E) shareholders earning a higher return on their investment in the firm than the bondholders earn on their debt.

15) Which one of the following statements represents a difference between business entities in

Japan and in the United States? A) Lenders in Japan frequently also take ownership positions in firms to which they lend. B) Debt-equity ratios tend to be higher in the U.S. than they are in Japan. C) There tends to be greater agency issues between stockholders and bondholders in Japan as compared to the U.S. D) Bondholders in Japan are prohibited from also being shareholders in the same firm. E) The debt-equity ratios for firms in Japan and in the U.S. tend to be relatively equal.

16) Which one of the following parties holds a marketable claim on a firm’s assets? A) Customers B) Employees C) Bondholders D) Internal Revenue Service E) State tax authorities

17) The value of a firm is maximized when the: A) cost of equity is maximized. B) tax rate is zero. C) levered cost of capital is maximized. D) weighted average cost of capital is minimized. E) debt-equity ratio is minimized.

18) The optimal capital structure has been achieved when the: A) debt-equity ratio is equal to 1. B) weight of equity is equal to the weight of debt. C) cost of equity is maximized given a pretax cost of debt. D) debt-equity ratio is such that the cost of debt exceeds the cost of equity. E) present value of the financial distress costs equals the present value of the tax shield

on debt.

19) In a world with taxes and financial distress, when a firm is operating with the optimal capital

structure the: A) debt-equity ratio will be minimized. B) weighted average cost of capital will be maximized. C) firm will be all-equity financed. D) required return on assets will be at its maximum point. E) overall benefits of debt have all been realized.

20) The optimal capital structure of a firm

the value of marketable claims and value of nonmarketable claims against the cash flows of the firm. A) minimizes; minimizes B) minimizes; maximizes C) maximizes; minimizes D) maximizes; maximizes E) equates; (leave blank)

the

21) The MM theory with taxes implies that firms should issue maximum debt. In practice, this

does not occur because: A) debt is more risky than equity. B) bankruptcy is a disadvantage to debt. C) the weighted average cost of capital is inversely related to the debt-equity ratio. D) the weighted average cost of capital is directly related to the debt-equity ratio. E) U.S. regulations require the debt-equity ratio of publicly-traded firms to be in the range of .3 to .7.

22) Assuming the interest on the debt is fully tax deductible, when firms issue additional debt,

the present value of the tax shield on debt distress costs . A) decreases; decreases B) increases; increases C) decreases; remains constant D) decreases; increases E) increases; remains constant

and the present value of the financial

23) Horizon Mortgage is considering issuing $2.5 million in bonds. The finance department at

Horizon has stated that issuing the bonds will decrease the value of the firm. Accordingly, you know the finance department believes the firm: A) currently is all-equity financed and adding debt will cause a decrease in firm value. B) wants to issue too few bonds to obtain the most benefit from debt. C) will suffer from a decrease in its WACC if the bonds are issued. D) is at, or has exceeded, its optimal debt-equity ratio. E) will realize greater tax benefits by issuing equity securities.

24) Which one of the following statements is true? A) A firm with low anticipated profits will likely take on a high level of debt. B) A successful firm will probably be all-equity financed. C) Rational firms raise debt levels when profits are expected to decline. D) Rational investors are likely to infer a firm is more valuable when its debt level

declines. E) Investors will generally view an increase in debt as a positive sign for the firm’s future value.

25) A decrease in a firm’s use of debt tends to imply: A) an increase in the firm’s market value. B) an increase in future dividend payouts. C) a decrease in the firm’s stock price. D) a decrease in the firm’s position within its industry. E) a decline in managerial efficiency.

26) For the next 30 days, the bondholders of Sound Effects have the option of exchanging their

bonds for common shares of the firm’s stock. As a result of these exchanges, you should expect the firm’s debt-equity ratio to and the stock price to . A) decrease; decrease B) decrease; remain constant C) decrease; increase D) increase; increase E) increase; remain constant

27) The free cash flow hypothesis states that: A) firms with greater free cash flow will pay higher dividends thereby reducing the risk

of financial distress. B) firms with greater free cash flow should issue new equity to help minimize the wasting of resources by managers. C) issuing debt requires payments to creditors thereby reducing the ability of managers to waste resources. D) firms should reduce their debt levels as their level of free cash flow rises. E) firms with higher levels of free cash flow should reward their managers with bonuses.

28) Issuing new debt instead of new equity in a closely held firm is most apt to cause: A) the owner-manager to work less hard and shirk duties. B) the owner-manager to consume more perquisites because the cost is passed to the

debtholders. C) both more shirking and perquisite consumption since the government provides a tax shield on debt. D) agency costs to fall as owner-managers do not need to worry about other shareholders. E) the owner-manager to reduce shirking and perquisite consumption.

29) According to the pecking-order theory, when funding capital projects, firms should: A) use internal financing first. B) always issue debt so the market won’t know when managers believe the stock is

overvalued. C) issue new equity first. D) issue debt first. E) always issue equity to avoid financial distress costs.

30) According to the pecking-order theory, a firm’s leverage ratio is determined by: A) the value of the tax benefit of debt. B) equating the tax benefit of debt to the financial distress costs of debt. C) the firm’s financing needs. D) the market rate of interest. E) the profitability of the firm.

31) Which one of the following is not implied by the pecking-order theory? A) Profitable firms tend to use less debt than unprofitable firms. B) Companies like having financial slack. C) Companies prefer to borrow up to the point where the financial distress costs offset

the tax benefit of debt. D) There is no target debt-equity ratio for a firm. E) Firms tend to accumulate cash in anticipation of future projects.

32) The introduction of personal taxes may reveal a disadvantage to the use of corporate debt if

the personal tax rate on: A) the distribution of income to stockholders is less than the personal tax rate on interest income. B) the distribution of income to stockholders is greater than the personal tax rate on interest income. C) the distribution of income to stockholders is equal to the personal tax rate on interest income. D) interest income is zero. E) dividends and interest are equal.

33) Ignore financial distress costs. When (1 − TC) × (1 − TS) = (1 − TB), then firms: A) should be all-equity financed. B) need to maintain a debt-equity ratio of .5. C) tend to be indifferent between issuing debt or issuing equity. D) discover that both dividends and interest payments are non-deductible business

expenses. E) can reduce their taxes by increasing their dividend payouts.

34) Of the following five U.S. industries, which one tends to have the highest level of debt as a

percentage of the market value of debt plus equity? A) Electric utilities B) Airlines C) Fabric apparel D) Drugs E) Steel works

35) Studies have found that firms with large investments in tangible assets tend to have: A) higher financial distress costs than firms with comparable investments in intangible

assets. B) zero debt. C) higher target debt-equity ratios than firms that primarily invest in intangible assets. D) the highest financial distress costs of any firm per dollar of debt. E) the same capital structure as firms that specialize in intangible asset investments.

36) When determining a target debt-equity ratio, which group of factors is generally considered

to be the most important? A) Taxes, asset types, and inflation rate B) Asset types, current operating income, and inflation rates C) Taxes, current operating income, and future operating income D) Taxes, asset types, and uncertainty of operating income E) Interest rates, inflation rates, and tax rates

37) Which one of the following is not empirically correct? A) Some firms use no debt. B) The capital structure of a firm can vary significantly over time. C) Capital structures are fairly constant across industries. D) Debt levels across industries vary widely. E) Debt ratios in most countries are considerably less than 100 percent.

38) The optimal capital structure: A) is identical for all firms in the same industry. B) will remain constant over time unless the firm makes an acquisition. C) of a particular firm can change if tax rates change. D) places more emphasis on the operations of a firm rather than the financing of a firm. E) is unaffected by changes in the financial markets.

39) As compared to firms in other countries, corporations in the U.S. tend to: A) have a median leverage ratio that’s equal to the average international median leverage B) C) D) E)

ratio. underutilize debt. rely less on equity financing than they should. have extremely high debt-equity ratios. have relatively high leverage ratios due to the tax benefits gained.

40) In general, U.S. firms: A) tend to overweigh debt in relation to equity. B) that are highly profitable tend to have lower target debt-equity ratios than unprofitable

firms. C) tend to maintain similar capital structures across all industries. D) tend to maximize the use of every dollar of the tax benefits of debt. E) that are family-owned tend to have very low levels of debt.

41) Many firms base their actual capital structure decisions on which two factors? A) Inflation and tax rates B) Interest and tax rates C) Need for financial slack and current interest rates D) Need for financial slack and industry averages E) Types of assets held and current interest rates

42) Garcia & Smith owes $96 to its bondholders for the payment of principal and interest. The

company expects to have a cash flow of $224 if the economy continues to be normal, but $88 if the economy enters a recession. If the company ever faces the real possibility of bankruptcy, it will incur legal and other fees of $22. What amount will the bondholders be paid in the case of a recession? A) $22 B) $96 C) $88 D) $0 E) $66

43) Houston Homes has outstanding debt of $78 that is due in one year. Given the financial

distress costs, debtholders will receive only $62 if the firm does well and $24 if it does poorly. The probability that the firm will do well is 75 percent and the probability that it will do poorly is 25 percent. Assuming a discount rate of 9.6 percent, what is the current value of the debt? A) $52.50 B) $71.17 C) $47.90 D) $53.38 E) $17.79

44) Assume Forrest Corporation debtholders are promised payments in one year of $42 if the

firm does well and $18 if the firm does poorly. There is a 50/50 chance of the firm doing well or poorly. If debtholders are willing to pay $28.65 today to purchase this debt, what is the promised return to those debtholders? A) 4.7 percent B) 4.5 percent C) −4.7 percent D) 3.8 percent E) −3.8 percent

45) Ortiz, Incorporated, is currently valued at $145,700 in a boom and $75,200 in a recession.

The chance of either economic state occurring is 50 percent. The firm owes $85,000 to its debtholders. What is the value of the firm to the shareholders in a recession? A) $22.50 B) $55.00 C) $27.50 D) −$10.00 E) $0

46) Thompson Lumber is currently valued at $390 in a boom and $185 otherwise. The chance of

a boom is 28 percent. What is the value of the firm to the shareholders if the firm owes $230 to its debtholders? A) $0 B) $28 C) $12.40 D) $44.80 E) $32.40

47) Patel Management Group is subject to claims from four parties as follows: tax claims =

$5,830; bondholder claims = $14,630; bankruptcy claims = $1,870; and shareholder claims = $25,750. What is the total value of the marketed claims? A) $25,750 B) $40,380 C) $48,080 D) $38,510 E) $42,250

48) Rachel owns 100 percent of a gift shop with an equity value of $150,000. If she keeps the

shop open 5 days a week, EBIT is $75,000. If the shop remains open 6 days a week, EBIT increases to $92,000 annually. Rachel needs an additional $50,000 which she can raise today by either selling stock or issuing debt at an interest rate of 7 percent. The principal amount would be repaid in equal annual payments at the end of the next five years. Ignore taxes. What will be the cash flow for the next year to Rachel if she issues stock to another individual, remains open 6 days a week, and distributes all the residual cash flow to the shareholders? A) $58,750 B) $61,333 C) $92,000 D) $42,000 E) $69,000

49) Rachel owns 100 percent of a gift shop with an equity value of $150,000. If she keeps the

shop open 5 days a week, EBIT is $75,000. If the shop remains open 6 days a week, EBIT increases to $92,000 annually. Rachel needs an additional $50,000 which she can raise today by either selling stock or issuing debt at an interest rate of 7 percent. The principal amount would be repaid in equal annual payments at the end of the next five years. Ignore taxes. What will be the cash flow for the year to Rachel if she issues debt, remains open 5 days a week, and distributes all the residual cash flow to the shareholders? A) $46,125 B) $61,500 C) $65,000 D) $71,500 E) $67,880

50) Rachel owns 100 percent of a gift shop with an equity value of $150,000. If she keeps the

shop open 5 days a week, EBIT is $75,000. If the shop remains open 6 days a week, EBIT increases to $92,000 annually. Rachel needs an additional $50,000 which she can raise today by either selling stock or issuing debt at an interest rate of 7 percent. The principal amount would be repaid in equal annual payments at the end of the next five years. Ignore taxes. What will be the cash flow for the next year to Rachel if she issues stock to another individual, remains open 5 days a week, and distributes all the residual cash flow to the shareholders? A) $92,000 B) $61,333 C) $69,000 D) $42,000 E) $56,250

51) Rachel owns 100 percent of a gift shop with an equity value of $150,000. If she keeps the

shop open 5 days a week, EBIT is $75,000. If the shop remains open 6 days a week, EBIT increases to $92,000 annually. Rachel needs an additional $50,000 which she can raise today by either selling stock or issuing debt at an interest rate of 7 percent. The principal amount would be repaid at the end of the fifth year. Ignore taxes. What will be the cash flow for this year to Rachel if she issues debt, remains open 6 days a week, and distributes all the residual cash flow to the shareholders? A) $46,125 B) $88,500 C) $65,000 D) $71,500 E) $81,500

52) Light Speed requires $180,000 to fund a new project next year. The firm expects to earn

excess cash of $68,000 this year after all expenses, taxes, and dividends are paid. The firm can borrow up to $150,000 at 6.5 percent interest for up to ten years, or it can issue up to 25,000 new shares of stock that will have an estimated value of $35 per share at the end of this year. According to the pecking-order theory, how much will the firm raise in new equity capital to fund this project? A) $0 B) $30,000 C) $112,000 D) $90,000 E) $180,000

53) Assume the corporate tax rate is 22 percent, the personal tax rate on interest income is 15

percent, and the personal tax rate on dividends is 10 percent. Also assume the firm earns $5 per share in taxable income and pays out 40 percent of its earnings. How much will a shareholder receive per share in aftertax income? A) $1.470 B) $1.782 C) $1.096 D) $1.232 E) $1.404

54) Assume O’Connell Enterprises is indifferent between issuing equity and issuing debt. The

corporate tax rate is 21 percent and dividends are taxed at the personal level at 20 percent. What is the personal tax on interest income? A) 20 percent B) 42 percent C) 40 percent D) 14 percent E) 37 percent

55) The Lunda Corporation is deciding whether to invest in a new one-year project. The project

would have to be financed by equity, the cost is $2,000, and the return will be a guaranteed $2,500 in one year. The discount rate for both bonds and stock is 15 percent and the tax rate is zero. The predicted cash flows excluding this new project are $4,500 in a good economy, $3,000 in an average economy, and $1,000 in a poor economy. Each economic outcome is equally likely to occur and the promised debt repayment is $3,000. Should the company take the project? What is the value of the firm and its debt and equity components before and after the project addition?

56) Abell Art Supply is currently all-equity financed, has an EBIT of $2 million, and has a

corporate tax rate of 21 percent. Jared, the company's founder, is the lone shareholder. All earnings are paid out as dividends to Jared. If the firm were to convert $4 million of equity into debt at a cost of 10 percent, what would be the total cash flow from the firm to Jared if he holds all the debt? Compare this to Jared’s total cash flow if the firm remains unlevered.

57) What is the pecking-order theory and what are the implications that arise from this theory?

58) McConn Manufacturing is currently all-equity financed, has an EBIT of $2 million, and has a

corporate tax rate of 21 percent. Natalie, the company’s founder, is the lone shareholder. All earnings are paid out as dividends to Natalie. If the firm were to convert $4 million of equity into debt, the cost would be 10 percent and Natalie would hold all the debt. Assume Natalie pays personal taxes on interest income at a rate of 37 percent but pays taxes on dividends at a rate of 20 percent. Calculate the total cash flow to Natalie after she pays personal taxes if the firm is unlevered and if it is levered.

59) Is there an easily quantifiable debt-equity ratio that will maximize the value of a firm? Why

or why not?

60) Describe some of the sources of business risk and financial risk. Do financial decision

makers have the ability to trade off one type of risk for another type of risk?

Answer Key Test name: Chapter 17 1) D 2) C 3) A 4) C 5) D 6) C 7) B 8) C 9) B 10) E 11) B 12) B 13) C 14) D 15) A 16) C 17) D 18) E 19) E 20) C 21) B 22) B 23) D 24) E 25) C 26) A 27) C 28) E 29) A 30) C 31) C 32) A 33) C 34) B 35) C 36) D 37) C

38) C 39) B 40) E 41) D 42) E 43) C 44) A 45) E 46) D 47) B 48) E 49) B 50) E 51) B 52) A 53) E 54) E 55) Essay 56) Essay 57) Essay 58) Essay 59) Essay 60) Essay

Chapter 18: 1) The acronym APV stands for: A) applied present value. B) all-purpose variable. C) accepted project verified. D) adjusted present value. E) applied projected value.

2) If you discount a project’s expected future unlevered aftertax cash flows using the

and

then subtract the initial investment, you will calculate the: A) cost of capital for the unlevered firm; adjusted present value. B) cost of equity capital; project NPV. C) weighted cost of capital; project NPV. D) cost of capital for the unlevered firm; all-equity net present value. E) cost of equity capital for the levered firm; all-equity net present value.

3) Capital budgeting decisions are treated separately from capital structure decisions, even

though these decisions may be highly interwoven. This interweaving is most apt to result in: A) firms rejecting positive NPV, all-equity projects because changing to a capital structure with debt will always create negative net present values. B) firms foregoing project analysis and making decisions at random. C) corporate financial managers first checking with their investment bankers to determine the best type of capital to raise before valuing a project. D) firms accepting some negative NPV all-equity projects because changing the capital structure adds enough positive leverage tax shield value to create a positive NPV. E) firms never changing their capital structure because all capital budgeting decisions will be overridden by capital structure decisions.

4) The four financing side effects, which are addressed by the APV method, are: A) tax subsidy of dividends, cost of issuing new securities, subsidy of financial distress,

and cost of debt financing. B) cost of issuing new securities, cost of financial distress, tax subsidy of debt, and other subsidies to debt financing. C) cost of issuing new securities, cost of financial distress, tax subsidy of dividends, and cost of debt financing. D) subsidy of financial distress, tax subsidy of debt, cost of other debt financing, and cost of issuing new securities. E) cost of financial distress, tax subsidy of debt, increased cost of equity capital, and cost of issuing new securities.

5) How does one calculate the adjusted present value? A) Multiply the additional effects of debt by the all-equity project value. B) Add the additional effects of debt to the all-equity project value. C) Divide the project’s levered cash flow by the risk-free rate. D) Divide the project’s levered cash flow by the risk-adjusted rate. E) Add the pretax cost of debt to the project’s all-equity NPV.

6) Subsidized financing the APV . A) has no impact on; as the lower interest rate is offset by the lower discount rate B) decreases; by increasing the interest on the debt C) increases; by decreasing the interest on the debt D) has no impact on; as the interest tax deduction is not allowed for subsidized loans E) increases; because subsidies offset all tax payments.

7) The flow-to-equity (FTE) approach in capital budgeting is defined as the: A) discounting of all project cash flows at the overall cost of capital. B) scale-enhancing discount process. C) discounting of a project’s levered cash flows to the equityholders at the required

return on equity. D) dividends and capital gains that will be available to flow to shareholders of a firm. E) discounting of a project’s unlevered cash flows to the equityholders at the WACC.

8) When employing the flow-to-equity approach to calculate NPV, the appropriate discount rate

is the: A) B) C) D) E)

all-equity cost of capital. cost of equity for the levered firm. all-equity cost of capital minus the weighted average cost of debt. weighted average cost of capital. all-equity cost of capital plus the weighted average cost of debt.

9) The flow-to-equity approach to capital budgeting involves all of the following except: A) calculating the levered cost of equity. B) determining the amount of the investment that is not borrowed. C) computing the PV of the cash flows using the cost of equity for an all-equity firm. D) discounting the levered cash flows using the levered cost of equity. E) computing the project’s NPV.

10) The term (RBB) represents the: A) pretax interest payment. B) pretax cost of equity dividends. C) aftertax cost of debt. D) average pretax cost of equity. E) weighted average cost of capital.

11) Given the all-equity cost of capital, the cost of levered equity can be computed as: A) RS = (B/S)(R0) + (1 − TC)B. B) RS = R0 + (B/S)(1 − TC)(R0 − RB). C) RS = R0 + (1 − TC)B. D) R0 = Rs + (B/S)(1 − TC)(R0 − RB). E) R0 = Rs + (1 − TC)B.

12) The weighted average cost of capital is determined by

the weighted average cost of

equity. A) B) C) D) E)

multiplying the weighted average aftertax cost of debt by adding the weighted average pretax cost of debt to adding the weighted average aftertax cost of debt to dividing the weighted average pretax cost of debt by dividing the weighted average aftertax cost of debt by

13) When calculating a firm’s weighted average cost of capital, the appropriate cost of debt to

employ is the: A) pretax market cost of debt. B) levered equity rate. C) aftertax market borrowing rate. D) pretax coupon rate. E) aftertax coupon rate.

14) If a project’s debt level is known over the life of the project, which of the following methods

is(are) most applicable? A) WACC B) APV C) FTE D) Either APV or FTE E) Either FTE or WACC

15) The adjusted present value method (APV), the flow to equity (FTE) method, and the

weighted average cost of capital (WACC) method produce equivalent results, but each can have difficulties making computation impossible at times. Accordingly, which one of the following statements is correct? A) The WACC method is preferred when evaluating a leveraged buyout. B) The APV method is the most commonly used method in actual practice. C) Use the FTE method when the level of debt is known over a project’s life. D) Use the WACC method when the level of debt is known over a project’s life. E) The WACC method is appropriate when the target debt-to-value ratio applies over a project’s life.

16) In leveraged buyouts, the WACC approach to valuation is not as useful as the APV approach

because: A) there is greater risk with an LBO. B) the future reductions in debt are known at the time of the LBO. C) there is no interest tax shield with the WACC. D) the value of the levered and unlevered firms are equal in an LBO. E) WACC only applies to unlevered projects.

17) When the debt-equity ratio changes over time, the best method(s) to use when evaluating a

project is(are): A) APV. B) FTE. C) WACC. D) either APV or WACC. E) either FTE or WACC.

18) Which of the following methods discount(s) levered cash flows? A) APV B) FTE C) WACC D) Both APV and WACC E) Both APV and FTE

19) The APV method is least useful in which one of the following situations? A) A leveraged buyout B) A project involving interest subsidies C) A project based on a target debt-to-value ratio D) A project with flotation costs E) A lease-versus-purchase decision

20) The cost of equity would be expected to be lowest when the debt-to-equity ratio is: A) zero. B) .15. C) .50. D) .65. E) 1.00.

21) Which one of the following statements is correct?

Flotation costs increase the value of RS. The weighted average cost of capital is equal to B/S(RS)(1 − Tc). The discount rate for levered equity is unaffected by the debt-equity ratio. The cost of equity for an all-equity firm is less than the cost of equity for a levered firm. E) The cost of levered equity is indirectly related to beta. A) B) C) D)

22) The cost of equity for an all-equity firm is designated as: A) Rs. B) RD. C) RS(1 − TC). D) R0. E) R0(1 − TC).

23) Flotation costs: A) are amortized using a declining-balance method over the life of the loan. B) are amortized using the straight-line method over the life of the loan. C) are deducted as a business expense in the year incurred. D) cannot be deducted as a business expense. E) are deducted as a business expense at the time the loan is repaid in full.

24) A firm currently has debt outstanding with a coupon rate of 4.5 percent. The firm is obtaining

subsidized financing for a new project at a rate of 3.6 percent. The current market rate is 5.4 percent and the firm’s tax rate is 21 percent. What discount rate should be used to compute the NPV of the loan? A) 3.6 percent B) 3.5 percent C) 5.4 percent D) 4.3 percent E) 4.5 percent

25) The beta of debt is commonly assumed to be: A) 1.0. B) .50. C) 0. D) −1. E) −5.

26) When valuing a project that is not scale enhancing, an analyst will typically need to: A) calculate the equity cost of capital using the risk-adjusted beta of another firm. B) double the firm’s beta value when computing the project WACC. C) apply the firm’s current WACC to the project’s cash flows. D) discount the project’s cash flows using the market rate of return since the project will

diversify the firm’s operations. E) replace the risk-free rate with the market rate of return when computing the project’s discount rate.

27) Harper Boatwrights is considering a new project with revenue of $422,000 per year for the

indefinite future. Cash costs are 67 percent of revenue. The initial cost of the investment is $498,000. The tax rate is 21 percent and the unlevered cost of equity is 15 percent. What is the net present value of the project? A) $991,097 B) $733,436 C) $322,097 D) $235,436 E) $430,400

28) Daughtry Centers is considering a new project with revenue of $522,000 per year for the

indefinite future. Cash costs are 65 percent of revenue. The initial cost of the investment is $703,000. The tax rate is 21 percent and the unlevered cost of equity is 13.5 percent. The firm is financing $250,000 of the project cost with debt. What is the adjusted present value of the project? A) $366,133 B) $418,633 C) $616,133 D) $313,633 E) $563,633

29) Blue Sky Ski Resorts has a levered equity cost of capital of 14.92 percent. The debt-to-value

ratio is .4, the assumed tax rate is 23 percent, and the pretax cost of debt is 7.2 percent. What is the estimated unlevered cost of equity? A) 12.08 percent B) 13.06 percent C) 12.30 percent D) 10.97 percent E) 11.23 percent

30) Ramos Land Management has a target debt-to-value ratio of .45. The pretax cost of debt is

7.4 percent, the assumed tax rate is 24 percent, and the unlevered cost of equity 14.3 percent. What is the target cost of equity? A) 18.59 percent B) 16.66 percent C) 17.18 percent D) 17.86 percent E) 20.71 percent

31) Desert Adventures has a target debt-to-value ratio of .6. The pretax cost of debt is 8.4

percent, the tax rate is 21 percent, and the unlevered cost of equity 13.2 percent. A project the firm is considering has a cash flow to the levered equityholders of $48,700 each year for the foreseeable future and an initial unborrowed cost of $216,000. What is the NPV of the project? A) $41,836 B) $48,208 C) $62,342 D) $61,003 E) $38,367

32) Naqvi, Incorporated, has a total market value of $632,000, with debt valued at $218,000.

What is the weighted average cost of capital if the aftertax cost of debt is 4.4 percent and the cost of equity is 12.6 percent? A) 10.78 percent B) 9.36 percent C) 11.18 percent D) 10.50 percent E) 9.77 percent

33) Ceramica maintains a debt-equity ratio of .36. The cost of equity is 12.8 percent, the pretax

cost of debt is 5.7 percent, and the tax rate is assumed to be 23 percent. What is the weighted average cost of capital? A) 10.92 percent B) 10.57 percent C) 12.07 percent D) 11.98 percent E) 12.63 percent

34) Paper Planet is planning to build a new shipping depot. The initial cost of the investment is

$1.18 million. Efficiencies from the new depot are expected to reduce aftertax annual costs by $105,000 forever. The corporation has a total value of $62.4 million and has outstanding debt of $38.7 million. What is the NPV of the project if the firm has an aftertax cost of debt of 5.8 percent and a cost equity of 12.6 percent? A) $72,581 B) $46,509 C) $163,669 D) −$102,422 E) −$531,736

35) A project has an initial cost of $336,000, projected annual revenue of $272,000, annual cash

costs of $163,200, an unlimited life, a tax rate of 21 percent, and a weighted average cost of capital of 11.6 percent. What is the net present value of the project? A) $388,627 B) $538,432 C) $404,966 D) $601,931 E) $740,965

36) Han Chiropractic is evaluating a project with an initial investment at Time 0 of $640,000.

The present value of the levered cash flows is $729,400 and the net present value of the project is $157,000. Using the flow-to-equity method of valuation determine the amount borrowed. A) $89,400 B) $246,400 C) $67,600 D) $54,300 E) $64,000

37) Elemental Investments is considering a new project with perpetual revenue of $435,000, cash

costs of $310,000, and a tax rate of 21 percent. The firm plans to issue $250,000 of debt at an interest rate of 7.3 percent to help finance the initial project cost of $475,000. The levered discount rate is 16.7 percent. What is the net present value of this project? A) $279,985 B) $284,022 C) $128,211 D) −$59,506 E) −$168,424

38) Cazares Properties has a beta of 1.12, a cost of debt of 8.6 percent, and a debt-to-value ratio

of .6. The current risk-free rate is 3.22 percent and the market rate of return is 14.47 percent. What is the company’s cost of equity capital? A) 12.97 percent B) 10.95 percent C) 15.82 percent D) 11.49 percent E) 13.96 percent

39) Granite Group wants to be levered at a debt-to-value ratio of .6. The cost of debt is 9 percent,

the tax rate is 21 percent, and the cost of equity for an all-equity firm is 12 percent. What will be the firm's cost of equity? A) 12.31 percent B) 16.45 percent C) 12.08 percent D) 15.56 percent E) 13.58 percent

40) Gudimetla Consulting has a beta of 1.08 and a cost of debt of 8 percent. The current risk-free

rate is 3.2 percent and the market rate of return is 11.47 percent. What is the company's cost of equity capital? A) 8.93 percent B) 16.93 percent C) 12.13 percent D) 20.13 percent E) 16.13 percent

41) Long Corporation is planning to raise $3.25 million for three years at an interest rate of 7.35

percent to finance its expansion. The municipal government has just offered the firm the $3.25 million they need at 5.25 percent if the firm builds inside the municipality, pays the interest annually, and repays the principal at the end of three years. What is the net present value of the loan to Long Corporation if the firm’s tax rate is 21 percent and it accepts the municipality’s offer? A) $293,651 B) $212,100 C) $271,405 D) $186,416 E) $346,090

42) Guven Corporation has decided to build a new facility for its R&D department. The cost of

the facility is estimated at $125 million. The firm plans to finance this project using its traditional debt-equity ratio of .65. The issue cost of equity is 6.1 percent and the issue cost of debt is 1.8 percent. What is the amount of the total flotation cost? A) $5,507,576 B) $6,003,121 C) $6,138,412 D) $5,761,428 E) $6,202,418

43) A project has an unlevered NPV of $1.5 million. To finance the project, debt is being issued

with associated flotation costs of $60,000. The flotation costs can be amortized over the project's 5-year life. The debt of $10 million is being issued at the market interest rate of 10 percent paid annually, with principal repaid in a lump sum at the end of the fifth year. If the firm's tax rate is 21 percent, calculate the project’s APV. A) $2,441,107 B) $1,494,028 C) $2,384,312 D) $2,245,618 E) $1,909,417

44) Kang Media is given the opportunity to raise $5 million in debt for four years through a local

government subsidized program. While Kang would normally be required to pay 12 percent on its debt issues, a special municipal program sets the rate at 9 percent. What is the NPV of this subsidized loan? Ignore taxes. A) $518,364 B) $296,007 C) $384,312 D) $455,602 E) $0

45) A global conglomerate has a debt beta of zero. If the cost of equity is 12.23 percent, and the

risk-free rate is 4.36 percent, what is the firm’s pretax cost of debt? A) 4.36 percent B) 8.30 percent C) 7.87 percent D) 0 percent E) 12.23 percent

46) Alpha Company has riskless debt, a debt-equity ratio of .46, a tax rate of 21 percent, and an

unlevered firm beta of 1.23. What is the equity beta? A) .67 B) .73 C) .86 D) 1.68 E) 1.47

47) VillaNet is valued at $5.8 million, has riskless debt of $2.3 million outstanding, and has an

equity beta of 1.81. What is the asset beta if there are no taxes? A) 1.11 B) 1.86 C) 1.15 D) 1.09 E) 1.71

48) Counter Resources has a capital structure of 30 percent riskless debt and 70 percent equity.

The assumed tax rate is 23 percent. If the asset beta is .9, what is the equity beta? A) .63 B) .41 C) 1.20 D) 1.26 E) 1.49

49) The Floor Store is valued at $8.6 million and has debt of $2.1 million outstanding. The

unlevered firm beta is 1.72, and the tax rate is 21 percent. What is the levered equity beta? A) .86 B) 1.18 C) 2.16 D) 1.98 E) 1.30

50) Bondurant Company’s latest project has an initial cost of $1.23 million and unlevered

perpetual cash flows of $238,000. The firm has a debt-equity ratio of .42, a pretax cost of debt of 7.6 percent, a cost of equity of 13.3 percent, and a tax rate of 21 percent. What is the NPV of the project? A) $864,010 B) $887,982 C) $906,056 D) $909,411 E) $892,020

51) Explain why the flow to equity approach uses levered, not unlevered, cash flows.

52) Discuss the adjusted present value, the flow to equity, and the weighted average cost of

capital methods of capital budgeting with leverage and the guidelines for using each method.

53) Explain how flotation costs affect the analysis of a levered project.

54) Assume a project is non-scale enhancing. Describe the basic steps required to determine the

net present value of the project.

Answer Key Test name: Chapter 18 1) D 2) D 3) D 4) B 5) B 6) C 7) C 8) B 9) C 10) A 11) B 12) C 13) C 14) B 15) E 16) B 17) A 18) B 19) C 20) A 21) D 22) D 23) B 24) C 25) C 26) A 27) D 28) B 29) C 30) A 31) A 32) E 33) B 34) A 35) C 36) C 37) A

38) C 39) D 40) C 41) C 42) D 43) D 44) D 45) A 46) D 47) D 48) C 49) C 50) C 51) Essay 52) Essay 53) Essay 54) Essay

Chapter 19: 1) River & Wood is an outdoors-focused firm with excellent prospects for growth. The firm’s

management wants to acknowledge the loyalty of its shareholders but must use all of the firm’s available cash to fund its rapid growth. The market price of its stock is currently at the upper end of its preferred trading range. Given this situation, a(n) is the firm’s best choice. A) liquidating dividend B) extra cash dividend C) reverse stock split D) stock dividend E) cash distribution

are payouts of earnings, in the form of cash or stock, that are made to a firm’s owners. A) Dividends B) Distributions C) Share repurchases D) Payments-in-kind E) Stock splits

3) A(n)

is a cash payment made by a firm to its owners in the normal course of

business. A) share repurchase B) liquidating dividend C) regular cash dividend D) special dividend E) extra cash dividend

4) Assume a firm sells off some of its long-term assets and distributes the proceeds to its

owners. The cash payment to the owners is called a(n) A) liquidating dividend. B) regular cash dividend. C) special dividend. D) extra cash dividend. E) share repurchase.

5) Assume a firm made a payment to its owners in the form of new shares of stock. The

transaction is called a(n) A) stock B) normal C) special D) extra E) liquidating

dividend.

6) A(n)

is simultaneously a cash payment shareholders, an alternative to cash dividends, and a method used to pay a firm’s earnings to shareholders. A) merger B) acquisition C) payment-in-kind D) stock split E) stock repurchase

7) The last date on which an investor could purchase shares of stock and still receive the

dividend is the date A) zero B) one C) two D) five E) seven

business day(s) prior to the date of record.

8) Tasneem purchased 100 shares of Bentwood stock on June 7th. Andre purchased 100 shares

of Bentwood stock on Monday, July 9th. Bentwood declared a dividend on June 20th to shareholders of record on July 13th that is payable on August 1st. Which one of the following statements concerning the dividend paid on August 1st is correct given this information? A) Neither Tasneem nor Andre are entitled to the dividend. B) Tasneem is entitled to the dividend but Andre is not. C) Andre is entitled to the dividend but Tasneem is not. D) Both Andre and Tasneem are entitled to the dividend. E) Both Andre and Tasneem are each entitled to one-half of the dividend amount.

9) Ignoring taxes and all else held constant, on the

, the market value of a stock should

decrease by the amount of the dividend. A) dividend declaration date B) ex-dividend date C) date of record D) date of payment E) day after the date of payment

10) The

equals the annual dividend per share stated as a percentage of the annual earnings per share. A) dividend yield B) dividend per share C) annual yield D) dividend rate E) dividend payout ratio

11) On the

date, the board of directors passes a resolution authorizing payment of a dividend to the shareholders. A) ex-rights B) ex-dividend C) record D) payment E) declaration

12) Before the

date, a purchaser of stock is entitled to receive a declared dividend, but on or after that date they cannot. A) ex-rights B) ex-dividend C) record D) payment E) declaration

13) A stockholder must be registered on the firm’s list as having share ownership by the

in order to receive a declared dividend. A) ex-rights date B) ex-dividend date C) date of record D) date of payment E) declaration date

14) The date on which a firm actually distributes a declared dividend is called the: A) ex-rights date. B) ex-dividend date. C) date of record. D) date of payment. E) declaration date.

15) Which one of the following choices reports dividend events in the correct chronological

order, from earliest to latest? A) Date of record, declaration date, ex-dividend date B) Date of record, ex-dividend date, declaration date C) Declaration date, date of record, ex-dividend date D) Declaration date, ex-dividend date, date of record E) Ex-dividend date, date of record, declaration date

16) Miller and Modigliani’s dividend-irrelevance proposition depends on which one of the

following relationships between investment policy and dividend policy? A) The level of investment does not influence or matter to the dividend decision. B) Once dividend policy is set the investment decision can be made. C) The investment policy is set ahead of time and not altered by changes in dividend policy. D) Since dividend policy is irrelevant there is no relationship between investment policy and dividend policy. E) Miller and Modigliani were only concerned about capital structure.

17) The ability of shareholders to undo the dividend policy of a firm and create an alternative

dividend payment policy by reinvesting dividends or selling shares of stock is referred to as: A) the perfect foresight model. B) MM Proposition I. C) capital structure irrelevancy. D) homemade leverage. E) homemade dividends.

18) Which one of the following statements is true? A) Dividends are irrelevant. B) Shareholders are unable to personally adjust the dividend policy set by a firm. C) According to Miller and Modigliani, a firm should alter its investment policy

whenever a change is made in its dividend policy. D) Dividend policy is relevant. E) Firms should never give up a positive NPV project to increase a dividend.

19) A firm has announced that it is willing to repurchase a number of shares at various prices.

Shareholders can indicate how many shares they are willing to sell at each of the various prices. This process is called a: A) homemade dividend. B) tender offer. C) free market sale. D) Dutch auction. E) targeted repurchase.

20) A firm can repurchase its shares in all the following ways except through: A) a tender offer. B) a reverse stock split. C) a targeted repurchase. D) open market purchases. E) a Dutch auction.

21) Ignore commissions, taxes, and other imperfections. If a firm substitutes a repurchase for a

cash dividend, the primary difference will be an increase in the: A) earnings per share. B) total value received by each investor. C) total earnings of the firm. D) excess cash reserves of the firm. E) number of shares outstanding.

22) Which one of the following is not a reason why firms choose repurchases rather than

dividends? A) provide flexibility to the firm B) increase the value of existing stock options C) provide shareholders with a tax advantage D) offset dilution E) conserve cash

23) Assume personal tax rates are lower than corporate tax rates. From a tax-paying

shareholder’s point of view, after the firm has funded all positive net present value projects, how should the firm spend its excess cash? A) Repurchase shares B) Acquire another firm C) Purchase financial assets D) Increase cash dividends E) Increase executive compensation

24) From a tax-paying investor’s point of view, a stock repurchase: A) is equivalent to a cash dividend if the stock is held for more than one year. B) is more desirable than a cash dividend if the stock is held for more than one year. C) has the same tax effects as a cash dividend. D) is more highly taxed than a cash dividend. E) creates a tax liability even if the investor does not sell any of the shares he owns.

25) A scenario exists that supports an argument in favor of a low dividend policy when: A) tax laws allow capital gains to be deferred until the gain is realized. B) few, if any, positive net present value projects are available to a firm. C) a preponderance of stockholders have minimal taxable income. D) the majority of the stockholders have other investment opportunities that offer higher

rewards with similar risk characteristics. E) corporate tax rates exceed personal tax rates.

26) The market’s reaction to the announcement of a change in the firm’s dividend payout is

referred to as: A) the information content effect. B) the clientele effect. C) the efficient markets hypothesis. D) MM Proposition I. E) MM Proposition II.

27) Which one of the following is cited as an argument favoring a high dividend payout? A) Flotation costs involved with a new securities issue B) High personal tax rates relative to corporate rates C) Desire to maintain constant dividends over time D) Restrictive covenant on dividend payouts contained in a bond indenture agreement E) Agency costs related to excess cash reserves

28) The information content of a dividend increase generally signals that: A) the firm has a one-time surplus of cash. B) the firm has several net present value projects to pursue. C) management believes the future earnings of the firm will be strong. D) the firm has more cash than it needs due to sales declines. E) future dividends will be lower.

29) The behavioral finance concept of self-control is an argument in favor of: A) frequent stock splits. B) low cash dividends. C) stock dividends. D) reverse stock splits. E) high cash dividends.

30) The information content effect implies that stock prices will rise when dividends are

increased provided that the dividend increase: A) is denoted as a one-time event. B) causes stockholders to increase their expectations of future cash flows. C) is greater than the average historical dividend increase. D) is substantial in both dollar amount and percentage terms. E) is combined with a stock repurchase.

31) The

refers to the observed empirical fact that stocks attract particular investors based on the firm’s dividend policy and the resulting tax impact on those investors. A) information content effect B) clientele effect C) efficient markets hypothesis D) MM Proposition I E) MM Proposition II

32) Based on the concept of the clientele effect, which one of these combinations correctly aligns

an investor group with its preferred type of stocks? A) Low-tax-bracket individuals; zero-to-low payout stocks B) High-tax-bracket individuals; low-to-medium payout stocks C) Corporations; low-to-medium payout stocks D) Tax-free institutions; medium-payout stocks E) High-tax-bracket individuals; high-payout stocks

33) According to the clientele effect, firms can boost their stock price only: A) by increasing the dividend payout ratio. B) by increasing their regular cash dividends. C) by setting their dividend to the level expected by the highest-dividend-receiving

satisfied clientele group. D) by commencing dividend payments if they are a non-dividend-paying firm. E) if an unsatisfied clientele group exists.

34) Of the following factors, which one is considered to be the primary factor affecting a firm’s

dividend payout decision? A) Considering the personal taxes of company stockholders B) Maintaining a consistent dividend policy C) Attracting retail investors D) Attracting institutional investors E) Avoiding flotation costs

35) Financial managers: A) are reluctant to cut dividends. B) tend to ignore past dividend policies. C) tend to prefer cutting dividends every time quarterly earnings decline. D) prefer cutting dividends over incurring flotation costs. E) place little emphasis on dividend policy consistency.

36) Which one of the following statements is correct? A) In the U.S. economy, dividends are quite insignificant. B) Over the last few decades, the percentage of U.S. firms paying dividends has

increased. C) The tax law change in May 2003 is cited as one reason why the percentage of dividend payers has decreased in the U.S. D) Dividends are more tax-advantaged than capital gains as of 2017. E) Much of the dividend income paid in the U.S. is related to a relatively small number of firms.

37) Firms generally: A) set high target payout ratios when they are relatively young. B) decrease their dividends as soon as they expect earnings to decline. C) allow their dividend changes to lag their earnings changes. D) set short-term target ratios of dividends to earnings. E) set the dividend growth rate equal to the firm’s earnings growth rate.

38) Which one of the following is a negative aspect of paying dividends? A) Paying dividends reduces agency costs when excess cash is available to a firm. B) Dividend payments can be used to signal a firm’s optimistic outlook. C) Dividends received are frequently taxed as ordinary income. D) Dividend payments appeal to income-seeking investors. E) Managers can pay dividends to keep cash from bondholders.

39) When setting dividend policy, financial executives place the greatest importance on which

one of the following factors? A) Setting a high-dividend payout ratio even when earnings are unstable B) Maintaining a consistent dividend policy C) Increasing current dividends even if those dividends need to be lowered in the near future D) Reducing dividends anytime future earnings are in doubt E) Attracting institutional investors

40) Which one of the following actions is a characteristic of a sensible payout policy? A) Over the course of time, pay out half of all free cash flows B) Set the current regular dividend consistent with a 100 percent payout ratio C) Increase regular dividends to distribute transitory cash flow increases D) Set the dividends high even if it means acquiring expensive external financing E) Avoid rejecting positive NPV projects to increase dividends or buyback shares

41) Share repurchases: A) reduce a firm’s demand for external financing. B) offer less of a tax advantage to shareholders than do cash dividends. C) tend to increase agency costs. D) are always positive net present value investments. E) can be difficult to verify.

42) A change in dividend policy does not affect the value of a share of stock as long as: A) the dividend payout ratio remains constant. B) all future dividends are changed by the same amount. C) all the distributable cash flow is paid out. D) there is an offsetting change in stock repurchases. E) shareholders are given ample warning.

43) All else equal, a stock dividend will

the number of shares outstanding and

the

value per share. A) increase; increase B) increase; decrease C) not change; increase D) decrease; increase E) decrease; decrease

44) A small stock dividend is generally defined as a stock dividend of less than A) 10 to 15 B) 15 to 20 C) 20 to 25 D) 25 to 30 E) 30 to 35

percent.

45) A stock split: A) increases the total book value of the common stock account. B) decreases the book value of the retained earnings account. C) does not affect the total book value of any of the equity accounts. D) increases the book value of the capital in excess of par account. E) decreases the total owners’ equity on the balance sheet.

46) Stock splits are often employed in order to: A) adjust the market price of a stock such that it falls within a preferred trading range. B) decrease the excess cash held by a firm. C) increase both the number of shares outstanding and the market price per share. D) increase the total equity of a firm. E) adjust the debt-equity ratio such that it falls within a preferred range.

47) Art Prints stock is currently trading for $114 per share. The firm’s management believes that

the firm’s primary clientele can afford to spend between $1,800 and $2,000 to purchase a round lot of 100 shares. The firm should consider a: A) reverse stock split. B) liquidating dividend. C) stock dividend. D) stock split. E) special dividend.

48) A one-for-four reverse stock split will: A) increase the par value by 25 percent. B) increase the number of shares outstanding by 400 percent. C) increase the market value but not affect the par value per share. D) increase a $1 par value to $4. E) increase a $1 par value by $4.

49) Probably the best argument in favor of a reverse stock split is to: A) decrease the liquidity of a stock. B) decrease the market value per share. C) increase the number of stockholders. D) maintain a minimum share price as set by a stock exchange. E) raise additional capital from current stockholders.

50) A

will increase the number of shares outstanding without affecting the book value of any of the owners’ equity account values. A) special dividend B) stock split C) share repurchase D) tender offer E) liquidating dividend

51) In a reverse stock split the: A) number of shares outstanding increases and the owners’ equity decreases. B) firm buys back existing shares of stock on the open market. C) firm sells new shares of stock on the open market. D) number of shares outstanding decreases while the book value of owners’ equity is

unchanged. E) shareholders make a cash payment to the firm.

52) Rhino Moving is paying a dividend of $.86 per share today. There are 164,000 shares

outstanding with a par value of $1 per share. As a result of this dividend, the firm’s: A) retained earnings will decrease by $141,040. B) retained earnings will decrease by $164,000. C) common stock account will decrease by $164,000. D) common stock account will decrease by $141,040. E) capital in excess of par value account will decrease by $141,040.

53) Fiber Corporation declared a dividend of $.90 per share on April 20th to holders of record as

of Monday, May 1st. The dividend is payable on June 1st. You purchased 100 shares of this stock on Wednesday, April 26th. How much dividend income will you receive on June 1st as a result of this declaration? A) $0 B) $2.25 C) $9.00 D) $22.50 E) $90.00

54) Chowdury, Incorporated, announced on May 1st that it will pay a dividend of $1.20 per share

on June 15th to all holders of record as of May 31st. The firm’s stock price closed today at $42 per share. Assume all investors are in the 22 percent tax bracket. If tomorrow is the exdividend date, what would you expect the opening price to be tomorrow morning assuming all else is held constant? A) $42.00 B) $43.20 C) $41.06 D) $42.94 E) $41.66

55) Assume you purchased 200 shares of Capricorn stock on March 15th. On March 20th, you

purchased another 100 shares and then on March 22nd you purchased your final 200. The company declared a dividend of $1.10 per share on March 5th to holders of record on Friday, March 23rd. The dividend is payable on March 31st. How much dividend income will you receive on March 31st? A) $0 B) $220 C) $330 D) $440 E) $550

56) An investor purchased 1,000 shares of Travertine stock on January 18th. On February 5th,

she sold 200 shares of this stock for $21 per share. On March 9th, she sold an additional 400 shares for $22.50 per share. The company declared a $.50 per share dividend on February 25th to holders of record as of Thursday, March 10th. The dividend is payable on March 31st. How much dividend income will the investor receive on March 31st? A) $100 B) $200 C) $300 D) $400 E) $500

57) Assume you own 300 shares of Sycamore stock. The firm plans on issuing a dividend of

$2.10 per share one year from today and then issuing a final liquidating dividend of $36.45 per share two years from today. Your required rate of return is 14.5 percent. Ignoring taxes, what is the value of one share of this stock to you today? A) $33.93 B) $29.64 C) $26.62 D) $27.80 E) $31.05

58) You own 200 shares of Galaxy stock. The firm announced that it will be issuing a dividend

of $.20 per share one year from today followed by a final liquidating dividend of $1.60 per share two years from today. If you can earn 7 percent on your funds, what will be the value of your total investment income in two years if you do not want to receive any funds until then? A) $362.80 B) $266.67 C) $302.30 D) $348.04 E) $247.78

59) Today is January 1, 2022. Adina owns 500 shares of Colorwheel stock. The company

recently issued a statement that it will pay a $1 per share dividend on December 31, 2022, a $2.50 per share dividend on December 31, 2023, and then will cease all dividend payments. Adina does not want any dividend income this year but does want as much dividend income as possible next year. Adina can earn 8 percent on her investments. Ignoring taxes, what will Adina’s homemade dividend per share be in 2023? A) $3.78 B) $3.50 C) $2.50 D) $3.58 E) $1.08

60) The market value of Scorpion Corporation equals its book value. Currently, the firm has

excess cash of $1,100 and other assets of $12,400. Equity is worth $13,500. The firm has 2,500 shares of stock outstanding and net income of $10,800. What will be the new earnings per share if the firm uses its excess cash to complete a stock repurchase? A) $4.32 B) $4.50 C) $4.82 D) $4.70 E) $4.40

61) Assume a firm has a market value equal to its book value, excess cash of $900, other assets

of $16,500, and equity valued at $17,400. The firm has 1,200 shares of stock outstanding and net income of $15,400. If the firm spends all of its excess cash on share repurchases, how many shares will be outstanding after the repurchases are completed? (Round your answer up to the nearest whole share.) A) 1,148 shares B) 1,135 shares C) 1,138 shares D) 1,164 shares E) 1,142 shares

62) The Bureau has 400 shares of stock outstanding and a market value equal to its book value. It

has excess cash of $400, other assets of $8,600, equity of $18,000, and net income of $2,000. What will be the stock price per share if the firm pays out its excess cash as a cash dividend? A) $36 B) $38 C) $40 D) $42 E) $44

63) Dollar & Ruiz has a market value equal to its book value, excess cash of $400, other assets of

$7,600, equity of $8,000, 200 shares of stock outstanding, and net income of $900. The firm has decided to pay out all its excess cash as a cash dividend. What will be the earnings per share after the dividend is paid? A) $4.68 B) $4.74 C) $4.59 D) $4.80 E) $4.50

64) A firm has a market value equal to its book value, excess cash of $1,000, and equity worth

$17,800. The firm has 5,000 shares of stock outstanding and net income of $31,200. What will be the new earnings per share if the firm uses its excess cash to complete a stock repurchase? A) $7.20 B) $6.50 C) $6.61 D) $5.89 E) $6.23

65) Assume you own 400 shares of Acosta, Incorporated, stock and receive a stock dividend of 6

percent. As a result, the number of shares you own will be wealth will increase by _ percent. A) 424; 6 B) 406; 0 C) 424; 0 D) 406; 6 E) 400; 6

shares while your total

66) Murphy’s has shares of stock outstanding with a par value of $1 per share and a market value

of $24.60 per share. The balance sheet shows $32,500 in the capital in excess of par account, $12,000 in the common stock account, and $68,700 in the retained earnings account. The firm just announced a stock dividend of 10 percent. What will be the balance in the retained earnings account after the dividend? A) $39,180 B) $48,300 C) $59,120 D) $67,520 E) $40,380

67) Aboulafia Logistics has 15,000 shares of stock outstanding with a par value of $1 per share

and a market value per share of $8. The firm just announced a stock dividend of 10 percent. What will be the market price per share after the dividend? A) $7.20 B) $7.27 C) $7.33 D) $8.00 E) $8.80

68) Griffo Group has 42,000 shares of stock outstanding with a par value of $1 per share and a

market price per share of $41. The balance sheet shows $1,358,000 in the capital in excess of par account and $2,212,500 in the retained earnings account. The firm just announced a stock dividend of 50 percent. What is the value of the capital in excess of par account after the dividend? A) $1,358,000 B) $612,500 C) $518,000 D) $497,000 E) $221,900

69) Huang Construction has 15,000 shares of stock outstanding with a par value of $1 per share

and a market value of $45 per share. The balance sheet shows $15,000 in the common stock account, $158,000 in the capital in excess of par account, and $132,500 in the retained earnings account. The firm just announced a stock dividend of 50 percent. What is the value of the retained earnings account after the dividend? A) $125,000 B) $117,500 C) $132,500 D) $140,000 E) $147,500

70) Ketubu Corporation has shares of stock outstanding with a par value of $1 per share and a

market-to-book ratio of 2.1. The balance sheet shows $5,000 in the common stock account, $58,000 in the capital in excess of par account, and $32,500 in the retained earnings account. The firm just announced a stock dividend of 50 percent. What is the book value of the common stock account after the dividend? A) $10,000 B) $8,500 C) $9,000 D) $7,500 E) $5,000

71) Havelund has 2,000 shares of stock outstanding with a par value of $1 per share and a market

value of $26 per share. The balance sheet shows $2,000 in the common stock account, $9,500 in the capital in excess of par account, and $14,500 in the retained earnings account. The firm just announced a stock dividend of 75 percent. What is the market value per share after the dividend? A) $36.00 B) $14.86 C) $45.50 D) $13.50 E) $12.00

72) Tangoes has 24,000 shares of stock outstanding with a par value of $1 per share and a market

price of $36 per share. How many shares of stock will be outstanding of the firm does a 3for-2 stock split? A) 40,000 shares B) 36,000 shares C) 32,000 shares D) 16,000 shares E) 28,000 shares

73) Rosco’s has 15,000 shares of stock outstanding with a market price of $6 per share. What

will be the market price per share if the firm does a 1-for-3 reverse stock split? A) $18 B) $24 C) $42 D) $48 E) $54

74) Metreo’s balance sheet shows $15,000 in the common stock account, $315,000 in the capital

in excess of par account, and $189,000 in the retained earnings account. The firm just announced a 3-for-2 stock split. What will be the value of the common stock account after the split if the par value per share is $1? A) $10,000 B) $12,500 C) $15,000 D) $18,500 E) $22,500

75) Assume Door Systems' latest balance sheet shows $15,000 in the common stock account,

$315,000 in the capital in excess of par account, and $189,000 in the retained earnings account. What will be the capital in excess of par account value if the firm does a 5-for-3 stock split? A) $126,000 B) $210,000 C) $283,500 D) $315,000 E) $472,500

76) Haskell’s has 8,000 shares of stock outstanding and the current market value of the firm is

$144,000. The company just announced a 4-for-1 stock split. What will be the market price per share after the split? A) $13.50 B) $18.00 C) $22.50 D) $9.00 E) $4.50

77) Cherish Corporation has 8,000 shares of stock outstanding with a par value of $1 per share.

The current market value of the firm is $620,000. The balance sheet shows a capital in excess of par account value of $66,000 and retained earnings of $234,000. The company just announced a 3-for-1 stock split. What will be the retained earnings account balance after the split? A) $117,000 B) $234,000 C) $351,000 D) $410,000 E) $468,000

78) Lupton Farms has 125,000 shares of stock outstanding at a market price of $93 per share.

The company has just announced a 5-for-2 stock split. How many shares of stock will be outstanding after the split? A) 50,000 B) 75,000 C) 156,250 D) 175,000 E) 312,500

79) Deep Water Drilling has 160,000 shares of stock outstanding at a market price of $109 per

share. The company has just announced a 7-for-3 stock split. What will be the market price per share after the split? A) $38.27 B) $46.71 C) $48.40 D) $46.18 E) $48.80

80) A firm has a total market value of $89,600 with 6,500 shares of stock outstanding. What will

be the total market value of the firm if it does a 1-for-2 reverse stock split? A) $179,200 B) $148,300 C) $122,300 D) $89,600 E) $44,800

81) Chelsea Peformance has 25,000 shares of stock outstanding at a market price of $4.50 per

share. What will be the market price per share if the company does a 1-for-5 reverse stock split? A) $.90 B) $1.20 C) $22.50 D) $27.00 E) $29.50

82) Rose & Sheridan has 125,000 shares of stock outstanding with a par value of $1 per share

and a market value of $5 per share. The company has retained earnings of $76,500 and capital in excess of par of $340,000. The company just announced a 1-for-5 reverse stock split. What will be the par value per share after the split? A) $.20 B) $.25 C) $2.50 D) $5.00 E) $10.00

83) The Cameron Company is paying a dividend of $.76 per share today. There are 180,000

shares outstanding with a par value of $1 per share. As a result of this dividend, the: A) retained earnings will decrease by $180,000. B) retained earnings will decrease by $136,800. C) common stock account will decrease by $136,800. D) common stock account will increase by $180,000. E) capital in excess of par value account will decrease by $43,200.

84) Explain why an ex-dividend date is a required step in the dividend payout process.

85) It has been shown that in the absence of taxes and other market imperfections firm value will

be unaffected by dividend policy. Explain the logic behind this conclusion.

86) Explain the general characteristics of a tender offer.

87) Explain what a targeted repurchase is and why a firm might do a repurchase of this type.

88) Explain why executives who hold stock options prefer stock repurchases over stock

dividends.

Answer Key Test name: Chapter 19(1) 1) D 2) A 3) C 4) A 5) A 6) E 7) C 8) D 9) B 10) E 11) E 12) B 13) C 14) D 15) D 16) C 17) E 18) E 19) D 20) B 21) A 22) E 23) A 24) B 25) A 26) A 27) E 28) C 29) E 30) B 31) B 32) D 33) E 34) B 35) A 36) E 37) C

38) C 39) B 40) E 41) E 42) C 43) B 44) C 45) C 46) A 47) D 48) D 49) D 50) B 51) D 52) A 53) E 54) C 55) C 56) D 57) B 58) A 59) D 60) D 61) C 62) E 63) E 64) C 65) C 66) A 67) B 68) A 69) A 70) D 71) B 72) B 73) A 74) C 75) D 76) E 77) B

78) E 79) B 80) D 81) C 82) D 83) B 84) Essay 85) Essay 86) Essay 87) Essay 88) Essay

Student name: 1) You own 270 shares of stock in Halestorm, Incorporated, that currently sells for $83.80 per

share. The company has announced a dividend of $3.50 per share with an ex-dividend date of February 4. Assuming no taxes, what is the value of the stock on February 4? A) $87.30 B) $80.30 C) $83.80 D) $79.25 E) $82.05

2) You own 250 shares of stock in Green Mild Chili Peppers, Incorporated, that currently sell

for $51.20 per share. The company has announced a dividend of $2.71 per share with an exdividend date of May 3. Assuming no taxes, what is the value of your portfolio on May 3? A) $12,397.50 B) $677.50 C) $12,800.00 D) $12,122.50 E) $12,475.00

3) A company has declared a dividend of $7.25 per share on its stock. Capital gains are not

taxed. Suppose the IRS has issued a new regulation that requires taxes of 10 percent be withheld at the time the dividend is paid. The stock currently sells for $117.65 per share. What will the ex-dividend price be? A) $117.65 B) $116.93 C) $114.03 D) $111.13 E) $110.40

4) The stock of Red's Hardware closed at $57.10 per share today. Tomorrow morning, the stock

goes ex-dividend, paying a dividend of $1.70 per share. The tax rate on dividends is 25 percent. All else the same, what price will the stock open at tomorrow morning? A) $56.68 B) $55.83 C) $55.40 D) $56.25 E) $57.10

5) A firm has a market value equal to its book value. Currently, the firm has excess cash of

$9,100 and other assets of $28,900. Equity is worth $38,000. The firm has 850 shares of stock outstanding and net income of $3,400. What will the stock price per share be if the firm pays out its excess cash as a cash dividend? A) $34 B) $89 C) $38 D) $42 E) $85

6) Bowzer Company has just received $4.3 million from the sale of one of its divisions. The

company has 455,000 shares outstanding that sell for $86.37 per share. If the company issues the entire proceeds from the sale as a special dividend, what will the ex-dividend stock price be? Ignore taxes. A) $86.37 B) $95.82 C) $86.26 D) $78.84 E) $76.92

7) Storico currently has 29,000 shares outstanding that sell for $47.14 per share. The company

plans to issue a stock dividend of 20 percent. How many new shares will be issued? A) 34,800 shares B) 5,800 shares C) 29,000 shares D) 5,940 shares E) 6,050 shares

8) Westhaven Corporation currently has 20,000 shares outstanding that sell for $52 per share.

The company plans to issue a stock dividend of 10 percent. The stock has a par value of $3. What is the total capital surplus on the new shares? A) $98,000 B) $176,000 C) $6,000 D) $118,500 E) $104,000

9) Murphy's, Incorporated, has 32,050 shares of stock outstanding with a par value of $1 per

share. The market value is $12 per share. The balance sheet shows $88,050 in the capital in excess of par account, $32,050 in the common stock account, and $149,950 in the retained earnings account. The firm just announced a stock dividend of 12 percent. What will the market price per share be after the dividend? A) $12.00 B) $11.61 C) $12.61 D) $11.71 E) $10.71

10) Murphy's, Incorporated, has 30,000 shares of stock outstanding with a par value of $1 per

share. The market value is $11 per share. The balance sheet shows $77,000 in the capital in excess of par account, $30,000 in the common stock account, and $146,500 in the retained earnings account. The firm just announced a stock dividend of 10 percent. What will the balance in the capital in excess of par account be after the dividend? A) $116,500 B) $110,000 C) $107,000 D) $104,000 E) $93,000

11) Robinson's has 32,000 shares of stock outstanding with a par value of $1 per share and a

market price of $46 a share. The balance sheet shows $32,000 in the common stock account, $445,000 in the paid in surplus account, and $390,000 in the retained earnings account. The firm just announced a 5-for-2 stock split. How many shares of stock will be outstanding after the split? A) 12,800 shares B) 128,000 shares C) 80,000 shares D) 67,200 shares E) 79,500 shares

12) Weiland, Incorporated, has 260,000 shares outstanding that sell for $76 per share. The

company plans a 3-for-2 stock split. How many shares will be outstanding after the split? A) 390,000 shares B) 1,300,000 shares C) 845,000 shares D) 173,333 shares E) 130,000 shares

13) A company has 320,000 shares outstanding that sell for $82.23 per share. The company plans

a 5-for-4 stock split. Assuming no market imperfections or tax effects, what will the stock price be after the split? A) $75.18 B) $102.79 C) $65.78 D) $82.23 E) $78.71

14) BGA has 275,000 shares outstanding that sell for $23 per share. The company plans a 1-for-2

reverse stock split. How many shares will be outstanding after the split? A) 114,583 shares B) 137,500 shares C) 550,000 shares D) 275,000 shares E) 157,143 shares

15) LTE stock sells for $27.69 per share and there are 280,000 shares outstanding. The company

plans a 4-for-3 reverse stock split. Assuming no market imperfections or tax effects, what will the stock price be after the split? A) $20.77 B) $32.82 C) $27.69 D) $27.69 E) $36.92

16) A firm has a market value equal to its book value. Currently, the firm has excess cash of

$1,800 and other assets of $4,500. Equity is worth $6,300. The firm has 700 shares of stock outstanding and net income of $900. The firm has decided to spend all of its excess cash on a share repurchase program. How many shares of stock will be outstanding after the stock repurchase is completed? A) 509 shares B) 709 shares C) 500 shares D) 309 shares E) 518 shares

17) Bo's Home Manufacturing has 360,000 shares outstanding that sell for $45.71 per share. The

company has announced that it will repurchase $56,000 of its stock. What will the share price be after the repurchase? A) $42.86 B) $45.71 C) $45.87 D) $39.86 E) $45.55

18) A firm has a market value equal to its book value. Currently, the firm has excess cash of

$500 and other assets of $7,000. Equity is worth $7,500. The firm has 750 shares of stock outstanding and net income of $810. What will the new earnings per share be if the firm uses its excess cash to complete a stock repurchase? A) $.63 B) $.71 C) $1.16 D) $1.08 E) $1.79

19) Boats and Bait has 76,000 shares outstanding that sell for a price of $72 per share. The stock

has a par value of $1 per share. The company's balance sheet shows capital surplus of $175,000 and retained earnings of $215,000. If the company declares a stock dividend of 12.5 percent, what is the new common stock value on the balance sheet? A) $282,375 B) $196,875 C) $438,750 D) $85,500 E) $524,250

20) Quaker State Wings has 275,000 shares outstanding and net income of $935,000. The

company stock is currently selling for $73.14 per share. If the company repurchases $625,000 of its stock, what is the earnings per share after the repurchase? A) B) C) D) E)

$3.40 $3.56 $3.61 $3.51 $3.68

21) Green Thumb Nursery has 52,000 shares outstanding at a market price of $63.55 per share.

The earnings per share are $3.55. The firm has total assets of $360,000 and total liabilities of $206,000. Today, the firm announced a share repurchase for $115,000 of its stock. What is the earnings per share after the repurchase? A) $3.81 B) $3.68 C) $3.55 D) $3.45 E) $3.74

22) The Cincinnati Chili Kitchen has just announced the repurchase of $175,000 of its stock. The

company has 49,000 shares outstanding and earnings per share of $3.49. The company stock is currently selling for $77.39 per share. What is the price–earnings ratio after the repurchase? A) 23.20 times B) 21.15 times C) 22.69 times D) 22.17 times E) 20.55 times

23) Cookies and Cream has 45,000 shares outstanding at a market price of $90.94. What will the

share price be if the company declares a stock dividend of 17.5 percent? A) $80.78 B) $77.40 C) $84.17 D) $106.85 E) $90.94

24) Heidi owns 500 shares of Boyd Enterprises, which is priced at $64.18 per share. The

company plans a 3-for-1 stock split. How many shares will Heidi own and what will the share price be after the stock split? A) 1,500; $192.54 B) 167; $21.39 C) 167; $192.54 D) 1,500; $21.39 E) 1,500; $64.18

25) Timothy owns 500 shares of Countess Corporation, which is priced at $13.45 per share. The

company plans a 1-for-3 reverse stock split. How many shares will Timothy own and what will the share price be after the reverse stock split? A) 167; $4.48 B) 167; $40.35 C) 1,500; $40.35 D) 1,500; $4.48 E) 167; $13.45

Answer Key Test name: Chapter 19(2) 1) B 2) C 3) D 4) B 5) A 6) E 7) B 8) A 9) E 10) C 11) C 12) A 13) C 14) B 15) E 16) C 17) B 18) C 19) D 20) D 21) B 22) B 23) B 24) D 25) B

Chapter 20: 1) The market for venture capital refers to the: A) private financial marketplace for servicing new, often high-risk firms. B) corporate bond market. C) market for selling unsubscribed rights. D) market for selling seasoned equity securities. E) public market for all issues of both company stocks and bonds.

2) In a typical deal, the venture capitalist will receive at least

percent of the equity of the

financed firm. A) 5 B) 20 C) 40 D) 50 E) 75

3) Venture capitalists are: A) intermediaries that raise funds from outside investors. B) investors who take a hands-off approach to investment management. C) generally interested in primarily long-term debt investments. D) easily contacted and tend to assist with most requests received. E) generally granted a maximum of 25 percent of a firm’s equity.

4) In exchange for providing financing to new firms, venture capitalists generally receive: A) the personal financial guarantees of all current owners. B) an equity position and board of director positions. C) the right to set the offer price in any future initial public offering. D) the protection provided by a court-appointed trustee. E) a government-funded guarantee of repayment for all funds provided.

5) It is often the case that venture capitalists will: A) hold voting preferred stock which grants them priorities in the event of a sale or

liquidation. B) hold voting common stock which grants them priorities over the debt holders. C) hold nonvoting preferred stock. D) hold nonvoting common stock. E) obtain seats on the board but not obtain shares of stock.

6) Reilly Motors has spent nearly all its startup funds and is now seeking venture capital to start

producing its hydrogen-powered vehicles. Which type of financing is it seeking? A) Mezzanine financing B) First-round financing C) Bridge financing D) Seed money financing E) Second-round financing

7) In 2019, the greatest amount of venture capital was raised in which three U.S. states? A) California, Texas, and New York B) California, Texas, and Massachusetts C) California, Massachusetts, and New York D) New York, Illinois, and Texas E) New York, California, and Illinois

8) Management’s first step in any issue of securities to the public is to: A) file a registration form with the SEC. B) distribute copies of the preliminary prospectus. C) distribute copies of the final prospectus. D) obtain approval from the board of directors. E) prepare the tombstone advertisement.

9) What information is in a red herring? A) The same information as the final prospectus except for the SEC approval. B) The same information as the final prospectus. C) Only a brief synopsis of the final prospectus. D) Only a description of how the funds raised will be used. E) Information very similar to the final prospectus but without the selling price.

10) A firm intends to sell new securities to the public. Under which one of the following

circumstances can the firm avoid filing a registration statement with the SEC? If the: A) issue is less than $50 million. B) securities are loans that mature in one year or less. C) issue is less than $2.5 million. D) securities are valued at less than $5 million and are being sold on the Internet. E) securities are loans that mature within nine months.

11) Regulation A governs securities issues that are: A) distributed solely among current company employees and directors. B) sold in full to a single purchaser. C) those that only include securities currently held by corporate insiders. D) limited such that only current shareholders can purchase them. E) valued at less than $5 million.

12) The primary way that potential investors obtain detailed information regarding a new issue of

securities is by reading the: A) SEC’s comment letter. B) preliminary prospectus. C) letter of commitment. D) registration statement. E) rights offering statement.

13) A registration statement is effective on the 20th day after filing unless: A) the SEC is backlogged with statements. B) a tombstone ad is issued indicating its demise. C) a letter of comment suggesting changes is issued by the SEC. D) a syndicate can be formed sooner. E) the issue exceeds $50 million in which case the wait period is 30 days.

14) By employing

, a firm can list its stock on a stock exchange without the help of an

underwriter. A) equity crowdfunding B) charitable crowdfunding C) token securities D) a direct listing E) venture capital

15) The maximum amount of equity that can be raised through crowdfunding in a 12-month

period is: A) $1 million. B) $25 million. C) $10 million. D) $50 million. E) $100 million.

16) Tokens offered in initial coin offerings: A) can be exchanged for services but not for cash. B) can only be obtained from Ethereum. C) must be exchanged for shares of common stock once the coin’s issuer has gone

public. D) are considered to be illiquid investments. E) may be obtained in the hope that the tokens will appreciate in value.

17) The first equity issue offered to the general public by a firm is a: A) rights offer. B) general cash offer. C) restricted placement. D) direct placement. E) seasoned offering.

18) An equity issue sold to the firm’s existing stockholders is called a: A) rights offer. B) general cash offer. C) private placement. D) restricted placement. E) direct placement.

19) The first public equity issue offered by a company is commonly referred to as a(n): A) initial private offering. B) initial public offering. C) secondary offering. D) seasoned new issue. E) registered issue.

20) A seasoned equity offering: A) may be either a cash offer or a rights offer. B) is a privileged subscription. C) must be a rights offer. D) must be a direct placement. E) must be a cash offer.

21) Assume a firm issued securities through an agreement where the investment bankers sold as

many shares as possible at a fixed price. This issue would be classified as a: A) Dutch auction. B) direct rights offer. C) direct placement. D) best-efforts cash offer. E) standby rights offer.

22) A firm commitment arrangement with an investment banker occurs when the: A) syndicate is in place to handle the issue. B) spread between the buying and selling price is less than one percent. C) issue is solidly accepted in the market as evidenced by a large price increase. D) investment banker buys the securities for less than the offering price and accepts the

risk of not being able to sell them. E) investment banker sells as much of the security as the market can bear without a price decrease.

23) The Green Shoe provision is used to: A) cover oversubscriptions. B) address unsold shares. C) provide additional reward to investment bankers for a risky issue. D) provide funding to investment bankers for unsold shares. E) reduce the number of shareholders.

24) Which one of the following services is least likely to be offered to a corporation by an

investment bank? A) Formulating a method to issue new securities B) Pricing of new securities C) Facilitating a merger D) Providing checking account management E) Selling new securities

25) Which one of the following is not one of the four main functions provided by underwriters? A) Assumption of some market risk B) Responsibility for marketing securities C) Auditing the financial statements D) Estimating the value of an offering E) Establishing the offer price

26) In a best efforts offering the investment bank makes its money primarily by earning: A) the spread between the buying and offering price. B) a commission on each share sold. C) a negotiated percentage of the offering price. D) a flat fee charged for services rendered. E) the difference between the offer price and the warrant price.

27) Under the

method, the underwriter buys the entire issue, while under the method, the underwriter does not purchase the shares but merely acts as an agent. A) best efforts; firm commitment B) firm commitment; best efforts C) negotiated offer; competitive offer D) competitive offer; negotiated offer E) seasoned; unseasoned

28) Empirical evidence suggests that new equity issues are generally: A) priced efficiently by the market. B) overpriced by investor excitement concerning a new issue. C) overpriced resulting from SEC regulation. D) underpriced, in part, to counteract the winner’s curse. E) underpriced resulting from SEC regulation.

29) In a Dutch auction underwriting arrangement, the price at which offered securities are sold is

determined by the: A) lead underwriter. B) bidders. C) SEC. D) issuing firm. E) venture capitalists.

30) Green Shoe options generally last days and benefit A) 30; the issuer B) 30; the underwriting syndicate C) 60; the underwriting syndicate D) 60; the issuer E) 90; both the issuer and the underwriting syndicate

31) Which one of the following actions takes place during the aftermarket period? A) The red herrings are distributed. B) Underwriters generally only sell shares at or above the offer price. C) Book building is conducted. D) The lead underwriter determines the offer price. E) Underwriting negotiations are completed.

32) Oversubscription is most commonly the result of: A) unsuccessful book building. B) underpricing. C) exercising the Green Shoe option. D) a negotiated, rather than a competitive, underwriting. E) unexercised rights.

33) Negotiated offers generally: A) are used as a last resort. B) involve an underwriting syndicate. C) result in higher issue costs than do competitive offers. D) involve only large issuers. E) reduce the probability an issue will be successful.

34) During a road show, the underwriting process known as A) capital reputation building B) bookbuilding C) locking-up D) syndication E) Dutch auctioning

takes place.

35) Historically, firms that issued new securities at a price that was above the file price range

have: A) B) C) D)

successfully avoided leaving any significant funds on the table. ended up overpricing their securities by at least 10 percent. left more money on the table than firms that issued within the file price range. ended up with unsold shares even though the final offer price was considered to be fair. E) left less money on the table than firms that issued at or below the file price range.

36) Empirical evidence suggests that upon announcement of a seasoned equity issue, current

stock prices generally: A) decrease perhaps because the issue reflects management’s view the stock is overvalued. B) remain fairly constant since an efficient market anticipates a new equity issue. C) decrease perhaps because the issues are associated with positive NPV projects. D) increase because the market supply is always less than demand. E) increase because underwriters exercise their Green Shoe option.

37) Debt capacity is often offered as a reason for a stock price to decline when additional equity

securities are issued. The primary reason that supports this argument is that: A) the high issue costs of a debt offering must be paid by the shareholders. B) an additional equity issue reduces the debt capacity of a firm. C) management feels the probability of default has risen, which limits the firm’s debt capacity and thus an equity issue is necessary. D) unless additional debt is issued in the future, stock dividends will tend to decline after the new securities are issued. E) additional equity is only issued when a firm cannot meet its current debt obligations, thereby signaling the firm is on the verge of bankruptcy.

38) Among the direct expenses of an IPO are the: A) gross spread plus other direct expenses. B) gross spread and underpricing. C) abnormal returns and underpricing. D) Green Shoe option and the abnormal returns. E) gross spread, Green Shoe option, and other direct expenses.

39) The total direct costs of equity issues are A) considerably less B) the same C) minimally less D) considerably greater E) minimally greater

_ than those of debt issues.

40) The lowest direct issue costs as a percentage of gross proceeds are generally incurred by: A) small-sized IPOs. B) issues of straight, investment-grade bonds. C) SEOs. D) large-sized IPOs. E) issues of convertible bonds.

41) To determine the total value of a rights offering, in addition to the number of rights issued the

stockholder needs to know the following two pieces of information, the: A) subscription price and the number of rights needed to acquire a new share. B) current market price per share and the number of rights needed to acquire a new share. C) current market price per share and the standby fee. D) detachment date and the subscription price. E) the number of rights needed to acquire a new share and the number of shares currently owned.

42) Assuming everything else is constant, when a stock goes ex-rights the stock price should: A) decrease since the stockholder is losing an option. B) increase since the corporation no longer has the right to force the stockholder to

convert. C) remain the same since an efficient market would anticipate this change. D) remain constant as shareholder value is unaffected by a rights offering. E) decrease by the amount of the tax applicable to the right.

43) If current shareholders want to acquire one share of stock under a rights plan they must: A) acquire new shares of stock that are being issued with rights attached. B) pay a registration fee plus the subscription price per share requested. C) submit the number of rights required plus the subscription price. D) inform the issuer and submit the market price per share desired. E) exchange their current shares for new shares that have rights attached.

44) Which one of the following statements is true concerning a rights offering? A) The subscription price is generally greater than the market price. B) The subscription price must be greater than the ex-rights price. C) The subscription price is generally less than the market price. D) The ex-rights price is generally higher than the rights-attached price. E) The market price tends to increase on the ex-rights date.

45) Shareholders who have rights are always: A) better off if they exercise the rights rather than sell them. B) better off if they sell their rights rather than exercise them. C) in the same financial position if they sell or if they exercise their rights. D) able to purchase one new share for each right they own. E) financially disadvantaged any time a rights offer is made, regardless of any action

they take.

46) A standby underwriting arrangement in conjunction with a rights offering provides the: A) issuer with methods to cancel the offering should they so desire. B) issuer with an alternate investment banker if a conflict between the issuer and the

original investment banker arises. C) investment banker with an oversubscription privilege to ensure profits are earned. D) issuer with an alternative avenue of sale to ensure success of the rights offering. E) investment bankers with a means of withdrawing from their firm offer.

47) Arguments offered as explanations, with or without market evidence, as to why most U.S.

equity issues are sold without rights include all the following except: A) underwriters buy at an agreed upon price and bear some risk of selling the issue. B) cash proceeds are available sooner in underwriting and the issue is available to a wider market. C) underwriters certify that the offering price is consistent with the true value of the issue. D) the underwritten offer price is generally set 48 hours prior to the offering while the rights price must be set much further in advance. E) underwriters tend to increase the stock price through their sales efforts.

48) Dilution generally refers to the: A) increase in stock value due to wider ownership of stock. B) the decrease in existing shareholders' ownership percentage when new equity is

issued. C) loss in new shareholders' equity. D) splitting of a single share of stock into multiple shares. E) issuance of debt to repurchase shares.

49) The type(s) of dilution that are most relevant to a firm’s shareholders when the firm’s shares

are issued with rights is(are) the dilution of: A) percentage ownership. B) stock price per share. C) both book value per share and earnings per share. D) both percentage ownership and book value per share. E) both stock price per share and earnings per share.

50) If existing shareholders are offered rights to a new issue of securities, those shareholders: A) will receive additional shares at no additional cost to themselves. B) will need to pay the current market price per share on the day they tend their rights. C) must participate in the offering if they wish to maintain their current ownership

position. D) will pay the book price per share for each share obtained through the rights process. E) should expect to receive the book value per share for each right they have been granted.

51) If a rights offer is used as the means of funding a positive net present value project, then

shareholders should expect the price of their shares to: A) remain constant as the value of the project will be offset by the issuance of the new shares. B) decrease due to the additional shares being offered. C) change but the direction of that change cannot be predicted. D) change in direct relation to the change in the book value per share. E) increase due to the increased value of the issuing firm.

52) Assume a firm issued rights to fund a new project. If this project immediately increases the

market value per share, then: A) no dilution of ownership position can occur. B) the book value per share had to remain constant. C) the EPS will also immediately increase. D) the shareholders will be worse off than before, whether or not they participate in the offering. E) the firm has acted in the best interest of its pre-rights shareholders.

53) Corporations primarily use the shelf registration method of security sales because: A) preregistered securities can be quickly brought to market. B) SEC registration is avoided. C) their stock is rated as junk. D) they are issuing securities to the general public for the first time. E) they are doing a private offering.

54) All the following are major requirements needed to qualify for shelf registration except: A) having a current rating of investment grade. B) having outstanding stock with a market value in excess of $150 million. C) not defaulting on debt in the past three years. D) having no violations of the Securities Act of 1933 in the past three years. E) having no violations of the Securities Exchange Act of 1934 in the past three years.

55) One argument against the use of shelf registration is: A) that it is limited to only technology and manufacturing firms which provides those

industries with a market advantage. B) that it provides an unfair advantage to debt issues. C) that it unfairly increases the market price of the registered security. D) the ability to use the dribble method in conjunction with the shelf registration. E) the age of the information disclosure.

56) Which one of the following statements related to debt financing is correct? A) Debt issues of any type, unlike equity issues, do not require SEC registration. B) Commercial banks specialize more in private placements than in term loans. C) Private placements generally have longer maturities than term loans. D) The majority of debt issues are public issues. E) Public debt issues generally have more restrictive covenants than private issues.

57) Assume there are three upcoming IPOs (A, B, and C) that are priced at $20 per share. You

place an order with your broker to purchase 500 shares of each of the three offerings. Further assume that A is oversubscribed and your allocation is only 100 shares. You receive a full allocation on both B and C. Offer A is undervalued by $13, B is overvalued by $8, and C is overvalued by $1. What will be your combined total profit or loss on these three investments? A) −$3,200 B) −$1,125 C) $2,000 D) $1,125 E) $3,200

58) Hayley placed an order for 300 shares of each of four separate IPOs (Orders A, B, C, and D)

with an offer price of $16 each. She received 100 shares of Order B, 200 shares of Order D, and 300 shares of the other orders. At the end of the first day, Order A was overpriced by $2 per share, Order B was underpriced by $4 per share, Order C was correctly priced, and Order D was overpriced by $1 per share. What was combined total profit or loss for the first day on these four orders? A) −$400 B) $400 C) $100 D) −$100 E) −$300

59) Olsson Outdoors recently offered 10,000 shares of stock for sale via a Dutch auction. The

firm received bids as follows: 1,000 shares at $32.25 per share; 5,000 shares at $32.00 per share; 6,600 shares at $31.90 per share; and 12,000 shares at $31.50 per share. Ignoring all costs, how much will the firm receive from this auction? A) $319,850 B) $315,000 C) $319,000 D) $322,000 E) $318,250

60) Andrew bid $32.50 per share for 500 shares in a Dutch auction for Vargas Resorts shares of

stock. The other bids were $33 for 200 shares, $32 for 600 shares, $35 for 100 shares, and $30 for 500 shares. Vargas was seeking to sell 1,000 shares. What price did Andrew pay for each share he purchased? A) $33 B) $32 C) $35 D) $30 E) $32.50

61) Read Machine needs $25.7 million to fund an expansion project. The firm has decided to

raise the funds through a negotiated offering. The terms of the offer include an offer price of $18.75 per share and an underwriting spread of 7.1 percent. How many shares must the firm sell in order to raise the funds it needs? A) 19,305,164 B) 454,033 C) 1,370,667 D) 1,273,349 E) 1,475,422

62) A firm has negotiated a seasoned equity offer that will provide the firm with $1.68 million in

net proceeds. The underwriting spread is 7.35 percent and the firm needs to sell 50,000 shares. What is the offer price? A) $36.07 B) $37.25 C) $36.27 D) $34.50 E) $33.60

63) Chong Resources requires $1.75 million to fund a new project and has decided to raise the

funds via a seasoned stock offering. Assume the firm will incur $140,000 in indirect costs and pay 8.63 percent of the gross proceeds in direct costs. How much does the firm need to raise in total to cover all the issue costs as well as fund the new project? A) $2,068,513 B) $2,037,825 C) $2,055,289 D) $1,914,650 E) $1,984,294

64) The Wordsmith Corporation has 40,000 shares outstanding with a market price of $25 each.

The firm expects to raise $200,000 via a rights offering at a subscription price of $20. How many rights must be submitted to acquire one new share? A) .20 B) .25 C) 5.00 D) 1.25 E) 4.00

65) Assume it requires 3 rights to obtain a new share in a rights offering. If the stock’s price prior

to the ex-rights date is $25 and the ex-rights price is $22.75, what is the value of each right? A) $.67 B) $.75 C) $.56 D) $1.25 E) $2.25

66) You currently own 200 shares of a stock valued at $21 per share. A rights offer has just been

announced that grants the option of obtaining one new share for two rights plus $17. Each current share is entitled to one right. What is the value of each right? A) $1.33 B) $1.25 C) $.33 D) $.67 E) $1.67

67) Mustin Custom Homes wants to raise $2.4 million in new equity via a rights offering with a

subscription price of $12. There are currently 2.6 million shares outstanding, each with one right. How many rights are needed to purchase one new share? A) 12 B) 18 C) 20 D) 13 E) 6

68) Chapa Cinemas has 150,000 shares outstanding with a market price per share of $15. Each

share is entitled to one right. If the firm sets a rights offer as 5 rights plus $10 for each new share, what will be the ex-rights price per share? A) $12.23 B) $14.17 C) $15.83 D) $13.77 E) $14.49

69) The Mendoza Company has 20,000 shares outstanding at $30 each. The firm expects to raise

$200,000 via a rights offering at a subscription price of $25. How many rights are required for each new share? A) 1.25 B) 1.50 C) 2.00 D) 2.50 E) 2.25

70) Assume a stock has an ex-rights price of $32. The rights offer has a requirement of 3 rights

per new share and a subscription price of $30. What is the rights-on stock price? A) $28.06 B) $32.67 C) $42.00 D) $40.94 E) $38.33

71) A rights offer was set at four rights plus $25 for each new share. What is the rights-on price if

the ex-rights price is $30? A) $35.00 B) $25.00 C) $30.00 D) $31.25 E) $32.50

72) A stock has a rights-on price of $20, an ex-rights price of $18.25, and the number of rights

needed to buy one new share is 5. Assuming everything else is held constant, what is the subscription price? A) $9.50 B) $11.25 C) $16.67 D) $14.50 E) $21.90

73) Schwartz and Company has 120,000 shares outstanding, which are trading for $26.42 per

share. The company will issue 40,000 additional shares at $19.85 per share. What will be the ex-rights price of the existing shares? A) $26.42 B) $21.49 C) $33.04 D) $24.78 E) $19.82

74) Fischer, Incorporated, has 250,000 shares of stock outstanding, $400,000 in perpetual annual

earnings, and a discount rate of 16 percent. The firm is considering a new project that has initial costs of $350,000 and annual perpetual cash flows of $60,000. How many new shares must be issued to fund the new project? Ignore taxes. A) 34,653 B) 33,928 C) 35,000 D) 36,028 E) 34,209

75) Discuss the stages of venture capital financing, defining each in detail.

76) What are venture capitalists and what is their role in raising capital for firms?

77) The Direct Interactive Publishing Company is planning to raise $200 million dollars in new

capital. There are currently 50 million shares outstanding with an estimated market price of $60 each. The corporate officers are debating whether to use a rights offering (with or without a standby underwriting) or have the issue fully underwritten. The company is currently listed on a regional exchange and plans to list on a national exchange after the new issue. List and explain three advantages/disadvantages of each issue method.

78) Discuss what a Dutch auction is and how it works.

79) Identify six components that comprise the total costs associated with issuing securities.

80) Identify and explain the key differences between public issues of debt and direct private

long-term debt financing.

Answer Key Test name: Chapter 20(1) 1) A 2) C 3) A 4) B 5) A 6) B 7) C 8) D 9) E 10) E 11) E 12) B 13) C 14) D 15) D 16) E 17) B 18) A 19) B 20) A 21) D 22) D 23) A 24) D 25) C 26) B 27) B 28) D 29) B 30) B 31) B 32) B 33) C 34) B 35) C 36) A 37) C

38) A 39) D 40) B 41) A 42) A 43) C 44) C 45) C 46) D 47) D 48) B 49) B 50) C 51) E 52) E 53) A 54) D 55) E 56) C 57) A 58) A 59) C 60) B 61) E 62) C 63) A 64) E 65) E 66) A 67) D 68) B 69) D 70) B 71) D 72) A 73) D 74) A 75) Essay 76) Essay 77) Essay

78) Essay 79) Essay 80) Essay

Student name: 1) The Peter Corporation, and the Sellers Company have both announced IPOs. You place an

order for 750 shares of each IPO. One of the IPOs is underpriced by $13.00 and the other is overpriced by $5.75. If you could get all of the shares you ordered for each IPO, what would your profit be? A) $4,984.50 B) $14,062.50 C) $4,531.25 D) $5,437.50 E) $9,750.00

2) The Bert Corporation, and Ernie, Incorporated, have both announced IPOs. You place an

order for 600 shares of each IPO. One of the IPOs is underpriced by $15.25 and the other is overpriced by $6.00. You will receive all of the shares you ordered of the overpriced IPO, but only one-half of the shares you ordered of the underpriced IPO. What profit do you expect? A) $4,575.00 B) $4,625.00 C) $5,550.00 D) $975.00 E) $12,750.00

3) Gravity, Incorporated, needs to raise $48.5 million to fund its expansion plans. The company

will sell shares at a price of $28.10 in a general cash offer and the company's underwriters will charge a spread of 7 percent. How many shares need to be sold? A) 1,725,979 shares B) 1,855,891 shares C) 1,613,064 shares D) 2,062,101 shares E) 1,382,626 shares

4) Jenny Corporation needs to raise $53 million to fund a new project. The company will sell

shares at a price of $29.00 in a general cash offer and the company's underwriters will charge a spread of 7.5 percent. The direct flotation costs associated with the issue are $925,000. How many shares need to be sold? A) 2,010,252 shares B) 1,763,833 shares C) 1,827,586 shares D) 1,918,919 shares E) 1,700,080 shares

5) Disturbed Corporation needs to raise $64.5 million to fund a new project. The company will

sell shares at a price of $25.20 in a general cash offer and the company's underwriters will charge a spread of 7 percent. The direct flotation costs associated with the issue are $1,100,000 and the indirect costs are $595,000. How many shares need to be sold? A) 2,824,501 shares B) 2,432,873 shares C) 2,559,524 shares D) 2,414,145 shares E) 2,692,012 shares

6) Under a firm commitment agreement, Zeke, Company, went public and received $34.00 for

each of the 8.4 million shares sold. The initial offer price was $37 and the stock rose to $40.13. The company paid $560,000 in direct flotation costs and $215,000 in indirect costs. What was the flotation cost as a percentage of funds raised? A) 29.46% B) 9.04% C) 31.08% D) 24.93% E) 18.35%

7) Northern Air would like to sell 4,100 shares of stock using Dutch auction underwriting. The

bids received are: Stock A B C D E

Quantity 800 900 1,300 1,500 1,700

Price $ 29.35 29.00 28.85 28.50 28.30

How much will the company raise in its offer? Ignore all flotation and transaction costs. A) $120,335 B) $116,850 C) $118,900 D) $161,185 E) $118,285

8) Kim placed an order with her broker for 650 shares of each of three IPOs being offered this

week. Each of the IPOs has an offer price of $22. The number of shares allocated to Kim along with the closing prices on the first trading day are: Stock A B C

Shares Allocated 650 350 220

Price $ 21.15 25.43 27.87

What is Kim's total profit on these three stocks at the end of the first day of trading? A) $1,939.40 B) $2,216.50 C) $5,492.50 D) $738.90 E) $3,715.95

9) Draiman Guitars is offering 70,000 shares of stock in an IPO by a general cash offer. The

offer price is $31 per share and the underwriter's spread is 9 percent. The administrative costs are $310,000. What are the net proceeds to the company? A) $1,354,700 B) $2,170,000 C) $1,664,700 D) $1,860,000 E) $1,974,700

10) Pawprints Paint recently went public in a best efforts offering. The company offered 130,000

shares of stock for sale at an offer price of $20 per share. The administrative costs associated with the offering were $370,000 and the underwriter's spread was 7 percent. After completing their sales efforts, the underwriters determined that they sold a total of 125,100 shares. What were the net proceeds to the company? A) $2,048,000 B) $1,678,000 C) $1,586,860 D) $1,956,860 E) $2,326,860

Answer Key Test name: Chapter 20(2) 1) D 2) D 3) B 4) A 5) A 6) E 7) B 8) A 9) C 10) D

Chapter 21: 1) In a direct lease arrangement, the owner of the asset is: A) either the lessee or the lessor. B) the lessee. C) the lessor. D) either the lessee or the manufacturer. E) the asset’s manufacturer.

2) Which one of the following characteristics does not apply to a financial lease? A) The lease is usually not fully amortized. B) The lessee is responsible for the maintenance of the leased assets. C) Generally, the lease cannot be cancelled. D) The lessee usually has the right to renew the lease on expiration. E) The lessee must pay all the lease payments.

3) Ramos Corporation has leased equipment directly from the equipment manufacturer.

Accordingly, the lease must be a: A) leveraged lease. B) sales and leaseback arrangement. C) capital lease. D) sales-type lease. E) bargain lease.

4) An operating lease generally: A) has a term that exceeds the economic life of the leased asset. B) is fully amortized. C) cannot be cancelled. D) requires the lessee to return the leased asset to the lessor if the lease is cancelled. E) requires the lessee to maintain the leased asset.

5) If the lessor borrows the majority of the purchase price of a leased asset, the lease is called a: A) leveraged lease. B) sale-and-leaseback arrangement. C) capital lease. D) nonrecourse lease. E) bargain purchase lease.

6) Which one of the following characteristics applies to a financial lease? A) Lessor maintains leased asset B) Cost of asset exceeds lease payments C) Cancellation clause D) Lessor must make all lease payments E) Fully amortized

7) A leveraged lease typically involves a nonrecourse loan, which means that in the case of

default the: A) lease payments go directly to the lender. B) the lessee obtains a first lien on the leased assets. C) lessor is obligated to fulfill the terms of both the lease and the loan. D) lessee assumes the loan obligation in exchange for the title to the leased assets. E) lease is automatically cancelled.

8) A firm sold its headquarters building in an all-cash transaction and used the proceeds to

improve its financial position. Immediately thereafter, the firm leased the building from the new owner on a non-cancellable basis. The firm retains responsibility for the maintenance and upkeep of the building. This circumstance involves: A) an operating lease. B) a leveraged lease. C) a sale and leaseback. D) a fully amortized lease. E) both an operating lease and a sale and leaseback.

9) For accounting purposes, which one of the following conditions would automatically cause a

lease to be classified as a capital lease? A) The lessee can purchase the asset at fair market value at the end of the lease. B) The lease transfers ownership of the asset to the lessee by the end of the lease term. C) The lease term equals 60 percent or more of the asset’s estimated economic life. D) The present value of the lease payments equals 75 percent of the asset’s fair market value at lease inception. E) The lessor can renew the lease at the end of the lease term.

10) Jaquess Logistics just signed a capital lease agreement with a present value of $640,000.

How will this lease first appear on the firm’s balance sheet? A) Capital leases do not appear on the balance sheet. B) Assets under capital lease $640,000; Obligations under capital lease $640,000 C) Assets under capital lease $320,000; Obligations under capital lease $320,000 D) Assets under capital lease $640,000; Retained earnings committed to leases $640,000 E) Assets under capital lease $320,000; Retained earnings committed to leases $320,000

11) As of 2019, FAS 13, Accounting for Leases requires: A) all leases, of any type, be recorded on the lessee’s balance sheet. B) capital leases be recorded in the footnotes or scheduled section of the lessee’s

financial statements. C) sale and leaseback arrangements be recorded on the lessee’s balance sheet with all other leases recorded elsewhere in the financial statements. D) operating leases be recorded on the lessee’s balance sheet as an asset and offsetting liability. E) all leases with bargain purchase price options to be recorded on the lessee’s balance sheet.

12) When a lease must be recorded on the balance to meet FAS 13, the asset amount equals the: A) amount of the lease payments due within the next 12 months. B) present value of the lease payments. C) amount of the lease payments due within the current fiscal year. D) present value of the lease payments due within the next 12 months. E) total sum of all the remaining lease payments.

13) FAS 13 sets forth four criteria for determining whether or not a lease must be classified as a

capital lease. How many of these criteria must be met for capital lease classification? A) All four criteria B) Any three of the four C) Any two of the four D) Any one of the four E) Any two of the four provided the lessee has ownership rights at the end of the lease

14) As of 2019, operating leases: A) appear as offsetting items on the lessee’s balance sheet. B) are fully expensed at the time the lease is established. C) are excluded from the lessee’s financial reports. D) are treated the same as a purchase. E) are disclosed in the financial statement footnotes.

15) Sizzler’s is considering either purchasing or leasing an asset that costs $28,000, has a life of 6

years, and a zero salvage value. The firm has a tax rate of 21 percent and a borrowing rate of 7 percent. The firm can lease the asset for five years with lease payments of $4,500 payable the first of each year. This lease would be classified as a(n): A) operating lease because the asset life is less than 10 years. B) operating lease because there is no cost reduction. C) leveraged lease because it is being financed with debt. D) capital lease because the lease term is greater than 75 percent of the economic life. E) sale and leaseback arrangement because Sizzler’s obtains full use of the asset.

16) Ibbeken Company is considering leasing a machine for a period of four years with monthly

payments of $680. The present value of the lease will be $27,325 and the tax rate will be 21 percent. If the lease is classified as an operating lease, what amount, if any, should appear in the asset section of the balance sheet on the effective date of the lease? A) $5,738 B) $21,587 C) $0 D) $27,325 E) $32,640

17) Shackleford Systems plans to lease a warehouse. The lease has a term of 35 years.

Accordingly, the IRS will classify the lease as a(n): A) financial lease. B) operating lease. C) capital lease. D) conditional sale. E) sale and leaseback arrangement.

18) To meet IRS guidelines for leasing, the lease should: A) limit the lessee’s right to issue debt or pay dividends while the lease is operative. B) offer renewal options only at fair market value. C) pay a very low rate of return to the lessor. D) transfer ownership of the asset at the end of the lease at below fair market value. E) have a term of 30 years or more.

19) One key reason why the IRS is concerned about the structure of lease contracts is because: A) firms that lease generally pay no taxes. B) leasing usually leads to bankruptcy. C) leases can be set up solely to avoid taxes. D) leasing leads to off-balance-sheet-financing. E) lease payments can never be deducted as a business expense.

20) A lease with which one of the following characteristics would not be qualified by the IRS? A) Term of 25 years B) Early balloon payments C) Lessee option to purchase asset at fair market value at lease expiration D) No lease provision limiting the lessee’s right to issue additional debt E) Lessee granted first option to meet a competing outside renewal offer

21) Which one of the following items can be ignored when valuing a purchase versus a lease? A) Tax shield from depreciation B) Investment outlay for the asset C) Changes in operating costs related to the acquired asset D) Lease payments E) Taxes

22) When computing the incremental cash flows from leasing relative to purchasing, the: A) cost of the asset is a negative cash flow. B) lost depreciation tax benefit is a negative cash flow. C) pretax lease payment is a positive cash flow. D) lease payments are ignored. E) tax benefit of the lease payment is a negative cash flow.

23) Assume the net present value of a lease relative to a purchase is $500. Accordingly, the: A) purchase price is less than the reduction in optimal debt level if leasing. B) lease is preferred relative to the purchase. C) optimal lease payment is $500 per period. D) net advantage of leasing is negative. E) lease provides an advantage only to the lessor.

24) In the presence of corporate taxes, riskless cash flows should be discounted at the: A) aftertax riskless rate of interest. B) aftertax cost of firm debt. C) pretax riskless rate of interest. D) pretax cost of firm debt. E) market rate of interest.

25) The appropriate discount rate that a lessee should use to value a financial lease is the: A) lessee’s aftertax weighted average cost of capital. B) lessor’s aftertax cost of borrowing. C) lessee’s aftertax cost of secured borrowing. D) capitalization rate stated in the lease contract. E) current U.S. Treasury T-bill rate.

26) Which one of these statements is false? A) Lenders are concerned about a firm’s total liabilities including lease obligations. B) Debt displacement occurs with leasing. C) Less future debt can be raised for a growing firm when leasing occurs. D) Leasing allows the lessee to increase the benefits of debt capacity. E) Leases should be ignored when computing debt-equity or liability-equity ratios.

27) Why must some debt be eliminated when a firm enters a lease agreement? A) FAS 13 requires an increase in equity equal to the present value of the lease

agreement. B) Lessors require lessees to reduce their debt to demonstrate an ability to make the lease payments. C) FAS 13 requires a debt offset equal to the present value of the lease payments. D) Leases are all debt which causes an imbalance in the firm’s debt-equity ratio. E) FAS 13 requires lease payments be offset by an equal decrease in debt payments.

28) In which one of the following cases would both the lessor and the lessee be indifferent to the

lease? A) When the lessor’s tax rate is lower than the lessee’s tax rate. B) When the lessor’s tax rate is equal to the lessee’s tax rate. C) When the lessor’s tax rate is higher than the lessee’s tax rate. D) Never, because a lease cannot be beneficial to both parties. E) Since leases always have a zero NPV, both parties are automatically indifferent to the

lease.

29) Assume that both the lessor and the lessee have the same interest and tax rates and there are

no transaction costs. Given this, the best lease agreement results in: A) a benefit for the lessor and a zero gain for the lessee. B) a benefit for the lessee and a zero gain for the lessor. C) an NPV of zero for both parties. D) a benefit for both parties. E) a loss for both parties.

30) The lease payment that the lessee sets as its bound is known as the: A) present value of the tax shields. B) reservation payment, LMIN. C) present value of operating savings. D) reservation payment, LMAX. E) reservation payment, LOPTIMAL.

31) Which one of the following is probably the best reason for leasing instead of buying? A) Increased ROA B) Circumvented expenditure controls C) One hundred percent financing D) Tax reduction E) Increased uncertainty

32) Which of these are offered as key considerations in the lease versus purchase decision

according to the research findings of Smith and Wakeman? A) Price discrimination opportunities and debt displacement options B) Cash flows and sensitivity to use and maintenance decisions C) Attracting clients with low prices and debt displacement D) Cash flows and debt displacement E) Price discrimination opportunities and sensitivity to use and maintenance decisions

33) Delgado’s is considering leasing industrial kitchen equipment. The lease terms include five

annual payments of $2,300 with the first payment occurring when the lease is signed. The equipment would cost $11,500 to buy and would be depreciated straight-line to a zero salvage value over 5 years. The actual salvage value is negligible. The firm can borrow at a rate of 6 percent and has a tax rate of 21 percent. What is the cash flow from leasing relative to purchasing in Year 4? A) −$2,300 B) −$1,817 C) −$483 D) −$1,334 E) −$2,783

34) Ibarra, Incorporated, is considering leasing new equipment. The lease terms include five

annual payments of $4,800 with the first payment occurring at the lease signing. The equipment would cost $25,500 to buy and would be depreciated straight-line to a zero salvage value over 5 years. The firm can borrow at a rate of 5.5 percent and has a tax rate of 21 percent. What is the cash flow from leasing relative to purchasing in Year 0? A) $20,700 B) $21,708 C) $16,353 D) $25,500 E) $20,145

35) A lease with a term of 4 years calls for annual payments of $3,400. The leased asset would

cost $11,300 to buy and would be depreciated straight-line to a zero salvage value over the 4 years. The actual salvage value is negligible. The firm can borrow at a rate of 6 percent. What is the NPV of the lease relative to the purchase if the lessee's tax rate is 21 percent? A) $197 B) −$194 C) −$1,699 D) −$399 E) $23,107

36) Grant-Hendrix is considering a lease with four annual payments of $4,000 each. The firm can

borrow at a rate of 6.7 percent and has a tax rate of 21 percent. The leased asset would cost $15,000 to purchase, have a tax life of 4 years, and would be depreciated on a straight-line basis to zero. What would be the incremental cash flow in Year 4 from leasing instead of purchasing if the purchased asset had a pretax salvage value of $500? A) −$4,318.10 B) −$3,605.50 C) −$4,211.51 D) −$4,342.50 E) −$3,900.00

37) A new robotic welder can be leased for 3 years with annual payments of $225,000 with the

first payment occurring at lease inception. The system would cost $850,000 to buy and would be depreciated straight-line to a zero salvage value over five years. The actual salvage value is expected to be $65,000 at the end of the five years. The firm can borrow at 8 percent and has a tax rate of 21 percent. What is the Year 0 incremental cash flow from leasing instead of buying? A) $1,027,750 B) $695,000 C) $672,250 D) $748,500 E) $684,750

38) A lease has a term of 5 years with annual payments of $6,400. The asset would cost $45,000

to buy and would be depreciated straight-line to a zero salvage value over 5 years. The actual salvage value is zero. If the firm has a tax rate of 21 percent, what is the incremental cash flow in Year 5 of leasing rather than purchasing? A) −$4,224 B) −$3,198 C) −$6,946 D) −$7,250 E) −$6,880

39) A lease has a term of 3 years and annual payments of $25,000. The leased asset would cost

$74,000 to buy and would be depreciated straight-line to a zero salvage value over 3 years. The actual salvage value is negligible. The lessee can borrow at a rate of 12 percent and has a tax rate of 21 percent. What is the incremental cash flow of purchasing instead of leasing for Year 3 from the lessee’s perspective? A) −$16,250 B) −$24,930 C) $24,930 D) $16,250 E) −$19,750

40) A lessor can borrow at a rate of 7 percent and has a tax rate of 21 percent. The lessee can

borrow at a rate of 8 percent and has a tax rate of 21 percent. Assume an asset costs $138,000 and can be leased in exchange for two annual payments of $70,000 with the first payment due at the time of signing. What is the incremental cash flow at Time 0 for the lessee for a purchase instead of a lease? A) −$92,500 B) $138,000 C) $92,500 D) −$82,700 E) −$138,000

41) Scott & Jacobs is considering the purchase of a new machine for $10,700 that has a life of 6

years and would be depreciated on a straight-line basis to a zero salvage value over its life. The machine is expected to save the firm $6,800 per year in operating costs. There is no actual salvage value. Alternatively, the firm can lease the machine for $2,200 annually for 6 years, with the first payment due at the end of the first year. The firm’s tax rate is 21 percent and its cost of debt is 7 percent. What is the net advantage to leasing for the lessee? A) $237 B) $21,243 C) $631 D) −$1,773 E) $157

42) A new robotic welder can be leased for 5 years with annual payments of $300,000 with the

first payment occurring at lease inception. The system would cost $1,050,000 to buy and would be depreciated straight-line to a zero salvage value. The actual salvage value is zero. The firm can borrow at 6 percent and has a tax rate of 23 percent. What discount rate should be used for valuing the lease? A) 6.00% B) 1.38% C) 4.62% D) 6.138% E) 7.38%

43) A machine that costs $280,000 would be depreciated using the straight-line method by a

leasing firm over a period of 3 years. Both the book value and the market value would be zero at the end of the 3 years. Both the lessor and the lessee have a tax rate of 21 percent. What is the NPV of the lease relative to the purchase to the lessor if the applicable pretax cost of borrowing is 7 percent and the lease payments are set at $102,100 annually for 3 years? A) −$1,025.58 B) −$9,658.92 C) $411.67 D) $882.09 E) $0

44) A lease has five annual payments of $115,000. The leased asset would cost $500,000 to buy,

would be depreciated straight-line to a zero salvage value over 5 years, and has an actual salvage value of zero. The firm can borrow at 8 percent on a pretax basis and has a tax rate of 23 percent. What is the net advantage of leasing? A) −$31,800.89 B) −$29,504.10 C) $32,149.05 D) −$30,690.00 E) $29,504.10

45) Carlton Uplift is considering leasing some new equipment for 5 years with annual payments

of $27,500. The equipment would cost $115,000 to buy and would be depreciated straightline to a zero salvage value. The actual salvage value is zero. The firm can borrow at 8 percent and does not expect to owe any taxes for the next several years. What is the maximum lease payment Carlton would be willing to pay? A) $24,840.00 B) $23,000.00 C) $18,842.56 D) $28,802.49 E) $21,780.30

46) Roth-Lo Suppy is considering leasing some new equipment for 5 years with annual payments

of $27,500. The equipment would cost $115,000 to buy and would be depreciated straightline to a zero salvage value. The actual salvage value is zero. The firm can borrow at 8 percent and has a tax rate of 21 percent. What is the maximum lease payment Roth-Lo would be willing to pay? A) $24,840.00 B) $29,908.16 C) $27,538.67 D) $23,708.03 E) $28,802.49

47) Patel Manufacturing is considering leasing some new equipment for 5 years with annual

payments. The equipment would cost $115,000 to buy and would be depreciated straight-line to a zero salvage value. The actual salvage value is zero. The applicable pretax borrowing rate is 8 percent. The lessee does not expect to owe taxes for several years. The lessor's tax rate is 21 percent. What is the minimum lease payment that will be acceptable to both parties? A) $28,603.33 B) $28,745.16 C) $27,750.00 D) $22,708.67 E) $26,709.12

48) Moon Design is considering leasing some equipment for 4 years with equal annual lease

payments. The equipment would cost $74,000 to buy and would be depreciated straight-line over 4 years to a zero salvage value. The actual salvage value is zero. The applicable pretax borrowing rate is 7.3 percent. The lessee does not expect to owe taxes for several years while the lessor's tax rate is 21 percent. What is the minimum lease payment that will be acceptable to both parties? A) $22,333.33 B) $21,970.82 C) $20,416.67 D) $22,802.49 E) $21,511.18

49) Blasco’s wishes to obtain new assets that will reduce their operating costs by $3,800 per year

on an aftertax basis. These assets can be either purchased or leased. Explain why these cost savings are omitted from the lease versus purchase analysis.

50) Discuss some of the pros and cons of leasing.

51) Explain the characteristics of both operating and financial leases.

52) Explain the term “bargain purchase price option” and identify at least one application of that

term.

Answer Key Test name: Chapter 21 1) C 2) A 3) D 4) D 5) A 6) E 7) A 8) C 9) B 10) B 11) E 12) B 13) D 14) A 15) D 16) D 17) D 18) B 19) C 20) B 21) C 22) B 23) B 24) A 25) C 26) D 27) D 28) B 29) C 30) D 31) D 32) E 33) A 34) B 35) D 36) D 37) C

38) C 39) C 40) D 41) E 42) C 43) B 44) C 45) D 46) C 47) B 48) B 49) Essay 50) Essay 51) Essay 52) Essay

Chapter 22: 1) A(n)

is a financial contract that provides its owner with the right, but not the obligation, to buy or sell a specified asset at an agreed-upon price on or before a given future date. A) option B) futures C) forward D) swap E) straddle

2) When an owner of an option buys or sells the underlying asset, as is his or her right, the

action is called A) striking B) exercising C) opening D) splitting E) strangling

3) An option’s

the option.

is the fixed price at which the owner can buy or sell the underlying

asset. A) B) C) D) E)

4) The

opening price intrinsic value strike price market price time value

date is the last day on which an owner of an option can elect to exercise that

option. A) B) C) D) E)

ex-payment ex-option opening expiration intrinsic

5) A(n) A) B) C) D) E)

option may be exercised only on the expiration date. European American Bermudian futures Australian

6) Unlike a European option, an American option: A) has a fixed exercise price. B) is an obligation to buy. C) has an expiration date. D) is written on 100 shares of the underlying security. E) can be exercised at any time up to the expiration date.

7) A(n) A) B) C) D) E)

option may be exercised at any time up to and including its expiration date. futures Asian Bermudian European American

8) A call option that is A) funded B) unfunded C) at the money D) in the money E) out of the money

has a positive intrinsic value at expiration.

9) A

is a derivative security that gives the owner the right, but not the obligation, to buy an asset at a fixed price for a specified period of time. A) futures contract B) call option C) put option D) swap E) forward contract

10) An owner of a European call option: A) is obligated to buy the specified assets prior to the option's expiration. B) has the right to sell the specified assets at the set price at any time up to and including

on the expiration date. C) has the right to buy the specified assets at the set price only on the expiration date. D) is obligated to sell the specified assets at the set price if the option is exercised. E) has the right to buy the specified assets at the set price at any time prior to the option's expiration.

11) Which of the following events will increase the value of a call option? 1. I. An increase in the market value of the underlying asset 2. II. An increase in the option's strike price 3. III. A decrease in the market value of the underlying asset 4. IV. A decrease in the option’s strike price A) I and II only B) II only C) II and III only D) I and IV only E) I only

12) An out-of-the-money call option is best defined as an option that: A) has an exercise price below the current market price of the underlying security. B) should not be exercised at this time. C) has an exercise price equal to the current market price of the underlying security. D) has expired. E) qualifies as an American option.

13) Tanaya owns a call option on Ulysses stock with a strike price of $17.50 per share. Currently,

Ulysses is selling for $19.25 per share. Tanaya would like to profit on this option but is not permitted to exercise the option for another two weeks. She believes the stock will decline in value before the two weeks is up. What should she do? A) Sell her option today B) Place an order to exercise her option on its expiration date C) Purchase an additional call option on Ulysses today with a strike price of $17.50 D) Place an order to exercise her option as soon as she is permitted to do so E) Convert her American option into a European option

14) The owner of a European put option has the: A) right, but not the obligation, to sell the underlying asset at the specified price only on

the specified date. B) right, but not the obligation, to sell the underlying asset at the specified price during a specified period of time. C) obligation to sell the underlying asset on the specified date, but only if they can do so at the specified price. D) obligation to buy the underlying asset sometime during the specified period at the specified price. E) right, but not the obligation, to buy the underlying asset at the exercise price on the expiration date.

15) An option that grants the right, but not the obligation, to sell shares of the underlying asset

during a particular time period at a specified price is called: A) either an American or a European option. B) an American call option. C) an American put option. D) a European put option. E) a European call option.

16) Which one of the following provides the right to sell a stock anytime during the option period

at the strike price, even if the market price of the stock declines to zero? A) American call B) European call C) American put D) European put E) Should the underlying stock price decline to zero, all options are null and void.

17) Which of the following events will decrease the value of a put option? 1. I. An increase in the market value of the underlying asset 2. II. An increase in the option's strike price 3. III. A decrease in the market value of the underlying asset 4. IV. A decrease in the option's strike price A) I and II only B) I and IV only C) II and III only D) III only E) IV only

18) An in-the-money put option: A) has an exercise price greater than the underlying stock price. B) has an exercise price less than the underlying stock price. C) expires today. D) should not be exercised at expiration. E) should not be exercised at any time.

19) On the expiration day, the maximum price of a put option on a stock is the greater of the: A) stock price minus the exercise price, or 0. B) the exercise price or 0. C) exercise price minus the stock price, or 0. D) stock price or 0. E) exercise price or the stock price.

20) Anish owns an American put option on 100 shares of Handle stock. The option has a strike

price of $32.50 and a September expiration date. The stock has recently been declining in value, currently sells for $27.65 per share, and is expected to continue declining in value. Ignore all costs and taxes. If today is Wednesday, August 14, he: A) cannot exercise his option even though he would like to do so. B) should hold his option until September. C) can exercise his option and earn a profit. D) should exercise his option today and then sell the shares of stock on the September expiration date. E) should let his option expire unless the stock price increases above $32.50 per share.

21) A put option on Ancestor stock with an exercise price of $35 expires today. The current price

of Ancestor stock is $36. The put is: A) funded. B) unfunded. C) at the money. D) in the money. E) out of the money.

22) Which one of the following statements concerning call option writers is true? A) Call option writers promise to purchase shares if the call option is exercised. B) The call option writer has the option, but not the obligation, to purchase shares if the

option is exercised. C) The call option writer is betting that the market price of the underlying asset will increase. D) The call option writer receives a cash payment when the option is written. E) The call option writer earns a profit when an in-the-money option is exercised.

23) Cole has an option position on McCarthy stock that results in a zero dollar payoff when the

stock price is equal to or greater than the option strike price. What did he do to obtain this position? A) Purchased a call option B) Purchased a put option C) Wrote a call option D) Wrote a put option E) No option position would have this result.

24) Assume you are reviewing a table that lists the current stock option contracts and quotes.

Which one of these statements would correctly apply to that table? A) If you write a contract you will pay the bid price per share listed in the table. B) If you write a contract you will receive the difference between the bid and ask prices per share. C) The bid price on a specific contract will be higher than the ask price on that same contract. D) To purchase one contract you must pay 1,000 times the quoted bid price shown in the table. E) To purchase one contract you must pay 100 times the quoted ask price shown in the table.

25) Assume you are reviewing a table that lists the current stock option contracts and quotes. On

a specific contract the table shows an option interest value of 43 and volume of 8. This means that: A) 8 contracts were exercised on that day while 43 more were traded. B) 43 contracts were traded on that day compared to only 8 traded on the previous day. C) 8 contracts were traded on that day at a price of $.43 per share. D) 43 contracts were traded on that day at the bid price and 8 were traded at the ask price. E) 8 of the 43 outstanding contracts traded on that day.

26) The relationship between the price of the underlying stock, a call option, a put option, and a

riskless asset is referred to as the A) put-call parity B) covered call C) protective put D) straddle E) strangle

relationship.

27) Given an exercise price, time to maturity, and European put-call parity, the present value of

the strike price plus the price of the call option is equal to the: A) current market value of the stock. B) present value of the stock minus the price of a put option. C) price of a put option minus the market value of one share of stock. D) value of a risk-free U.S. Treasury bill. E) price of the stock plus the price of the put option.

28) Selling a covered call is equivalent to: A) buying a zero coupon bond and selling a put. B) selling a put and buying an offsetting call. C) buying the stock and selling the call. D) selling a zero coupon bond and buying a put. E) buying a zero coupon bond and buying a call.

29) An investor could realize the same value as that derived from stock ownership by: A) selling a put option and investing the proceeds at the risk-free rate of return. B) buying a call option and writing a put option on a stock, and also borrowing funds at

the risk-free rate. C) selling a put, buying a call, and buying a zero-coupon bond. D) lending out funds at the risk-free rate of return and selling a put option on the stock. E) borrowing funds at the risk-free rate of return and investing the proceeds in equivalent amounts of put and call options.

30) Put-call parity can be used to show: A) how far in the money put options can be. B) how far in the money call options can be. C) the precise relationship between put and call prices given equal exercise prices and

equal expiration dates. D) that the value of a call option is always twice that of a put given equal exercise prices and equal expiration dates. E) that the value of a call option is always half that of a put given equal exercise prices and equal expiration dates.

31) Which combination is referred to as a protective put? Assume all sales and purchases refer to

a particular stock and its option contract. A) Buying 100 shares of stock and writing one put option contract B) Selling a put option contract and buying an offsetting call option contract C) Buying 300 shares of stock and selling three call option contracts D) Buying a put option contract and buying 100 shares of stock E) Buying a put option contract and selling a call option contract with the same strike price and expiration date

32) Assume you purchase one share of a stock and sell a call option on a single share of that

same stock with an exercise price of $32. What is the maximum payoff you can realize on this combination? A) The exercise price of $32 B) An amount equal to the stock price on the option expiration date C) An amount equal to $32 minus the stock price on the option expiration date D) An amount equal to the stock price on the expiration date plus $32 E) Zero

33) Ramba announced a major discovery which caused both the price and volatility of its stock to

increase. How will these two reactions affect the value of call options on this stock? A) Both reactions will decrease the value. B) Both reactions increase the value. C) Neither reaction will affect the value. D) The reactions will have offsetting effects on the value. E) The change in volatility will have no effect while the increased stock price will increase the value.

34) Flores Floral announces a major expansion which causes both the price of its stock and the

volatility of the stock price to increase. How will these two reactions affect the value of put options on this stock? A) Both reactions will decrease the value. B) Both reactions will increase the value. C) Neither reaction will affect put option values. D) The reactions will have offsetting effects on the value. E) The change in volatility will have no effect while the increased stock price will decrease the value.

35) A trading opportunity that offers a riskless profit is called a(n): A) put option. B) call option. C) market equilibrium. D) arbitrage. E) cross-hedge.

36) The value of an option if it were to expire immediately, that is, its lower pricing bound, is

called an option's A) strike B) market C) volatility D) time E) intrinsic

value.

37) The maximum value of a call option is equal to the: A) strike price minus the initial cost of the option. B) exercise price plus the price of the underlying stock. C) strike price. D) price of the underlying stock. E) purchase price.

38) The lower bound on a call’s value is defined as the: A) greater of the strike price or zero. B) greater of the stock price minus the exercise price or zero. C) lesser of the strike price or the stock price. D) lesser of the strike price or zero. E) lesser of the stock price minus the exercise price or zero.

39) The lower bound of a call option’s value: A) can be a negative value regardless of the stock or exercise prices. B) can be a negative value but only when the exercise price exceeds the stock price. C) can be a negative value but only when the stock price exceeds the exercise price. D) must be greater than zero. E) can be equal to zero.

40) The intrinsic value of a call equals the: A) exercise price minus the stock price. B) upper bound of the call’s value. C) market price of the call option. D) lower bound of the call’s value. E) premium paid to purchase the call.

41) The intrinsic value of a put is equal to the: A) lesser of the strike price or the stock price. B) lesser of the stock price minus the exercise price or zero. C) lesser of the stock price or zero. D) greater of the strike price minus the stock price or zero. E) greater of the stock price minus the exercise price or zero.

42) Which one of the following statements is correct concerning in-the-money option values? A) The value of a put decreases as the exercise price increases. B) The value of a put increases as the price of the underlying stock increases. C) The value of a call decreases as the exercise price increases. D) An increase in the underlying stock price decreases both the value of a put and a call. E) The value of a call decreases as the price of the underlying stock increases.

43) All else held constant, the value of a call decreases when the: A) time to expiration increases. B) risk-free rate of return increases. C) stock price increases. D) exercise price increases. E) volatility of the price of the underlying stock increases.

44) Which one of the following events will cause the value of a call to decrease? A) Lowering the exercise price B) Increasing the time to expiration C) Increasing the risk-free rate D) Lowering the risk level of the underlying security E) Increasing the stock price

45) Assume you own both a May 40 put and a May 40 call on Heartfelt stock. Which one of the

following statements is correct concerning your option positions? Ignore taxes and transaction costs. A) An increase in the stock price will increase the value of your put and decrease the value of your call. B) Both a May 45 put and a May 45 call will have higher values than your May 40 options. C) The time premiums on both your put and call are less than the time premiums on equivalent June options. D) A decrease in the stock price will decrease the value of both of your options. E) You can never profit on your positions as your profits on one option will be offset by losses on the other option.

46) You own both a May 20 call and a May 20 put. If the call finishes in the money, then the put

will: A) B) C) D) E)

also finish in the money. finish at the money. finish out of the money. either finish at the money or in the money. either finish at the money or out of the money.

47) An increase in the will decrease the value of a call option. A) interest rate B) exercise price C) time to expiration D) stock volatility E) underlying asset price

48) The option

is the effect on an option’s value caused by a small change in the value of the underlying asset. A) theta B) vega C) rho D) delta E) gamma

49) In the Black-Scholes option pricing formula, N(d1) is the probability that a standardized,

normally distributed random variable is: A) less than or equal to N(d2). B) less than one. C) equal to one. D) equal to d1. E) less than or equal to d1.

50) The Black-Scholes option pricing model is dependent on which five parameters? A) Stock price, exercise price, risk-free rate, probability of occurrence, and time to

expiration B) Stock price, risk-free rate, probability of occurrence, time to maturity, and variance of the underlying asset C) Stock price, risk-free rate, probability of occurrence, variance of the underlying asset, and exercise price D) Stock price, exercise price, risk-free rate, variance of the underlying asset, and time to expiration E) Exercise price, probability of occurrence, stock price, variance of the underlying asset, and time to expiration

51) The delta of a call measures the: A) time remaining to expiration compared to the option’s original maturity. B) C) D) E)

change between an option’s original value and its current value. change in the price of the call relative to the change in the underlying stock price. ratio of the change in the option price to the change in the time to expiration. volatility of the underlying security.

52) A firm has a pure discount loan with face value of $75,000 that is due in six months. The

assets of the firm are currently worth $96,000. The stockholders in this firm basically own options on the assets of the firm with a strike price of . A) put; $96,000 B) put; $75,000 C) warrant; $96,000 D) call; $96,000 E) call; $75,000

53) If the equity of a firm can be considered to be an option on the firm’s assets, then the act of

paying off debt is comparable to on the assets of the firm. A) purchasing a put option B) purchasing a call option C) exercising an in-the-money put option D) exercising an in-the-money call option E) selling a call option

54) When a firm implements a positive net present value project, the equity in the firm will

experience the greatest possible increase if the delta of the call option on the firm’s assets is: A) equal to one. B) between zero and one. C) equal to zero. D) between zero and minus one. E) equal to minus one.

55) Assume a risky firm has both bondholders and stockholders. If the firm obtains a government

loan guarantee on its existing debt, who will gain from this guarantee? A) Existing stockholders only B) Both existing bondholders and stockholders in proportion to the firm’s debt-equity ratio C) Existing bondholders and stockholders on an equal basis D) Existing bondholders only E) Future stockholders only

56) If you consider bondholders to be the owners of a firm, then those bondholders: A) own a call option on the firm with an exercise price equal to the firm’s total equity. B) own a put option on the firm with an exercise price equal to the firm’s total debt. C) have written a put option on the firm with an exercise price equal to the firm’s total

equity. D) have written a call option on the firm with an exercise price equal to the firm’s total debt. E) own a put option on the firm with an exercise price equal to the firm’s total assets.

57) If you consider stockholders to be the owners of a firm, then those stockholders: A) own a call option on the firm with an exercise price equal to the firm's total equity. B) own a put option on the firm with an exercise price equal to the firm's total debt. C) have written a put option on the firm with an exercise price equal to the firm's total

equity. D) have written a call option on the firm with an exercise price equal to the firm's total debt. E) own a put option on the firm with an exercise price equal to the firm’s total assets.

58) A purely financial merger: A) increases shareholder value but does not affect bondholders. B) decreases both bondholder and shareholder values. C) transfers bondholder value to shareholders. D) increases bondholder value but does not affect shareholder value. E) reduces shareholder value while increasing bondholder value.

59) Shareholders in a levered firm might wish to accept a negative net present value project if it: A) increases the standard deviation of the returns on the firm’s assets. B) lowers the variance of the returns on the firm’s assets. C) lowers the firm’s volatility. D) diversifies the cash flows of the firm. E) decreases the risk that a firm will default on its debt.

60) Alicia is considering purchasing a small building with the intent of opening a craft and

sewing center. The cost of the building is $49,000 and the cost to open the center is an additional $150,000. If the center is opened and no other competition is nearby the project will provide a hefty return. However, should the vacant building down the street be used for a competitive type entity, then the center could be a losing proposition. Assume the building is purchased but the opening of the center is delayed. This situation would best be described as on a craft and sewing center. A) purchasing a call option B) writing a call option C) purchasing a put option D) writing a put option E) exercising a call on the land and writing a put

61) You purchased six Framingham, Incorporated, call option contracts with a strike price of

$42.25 when the option quote was $.62. The option expires today when the value of Framingham stock is $39.20. Ignoring trading costs and taxes, what is your total profit on your investment? A) $0 B) −$372 C) −$677 D) $305 E) −$305

62) You purchased eight Pangolin Corporation call options with a strike price of $30.00 at a

quoted price of $.29. What is your total profit on this investment if the price of Pangolin is $32.40 on the option expiration date? A) −$232 B) $1,688 C) $1,920 D) $2,152 E) $232

63) You own two call option contracts on Jenieve Events stock with a strike price of $28. When

you purchased the contracts the option price was $1.15 and the stock price was $28.20. What is the total intrinsic value of these options if Jenieve stock is currently selling for $27.80 per share? A) $40 B) $80 C) −$80 D) $0 E) −$30

64) Last week, you purchased one call option contract on Blakely stock with a strike price of

$18.22 and an option price of $1.14. What is the intrinsic value per share of stock if Blakely is currently priced at $19.80? A) $1.58 B) $.44 C) $2.02 D) $2.46 E) $0

65) You purchased four SpeakerPro call option contracts with a strike price of $62 when the

option was quoted at $2.98. The option expires today when the value of SpeakerPro stock is $64.60. Ignoring trading costs and taxes, what is your total profit on your investment? A) $0 B) −$1,192 C) $1,040 D) $1,192 E) −$152

66) You purchased three TranSport 16 call option contracts at a quoted price of $.11. What is

your total profit on this investment if the price of TranSport is $15.75 on the option expiration date? A) −$33 B) −$108 C) −$75 D) $33 E) $75

67) Three weeks ago, you purchased a July put option with a strike price of $56.00 on

CloudMaker stock at an option price of $2.90. The market price of CloudMaker stock three weeks ago was $52.60. Today, the stock is selling at $55.10 per share and the July 45 put is priced at $.78. What is the intrinsic value of your put contract? A) $0 B) $340 C) $90 D) $200 E) $250

68) You own ten put option contracts on RainTree stock with an exercise price of $25. What is

the total intrinsic value of these contracts if RainTree stock is currently selling for $24.50 per share? A) −$500 B) −$50 C) $0 D) $50 E) $500

69) Three months ago, you purchased three put option contracts on Weatherwell stock with a

strike price of $60 and an option price of $.60. The option expires today when the value of the stock is $48.10. Ignoring trading costs and taxes, what is your total profit on your investment? A) $180 B) $3,390 C) $60 D) $1,130 E) $1,090

70) Three months ago, you purchased a put option contract on ConnerCo stock with a strike price

of $61 and an option price of $.60. The option expires today when the value of the stock is $63.50. Ignoring trading costs and taxes, what is your total profit on your investment? A) $310 B) −$60 C) $0 D) $60 E) −$190

71) You sold ten put option contracts on Preston Road stock with an exercise price of $31.20 and

an option price of $1.20. Today, the option expires and the underlying stock is selling for $33 per share. Ignoring trading costs and taxes, what is your total profit on this investment? A) −$3,300 B) −$1,200 C) $120 D) $1,200 E) $3,300

72) You sold a put contract on De La Cruz stock at an option price of $.50 and an exercise price

of $21. Today, the stock is selling for $20 per share and your option position was closed out. Ignoring transaction costs and taxes, what is your total profit? A) $50 B) $60 C) −$50 D) −$60 E) $0

73) You wrote ten call option contracts on Santiago stock with a strike price of $41 and an option

price of $.60. What is your total profit on this investment if the price of the stock is $46.05 on the option expiration date? A) −$5,050 B) −$4,450 C) $4,100 D) $4,450 E) $5,050

74) You wrote ten put option contracts on Sun & Sand stock with a strike price of $40 and an

option price of $.40. What is your total profit on this investment if the price of the stock is $41.05 on the option expiration date? A) $6,450 B) $5,650 C) $400 D) −$5,650 E) −$6,450

75) You sold ten put option contracts on SkyBoard stock with an exercise price of $32.50 and an

option price of $1.10. Today, the option expires when the underlying stock is selling for $34.30 per share. Ignoring trading costs and taxes, what is your total profit on this investment? A) $2,900 B) −$1,100 C) $700 D) $1,100 E) −$2,900

76) You sold a put contract on Brusewitz, Incorporated, stock at an option price of $.25 and an

exercise price of $22.50. The option expires today when the stock is selling for $21.70 per share. Ignoring transaction costs and taxes, what is your total profit on this investment? A) $105 B) −$55 C) −$25 D) $55 E) $0

77) What is the cost of four October 40 put option contracts on a stock given the following price

quotes? Stock price $40.86 Expiration: July October July October July October

Strike 35 35 40 40 45 45

Call bid 6.03 6.17 1.06 1.23 0 0

Call ask 6.12 6.26 1.14 1.31 0 0

Put bid 0 0 .05 .22 5.13 5.46

Put ask 0 0 .08 .26 5.25 5.50

A) $22 B) $26 C) $240 D) $88 E) $104

78) What is the value of one August 25 call option contract? KNJ (KNJ) Underlying stock price: 30.86 Call Expiration August November August November A) $4.60 B) $.10 C) $615 D) $10 E) $6.15

Strike 25 25 35 35

Last 6.15 6.60 .10 .70

Put Last .05 .10 4.60 5.10

79) The market price of Pokkula Healthcare stock has been very volatile and you think this

volatility will continue for several weeks. Thus, you decide to purchase one two-month call option contract on the stock with a strike price of $25 and an option price of $1.30. You also purchase one two-month put option on the stock with a strike price of $25 and an option price of $.50. What will be your total profit on these positions if the stock price is $25.60 on the day the options expire? A) −$180 B) −$120 C) $100 D) $120 E) $180

80) Several rumors concerning Cadence stock have started circulating. These rumors are causing

the market price of the stock to become increasingly volatile. Given this situation, you decide to buy both a one-month put and a one-month call option on this stock with an exercise price of $15. You purchased the call at a quoted price of $.20 and the put at a price of $2.10. What will be your total profit on these option positions if the stock price is $6 on the day the options expire? A) $30 B) $670 C) $690 D) $710 E) $1,110

81) Universal Fence stock is selling for $41 per share. A 6-month call on the stock with a strike

price of $45 is priced at $1.60. Risk-free assets are currently returning .15 percent per month. What is the price of a 6-month put on the stock with a strike price of $45? A) $5.53 B) $4.27 C) $5.20 D) $4.82 E) $4.90

82) Wayward Tours stock is selling for $32.60 per share. A 4-month call on the stock with a

strike price of $35 is priced at $.55. Risk-free assets are currently returning .2 percent per month. What is the price of a 4-month put on the stock with a strike price of $35? A) $2.12 B) $2.32 C) $2.87 D) $2.73 E) $2.67

83) Sarwar Company stock has a current market price of $47.60 per share. The one-year call on

this stock with a strike price of $45 is priced at $3.20 while the one-year put with a strike price of $45 is priced at $.15. What is the risk-free rate of return? A) 2.71% B) 1.76% C) 1.01% D) 2.04% E) 2.87%

84) The market price of Musa stock has been very volatile and you think this volatility will

continue for a few weeks. Thus, you decide to purchase a one-month call option contract on this stock with a strike price of $25 and an option price of $1.50. You also purchase a onemonth put option on this stock with a strike price of $25 and an option price of $.70. What will be your total profit on these option positions if the stock price is $24.60 on the day the options expire? A) −$180 B) −$140 C) −$100 D) $220 E) $140

85) Due to technological and market developments, the price of Atubo stock has become quite

volatile. Given this, you decide to buy two one-month put option contracts and two onemonth call option contracts on this stock with an exercise price of $15. You purchased the calls at a quoted price of $.40 and the puts at a price of $2.30. What will be your total profit on these positions if the stock price is $29 on the day the options expire? A) $1,890 B) $2,720 C) $2,260 D) $1,130 E) $1,360

86) You own a call option on Jasper Company stock that expires in one year. The exercise price

is $35. The current price of the stock is $48 and the risk-free rate of return is 4.5 percent. Assume the option will finish in the money. What is the current value of the call option per share? A) $13.00 B) $13.59 C) $13.97 D) $14.51 E) $15.46

87) You currently own a one-year call option on Kang Company stock with a strike price of $20.

The current stock price is $22.10 and the risk-free rate of return is 3.75 percent. If you assume the option finishes in the money, what is the current value of your call option per share? A) $2.02 B) $2.18 C) $1.76 D) $3.13 E) $2.82

88) The common stock of Climate Systems is selling for $28.97 per share while one-year U.S.

Treasury securities are currently yielding 2.8 percent. What is the current value per share of a one-year call option on Climate Systems stock if the exercise price is $22.50 and you assume the option will finish in the money? A) $6.29 B) $6.40 C) $6.65 D) $7.67 E) $7.08

89) The common stock of Teak Design is currently priced at $52.50 per share. One year from

now, the stock price is expected to be either $54 or $60 per share. The risk-free rate of return is 4 percent. What is the per share value of one call option on Teak stock with an exercise price of $55? A) $.39 B) $.41 C) $.45 D) $.48 E) $.51

90) You own one call option with an exercise price of $30 on Hable stock. This stock is currently

selling for $27.80 per share but is expected to increase to either $28 or $34 per share over the next year. The risk-free rate of return is 5 percent. What is the current per share value of your option if it expires in one year? A) $.76 B) $.79 C) $.89 D) $.92 E) $.95

91) The assets of Concrete Value are currently worth $2,100. These assets are expected to be

worth either $1,800 or $2,300 one year from now. The company has a pure discount bond outstanding with a $2,000 face value and a maturity date of one year. The risk-free rate is 5 percent. What is the value of the equity in this firm? A) $166.67 B) $231.43 C) $385.71 D) $405.00 E) $714.29

92) Vozza Development has a pure discount bond that comes due in one year and has a face

value of $1,000. The risk-free rate of return is 4 percent. The assets of Vozza are expected to be worth either $800 or $1,300 in one year. Currently, these assets are worth $1,140. What is the current value of Vozza’s debt? A) $222.46 B) $370.77 C) $514.28 D) $769.23 E) $917.54

93) Baskar Consulting has total assets of $1,810. These assets are expected to increase in value to

either $1,900 or $2,400 by next year. The company has a pure discount bond outstanding with a face value of $2,000. This bond matures in one year. Currently, U.S. Treasury bills are yielding 5.5 percent. What is the value of the equity in this firm? A) $6.98 B) $7.24 C) $6.67 D) $7.08 E) $7.89

94) What is the value of d2 given the following information? Stock price Exercise price Time of expiration Risk-free rate Standard deviation d1

$ 59 $ 60 .50 4.5% 18% .108367

A) .0133 B) −.0189 C) −.0460 D) .0867 E) −.0019

95) Given the following information, what is the value of d2 as it is used in the Black-Scholes

model? Stock price Exercise price Time of expiration Risk-free rate Standard deviation d1

$ 36 $ 40 .25 3.75% 26% −.673350

A) .0216 B) −.8034 C) .1756 D) −.20021 E) .0251

96) What is the value of a call given the Black-Scholes model and the following information?

Stock price = $44, Exercise price = $40, Time to expiration = .75, Risk-free rate = 4.5%, Standard deviation = 25%, N(d1) = .759395, and N(d2) = .687172. A) $2.03 B) $4.86 C) $6.84 D) $8.81 E) $9.27

97) Assume the delta of a call option on a firm’s assets is .608. This means a project valued at

$65,000 will increase the value of the firm’s equity by: A) $27,902. B) $39,520. C) $43,820. D) $63,131. E) $89,600.

98) The current market value of the assets of Bui Partners is $91 million, with a standard

deviation of 19 percent per year. The firm has zero coupon bonds outstanding with a total face value of $45 million. These bonds mature in 2 years. The risk-free rate is 4 percent per year compounded continuously. What is the value of d1? A) 3.05 B) 3.62 C) 2.48 D) 2.71 E) 3.46

99) The current market value of the assets of Williams & King is $86.28 million. The call option

value on the firm’s assets is $53.09 million. What is the market value of the firm’s debt? A) $74.49 million B) $31.36 million C) $33.19 million D) $44.08 million E) $139.37 million

100)

Suppose your wealthy Aunt Destiny has asked you to manage her large stock portfolio. You would like to use options to increase her total return and also reduce her risks. Describe the types of options you would buy or sell, as well as your rationale, given the following circumstances: a. Aunt Destiny owns 10,000 shares of a large oil company common stock. You believe the stock is overpriced, but she won't let you sell any shares because her late husband told her to never, ever sell any. How do you protect her from what you believe is an impending price decline? b. Your analysis suggests that a technology stock is poised for a large price increase within the next year. Aunt Destiny won’t agree to spend the dollars required to obtain shares but has consented to allow you to spend some money on options but only because she trusts you. You don’t want to disappoint her. What should you do?

101)

Suppose you look in the newspaper and see ABC trading at $50 per share. Calls on ABC with one month to expiration and an exercise price of $45 are trading at $6.50 each. Puts on ABC with one month to expiration and an exercise price of $55 are trading at $3.50 each. Are these prices reasonable? Explain. (Ignore transactions costs.)

102)

Suppose XYZ is priced at $125 per share. The 150 call has six months to expiration and is quoted at $.05. Why do you suppose investors would be willing to purchase a call that is so far out of the money?

103)

What are the upper and lower bounds of an American call option? Explain what would happen in each case if the bound was violated.

104)

Explain the rationale behind the statement that equity is a call option on the firm’s assets. When would a shareholder allow the call to expire?

105)

How do options apply to capital budgeting? Explain and provide an example.

Answer Key Test name: Chapter 22 1) A 2) B 3) C 4) D 5) A 6) E 7) E 8) D 9) B 10) C 11) D 12) B 13) A 14) A 15) C 16) C 17) B 18) A 19) C 20) C 21) E 22) D 23) D 24) E 25) E 26) A 27) E 28) A 29) C 30) C 31) D 32) A 33) B 34) D 35) D 36) E 37) D

38) B 39) E 40) D 41) D 42) C 43) D 44) D 45) C 46) C 47) B 48) D 49) E 50) D 51) C 52) E 53) D 54) A 55) D 56) D 57) B 58) E 59) A 60) A 61) B 62) B 63) D 64) A 65) E 66) A 67) C 68) E 69) B 70) B 71) D 72) C 73) B 74) C 75) D 76) B 77) E

78) C 79) B 80) B 81) C 82) E 83) C 84) A 85) C 86) D 87) E 88) E 89) D 90) A 91) B 92) E 93) B 94) B 95) B 96) C 97) B 98) A 99) C 100) 101) 102) 103) 104) 105)

Essay Essay Essay Essay Essay Essay

Chapter 23: 1) Executives are prohibited from exercising their options during the A) investing B) freeze-out C) valuation D) guaranteed E) strike

period.

2) Executive stock options generally have all the following characteristics except: A) aligning executive goals with shareholder goals. B) linking executive compensation to performance. C) providing tax efficiency. D) increasing executive base salaries. E) putting executive pay at risk.

3) When compared to a call option on a comparable non-dividend-paying stock, the call option

on a dividend-paying stock is: A) more valuable because of the dividend payments. B) equal in value. C) less valuable because cash dividends lower the stock price. D) equal to the cost of the non-dividend paying stock option. E) either equal to or greater than the value of the non-dividend paying stock option.

4) Which one of these is not a reason why executives place less value on employee stock

options than their face value would indicate? A) The option’s value depends on the stock price exceeding the exercise price. B) Options must generally be held for a period of time. C) Options may create a highly undiversified portfolio for the executive. D) Options always create taxable income for the executive when granted. E) Options could be out of the money.

5) The value of an executive stock option will decrease if: A) the volatility of the firm's stock returns increases. B) the executive improves firm performance causing the stock price to rise. C) a freeze-out period is required. D) the firm extends the option expiration date. E) the strike price is lowered.

6) Investing in a negative NPV project today may be a feasible choice if: A) the project has future option alternatives. B) all the project’s future options were included in the NPV analysis. C) the current discount rate is low. D) all the project’s future options will be ignored by decision makers. E) the discount rate is expected to increase over time.

7) The main reason why the opportunity to defer investing in a project until a later date may

have value is: A) the cost of capital may increase. B) project cash flows may be lower in the future. C) investment costs tend to increase over time. D) the option to abandon may disappear. E) market conditions may improve.

8) The main reason why permanently rejecting an investment project today may be a poor

decision is: A) the size of the firm will be less than it would be with the project. B) there are always errors in the estimation of NPVs. C) the management team may be replaced. D) the company is foregoing all future options. E) the firm may not have any other investment opportunities.

9) Which of the following factors is frequently ignored during net present value analysis? A) Project risk B) Cash flows after the depreciable life of the asset expires C) The time value of money D) Some or all of a project’s options E) Startup costs

10) When valuing a project using the Black-Scholes option pricing model, R is set equal to the: A) historical real market rate of return. B) annually compounded risk-free rate. C) expected future real market rate of return. D) continuously compounded risk-free rate. E) project’s CAPM rate of return.

11) Which one of the following statements is true? A) If virtually all projects have embedded options, then ignoring these options does not

affect the value of the projects. B) Every business will benefit if it exercises its expansion option. C) The option to abandon a project lowers the project’s value. D) Startup businesses do not have any options until they have succeeded for one year. E) Every business idea has at least two possible outcomes.

12) Which one of the following factors is not included as an input for the Black-Scholes option

pricing model? A) Standard deviation B) Time to maturity C) Exercise price D) Par value E) Continuously compounded interest rate

13) With the binominal option pricing model, it is reasonable to assume: A) there is a varying rate of price change from one time interval to the next time interval. B) any new information impacting prices is similar from one interval to another interval. C) the discount rate increases with each time interval. D) the call price will only be usable if the time interval is extremely small. E) that each project is limited to two outcomes over its life.

14)

A branching tree depicting the binomial model of a projected investment: A) should capture all possible future paths the investment could take. B) will have more up-branches than down-branches if there are two or more time intervals. C) can only have one final point that has an option value of zero. D) only depicts paths that will lead to acceptable project decisions. E) should lead to the same result if you take an up-branch followed by a down-branch or a down-branch followed by an up-branch.

15) Under risk neutrality, the expected return on an asset will equal: A) the market risk premium. B) the market rate of return. C) zero. D) the risk-free rate of interest. E) the asset beta times the market risk premium.

16) The binomial option pricing model is: A) bell-curve shaped. B) symmetrical. C) hyperbolic. D) asymmetric. E) curvilinear.

17) If an infinite number of intervals is applied to the binomial option pricing model, then the

value of a call is equal to: A) the risk-free rate of return. B) zero. C) the exercise price. D) the Black-Scholes model’s call value. E) the stock price.

18) An analyst is calculating the risk-neutral probabilities of a price increase and decrease.

Accordingly, the analyst knows the expected return on the asset equals the: A) sponsoring firm’s cost of capital. B) risk-free rate. C) market rate of return. D) annual inflation rate. E) CAPM rate of return.

19) In the binomial option pricing model the: A) number of intervals required for convergence is quite large. B) interval time span decreases as time moves forward. C) result based on infinitesimally small intervals will differ significantly from the value

developed by the Black-Scholes model. D) percentage increase in price in each interval can differ from the percentage decrease in price. E) value of u remains constant as the number of intervals increases.

20) Zefir owns an oil field with a number of producing wells. In the past, he has started and

stopped production among these wells as the price of oil fluctuated. Assume the government imposes additional requirements on non-producing wells that are still production capable. These requirements are expected to increase the cost of stopping well production by 30 percent. As a result, Zefir should be: A) keeping all wells open continuously. B) closing wells only if he plans to keep them closed permanently. C) willing to keep wells operating at a lower level of profitability than he has in the past. D) increasing the cost of capital he applies to his well evaluation analysis. E) opening wells at a lower popen price.

21) Assume a firm in the surface mining industry has major assets consisting solely of cash,

equipment, and a closed facility, yet the firm appears to have extraordinary value. This value is least apt to be attributable to the: A) low exercise price held by the shareholders. B) option to open the facility when prices rise dramatically. C) option to keep the facility closed for an extended period of time. D) current operating cash flow. E) potential sale of the firm.

22) If a project has both expansion and abandonment options, then the: A) shorter the available life of the project the less valuable the project is. B) longer the available life of the project the less valuable the project is. C) options will offset each other and therefore add no value to the project. D) project life becomes irrelevant. E) project should always be accepted.

23) The option to abandon is: A) a real option. B) usually of little value because of the costs associated with abandonment. C) irrelevant in capital budgeting analysis. D) generally ignored. E) of no value to a project.

24) Which one of the following statements is true? A) The Black-Scholes model is most applicable to complex situations. B) The binomial model is limited to a two-period time sequence. C) The binomial model is limited to ten time intervals for any single analysis. D) The binomial model is basically equivalent to the Black-Scholes model when there is

a single time interval. E) The Black-Scholes model is simpler to use, but for complex situations the binomial model is preferred.

25) Giovanna has just been granted at-the-money options on 500,000 shares of her employer’s

stock. The options expire in three years. The stock is currently trading at $22 per share, the volatility of the returns as measured by standard deviation is 19 percent, and the continuously compounded risk-free rate is 3.6 percent. What is the value of d1 as it is used in the BlackScholes option pricing model? A) .1842 B) .4102 C) .4583 D) .4927 E) .5412

26) Assume you are being granted at-the-money stock options today when the stock is trading at

$32 per share. These options mature in one year, the continuously compounded risk-free rate is 4.2 percent, and the volatility of the stock’s returns is 22 percent. What is the value of d2 as it is used in the Black-Scholes model? A) .0927 B) .0752 C) .0809 D) .0847 E) .0936

27) Shreya has been granted options on 300,000 shares. The stock is currently trading at $27 per

share and the options are at the money. The standard deviation of returns averages 28 percent. The options mature in 5 years and the risk-free rate is 2.36 percent. What is the value of e−Rt? A) .0239 B) .1252 C) .8887 D) .1180 E) .9818

28) Mustafa has been granted options on 50,000 shares. The stock is currently trading at $17 per

share and the options are at the money. The volatility of the stock returns averages 16 percent. The options mature in 2 years and the risk-free rate is 3.45 percent. N(d1) is .662055 and N(d2) is .576052. Given this information, what is the value of a call option on one share of this stock? A) $2.11 B) $1.70 C) $1.89 D) $2.28 E) $2.21

29) Reddy stock is currently trading at $34.50 per share and the 6-month call options are at the

money. The stock returns have a standard deviation of 21 percent and the risk-free rate is 4.21 percent. What is the price of the call option per share given that N(d1) is .585508 and N(d2) is .526913? A) $1.07 B) $2.79 C) $1.38 D) $2.40 E) $1.64

30) A stock has a market price of $25 and a standard deviation of returns of 24 percent. The $25

call option matures in 4 months and the risk-free rate is 2.89 percent. N(d1) is .555198 and N(d2) is .500096. What is the value of the call option per share of stock? A) $1.71 B) $1.86 C) $1.50 D) $1.62 E) $2.16

31) Meera is analyzing an expansion project for a new business and has developed this input for

a Black-Scholes model. Stock price = $7,365,000, exercise price = $12,400,000, time period = 3 years, standard deviation = 14.5 percent, and the continuously compounded interest rate = 4.2 percent. What is the value of d1 as it is used in the model? A) .1945 B) .5487 C) −1.4102 D) .4593 E) −1.4470

32) Grant is analyzing an expansion project for a new business and has developed this input for a

Black-Scholes model. Stock price = $4,186,300, exercise price = $7,250,000, time period = 4 years, standard deviation = 13.8 percent, and the continuously compounded interest rate = 3.84 percent. What is the value of d2 as it is used in the model? A) .01338 B) 1.2784 C) 1.2953 D) −1.5713 E) −1.0293

33) Ryan is evaluating some options for a firm. If the rate is 2.46 percent and the time period is 6

months, what is the value of e−Rt? A) .9783 B) .9878 C) .9876 D) .9757 E) .9520

34) What are the values of u, the up state multiplier, and d, the down state multiplier, if there are

monthly intervals and the standard deviation is .38? A) 1.1159; .8961 B) .0317; 1.0327 C) .0317; .9683 D) .2193; .7807 E) 1.1159; −.1159

35) The price of flax is currently at $20 but you expect it to either increase by 18 percent or

decrease by 7 percent over the next 6 months. The 6-month risk-free rate of interest is 1.98 percent. What is the probability that the price will increase? A) 32.47% B) 36.03% C) 38.06% D) 35.92% E) 37.94%

36) A potential client of Midway Signs would like to buy a 6-month option to purchase 500,000

electronic signs for $119 each. These signs currently sell for $110 each. Assume u equals 1.0994 and d equals .9096. What price should Midway charge for the option if the annual risk-free rate is 3.2 percent? Round your answer to the nearest $100. A) $338,400 B) $421,900 C) $598,100 D) $479,900 E) $533,600

37) A customer of Slice Cutlery would like to obtain a 3-month option to purchase additional

units of a product for $77 each. This product currently sells for $76 each. Assume u equals 1.1502 and d = .8694. Approximately what price per unit should Slice charge for this option if the annual risk-free rate is 2.8 percent? A) $4.79 B) $5.98 C) $6.17 D) $6.02 E) $5.07

38) Lauren has just been granted at-the-money company options on 300,000 shares. These

options expire in 5 years and are exercisable after 3 years. The options are valued at $1.2 million. It is normal for her to receive annual option grants such as this. She also receives a current salary of $550,000. Why might Lauren prefer to receive a straight annual salary of $1.5 million rather than this salary and option combination?

39) A CEO is being granted 1,000,000 at-the-money options. The current stock price is $45, the

continuously compounded risk-free rate is 5 percent, and the variance on the stock’s return is .04. The options expire in 5 years. What is the value of the options contract? If the CEO had negotiated a larger salary and only 10,000 options, what would be the value of that options contract?

40) Why would a company pay an executive in options as opposed to salary?

41) You want to become a very successful entrepreneur. Your desire is to operate a business

from a single location without becoming so large you lose personal touch with all the firm’s employees and the day-to-day operations. Before determining what type of business you want to open, you have decided to compile a list of options that would add value to whatever business you select. Identify options that you would include in this list.

42) Why is straight NPV analysis flawed as compared to models that include option pricing in

the analysis?

43) In what instances is the binomial option pricing model superior to the Black-Scholes option

pricing model?

Answer Key Test name: Chapter 23 1) B 2) D 3) C 4) D 5) C 6) A 7) E 8) D 9) D 10) D 11) E 12) D 13) B 14) E 15) D 16) B 17) D 18) B 19) D 20) C 21) D 22) A 23) A 24) E 25) D 26) C 27) C 28) A 29) D 30) C 31) E 32) D 33) B 34) A 35) D 36) E 37) E

38) Essay 39) Essay 40) Essay 41) Essay 42) Essay 43) Essay

Chapter 24: 1) The owner of a warrant has the: A) obligation to sell securities directly to the issuer at a fixed price for a stated period of

time. B) right to purchase securities directly from the issuer at a fixed price for a stated period of time. C) obligation to purchase securities directly from the issuer at a fixed price for a stated period of time. D) right to sell securities directly to the issuer at a fixed price for a stated period of time. E) right to sell securities directly to the issuer at the prior day’s closing price for a stated period of time.

2) Warrants are most often issued in combination with new: A) publicly placed shares of common stock. B) privately placed shares of common stock. C) publicly placed bonds. D) privately placed bonds. E) shares of preferred stock.

3) The lower limit of a warrant’s value is defined as: A) zero. B) MIN(0, Exercise price − Stock price). C) MAX(0, Stock price − Exercise price). D) MAX(0, Exercise price − Stock price). E) MIN(0, Stock price − Exercise price).

4) The upper limit of a warrant’s value is best defined as the: A) exercise price. B) MAX(0, Stock price − Exercise price). C) underlying stock price. D) MAX(0, Exercise price − Stock price). E) MIN(0, Stock price − Exercise price).

5) The value of a warrant is least likely to be affected by the: A) exercise price. B) underlying stock price. C) risk-free interest rate. D) variance of underlying stock returns. E) market rate of return.

6) Snowplow issued warrants with an exercise price of $43. The firm’s common stock is

currently trading for $42 per share. The warrants are: A) in the money. B) out of the money. C) valuable. D) not very valuable. E) both in the money and valuable.

7) Which one of the features noted below applies to call options but not to warrants? A) Market value that changes B) Value based on underlying asset C) Absolute minimum value of zero D) Issued by individuals E) Exercise price

Which one of the following actions occurs whenever a warrant is exercised? A) The issuer receives the greater of the exercise price or the stock price. B) The number of shares outstanding increases. C) Currently outstanding shares are exchanged between individual shareholders. D) A new warrant is issued to replace the exercised warrant. E) The issuer pays the lower of the exercise price or the stock price.

9) Which of the following features is generally true of Warrants? They: A) cannot be detached. B) expire within 30 days. C) remain attached to their original security until the expiration date. D) increase in value when the underlying stock price decreases. E) have longer maturity periods than calls.

10) With respect to warrants and call options, which one of the following statements generally is

correct? A) The issue procedures for both are quite similar. B) When a call option is exercised, the firm must issue new stock. C) When a warrant is exercised, existing stock changes hands. D) Exercise of a call option does not affect share value but warrant exercise does. E) The issuance of a call option generally decreases share value.

11) Which one of the following events would harm the financial position of a warrant holder? A) A 3-for-1 stock split B) A 20 percent stock dividend C) A large cash dividend D) A listing of the warrants on the NYSE E) A reverse stock split

12) The gain from exercising a warrant is

the gain from exercising a comparable call

option. A) B) C) D) E)

less than generally greater than always greater than equal to either equal to or greater than

13) When warrants are exercised, new shares are created. This: A) increases the total number of shares but does not affect share value. B) increases the total number of shares and can reduce the value per share. C) does not change the number of shares outstanding, similar to options. D) increases share value because cash is paid into the firm at the time of warrant

exercise. E) increases the number of shares outstanding while maintaining the current price per share.

14) The gain on a call is calculated as follows: A) [Firm’s value net of debt + Exercise price(Nw)]/(N + Nw). B) [Firm’s value net of debt + Exercise price(Nw)]/N. C) Firm’s value net of debt/N − Exercise price. D) Firm’s value net of debt/(N + Nw) − Exercise price. E) (Firm’s value net of debt − Exercise price)/N.

15) The gain on a warrant is calculated as follows: A) {[Firm’s value net of debt + Exercise price(Nw)]/(N + Nw)} − Exercise price. B) [Firm’s value net of debt + Exercise price(Nw)]/N − Exercise price. C) Firm’s value net of debt/N − Exercise price. D) Firm’s value net of debt/(N + Nw) − Exercise price. E) (Firm’s value net of debt − Exercise price)/(N + Nw).

16) The gain on a warrant compared to the gain on a similar call is expressed as: A) (N + Nw)/N. B) N/(N + Nw). C) Nw/(N + Nw). D) Nw/N. E) 1 + (Nw/N).

17) A security issued by Strong Corporation can be exchanged for a fixed number of shares of

stock. Accordingly, the security is: A) callable. B) convertible. C) protected. D) putable. E) inflated.

18) A convertible preferred stock is similar to a convertible bond except that: A) the conversion ratio is fixed. B) the conversion price is fixed. C) the time to maturity is infinite. D) preferred stock converts to common stock while bonds convert to preferred stock. E) preferred stock converts to bonds while bonds convert to common stock.

19) The holder of a $1,000 face value bond has the right to exchange the bond any time prior to

maturity for shares of stock priced at $36 per share. The $36 is called the: A) conversion price. B) stated price. C) exercise price. D) striking price. E) par value.

20) Concerning convertible bonds, which one of these statements is false? A) The value of a convertible bond can be greater than its straight bond value. B) The value of a convertible bond may be greater than its conversion value. C) A convertible bond can be separated into two distinct securities. D) The coupon rate on a nonconvertible bond will generally exceed the coupon rate on

an otherwise identical convertible bond. E) An increase in the conversion price lowers the conversion ratio.

21) The option value of a convertible bond equals the market value of the bond minus the: A) straight bond value. B) conversion value. C) conversion premium. D) maximum of the straight bond value or conversion value. E) minimum of the conversion value or the straight bond value.

22) A firm has experienced a significant increase in its share value. In retrospect, which one of

the following securities would generally have provided the most benefit to the firm assuming the securities had been issued prior to the change in share value? A) Bonds with attached warrants B) Convertible preferred stock C) Straight bonds D) Convertible bonds E) Common stock

23) A firm has experienced a significant decrease in its share value. In retrospect, which one of

24) A convertible bond: A) generally has fewer restrictive covenants than an otherwise identical nonconvertible

bond. B) is generally issued with a higher coupon than a comparable non-convertible bond. C) provides a greater benefit to its issuer than a straight bond if the underlying stock price rises in the future. D) retains its option value even after the bond matures. E) tends to increase agency costs.

25) Convertible bonds: A) are secured by shares of common stock. B) require conversion on or before the bond’s maturity date. C) grant the owner the option of receiving either cash or shares of stock on conversion. D) are generally issued by firms that have lower bond ratings than the average firm. E) are generally granted seniority over all other bonds.

26) Assume a firm issues convertible bonds at a time when the risk of the firm is difficult to

properly assess. If the firm is subsequently determined to have low risk, then the: A) straight bond component of the convertible bond will have high value. B) bond should be immediately converted. C) conversion value will always exceed the straight bond value. D) call option of the convertible bond will have high value. E) firm will eliminate the conversion option.

27) Issuing convertible bonds or bonds with warrants is useful for a company of unknown risk

because: A) risk affects the two value components of these securities in opposing ways. B) if the firm turns out to be high risk, both the option premium and the straight bond value will be high. C) generally only well-established, high-grade companies issue these instruments. D) the equity value is dependent on current risks rather than future risks. E) these securities generally carry significant restrictive covenants.

28) Transfer or expropriation of wealth from bondholders to stockholders is less likely to occur

when: A) subordinated straight debt is issued because the senior bondholders provide protection

for the subordinated bondholders. B) convertible debt is issued because the equity component will reduce agency costs. C) convertible debt is issued because the holders can more readily sue when a high-risk project is undertaken. D) subordinated debt is issued because monitoring is much easier when subordinated straight debt is issued. E) straight debt is issued because there is a clearer distinction between creditors and shareholders.

29) Assuming market efficiency, which one of the following statements is the least sensible

explanation of why convertibles and warrants are issued? A) Cash flows from these securities best match the cash flows of the firm. B) The firm is relatively large with a low level of financial leverage. C) The securities are useful when it is costly to assess the risk of the issuing firm. D) The securities may resolve agency problems associated with raising money. E) The issuer has a low bond rating.

30) From the bondholder’s point of view, the optimum time to convert a convertible bond is

when the bond’s conversion value is: A) less than the call price, but greater than the face value. B) greater than the call price, but less than the straight debt's value. C) equal to the face value. D) less than the straight debt's value, but greater than the call price. E) greater than the both the call value and straight bond value on the call date.

31) Empirical studies indicate that firms tend to call convertible bonds when the conversion

value is: A) less than the conversion price. B) greater than the straight bond value. C) greater than the call price. D) less than the face value. E) equal to the straight bond value.

32) Transom issued warrants for one share per warrant with an exercise price of $42. On July 1,

the common stock is selling for $45 per share. What are the lower and upper limits on the warrant value on this date? A) $0 and $45 B) $0 and $42 C) $3 and $4 D) $3 and $45 E) $42 and $45

33) Fire & Ice has 26,000 shares of stock outstanding. Each share has a .5 warrant attached.

These warrants expire today. The market value of the firm's assets net of its debt is $390,000. One new share can be obtained for one warrant plus $18. Assuming all else held constant, what would you expect the market price per share to be tomorrow morning when the stock market opens? A) $15.00 B) $16.50 C) $16.00 D) $18.00 E) $17.50

34) Wijono Group has 450,000 shares outstanding with a market value of $32 per share. Each

share has a .2 warrant attached. One warrant plus $30 can be exchanged for one new share of stock. What will be the value of the firm if all the warrants are exercised? Assume all else held constant. A) $16.3 million B) $19.2 million C) $14.4 million D) $17.1 million E) $42.3 million

35) Custom Cladding has 60,000 shares outstanding. Each share has one-third of a warrant

attached. One warrant plus $25 can be exchanged for one new share of stock. The stock is currently selling for $27 per share. All else held constant, what will the stock price be if all the warrants are exercised? A) $26.38 B) $26.50 C) $25.00 D) $27.00 E) $26.67

36) Maritime Supply has 150,000 shares and 150,000 warrants outstanding. One new share can

be purchased for every 10 warrants plus $25 per new share. The stock is currently selling for $28 per share. If all the warrants are exercised immediately, what would be the adjusted market price of the stock? A) $30.50 B) $25.13 C) $26.96 D) $28.00 E) $27.73

37) Skyfall Corporation has 75,000 shares and 50,000 warrants currently outstanding. A warrant

holder can purchase one new share of stock in exchange for four warrants plus $20. The stock is currently selling for $20.60 per share. What would be the gain per new share from exercising the warrants, assuming all warrants are exercised? A) $.15 B) $.51 C) $.60 D) $2.40 E) $2.04

38) A firm has 1,000 shares of stock and 200 warrants outstanding. Assume the warrants are all

exercised. The market value of the firm's assets is $40,000 and the market value of its debt is $12,000. Each warrant grants its owner the right to buy one new share at $26.80. What is the gain on one warrant? A) $.70 B) $1.00 C) $.36 D) $.56 E) $.71

39) Algarve Recruiting has 100,000 shares of stock outstanding. The firm's value net of debt is

$2 million. Algarve has 1,000 warrants outstanding with an exercise price of $18, where each warrant entitles the holder to purchase one share of stock. Calculate the gain from exercising a single warrant. A) $1.87 B) $1.72 C) $1.45 D) $.38 E) $1.98

40) Trusted Property Management currently has 300,000 shares of common outstanding. Firm

value net of debt is $3,450,000. The firm has warrants outstanding with an exercise price of $10. How many warrants must the firm have issued if the gain from exercising a single warrant is $1.25? Assume each warrant entitles its owner to one new share. A) 24,000 B) 45,000 C) 50,000 D) 80,000 E) 60,000

41) Abletree Corporation’s bonds have a face value of $1,000. Each bond can be exchanged by

the boldholders for 50 shares of stock. The stock is selling for $25 per share. What is the conversion price? A) $25.00 B) $40.00 C) $20.00 D) $50.00 E) $15.00

42) Sapphire Software has 300,000 shares of stock outstanding at a market price of $38 per

share. The holder of a $1,000 face value bond can exchange the bond at any time for 20 shares of stock. What is the conversion price? A) $40 B) $38 C) $57 D) $50 E) $20

43) The bonds issued by Mobility Systems have a face value of $1,000 and can be exchanged for

35 shares of stock. The stock has a market price of $22 per share. If Mobility declared a 3for-1 stock split, what would the bonds’ conversion ratio and conversion price be? A) 75; $7.33 B) 105; $9.52 C) 105; $22.00 D) 35; $22.00 E) 105; $7.33

44) A bond with a face value of $1,000 can be converted into 33 shares of stock. What is the

conversion value if the stock is selling for $29.80 per share? A) $30.30 B) $33.33 C) $983.40 D) $1,000 E) $0

45) The bonds issued by Onpoint Publishing have a face value of $1,000 and can be exchanged

for 30 shares of stock. What is the conversion price if the stock is selling for $28.20 per share? A) $25.00 B) $33.33 C) $35.46 D) $28.20 E) $0

46) The bonds issued by Unfurled have a face value of $1,000 and can be exchanged for 20

shares of stock. The stock is selling for $49.40 per share. What is the conversion premium? A) 0% B) 1.33% C) 1.21% D) −1.33% E) 1.67%

47) Assume a bond had a conversion price of $40 and a conversion ratio of 25. What would be

the conversion ratio and conversion price if the bond issuer declared a stock split of 4-for-1? A) 2.50; $400 B) 100; $10 C) 25; $40 D) 6.25; $160 E) 100; $25

48) A convertible bond is selling for $800, matures in 10 years, has a face value of $1,000, and a

coupon rate of 10 percent. Similar nonconvertible bonds are priced to yield 14 percent. The conversion price is $32. The stock currently sells for $31.30 per share. What is the conversion premium? A) 0% B) 1.67% C) 2.50% D) 3.33% E) 2.24%

49) The bonds issued by Gibault Air Systems have a face value of $1,000 and can be exchanged

for 20 shares of stock. Assume Gibault declares a 3-for-1 stock split. What conversion price will be needed following the stock split for the conversion value and the straight bond value to be equal assuming the bond continually sells at par? A) $16.67 B) $33.33 C) $50.00 D) $150.00 E) $66.67

50) A convertible bond is selling for $967, matures in 15 years, has a $1,000 face value, pays

interest semiannually, and has a coupon rate of 8 percent. Similar non-convertible bonds are priced to yield 4.25 percent per six months. The conversion ratio is 20. The stock currently sells for $47.50 per share. Calculate the convertible bond's option value. A) $2.92 B) $7.27 C) $2.03 D) $8.95 E) $1.48

51) A convertible bond is selling for $1,222.70. It has 10 years to maturity, a $1,000 face value, a

coupon rate of 10 percent, and semiannual interest payments. Similar non-convertible bonds are priced to yield 4 percent per six months. The conversion ratio is 40. The stock currently sells for $30.13 per share. Calculate the convertible bond's option value. A) $8.68 B) $22.70 C) $13.59 D) $17.50 E) $86.80

52) A convertible bond is valued at $1,062, has a conversion ratio of 25 and an option premium

of $3. What is the conversion value if the straight bond value is equal to the bond’s par value? A) $1,062.00 B) $1,042.36 C) $1,059.00 D) $1,042.48 E) $1,065.00

53) Leung Industries has 400,000 shares of stock outstanding with a market price of $32 per

share. The firm also has 10,000 bonds outstanding with a face value of $1,000 and a conversion price of $40. The bonds mature tomorrow. You currently own 25,000 shares of this stock but no bonds. What percent ownership in the firm should you expect to have after tomorrow? A) 3.52% B) 3.85% C) 4.25% D) 6.25% E) 3.13%

54) Jadhav Investments has 500 shares of stock and 100 bonds outstanding. The bonds have a

face value of $1,000, are convertible into 5 shares of newly issued common stock, and mature today. What is the value of this firm to its shareholders if the total value of the firm is $184,500? What if the value is $225,000? A) $0; $125,000 B) $84,500; $112,500 C) $92,250; $112,500 D) $84,500; $125,000 E) $92,250; $125,000

55) A bond with a face value of $5,000 can be exchanged for 70 shares of stock. The bond has a

coupon rate of 6.5 percent which equals the market rate of interest. Assume the option premium is $50. What is the market value of the bond if the stock is selling for $68.90 per share and the bond matures in exactly one year? A) $4,744.84 B) $4,873.00 C) $5,000.00 D) $4,940.00 E) $5,050.00

56) Carrillo Cable’s convertible bonds each have a face value of $1,000 and a market value of

$1,041.25. Each bond can be exchanged 25 shares of stock. The stock is selling for $41.54 per share. The straight bond value is $1,010. What is the option value per bond? A) $0 B) $2.75 C) $3.08 D) $38.50 E) $.11

57) A convertible bond matures in 15 years, pays annual coupons, and has a coupon rate of 8

percent. The face value is $1,000 and the conversion ratio is 40. The stock currently sells for $22.80 per share. Similar nonconvertible bonds are priced to yield 9 percent. What is the minimal value of the convertible bond? A) $835.00 B) $919.39 C) $1,000.00 D) $1,070.11 E) $912.00

58) Phan Merchandising bonds have a face value of $1,000 and can be exchanged for 30 shares

of stock. The stock is selling for $35 per share. Phan has an outstanding call option on the bonds at $1,040. If the bonds are called, the holders must either convert or surrender their bonds. What should be the current market value of one of these bonds if the option premium per bond is $15? Assume the bond coupon rate equals the market rate of interest at time of call. A) $1,040 B) $1,065 C) $1,025 D) $1,030 E) $1,035

59) Identify five factors that help determine the value of a warrant above its lower limit.

60) Explain how a noncallable convertible bond’s value is determined.

61) Explain why there is neither a “Free Lunch” nor an “Expensive Lunch” when convertible

bonds are issued.

62) Why are warrants and convertibles issued?

63) Discuss the factors that management must consider before calling a convertible bond.

Answer Key Test name: Chapter 24 1) B 2) D 3) C 4) C 5) E 6) B 7) D 8) B 9) E 10) D 11) C 12) A 13) B 14) C 15) A 16) B 17) B 18) C 19) A 20) C 21) D 22) C 23) E 24) A 25) D 26) A 27) A 28) B 29) B 30) E 31) C 32) D 33) A 34) D 35) B 36) E 37) B

38) B 39) E 40) E 41) C 42) D 43) B 44) C 45) B 46) C 47) B 48) E 49) A 50) D 51) D 52) C 53) D 54) B 55) E 56) B 57) B 58) B 59) Essay 60) Essay 61) Essay 62) Essay 63) Essay

Chapter 25: 1) The value of a financial instrument called a derivative is derived from a: A) regulatory body such as the FTC. B) primitive or underlying asset. C) specified risk. D) negotiated contract. E) probability of occurrence.

2) Derivatives can be used to either hedge or speculate. These strategies: A) increase risk in both cases. B) decrease risk in both cases. C) spread or minimize risk in both cases. D) offset risk by hedging and increase risk by speculating. E) offset risks by speculating and increase risk by hedging.

3) The parties in a forward contract agree today to either purchase or sell an asset or security: A) at a later date, at a price to be set in the future. B) today, at the current market price. C) at a later date, at a price set today. D) if it is advantageous to do so in the future. E) with delivery today and payment in the future.

4) The buyer of a forward contract: A) takes delivery of the goods today, at today’s price. B) makes delivery of the goods at a later date, at that date’s price. C) makes delivery of the goods today, at today’s price. D) takes delivery of the goods at a later date, at a pre-specified price. E) decides on a future date whether or not to take delivery at a pre-specified price.

5) Which of the following statements describes the primary difference between a forward

contract and a cash transaction? A) A forward contract provides an option while a cash transaction is an obligation. B) A forward contract is fulfilled at a later date while the cash transaction is carried out immediately. C) The price of a forward contract is decided at a later date while a cash transaction occurs at the current spot rate. D) A cash transaction can be reversed but a forward contract cannot. E) The forward contract can be negotiated while a cash transaction cannot.

6) Which one of the following actions or features is not associated with a forward contract? A) Making delivery B) Taking delivery C) Deliverable instrument D) Cash transaction E) Delayed delivery

7) A potential disadvantage of forward contracts relative to futures contracts is: A) the extra liquidity required to cover the potential outflows that can occur prior to

delivery. B) the higher incentive for a particular party to default. C) that the buyers and sellers don’t know each other and never meet. D) the obligatory requirements rather than the optional opportunities. E) the increased ability to close out a position prior to expiration.

8) A 6-month futures contract on gold is priced at $1,800 per troy ounce when the contract is

initiated. If the price of gold rises every day over the 6-month period, then when the contract is settled, the buyer will and the seller will . A) lose; gain B) gain; lose C) gain; break even D) gain; gain E) lose; lose

9) Unlike forward contracts, futures contracts: A) provide an option for the buyer, rather than an obligation. B) mark to the market on a weekly basis. C) allow the seller to deliver any day during the delivery month. D) allow the parties to negotiate the contract size. E) require contract fulfillment by the two originating parties.

10) Futures contracts: A) are traded off-exchange. B) require delivery on a specific date. C) are standardized. D) are individually negotiated. E) marked to market on a weekly basis.

11) Which one of the following parties would generally have the greatest reason to take a short

hedge position in the agricultural futures market? A) A local bakery B) A wheat farmer C) A major breakfast food company D) A beverage maker E) An international investor

12) A tortilla manufacturer who needs corn to make cornmeal most likely uses the futures market

for taking a: A) long hedge position to lock in production costs. B) short hedge position to lock in delivery. C) long hedge position to lock in a sales price for flour. D) seller’s position in wheat. E) speculator’s position in corn.

13) Of the following choices, the firm most likely to take a long position in agriculture futures is

the firm that: A) harvests lumber. B) raises wheat. C) harvests soybeans. D) uses corn to make packaged popcorn. E) supplies flaxseed to cooking oil manufacturers.

14) If the producer of a product has entered into a fixed price sale agreement for their output, the

producer generally faces: A) a nice steady profit because the output price is fixed. B) an uncertain profit if the input prices are volatile. This risk can be reduced by a short hedge. C) an uncertain profit if the input prices are volatile. This risk can be reduced by a long hedge. D) a modest profit if the input prices are stable. This risk can be reduced by a long hedge. E) a modest profit if the input prices are stable. This risk can be reduced by a short hedge.

15) Assume you hold a futures contract to take delivery of U.S. Treasury bonds in 6 months. If

the entire term structure of interest rates shifts downward during the 6-month period, the value of the forward contract will have the date of delivery. A) increased in value by B) decreased in value by C) the same value as when obtained on D) either decreased in value or have a zero value by E) zero value by

16) What is the primary way in which mortgage bankers earn income? A) Speculating in Treasury futures B) Collecting interest on long-term mortgages C) Offsetting long and short hedge positions in Treasury futures D) Charging origination and servicing fees E) Hedging all interest rate risk

17) To protect against interest rate risk, the mortgage banker who has committed to lending

funds, but has yet to raise those funds should: A) buy futures, as this position will hedge losses if rates rise. B) sell futures, as this position will hedge losses if rates rise. C) sell futures, as this position will add to his gains if rates rise. D) buy futures, as this position will add to his gains if rates rise. E) avoid the futures market.

18) Futures market transactions are commonly used to reduce risk. The greatest amount risk

reduction can be obtained when the asset at risk and the futures contract have: A) different maturities. B) payoff schedules that differ. C) differing volatilities. D) uncorrelated price movements. E) perfectly correlated price movements.

19) Hedging in the futures markets can reduce all risk if: A) price movements in both the cash and futures markets are perfectly correlated. B) price movements in both the cash and futures markets have zero correlation. C) price movements in both the cash and futures markets are less than perfectly

correlated. D) the hedge is a short hedge, but not a long hedge. E) the hedge is a long hedge, but not a short hedge.

20) Long-term bonds are

volatile short-term bonds and therefore experience a(n) change in price than short-term bonds in response to the same change in interest

rates. A) B) C) D) E)

less; lesser less; greater more; greater more; lesser more; equivalent

21) In response to a change in interest rates, the price of zero coupon bonds are A) B) C) D) E)

volatile

more; if they have a short maturity rather than a long maturity. not; because their duration always matches their maturity. equally; regardless of their maturity. less; than coupon bonds of the same maturity. more; than coupon bonds of the same maturity.

22) The duration of a pure discount bond is: A) equal to its half-life. B) less than that of a comparable coupon bond. C) independent of the bond’s maturity. D) equal to the bond’s maturity. E) always equal to one year.

23) Given a stated change in market interest rates, higher coupon bonds experience a

price change in percentage terms as compared to lower coupon bonds of the same maturity. A) greater B) smaller C) similar D) equal E) zero

24) Of the following choices, the bonds with the greatest potential price volatility are: A) short-term, high-coupon bonds. B) long-term, low-coupon bonds. C) long-term, zero-coupon bonds. D) short-term, zero-coupon bonds. E) short-term, low-coupon bonds.

25) Which one of the following bonds has the highest duration? A) 15-year high coupon B) 15-year zero coupon C) 10-year zero coupon D) 10-year high coupon E) 15-year low coupon

26) Which one of the following bonds will have the lowest percentage price change in response

to a stated shift in interest rates? A) 5-year, zero coupon B) 5-year, high coupon C) 5-year, low coupon D) 10-year, low coupon E) 10-year, high coupon

27) A financial institution can hedge its interest rate risk by: A) matching the duration of its assets to the duration of its liabilities. B) setting the duration of its assets equal to half that of the duration of its liabilities. C) matching the duration of its assets, weighted by the market value of its assets with the

duration of its liabilities, weighted by the market value of its liabilities. D) setting the duration of its assets, weighted by the market value of its assets to one half that of the duration of the liabilities, weighted by the market value of the liabilities. E) setting the duration of its assets equal to 1.0.

28) Neha wants to own bonds but also wants their market values to remain as steady as possible.

Which type of bonds are best suited for her? A) High-coupon, short-term B) Zero-coupon, long-term C) High-coupon, long-term D) Low-coupon, short term E) Zero coupon, short term

29) The duration of a coupon bond is: A) equal to its number of payments. B) less than that of a zero coupon bond of equal maturity. C) equal to the zero coupon bond of the same maturity. D) equal to its maturity. E) increases as the time to maturity decreases.

30) A financial institution has equity equal to one-tenth of its assets. If its asset duration is

currently equal to its liability duration, then to immunize, the firm needs to: A) decrease the duration of its assets. B) increase the duration of its assets. C) decrease the duration of its liabilities. D) maintain the equal durations. E) increase either the duration of its assets or of its liabilities.

31) If a financial institution has equated the dollar effects of interest rate risk on its assets with

the dollar effects on its liabilities, it has engaged in: A) a long futures hedge. B) a short futures hedge. C) a protected swap. D) hedging by matching. E) hedging by swapping.

32) Duration is a measure of the: A) yield to maturity of a bond. B) coupon yield of a bond. C) price of a bond. D) effective maturity of a bond. E) probability of a bond defaulting.

33) A swap is an arrangement between two counterparties who: A) exchange cash flows over time. B) permit fluctuation in interest rates. C) help exchange markets clear. D) temporarily exchange fixed assets. E) insure natural catastrophes.

34) LIBOR stands for: A) London Interest Basis Offered Rate. B) London International Offered Rate. C) London Interbank Offered Rate. D) London Interagency Offered Rate. E) London International Option Rate.

35) Interest rate swaps allow one party to exchange a: A) floating interest rate for a fixed rate. B) fixed interest rate for a lower fixed rate. C) floating interest rate for a lower floating rate. D) floating interest rate for a one-time immediate cash payment. E) fixed interest rate for a one-time future cash payment.

36) A U.S. firm involved in foreign exports is most likely to highly engage in: A) inverse floaters. B) super floaters. C) Treasury futures. D) currency swaps. E) interest rate swaps.

37) An inverse floater and a super-inverse floater probably become the most valuable to a

purchaser when: A) interest rates remain constant. B) interest rates fall. C) interest rates rise. D) their maturities are shorter rather than longer. E) capped and floored.

38) Assume a firm has a floating-rate loan and purchases a 10 percent cap on that loan. As a

result, the firm will receive payments equal to: A) .10 × Assets. B) .10 × Annual interest payment. C) (LIBOR − .10) × Principal loan amount. D) (LIBOR + .10) × Principal loan amount. E) .10 × Principal loan amount.

39) Caps and floors are used in conjunction with derivatives to: A) limit any impact from interest rate changes. B) increase the rate of return to the derivative holder. C) increase the volatility of the at-risk asset. D) offset the costs associated with establishing the derivative position. E) lower acquisition costs irrespective of financing costs.

40) Credit default swaps: A) have no standardized agreement template. B) are traded on international exchanges. C) are traded only on national exchanges. D) are rarely used in actual practice. E) must follow the structure outlined by the SEC.

41) Credit default swaps are most like: A) inverse floaters. B) call options on fixed assets. C) an insurance policy. D) an interest rate swap. E) a delinquent loan.

42) There are always at least A) 0 B) 1 C) 2 D) 3 E) three or more

counterparties in a credit default swap.

43) Which one of the following statements is true about the use of derivatives? A) Derivatives usually appear explicitly in the financial statements. B) Academic surveys account for much of our knowledge of corporate derivatives use. C) Small firms are more likely to use derivatives than large firms. D) The most frequently used derivatives are commodity and equity futures. E) Derivatives are primarily used by firms that have easy access to capital markets.

44) Today, you purchased two natural gas futures contracts at the settle price for a May delivery.

The contract size is 10,000 MMBtu with quotes in dollars per MMBtu. The day’s high was 2.954, the low was 2.939, and the settle was 2.948. What was the total amount you had to pay today? A) $14,740 B) $14,695 C) $14,770 D) $14,755 E) $0

45) Assume you write a futures contract on corn at $4.35 per bushel. Over the next 5 trading days

the contract settled at $4.38, $4.36, $4.34, $4.32, and $4.34. You then decide to reverse your position in the futures market on the fifth day at close. What is the net amount you receive on this contract per bushel? A) $4.35 B) $4.34 C) $4.37 D) $4.38 E) $4.36

46) Assume you write a futures contract on corn at $4.40 per bushel. Over the next 5 days the

contract settles at $4.35, $4.37, $4.32, $4.30, and $4.25. Before you can reverse your position in the futures market you are notified to complete delivery on Day 5. What will you receive on delivery per bushel and what is the net amount per bushel you receive in total? A) $4.40; −$.15 B) $4.40; $.15 C) $4.40; $4.55 D) $4.25; $4.40 E) $4.25; $4.55

47) You bought a futures contract on corn for $3.55 per bushel and closed the contract five days

later at $3.56. The daily closing prices were $3.57, $3.54, $3.53, $3.58, and $3.56. What was the mark-to-market sequence of payments per bushel from (+) and to (−) the clearing house? A) +$.02, −.03, −.01, +.05, −.02 B) +$.01, −.03, −.01, +.05, −.02 C) +$.02, +.01, −.02, −.06, +.04 D) −$.02, +.03, +.01, −.05, +.02 E) −$.01, +.03, +.01, −.05, +.02

48) Today, you purchased a futures contract obligating you to purchase 500 troy ounces of gold

for $1,816 per ounce any time over the next month. Assume the spot price of gold falls to $1,814 tomorrow. What will be your cash flow tomorrow for this contract? A) −$1,000 B) $500 C) $0 D) −$500 E) $1,000

49) Last week, you sold a futures contract on 5,000 troy ounces of silver at a settle price of

$23.10. Today, you made delivery and the daily settle price was $23.15. What amount will you receive at the time of delivery? Assume yesterday's settle price was $23.19. A) $115,500 B) −$200 C) $115,750 D) $25,000 E) $115,950

50) Assume a futures contract on gold is based on 100 troy ounces with prices quoted in dollars

per troy ounce. Assume one contract called for delivery some time during the month of April. The price of gold opened the month at $1,194. The low quote for April was $1,189, the high was $1,212, and the end of month settle quote was $1,197. By what amount did the value on one contract vary over the month of April? A) $30 B) $23 C) $3,000 D) $2,300 E) $300

51) Assume the futures contracts on silver are quoted in dollars per troy ounce with a contract

size of 5,000 troy ounces. Contract quotes for the day included an open value of $16.650, a high of $16.660, a low of $16.620, and a settle of $16.645. If you purchased three contracts at the closing price what was the dollar cost of your purchase ignoring all transaction costs? A) $83,250 B) $82,500 C) $249,675 D) $249,750 E) $83,225

52) Assume a bank has a $25 million mortgage bond risk position which it hedges in the

Treasury bond futures market. Approximately how many futures contracts would be needed for this hedge if you assumed mortgage bonds and Treasury bonds were perfectly correlated? A) 5 B) 25 C) 250 D) 500 E) 2,500

53) A mortgage banker has forward contracts to lend $12 million at 4.5 percent for 15 years.

What position in Treasury bond futures does this banker need to hedge the interest rate risk? A) Short position in 12 contracts B) Short position in 120 contracts C) Long position in 12 contracts D) Long position in 120 contracts E) Long position in 1,200 contracts

54) Assume a bond matures in 2 years, has a coupon rate of 6 percent, pays interest annually, and

has a face value of $1,000. What is the duration of this bond if it is priced at par? A) 1.00 year B) 1.94 years C) 1.97 years D) 1.91 years E) 2.03 years

55) Alpha Corporation is paying $300,000 in fixed interest payments per year while Gamma

Corporation is paying LIBOR plus 30 basis points on $5 million loans. The current LIBOR rate is 5.5 percent. Alpha Corporation and B have agreed to swap interest payments. What is the net payment between these firms this year? A) Alpha Corporation pays $10,000 to Gamma Corporation B) Gamma Corporation pays $10,000 to Alpha Corporation C) Gamma Corporation pays $12,500 to Alpha Corporation D) Alpha Corporation pays $15,000 to Gamma Corporation E) Gamma Corporation pays $15,000 to Alpha Corporation

56) Calculate the duration of a $1,000 zero coupon bond with a current price of $531.01, a

maturity of 7 years, and a yield to maturity of 9.25 percent. A) 6.78 years B) 6.87 years C) 7.23 years D) 7.00 years E) 7.15 years

57) Calculate the duration of a $1,000 face value bond with annual coupon payments, a coupon

rate of 7 percent, a maturity of 4 years, and a yield to maturity of 8.2 percent. A) 3.49 years B) 3.62 years C) 3.69 years D) 3.81 years E) 3.74 years

58) Community Bank has total assets with a market value of $14.23 million and a duration of

2.64 years. The bank's liabilities equal $12.87 million and its equity is $1.36 million on a market value basis. To hedge interest rate risk, what duration should the bank seek for its liabilities? A) 2.86 years B) 2.78 years C) 2.39 years D) 2.48 years E) 2.92 years

59) You have gathered the following market value and duration information on Capital Banking

System: Assets: Overnight money 1-year Treasury Securities Loans Mortgages

Market value (in millions) $ 3.1 7.4 18.6 9.3

Duration .0 .6 2.1 7.6

$ 38.4 Liabilities: Checking accounts Short-term CD’s Long-term CD’s

$ 14.6 4.1 11.6 $ 30.3

.0 .3 3.1

Calculate the duration of the bank’s assets and of its liabilities. A) 2.86 years; 1.23 years B) 2.97 years; 1.06 years C) 2.86 years; 1.06 years D) 2.48 years; 1.06 years E) 2.97 years; 1.23 years

60) You have gathered the following market value and duration information on Friendly Bank: Assets: Overnight money 1-year Treasury securities Loans Mortgages

Market value (in millions) $ 3.7 8.2 11.6 11.9 $ 35.4

Duration .0 .5 1.8 7.9

Liabilities: Checking accounts Short-term CD’s Long-term CD’s

$ 13.9 4.5 10.9 $ 29.3

.0 .4 3.5

What new asset duration will immunize the balance sheet? A) 1.22 years B) .99 years C) 1.36 years D) 1.48 years E) 1.13 years

61) The futures markets are considered by some to be highly risky and equivalent to gambling.

Why is this an inaccurate portrayal of the market’s function?

62) Identify several of the differences between a forward contract and a futures contract.

63) Duration is defined as the weighted average time to maturity of a financial instrument. List at

least four other key things you know about duration.

64) Explain why credit default swaps act like an insurance policy.

Answer Key Test name: Chapter 25 1) B 2) D 3) C 4) D 5) B 6) D 7) B 8) B 9) C 10) C 11) B 12) A 13) D 14) C 15) A 16) D 17) B 18) E 19) A 20) C 21) E 22) D 23) B 24) C 25) B 26) B 27) C 28) A 29) B 30) A 31) D 32) D 33) A 34) C 35) A 36) D 37) B

38) C 39) A 40) A 41) C 42) C 43) B 44) E 45) A 46) D 47) A 48) A 49) C 50) D 51) C 52) C 53) B 54) B 55) B 56) D 57) B 58) E 59) E 60) E 61) Essay 62) Essay 63) Essay 64) Essay

Chapter 26: 1) Net working capital is defined as the: A) current assets of a business. B) difference between current assets and current liabilities. C) present value of short-term cash flows. D) difference between all assets and liabilities. E) difference between total current assets and cash.

2) Which one of the following actions is a source of cash? A) An increase in accounts receivable B) An increase in fixed assets C) A decrease in long-term debt D) The payment of a cash dividend E) An increase in accounts payable

3) Which one of the following actions is a use of cash? A) Selling goods from inventory B) Sale of a marketable security held by the firm C) Submitting taxes to the government D) Obtainment of a long-term loan E) Collection of a past-due accounts receivable

4) Assume the current ratio is greater than 1.0. Which one of the following actions will cause an

increase in net working capital? A) Using cash to pay an accounts payable B) Using cash to pay a long-term debt C) Selling inventory at cost D) Collecting an accounts receivable E) Using a long-term loan to buy inventory

5) Assume the current ratio is greater than 1.0. Which one of the following actions will cause a

decrease in net working capital? A) Selling inventory at a profit B) Collecting an accounts receivable C) Paying a payment on a long-term debt D) Selling a fixed asset for book value E) Paying an accounts payable

6) Which one of the following actions is a use of cash? A) An increase in borrowing B) An increase in operating cash flow C) A decrease in accounts payable D) An increase in notes payable E) A decrease in inventory

7) Which of the following actions results in a use of cash? A) A decrease in a liability only B) An increase in an asset only C) An increase in retained earnings only D) Both an increase in an asset and an increase in retained earnings E) Both a decrease in a liability and an increase in an asset

When , cash increases. A) long-term debt decreases B) equity decreases C) current liabilities decrease D) accounts payable increases E) fixed assets increase

9) If a firm needs to increase its cash holdings it could: A) increase fixed assets. B) decrease accounts payable. C) decrease long-term debt. D) increase other current assets. E) increase current liabilities.

10) When , cash decreases. A) current assets other than cash increase B) fixed assets decrease C) current liabilities increase D) retained earnings increase E) long-term debt increases

11) The cash cycle is defined as the time between: A) the arrival of inventory and cash collected from receivables. B) selling a product and paying the supplier of that product. C) selling a product and collecting the accounts receivable. D) cash disbursements and cash collection for an item. E) the sale of inventory and cash collection.

12) The cash cycle equals the: A) inventory period plus the accounts receivable period. B) change in net working capital divided by daily sales. C) operating cycle plus the accounts payable period. D) operating cycle minus the inventory period. E) operating cycle minus the accounts payable period.

13) A firm’s operating cycle will decrease if the firm: A) pays accounts payable faster. B) discontinues the discount given for early payment of an accounts receivable. C) decreases the inventory turnover rate. D) collects accounts receivable faster. E) increases the accounts payable turnover rate.

14) A firm’s operating cycle will decrease if the firm decreases the: A) days' sales in inventory. B) days in accounts payable. C) cash cycle by increasing the accounts payable period. D) accounts receivable turnover rate. E) speed at which inventory is sold.

15) Which one of the following actions will not impact the operating cycle? A) Decreasing the payables turnover from 7 times to 6 times B) Increasing the days' sales in receivables C) Decreasing the inventory turnover rate D) Increasing the average receivables balance E) Decreasing the credit repayment times for the firm’s customers

16) A firm can decrease its cash cycle by: A) increasing the cash discount offered to customers who pay their accounts early. B) increasing the percentage of customers paying with credit rather than cash. C) increasing the amount of raw materials kept in inventory. D) paying your suppliers earlier to receive a discount on your purchases. E) increasing your inventory to prevent stock-outs.

17) The cash cycle will decrease as a result of increasing the: A) payables turnover. B) days' sales in inventory. C) operating cycle. D) inventory turnover rate. E) accounts receivable period.

18) In the past, Rodriquez Manufacture manufactured products and held them in inventory until

they could be sold. The firm is changing its processes and will now only produce a product upon receiving an order from a customer. All else equal, this change will: A) increase the operating cycle. B) lengthen the accounts receivable period. C) shorten the accounts payable period. D) decrease the cash cycle. E) decrease the inventory turnover rate.

19) Which one of the following statements concerning the cash cycle is correct? A) The cash cycle is equal to the operating cycle minus the inventory period. B) A negative cash cycle is actually preferable to a positive cash cycle. C) Granting credit to slower paying customers tends to decrease the cash cycle. D) The cash cycle plus the accounts receivable period is equal to the operating cycle. E) The most desirable cash cycle is the one that equals zero days.

20) Which one of the following statements concerning the cash cycle is correct? A) The longer the cash cycle, the more likely a firm will need external financing. B) Increasing the accounts payable period increases the cash cycle. C) A positive cash cycle is preferable to a negative cash cycle. D) The cash cycle can exceed the operating cycle if the payables period is equal to zero. E) Adopting a more liberal accounts receivable policy will tend to decrease the cash

cycle.

21) If a firm delays paying its suppliers by an additional ten days, then: A) its payables turnover rate will increase. B) it should require less bank financing of its daily operations. C) its cash cycle will increase by ten days. D) its operating cycle will increase by ten days. E) its stock-out costs will rise.

22) Given a fixed level of sales and a constant profit margin, an increase in the accounts payable

period can result from: A) an increase in the cost of goods sold account value. B) an increase in the ending accounts payable balance. C) an increase in the cash cycle. D) a decrease in the operating cycle. E) a decrease in the average accounts payable balance.

23) A firm’s accounts receivable policy is generally set by the: A) purchasing manager. B) credit manager. C) controller. D) production manager. E) payables manager.

24) The manager typically responsible for applying payments to customers’ accounts is the: A) controller. B) payables manager. C) credit manager. D) purchasing manager. E) production manager.

25) The

is the length of time between the acquisition of inventory and the collection of

receivables. A) operating cycle B) inventory period C) accounts receivable period D) accounts payable period E) cash cycle

26) The A) B) C) D) E)

is the length of time between the acquisition and sale of inventory. operating cycle inventory period accounts receivable period accounts payable period cash cycle

27) The length of time between the sale of inventory and the collection of cash from receivables

is called the: A) operating cycle. B) inventory period. C) accounts receivable period. D) accounts payable period. E) cash cycle.

28) The length of time between the acquisition of inventory by a firm and the payment by the

firm for that inventory is called the: A) operating cycle. B) inventory period. C) accounts receivable period. D) accounts payable period. E) cash cycle.

29) The length of time between the payment for inventory and the collection of cash from

receivables is called the: A) operating cycle. B) inventory period. C) accounts receivable period. D) accounts payable period. E) cash cycle.

30) If the average accounts receivable that a firm holds decreases without any decrease in credit

sales, the operating cycle will: A) remain constant because sales remained constant. B) remain constant because the change will only affect the cash cycle. C) decrease because the days’ sales outstanding will decrease. D) increase because the accounts receivable turnover will decrease. E) decrease because the accounts receivable turnover will decrease.

31) Flexible short-term financial policies tend to: A) maintain low accounts receivable balances. B) support few investments in marketable securities. C) minimize the investment in inventory. D) maintain large cash balances. E) tightly restrict credit sales.

32) The short-term financial policy a firm adopts will be reflected in: A) the size of the firm’s investment in current assets. B) the financing of current assets. C) the financing of fixed assets. D) both the size and the financing of current assets. E) both the size and the financing of fixed assets.

33) Costs of the firm that rise with increased levels of investment in its current assets are called

costs. A) carrying B) shortage C) order D) safety E) trading

34) Costs of the firm that fall with increased levels of investment in its current assets are called

costs. A) carrying B) shortage C) debt D) equity E) payables

35) A restrictive short-term financial policy tends to: A) reduce future sales more than a flexible policy does. B) grant credit to more customers. C) incur more carrying costs than a flexible policy does. D) encourage credit sales over cash sales. E) reduce order costs as compared to a more flexible policy.

36) A firm that adopts a flexible short-term financial policy is more likely to have: A) lower carrying costs than shortage costs. B) lower shortage costs than carrying costs. C) stricter limits on credit sales than the average firm. D) a relatively low level of current assets. E) greater short-term financing needs than if the firm adopted a restrictive policy.

37) A flexible short-term financial policy: A) increases the likelihood that a firm will face financial distress. B) incurs an opportunity cost due to the rate of return that applies to short-term assets. C) advocates a smaller investment in net working capital than a restrictive policy does. D) increases the probability that a firm will earn high returns on all its assets. E) utilizes short-term financing to fund all the firm’s assets.

38) Noemi Swim Supply has a flexible short-term financing policy. Over the course of one year,

the firm should expect to have some months that allow it to: A) repay all its debts. B) invest in marketable securities. C) reduce its total costs below the firm’s normal minimum total cost point. D) finance all its assets with short-term loans. E) earn high returns on all its current assets.

39) Shortage costs include all the following except the: A) opportunity costs related to a low return on assets. B) order costs. C) disruption of production schedules. D) production setup costs. E) lost sales.

40) Given a flexible financing policy, a growing firm generally has a permanent requirement for: A) both current and long-term assets. B) long-term assets only. C) short-term debt only. D) both short- and long-term debt. E) current assets and short-term debt.

41) If a firm’s accounts receivable period is 30 days, it will collect payment for

sales

during the second quarter of a calendar year. A) December, January, and February B) January, February, and March C) February and March D) February, March, and April E) March, April, and May

42) Victory Marketing collects 30 percent of its sales in the month of sale, 55 percent in the

month following the month of sale, and 13 percent in the second month following the month of sale. Given this, the company will collect sales during the month of May. A) 30 percent of May B) 55 percent of March C) 13 percent of April D) 55 percent of May E) 13 percent of February

43) A manufacturing firm has a 90-day collection period. The firm produces seasonal

merchandise and thus has the least sales during the first quarter of the year and the highest level of sales during the third quarter of the year. The firm maintains a relatively steady level of production which means that its cash disbursements are approximately equal in all quarters. The firm is most apt to face a cash-out situation in: A) the first quarter. B) the second quarter. C) the third quarter. D) the fourth quarter. E) any quarter, equally.

44) A financially solid firm is most likely to have a quarterly cash shortfall when it encounters a: A) period of relatively constant sales. B) major fixed asset expenditure. C) period of rising interest rates. D) period of declining interest rates. E) period of increased cash collections.

45) Which one of the following statements is true? A) The cumulative finance surplus requirement is computed prior to adjusting for the

minimum cash balance. B) A financially sound firm will always have a positive quarterly net cash flow. C) A negative cumulative cash surplus indicates a borrowing need. D) Most firms plan on maintaining a zero cash balance. E) The minimum cash balance generally increases on a quarterly basis.

46) A cumulative cash deficit indicates a firm: A) has at least a short-term need for external funding. B) is facing long-term financial distress. C) will go out of business within the year. D) is capable of funding all its needs internally. E) is using its cash wisely.

47) A prearranged, short-term bank loan up to a specified limit, made on a formal or informal

basis, is called a: A) letter of credit. B) cleanup loan. C) compensating balance. D) line of credit. E) roll-over.

48) A fraction of the available credit on a loan agreement, deposited by the borrower in a low or

non-interest-bearing account is called a: A) compensating balance. B) cleanup loan. C) letter of credit. D) line of credit. E) roll-over.

49) A short-term loan that calls for the lender to hold the borrower's receivables as security is

called: A) B) C) D) E)

a compensating balance. assigned receivables financing. a letter of credit. factored receivables financing. a bond.

50) A type of short-term loan in which the borrower sells its receivables to the lender up-front,

but at a discount to face value, is called: A) a compensating balance. B) assigned receivables financing. C) a letter of credit. D) factored receivables financing. E) a bond.

51) A short-term loan which is secured by inventory that is held in trust is referred to as: A) a blanket inventory lien. B) a secured line of credit. C) a banker’s acceptance. D) a trust receipt financing arrangement. E) field warehousing financing.

52) The most common means of financing a temporary cash deficit is a: A) long-term secured bank loan. B) short-term secured bank loan. C) short-term issue of corporate bonds. D) long-term unsecured bank loan. E) short-term unsecured bank loan.

53) A compensating balance: A) requirement generally applies to inventory-type loans. B) is a means of paying for banking services received. C) requirement is generally set equal to one percent of the amount borrowed. D) decreases the cost of short-term bank financing. E) refunds a portion of the borrower’s interest if a loan is repaid early.

54) Which one of the following statements is correct? A) A farmer generally uses trust receipt financing to finance operations during the

growing season. B) An auto dealer is most apt to use purchase order financing. C) A drug store is most apt to use trust receipt financing. D) Trust receipt financing is most applicable to large, easily identifiable types of inventory. E) Blanket inventory lien financing is another term for purchase order financing.

55) Commercial paper is generally issued: A) by large firms. B) for 190 days or less. C) by commercial banks. D) for 90 to 180 days. E) at the prime rate offered by the firm’s bank.

56) Which party(parties) is(are) ultimately responsible for an invoice from a supplier that is

subject to a bankers’ acceptance? A) The bank which issued the acceptance B) The purchasing firm C) The investors who purchased the banker’s acceptance D) The vendor who issued the invoice E) Both the bank and the purchasing firm jointly

57) Sierra Shoes reported sales of $23,000 and cost of goods sold of $12,400 for the year. The

firm had a beginning inventory of $1,400 and an ending inventory of $1,000. What is the length of the inventory period? A) 19.2 days B) 35.3 days C) 67.7 days D) 70.7 days E) 1.9 days

58) Last year, Woodward’s had credit sales of $927,000 and cost of goods sold of $762,000. The

beginning of the year inventory was $138,000 and the end of the year inventory was $154,300. If the accounts receivables average $87,400, what is the operating cycle? A) 88.23 days B) 104.42 days C) 78.60 days D) 70.01 days E) 92.09 days

59) Plume has sales of $1.62 million with costs of goods sold equal to 78 percent of sales. The

average inventory is $369,000, accounts payable average $438,000, and receivables average $147,000. How long is the cash cycle? A) 13.19 days B) 13.30 days C) 17.29 days D) 7.54 days E) 11.77 days

60) Levy’s has sales of $23,000 and cost of goods sold equal to 54 percent of sales. The

beginning accounts receivable balance is $3,200 and the ending accounts receivable balance is $1,800. How long on average does it take the firm to collect its receivables? A) 9.2 days B) 40.0 days C) 39.7 days D) 92.0 days E) 33.6 days

61) Battisti Design-Build has credit sales of $2,414,000, costs of goods sold of $750,000, and

average accounts receivable of $728,000. How long does it take its credit customers to pay for their purchases? A) 110.1 days B) 3.3 days C) 84.7 days D) 33.2 days E) 12.1 days

62) Elevate has sales of $437,000 and average accounts payable of $44,000. The cost of goods

sold is equivalent to 44.6 percent of sales. How long does it take the firm to pay its suppliers? A) 4.4 days B) 36.8 days C) 5.5 days D) 82.4 days E) 202.1 days

63) Battle’s had an average accounts payable balance of $1,000,000. Sales for the period were

$13,900,000 and costs of goods sold were $8,600,000. If the operating cycle is 86 days, how long is the firm’s cash cycle? A) 13.3 days B) 128.4 days C) 76.8 days D) 59.2 days E) 43.6 days

64) A firm has inventory turnover of 15.7, receivables turnover of 20.2, and payables turnover of

14.6. How long is the cash cycle? A) 28.46 days B) 16.32 days C) 32.87 days D) 13.08 days E) 23.37 days

65) Kufour Marketing has an operating cycle of 54.7 days. It is planning some operational

changes that are expected to decrease the accounts receivable period by 3.2 days and decrease the inventory period by 1.9 days. Accounts payable turnover is expected to increase from 9 to 14 times per year. If all these changes are adopted, what will be the firm’s new operating cycle? A) 56.0 days B) 53.4 days C) 49.6 days D) 59.8 days E) 52.2 days

66) On average, Keely Boards sells its inventory in 37 days, collects on its receivables in 3.4

days, and takes 35 days to pay for its purchases. What is the length of the firm's operating cycle? A) −1.4 days B) 5.4 days C) 33.6 days D) 40.4 days E) 41.6 days

67) Dattam’s Market has an inventory period of 48.6 days, an accounts payable period of 36.2

days, and an accounts receivable period of 29.3 days. Management is considering offering a discount of 5 percent if its credit customers pay for their purchases within 10 days. This discount is expected to reduce the receivables period by 17 days. If the discount is offered, the operating cycle will decrease from days to days. A) 28.3; 11.3 B) 77.9; 60.9 C) 28.3; 45.3 D) 77.9; 94.9 E) 54.2; 37.2

68) Hasan’s has an inventory turnover rate of 16, an accounts payable period of 47 days, and an

accounts receivable period of 37 days. What is the length of the cash cycle? A) 32.81 days B) −6.00 days C) 2.00 days D) 6.00 days E) 12.81 days

69) Martinez Lighting has an inventory turnover of 15 and an accounts receivable turnover of 9.

The accounts payable period is 51 days. What is the length of the cash cycle? A) 13.89 days B) 14.07 days C) 14.23 days D) 18.79 days E) 23.00 days

70) A firm currently has a cash cycle of 36 days. Assume the firm changes its operations such

that it decreases its receivables period by 4 days, decreases its inventory period by 1 day, and decreases its payables period by 2 days. What will be the length of the cash cycle after these changes? A) 31 days B) 35 days C) 33 days D) 37 days E) 38 days

71) Castro & Kwon currently has a cash cycle of 43 days. Assume the firm changes its

operations such that it decreases its receivables period by 2 days, increases its inventory period by 1 day, and increases its payables period by 3 days. What will be the length of the cash cycle after these changes? A) 38 days B) 41 days C) 39 days D) 43 days E) 45 days

72) The inventory turnover for the Outriggers was 9.4 times and its days' sales in receivables was

46. What is the operating cycle given a 365-day year? A) 45.63 days B) 55.40 days C) 63.25 days D) 84.83 days E) 74.29 days

73) Gonzalez Mercantile has an inventory turnover of 8.3, days’ sales in receivables of 57, and an

average payables turnover of 7.2. What is the cash cycle given a 365-day year? A) 50.28 days B) 58.04 days C) 55.00 days D) 49.29 days E) 61.37 days

74) In 2021, Blossom had sales of $318,000, cost of goods sold of $249,000, and ending

inventory of $138,000. In 2022, sales were $349,000, cost of goods sold were $256,000, and ending inventory was $151,000. What was the inventory period in 2022? A) 194.01 days B) 216.99 days C) 231.09 days D) 206.03 days E) 189.42 days

75) In 2021, Trinh Products had sales of $438,000, cost of goods sold of $286,000, ending

inventory of $154,000, ending accounts receivable of $46,000, and ending accounts payable of $38,000. In 2022, sales were $413,000, cost of goods sold was $281,000, ending inventory was $149,000, ending accounts receivables were $48,000, and ending accounts payable were $36,000. What was the cash cycle in 2022 based on a 365-day year? A) 202.96 B) 190.27 C) 203.17 D) 185.87 E) 186.05

76) MacKenzies has an operating cycle of 112 days, a receivables period of 42 days, and a

payables period of 36 days. If the firm revises its credit policy, it believes it can reduce its receivables period by 4 days. Given this revision, what will be the firm’s cash cycle? A) 72 days B) 144 days C) 80 days D) 66 days E) 150 days

77) Martinique’s has a collection period of 60 days. Sales for the next calendar year are estimated

at $1,550, $1,230, $1,780 and $2,800, respectively, by quarter starting with the first quarter of the year. Given this information, which one of the following statements is correct? Assume a 30-day month. A) The firm will collect $1,133.33 in Quarter 2. B) The accounts receivable balance at the beginning of Quarter 4 will be $1,066.67. C) The firm will collect $593.33 from Quarter 2 sales in Quarter 3. D) The firm will have an accounts receivable balance of $1,866.67 at the end of the year. E) The firm will collect a total of $1,033.33 in Quarter 4.

78) The Cheung Company has a beginning receivables balance on January 1st of $930. Sales for

January through April are $970, $1,050, $1,330, and $1,460, respectively. The accounts receivable period is 36 days. How much did the firm collect in the month of March? Assume a 30-day month. A) $1,034 B) $1,316 C) $1,289 D) $1,350 E) $1,180

79) Chibuzor’s had sales of $2,380, $2,840, $4,430, and $4,480 for the months of January

through April, respectively. The accounts receivable period is 15 days. How much did the firm collect in the month of March? Assume a 30-day month. A) $2,215 B) $4,160 C) $3,635 D) $3,430 E) $1,420

80) Landplan has a beginning receivables balance on January 1st of $685. Sales for January

through April are $735, $690, $770, and $850, respectively. The accounts receivable period is 30 days. How much did the firm collect in the month of April? Assume a 30-day month. A) $735 B) $690 C) $730 D) $810 E) $770

81) Madison Cleaners has an accounts receivable period of 38 days. The estimated quarterly

sales for this year, starting with the first quarter, are $1,200, $1,400, $1,900, and $1,200, respectively. How much does the firm expect to collect in the fourth quarter? Assume a 30day month. A) $1,592.08 B) $1,604.44 C) $1,495.56 D) $1,509.11 E) $1,660.02

82) Tropic Palms expects credit sales of $980, $1,460, $1,730 and $950 for the months of April

through July, respectively. The firm collects 25 percent of sales in the month of sale, 65 percent of sales in the month following the month of sale, and 8 percent in the second month following the month of sale. The remaining sales are never collected. How much money does the firm expect to collect in the month of July? A) $1,645.50 B) $1,478.80 C) $1,571.10 D) $1,374.20 E) $1,475.50

83) Mercy Supply purchases its inventory one quarter prior to the quarter of sale. The purchase

price is 60 percent of the sales price. The accounts payable period is 45 days. The accounts payable balance at the beginning of Quarter 1 is $39,500. The expected sales are: Quarter 1 = $32,000; Quarter 2 = $34,500; Quarter 3 = $40,600; Quarter 4 = $50,200. What is the amount of the expected disbursements for Quarter 2? Assume a 30-day month. A) $19,280 B) $20,470 C) $22,530 D) $25,220 E) $19,950

84) Sunu Shipping has an accounts payable period of 60 days. The firm has expected sales of

$17,800, $22,100, $24,400 and $28,800, respectively, by quarter for the next calendar year. The purchases for a quarter are equal to 65 percent of the following quarter's sales. What is the amount of the projected cash disbursements for accounts payable for Quarter 3? Assume a 30-day month. A) $11,126.67 B) $16,813.33 C) $12,693.33 D) $17,125.50 E) $12,250.33

85) As of the beginning of the quarter, Tabitha Nursery had a cash balance of $326. During the

quarter the nursery paid suppliers $310, collected $418 on its accounts receivables, paid an interest payment of $32, and a tax bill of $184. In addition, the firm borrowed $80. What was the cash balance at the end of the quarter? A) $298 B) $267 C) $255 D) $272 E) $286

86) On April 1st, Morning Coffee had a beginning cash balance of $318. Sales for March were

$460 and April sales were $510. During April the firm had cash expenses of $327 and payments on accounts payable of $262. The accounts receivable period is 30 days. What is the firm’s beginning cash balance on May 1st? A) $189 B) $173 C) $211 D) $239 E) $210

87) Faizaan’s has a beginning cash balance of $536 on February 1st. The firm has projected sales

of $660 in January, $810 in February, and $890 in March. The cost of goods sold is equal to 70 percent of sales. Goods are purchased one month prior to the month of sale. The accounts payable period is 30 days and the accounts receivable period is 15 days. The firm has monthly cash expenses of $225. What is the projected ending cash balance at the end of February? Assume 30-day months. A) $437 B) $502 C) $479 D) $423 E) $486

88) Tabletop Events has a beginning cash balance of $27 and a net cash inflow for the quarter of

−$52. Company policy is to maintain a minimum cash balance of $20 and borrow only the amount that is necessary to maintain that balance. How much, if any, does the firm need to borrow this quarter? A) $17 B) $52 C) $45 D) $25 E) $0

89) Baxter Trucking has a net cash inflow for the quarter of $38 including interest, a beginning

cash balance of $22, and a beginning loan balance of $45. Company policy is to maintain a minimum cash balance of $20. What is the minimum amount the firm must borrow or can repay to end the month with a zero cumulative surplus? A) Borrow $4 B) Borrow $9 C) Repay $36 D) Repay $422 E) Repay $40

90) Xochitl Fabrics has a line of credit with a local bank for $250,000. The loan agreement calls

for interest of 7.6 percent with a compensating balance requirement of 5 percent, which is based on the total amount borrowed. What is the effective interest rate if the firm needed $138,000 for one year to cover its expansion costs? A) 8.55% B) 7.60% C) 8.13% D) 8.38% E) 8.00%

91) Pluto Company has arranged a line of credit of $225,000 with an interest rate of 8.25 percent

and a compensating balance requirement of 1.5 percent, which is based on the total amount borrowed. Assume the firm uses this source of funding to purchase a $167,000 piece of equipment and repays the loan in a lump sum at the end of one year. What is the effective interest rate? A) 9.75% B) 9.27% C) 8.08% D) 8.26% E) 8.38%

92) Midtown Bank has granted a line of credit of $80,000 with an interest rate of 7.5 percent and

a compensating balance requirement of 2.5 percent to Xu Pianos. The compensating balance requirement is based on the total amount borrowed. What is the effective annual interest rate if the firm needs $55,000 for one year to finance its inventory? A) 8.80% B) 9.44% C) 8.12% D) 7.69% E) 7.78%

93) In working capital management, there are some actions that increase or decrease cash. What

are some of the items that increase and decrease the cash account, respectively?

94) As the owner of Better Built Products, you plan to implement a system whereby customers

who pay their bills within 30 days will receive a rebate of 2 percent on their purchases. Those who pay within 5 days will receive a rebate of 3 percent. Explain the impact of this proposal on the firm.

95) Identify the three primary characteristics of a restrictive short-term financial policy.

96) List and describe three basic types of secured inventory loans. What are the advantages and

disadvantages of each type of loan?

97) Accounts receivable and inventory are some of the most liquid assets a firm owns and their

market values are typically fairly close to book value. Even so, in the eyes of many lenders, these assets make for inadequate collateral on loans, particularly if the business looking to borrow the money is in a liquidity crisis. Why do you think this is the case?

98) Compensating balances are often included as a requirement for a line of credit. These

balances provide income to banks but add to the cost of financing for the borrower. Why, then, would borrowers agree to such an arrangement?

Answer Key Test name: Chapter 26(1) 1) B 2) E 3) C 4) E 5) C 6) C 7) E 8) D 9) E 10) A 11) D 12) E 13) D 14) A 15) A 16) A 17) D 18) D 19) B 20) A 21) B 22) B 23) B 24) A 25) A 26) B 27) C 28) D 29) E 30) C 31) D 32) D 33) A 34) B 35) A 36) A 37) B

38) B 39) A 40) A 41) E 42) A 43) B 44) B 45) C 46) A 47) D 48) A 49) B 50) D 51) D 52) E 53) B 54) D 55) A 56) A 57) B 58) B 59) A 60) C 61) A 62) D 63) E 64) B 65) C 66) D 67) B 68) E 69) A 70) C 71) C 72) D 73) A 74) D 75) B 76) A 77) D

78) A 79) C 80) E 81) C 82) B 83) C 84) B 85) A 86) A 87) C 88) C 89) E 90) E 91) E 92) D 93) Essay 94) Essay 95) Essay 96) Essay 97) Essay 98) Essay

Student name: 1) Road Kill Restaurant had the following account balances. The change in these accounts

represents a net

of cash for the year in the amount of

Beginning Balance Accounts receivable Accounts payable Inventory

$ 29,400 42,140 21,460

Ending Balance $ 27,080 43,420 25,240

A) Source; $4,820 B) Use; $180 C) Source; $180 D) Source; $2,740 E) Use; 4,820

2) A company has an inventory period of 25.6 days, an accounts payable period of 37.7 days,

and an accounts receivable period of 32.0 days. What is the company's operating cycle? A) 95.3 days B) 31.3 days C) 57.6 days D) 19.9 days E) 44.1 days

3) Ives Corporation, has an inventory period of 21.7 days, an accounts payable period of 32.6

days, and an accounts receivable period of 29.2 days. What is the company's cash cycle? A) 18.3 days B) 40.1 days C) 50.9 days D) 83.5 days E) 25.1 days

4) You are researching a company and find that it has an inventory period of 23.7 days, an

accounts payable period of 42.9 days, and an accounts receivable period of 35.1 days. The company's cash cycle is days and its operating cycle is days. A) 31.5; 66.6 B) 58.8; 15.9 C) 66.6; 31.5 D) 78.0; 54.3 E) 15.9; 58.8

5) Stoney Brooke, Incorporated, has sales of $980,000 and cost of goods sold of $685,300. The

firm had a beginning inventory of $37,000 and an ending inventory of $52,000. What is the length of the inventory period? Assume 365 days per year. A) 23.38 days B) 19.44 days C) 16.57 days D) 19.71 days E) 23.70 days

6) On average, your firm sells $32,400 of items on credit each day. The average inventory

period is 28 days and your operating cycle is 48 days. What is the average accounts receivable balance? A) $1,296,000 B) $1,555,200 C) $648,000 D) $939,600 E) $907,200

7) Gibson's has sales for the year of $541,400, cost of goods sold equal to 78 percent of sales,

and an average inventory of $79,800. The profit margin is 8 percent and the tax rate is 40 percent. How many days, on average, does it take the company to sell an inventory item? Assume 365 days per year. A) 68.97 days B) 53.80 days C) 55.18 days D) 63.23 days E) 73.90 days

8) Mariota's has annual sales of $500,500 and cost of goods sold of $325,325. The beginning

accounts receivable was $44,100 and the ending receivables is $48,400. How many days on average does it take the company to collect its accounts receivable? Assume 365 days per year. A) 30.92 days B) 32.16 days C) 33.73 days D) 10.82 days E) 35.30 days

9) The Monster Truck operates several specialty vehicles that provide hot food and beverages

for firms that have workers employed in outlying regions. The company has annual sales of $625,400. Cost of goods sold average 32 percent of sales and the profit margin is 4.5 percent. The average accounts receivable balance is $34,700. On average, how long does it take the company to collect payment for its services? Assume 365 days per year. A) 18.56 days B) 20.25 days C) 16.71 days D) 18.02 days E) 17.76 days

10) The inventory turnover for Haute Hippie has gone from an average of 10.15 times to 10.90

times per year. How does this affect the inventory period? Assume 365 days per year. A) Decrease of 2.47 days. B) Increase of 2.27 days. C) Decrease of 2.27 days. D) Increase of 2.47 days. E) Decrease of 2.72 days.

11) Big Al's Meat Market has annual sales of $559,500 and cost of goods sold of $380,800. The

profit margin is 6.7 percent and the accounts payable period is 30.8 days. What is the average accounts payable balance? Assume 365 days per year. A) $29,455.49 B) $32,133.26 C) $36,723.73 D) $82,836.36 E) $34,428.49

12) Underground Funeral Services has annual sales of $865,700. The cost of goods sold is equal

to 72 percent of sales. The firm has an average accounts receivable balance of $84,000 and an average accounts payable balance of $72,000. How many days on average does it take the firm to pay its suppliers? A) 49.19 days B) 38.65 days C) 45.17 days D) 42.16 days E) 30.36 days

13) The Fried Green Tomatoes Restaurant has increased its operating cycle from 95.4 days to

99.7 days while the cash cycle has decreased by 1.9 days. How have these changes affected the accounts payable period? A) Decrease of 6.2 days B) Increase of 6.2 days C) Increase of 4.3 days D) Increase of 2.4 days E) Decrease of 2.4 days

14) Ferry's Furniture Outlet has an accounts receivable period of 49.76 days and an accounts

payable period of 37.87 days. The company turns over its inventory 5.29 times per year. What is the length of the company's operating cycle? Assume 365 days per year. A) 31.13 days B) 80.89 days C) 87.63 days D) 118.76 days E) 106.87 days

15) The Fried Green Tomatoes Restaurant has increased its operating cycle from 96.8 days to

101.1 days while the cash cycle has decreased by 2.6 days. How have these changes affected the accounts payable period? A) Increase of 1.7 days. B) Increase of 6.9 days. C) Decrease of 1.7 days. D) Increase of 4.3 days. E) Decrease of 6.9 days.

16) Carter's Gym Supply currently has an operating cycle of 72.84 days. The company has a goal

to increase its inventory turnover from 8.44 times to 9.58 times. What will the company's new operating cycle be if it can achieve this goal? Assume 365 days per year. A) 29.59 days B) 72.84 days C) 77.99 days D) 67.69 days E) 34.74 days

17) GPR, Incorporated, has an inventory turnover of 18.96 times, a payables turnover of 11.19

times, and a receivables turnover of 8.26 times. What is the length of the company's cash cycle? Assume 365 days per year. A) 30.82 days B) 96.06 days C) 16.03 days D) 57.56 days E) 44.19 days

18) ABC, Incorporated, has a beginning receivables balance on January 1st of $650. Sales for

January through April are $410, $440, $520 and $540, respectively. The accounts receivable period is 60 days. How much did the firm collect in the month of March? Assume that a year has 360 days. A) $540 B) $440 C) $520 D) $410 E) $650

19) Weisbro and Sons purchases its inventory one quarter prior to the quarter of sale. The

purchase price is 60 percent of the sales price. The accounts payable period is 60 days. The accounts payable balance at the beginning of Quarter 1 is $28,600. What is the amount of the expected disbursements for Quarter 2 given the following expected quarterly sales? Quarter 1: Quarter 2: Quarter 3: Quarter 4: A) B) C) D) E)

$ 81,000 $ 122,000 $ 114,000 $ 123,000

$65,400 $70,000 $71,600 $48,600 $73,400

20) Wigmore, Incorporated, has estimated sales of $13,400, $15,450, $16,940, and $15,100 for

each quarter next year, respectively. The accounts receivable period is 70 days. What is the expected accounts receivable balance at the end of the second quarter? Assume each month has 30 days. A) $12,016.67 B) $10,422.22 C) $13,175.56 D) $3,433.33 E) $3,764.44

21) Westmore Products has projected the following quarterly sales. The accounts receivable at

the beginning of the year is $420 and the collection period is 45 days. What are collections for the first quarter?

Sales A) B) C) D) E)

$ 695

$ 750

$ 835

$ 1,120

$695.00 $347.50 $767.50 $731.67 $651.67

22) Dora Distribution has projected the following quarterly sales. The accounts receivable at the

beginning of the year is $995 and the collection period is 60 days. What are collections for the first quarter? Q1 Sales

Q2 $ 1,635

Q3 $ 1,730

Q4 $ 2,045

$ 2,100

A) $1,540.00 B) $817.50 C) $1,635.00 D) $1,698.33 E) $1,812.50

23) Chasteen Hall currently has 52 days in its cash cycle and 126 days in its operating cycle. The

firm purchases its inventory from one supplier. This supplier has offered a 5 percent discount to the firm if it will pay for its purchases within 15 days instead of the normal 35 days. If the firm opts to take advantage of the discount offered, its new operating cycle will be days and its new cash cycle will be days. A) 126 days; 52 days B) 106 days; 106 days C) 106 days; 32 days D) 126 days; 72 days E) 146 days; 52 days

24) Dillingham, Incorporated, has a 60-day collection period. The projected sales for each

quarter next year are shown below. What are collections for the third quarter? Q1 Sales A) B) C) D) E)

Q2 $ 3,730

Q3 $ 4,335

Q4 $ 4,735

$ 5,235

$4,133.33 $3,156.67 $4,601.67 $4,468.33 $5,068.33

25) The Lumber Yard has projected the sales below for the next four months. The company

collects 33 percent of its sales in the month of sale, 48 percent in the month following the month of sale, 18 percent two months after the month of sale, and never collects 1 percent of its sales. How much will the company collect in April? January Sales A) B) C) D) E)

February

$ 138,500

March

$ 144,900

April

$ 151,975

$ 166,600

$150,928 $156,202 $155,393 $154,008 $119,704

26) Keedis Products has projected the following sales for the coming year: Q1 Sales

Q2 $ 16,850

Q3 $ 14,250

Q4 $ 15,075

$ 15,875

The company places orders each quarter that are 40 percent of the following quarter's sales and has a 60-day payables period. What is the payment of accounts for the second quarter? A) $5,700.00 B) $6,393.33 C) $5,920.00 D) $4,020.00 E) $5,810.00

27) JoAnn Manufacturing has projected the following sales for the coming year: Q1 Sales

Q2 $ 55,125

Q3 $ 62,475

Q4 $ 70,425

$ 76,250

The company places orders each quarter that are 40 percent of the following quarter's sales and has a 30-day payables period. What is the payment of accounts for the third quarter? A) $29,723.33 B) $27,110.00 C) $26,050.00 D) $28,946.67 E) $30,466.42

28) The company places orders each quarter that are 54 percent of next quarter's sales and has a

30-day payables period. The projected sales for next year are: Q1 Sales

Q2 $ 54,075

Q3 $ 60,725

Q4 $ 69,375

$ 74,850

What is the accounts payable balance at the end of the second quarter? A) $21,861 B) $17,174 C) $12,488 D) $24,975 E) $10,931

29) All That Remains Products has projected sales for next year of: Q1 Sales

Q2 $ 77,700

Q3 $ 81,050

Q4 $ 87,350

$ 95,520

The company places orders each quarter that are 69 percent of the following quarter's sales and has a 60-day payables period. What is the accounts payable balance at the end of the third quarter? A) $20,091 B) $43,939 C) $18,642 D) $32,015 E) $21,970

30) A company has a collection period of 33 days and factors all receivables immediately at a

discount of 2.3 percent. What is the effective annual cost of borrowing? Assume 365 days per year. A) 28.60 percent B) 27.01 percent C) 26.04 percent D) 29.35 percent E) 25.42 percent

31) Franklin, Incorporated, has an inventory turnover of 20.5 times, a payables turnover of 11.7

times, and a receivables turnover of 10.5 times. What is the company's cash cycle? Assume 365 days per year. A) 48.15 days B) 14.24 days C) 21.37 days D) 42.80 days E) 24.42 days

32) Gifts For All has projected sales for next year of: Q1 Sales

Q2 $ 27,400

Q3 $ 29,600

Q4 $ 37,000

$ 43,900

Purchases are equal to 53 percent of next quarter's sales. Each month has 30 days, the accounts receivable period is 30 days, and the accounts payable period is 33 days. How much will the company pay suppliers in the third quarter? A) $20,951 B) $18,172 C) $21,926 D) $22,048 E) $15,722

33) The Cookie Shop's purchases are equal to 58 percent of the following month's sales. The

accounts payable period for purchases is 30 days while all other expenditures are paid in the month they are incurred. Assume each month has 30 days. The company has compiled the following information. April Sales Other expenses Interest and taxes

May

$ 9,100 3,125 580

June $ 9,400 3,175 590

$ 9,800 3,425 610

What are the company's total cash disbursements for May? A) $9,719 B) $9,043 C) $8,983 D) $9,449 E) $9,217

34) The York Company has arranged a line of credit that allows it to borrow up to $59 milion at

any time. The interest rate is .635 percent per month. Additionally, the company must deposit 5 percent of the amount borrowed in a non-interest bearing account. The bank uses compound interest on its line-of-credit loans. What is the effective annual rate on this line of credit? A) 7.29% B) 7.89% C) 8.31% D) 9.23% E) 6.68%

35) Yoo, Incorporated, has arranged a line of credit that allows it to borrow up to $62 million at

any time. The interest rate is .638 percent per month. Additionally, the company must deposit 4 percent of the amount borrowed in a non-interest bearing account. The bank uses compound interest on its line-of-credit loans. If the company needs $38 million for 7 months, how much will it pay in interest? A) $2,002,210.32 B) $1,729,909.72 C) $1,092,574.56 D) $1,801,989.29 E) $1,411,242.14

36) Your company has arranged a revolving credit agreement for up to $84 million at an interest

rate of 1.53 percent per quarter. The agreement also requires your company to maintain a compensating balance of 6 percent of the unused portion of the credit line, to be deposited in a non-interest bearing account. Your company's short-term investment account at the same bank pays an interest rate of .67 per quarter. What is the effective annual interest rate if your company does not use the revolving credit arrangement during the year? A) 2.98% B) 2.71% C) 3.40% D) 3.97% E) 6.26%

37) Your company has arranged a revolving credit agreement for up to $71 million at an interest

rate of 1.40 percent per quarter. The agreement also requires your company to maintain a compensating balance of 5 percent of the unused portion of the credit line, to be deposited in a non-interest bearing account. Your company's short-term investment account at the same bank pays an interest rate of .54 per quarter. What is the effective annual interest rate if your company borrows $36 million for one year? A) 5.72% B) 6.41% C) 7.32% D) 6.27% E) 5.82%

38) Your company has agreed to a $350 million fixed-commitment line of credit. The loan

agreement calls for your company to pay 1.42 percent per quarter on any funds borrowed and maintain a 3 percent compensating balance on any funds borrowed at zero percent interest. What is the effective annual interest rate on this line of credit? A) 5.16% B) 5.80% C) 5.89% D) 5.98% E) 4.97%

39) Denver's Designs had sales for the year of $678,500 and cost of goods sold equal to 64

percent of sales. The inventory at the beginning of the year was $121,300 and the end-of-year inventory was $137,000. What was the inventory turnover? A) 3.17 times B) 3.58 times C) 3.36 times D) 2.77 times E) 5.25 times

40) Cloche's Hats had sales for the year of $653,700 and cost of goods sold equal to 72 percent of

sales. The inventory at the beginning of the year was $114,100 and the end-of-year inventory was $128,200. What was the company's inventory period? Assume 365 days in a year. A) 88.48 days B) 85.67 days C) 99.42 days D) 82.85 days E) 93.95 days

41) McCallister's just purchased $17,000 worth of inventory. The terms of the sale were 3/10, net

45. What is the implicit interest? A) $510 B) $542 C) $574 D) $459 E) $476

42) Your firm is offered credit terms of 2/20, net 60. What is the effective annual interest rate on

this arrangement? Assume 365 days in each year. A) 20.24% B) 16.43% C) 17.34% D) 21.79% E) 18.25%

43) Cosplay Unlimited sells 960 outfits per year at an average price of $152. The terms of the

sale are 2/15, net 40. The discount is taken by 78 percent of customers. What is the company's accounts receivable balance? Assume 365 days per year. A) $7,118.05 B) $8,195.51 C) $15,991.23 D) $7,656.78 E) $17,590.36

44) Cat Supplies offers terms of 2/15, net 40. The discount is taken by 77 percent of customers.

What is the company's average collection period? A) 20.75 days B) 24.13 days C) 27.50 days D) 19.52 days E) 17.59 days

45) Black Guard Security has annual sales of $391,000 and a collection period of 21.55 days.

What is the company's average balance in accounts receivable? Assume 365 days per year. A) $23,854.57 B) $17,625.46 C) $18,143.85 D) $20,614.46 E) $23,085.07

46) Silver Eyes, Incorporated, has an average collection period of 23.57 days and its average

daily accounts receivable is $353,000. What are the company's annual credit sales assuming 365 days per year? A) $7,348,886.64 B) $6,377,563.29 C) $6,073,869.80 D) $5,466,482.82 E) $8,320,210.00

47) A company has annual sales of $5,270,000 and its average daily accounts receivable is

$379,000. What is the average days' sales in receivables? Assume 365 days per year. A) 26.25 times B) 29.17 times C) 30.62 times D) 22.26 times E) 13.91 times

Answer Key Test name: Chapter 26(2) 1) B 2) C 3) A 4) E 5) E 6) C 7) A 8) C 9) B 10) A 11) B 12) D 13) B 14) D 15) B 16) D 17) A 18) D 19) C 20) A 21) C 22) A 23) D 24) D 25) D 26) E 27) A 28) C 29) B 30) D 31) C 32) C 33) E 34) C 35) D 36) B 37) E

38) D 39) C 40) E 41) A 42) A 43) B 44) A 45) E 46) D 47) A

Chapter 27: 1) Financial managers frequently broaden their definition of cash to include: A) currency, bank checking accounts, as well as stock and bond investments. B) currency, bank checking accounts, and bond investments. C) cash, bond investments, bank checking accounts, and short-term marketable

securities. D) currency, bank checking accounts, and short-term marketable securities. E) cash and bank accounts only.

2) Determining the appropriate cash balance for a firm involves assessing the trade-off between: A) income and diversification. B) the benefits and costs of liquidity. C) balance sheet strength and transaction needs. D) short-term and long-term investment returns. E) cash needs and cash preferences.

3) An appropriate cash balance is reached when the: A) interest on any marketable security is maximized. B) interest foregone from not investing in Treasury bills is minimized. C) value of cash liquidity equals interest foregone on an equivalent amount of Treasury

bills. D) liquidity value is greater than the interest foregone on an equivalent amount of Treasury bills. E) balance is maintained at a zero level.

4) If all outgoing cash transactions could be

, firms would not need to hold any cash

for transaction purposes. A) greater than total cash inflows B) less than total cash inflows C) separated from all incoming transactions D) perfectly synchronized with cash inflows E) performed electronically

5) Firms hold cash to satisfy the transaction motive. This means that cash is held to: A) fulfill disbursement requirements for normal operations only. B) balance the flow between cash inflows and outflows only. C) meet unexpected emergency cash needs. D) fulfill disbursement requirements for normal operations, and balance the flow

between cash inflows and outflows. E) offset fees that would otherwise be charged by the firm’s bank.

6) Firms hold cash, in part, to satisfy compensating balance requirements. Compensating

balances are cash balances held at: A) the firm, in excess of its transactions needs. B) the firm, that are below that of its transactions needs. C) the firm, in excess of its cash inflows. D) commercial banks to pay implicitly for bank services. E) commercial banks as emergency funds.

7) The cost of holding cash: A) is the opportunity cost of the lost investment income. B) is zero because it is the most liquid asset a firm can hold. C) decreases as cash holdings increase. D) increases as market rates decline. E) is irrelevant in today’s electronic world.

8) Most large firms hold a larger cash balance than most models imply because: A) it is too difficult to estimate the costs of security transactions. B) banks are compensated by account balances for payment of services. C) corporations have few bank accounts and it is difficult to manage their cash. D) cash is costless and need not be managed closely. E) the costs of holding cash for these firms is negligible.

9) The difference between available cash and book cash is called: A) float. B) disbursement float. C) surplus. D) collection float. E) the net deficit.

10) All the following actions can create disbursement float except the: A) payment of wages. B) payment for raw materials. C) disbursement of funds to a supplier. D) distribution of cash dividends. E) sale of an asset.

11) Checks written by a firm are said to generate A) collection B) ledger C) disbursement D) book E) accounting

float.

12) When a firm writes a check, there is an immediate decrease in the

immediate change in the A) bank; collected B) ledger; book C) bank; ledger D) book; bank E) available; book

balance, but no

balance.

13) Collection float increases: A) as disbursement float decreases. B) the bank balance. C) the book balance. D) the collected balance. E) both book and bank balances.

14) Net collection float means the: A) book balance is greater than the ledger balance. B) available balance is less than the book balance. C) disbursement float equals the book cash. D) disbursement float exceeds the collection float. E) collection float equals the disbursement float.

15)

With respect to float management, which one of the following statements is true? A) Float management is the practice of speeding up the disbursement of cash. B) An objective of float management is the elimination of disbursement float. C) An objective of float management is to reduce float by reducing sales. D) Firms prefer net disbursement float over net collection float. E) Float management is no longer needed.

16) Average daily float equals: A) Average daily receipts/Weighted average delay. B) Annual sales/365. C) Total receipts/Total days. D) Total float × Total days. E) Average daily receipts × Weighted average delay.

17) Collection float includes: A) availability delay and processing delay only. B) billing time, mailing time, processing delay, and availability delay. C) mailing time, processing delay, and availability delay. D) availability delay only. E) mailing time and processing delay only.

18) Which one of the following products probably has reduced collection time the most? A) Traditional lockboxes B) Concentration accounts C) Financial EDI D) Zero-balance accounts E) Depository transfer checks

19) Lockboxes can reduce A) availability B) mailing C) in-house processing D) disbursement E) clearing

float by being located close to the source of payment.

20) The fastest but most expensive way for a firm to transfer surplus funds from the local deposit

bank to the concentration bank is: A) a depository transfer check. B) a cashier’s check. C) a wire transfer. D) the firm’s in-house transfer system. E) an automated clearinghouse transfer.

21) Which one of the following parties deposits the checks into the payee’s account when those

checks are mailed to a traditional lockbox? A) Any postal employee B) A specially designated postal employee C) A bank employee D) The payee E) The payers

22) One primary reason concentration bank accounts are established is to: A) reduce default risk. B) increase disbursement float. C) control disbursements for a specific purpose. D) pool funds. E) replace traditional lockboxes.

23) With respect to a lockbox system of cash collections, which one of the following statements

is correct? A) Mailing time is reduced while the collection time remains constant. B) Electronic lockboxes have totally replaced traditional lockbox systems. C) Checks can be deposited prior to the payments being applied to the customers’ accounts. D) Mailing time is reduced but the processing delay is increased. E) Checks are held by the bank until the payee firm approves them to start the checkclearing process.

24) With respect to zero-balance accounts, which one of the following statements is false? A) Zero-balance accounts are set up to process disbursements only. B) Each zero-balance account maintains a minimal level of safety stock. C) Funds are automatically transferred into the zero-balance account as checks are

presented for payment. D) Zero-balance accounts are frequently used for payroll disbursements. E) The master and the zero-balance accounts are frequently located within the same bank.

25) Which one of the following practices is the best means of managing disbursements from an

ethical, business, and economic point of view? A) Purposely mailing checks without a signature as a means of delaying payment B) Delaying paying suppliers until 30 days past the due date of each invoice C) Purposely mailing payments to suppliers from locations that maximize mailing time D) Taking early payment discounts while paying bills after their due dates E) Funding your bank account with the minimum amount needed to pay bills in a timely manner

26) If a firm has seasonal sales, then it is highly likely the firm will: A) hold extra excess cash throughout the year. B) borrow short term for part of the year and invest in marketable securities the rest of

the year. C) never be able to invest any excess funds. D) continually have short-term loans outstanding. E) have less volatile cash flows than a comparable firm with constant sales.

27) Short-term marketable securities generally have: A) high maturity risk. B) little, if any, marketability. C) significant default risk. D) a high level of liquidity. E) maturities between one and two years.

28) Money market securities are best defined as securities: A) purchased through a bank. B) that are risk-free. C) with maturities of one year or less. D) that are purchased with cash and held until maturity. E) that are held for one week or less.

29) Which one of the following securities is a money-market security that has limited

marketability? A) Jumbo certificates of deposit (CD’s) B) Commercial paper C) Common stock D) U.S. Treasury bills E) Ordinary preferred stock

30) Money market preferred stock offers competitive rates of return similar to traditional money-

market instruments but: A) forfeits the tax benefits normally provided to corporate shareholders. B) still provides the corporate investor with the tax exclusion on dividend income. C) has a fixed rate of dividend income. D) is only an overnight investment. E) has highly volatile stock prices due to the fixed coupon.

31) Probably the most sensible cash management policy would be to maintain: A) sufficient cash on hand to meet all ordinary business needs plus some excess cash to

invest in marketable securities as a precautionary measure. B) about 90 percent of the firm’s ordinary cash needs in cash and delay payment on the remaining 10 percent. C) enough cash on hand to meet any potential demand for cash. D) a zero-cash balance and transfer funds semi-monthly to pay bills. E) twice the amount of cash on hand that would be typically indicated based on the firm’s normal cash flows.

32) U.S. Treasury bills: A) are subject to the same risks as short-term tax exempts. B) all have initial maturities of 90 days or less. C) are issued for time periods as short as one week. D) must be held to maturity and may not be resold. E) are sold at weekly auctions.

33) Which one of the following money market securities generally has the shortest life? A) Repurchase agreements B) Jumbo certificates of deposit C) Money market preferred stock D) Commercial paper E) U.S. Treasury bills

34) The 2017 Tax Cuts and Jobs Act set the dividend exclusion for dividend income received by

corporate shareholders at A) 50 B) 0 C) 25 D) 70 E) 33

percent (or more).

35) Which one of the following is the most marketable and has the least default risk? A) Money market preferred stock B) Commercial paper C) Municipal bonds D) Repurchase agreements E) U.S. Treasury bills

36) On an average day, Amaranth writes checks totaling $3,000. These checks take an average of

4 days to clear. Also on an average day, Amaranth receives checks totaling $3,500 which take 2 days to clear. The cost of debt is 6.8 percent. What is the firm’s disbursement float? A) −$7,000 B) −$5,000 C) $12,000 D) $5,000 E) $7,000

37) This morning, Pineapple Hospitality had both a book and a bank balance of $1,500. Today,

the firm received 20 checks from customers that averaged $110 each. The funds from these checks will be delayed by one day, which will cover both the processing and availability delays. Wilson's also received $4,000 of payments from customers who are billed and pay electronically. The electronic payments are available immediately. What is the firm's collection float as of the end of this day? A) −$6,200 B) −$2,200 C) −$1,200 D) −$1,800 E) −$3,700

38) Varela Bikes has a checkbook balance of $107,232. This morning, the firm’s account balance

on the bank’s website is $131,318. What is the net float? Is it a collection float or a disbursement float? A) −$24,086; collection float B) −$24,086; disbursement float C) $24,086; collection float D) $24,086; disbursement float E) $0; neither collection nor disbursement float

39) The average daily receipts at Bailey Hardware are $4,320. These receipts are available, on

average, after 1.5 days. What is the NPV of eliminating the float if the cost to do so is $2,600? A) $3,880 B) $1,720 C) $2,580 D) $6,480 E) $4,320

40) Avery Timekeeping receives four checks per month. The amounts of the checks and their

respective processing and availability delays are as follows:

Check 1 Check 2 Check 3 Check 4

Amount

Average Delay

$ 1,500 $ 2,500 $ 1,000 $ 3,000

1.2 days 2.4 days 1.6 days 2.5 days

What is the weighted average delay? A) 1.96 days B) 1.93 days C) 2.03 days D) 2.11 days E) 2.07 days

41) Dog Trainingby Marissa receives the same checks each month from its customers. Of these

monthly checks, 48 are for $82.60 each, 15 are for $71.50 each, and 9 are for $40.70 each. The delay for the $82.60 checks is 1.8 days, for the $71.50 checks 1.1 days, and for the $40.70 checks 1.3 days. Calculate the average daily float. Assume a 30-day month. A) $293.09 B) $287.46 C) $309.10 D) $299.47 E) $358.02

42) Melgar Engineering receives three checks per month. The first check is for $194,000 and

takes two days to clear. The second check is for $318,000 and clears in one day. The third check is for $38,000 and clears in 2.5 days. What is the weighted average delay, the average daily receipts, and the average daily float? Assume a 30-day month. A) 1.83 days; $16,667; $23,333 B) 1.46 days; $18,667; $27,333 C) 1.83 days; $18,447; $26,700 D) 1.46 days; $18,333; $26,700 E) 1.51 days; $18,447; $27,800

43) Schnee Ice Cream receives three checks per month. The first check averages $842,000 and

clears in 1.2 days. The second check averages $318,000 and clears in .7 days. The third check averages $465,000 and clears in 2 days. What is the average daily float? Assume a 30day month. A) $69,600 B) $72,100 C) $73,600 D) $74,500 E) $68,900

44) Maatz Fitness just received a check from a customer for $1,289 that it has recorded in its

checkbook but has not yet deposited this check into the bank. After recording this check, the firm has a bank balance of $16,218 and a book balance of $16,309. All the firm's other deposits have cleared and those funds are currently available. What is the amount of the disbursement float? A) $91 B) $246 C) $1,198 D) $2,487 E) $1,807

45) Weng Window Treatments receives five checks per month. These checks average $811,

$416, $6,420, $22,900, and $8,700. The three larger sized check amounts are available after 1.5 days while the two smaller check amounts are available after one day. What is the weighted average delay? A) 1.48 days B) 1.39 days C) 1.46 days D) 1.37 days E) 1.00 day

46) Fly-By-Night Airlines currently has $2.4 million on deposit with its bank. It also has a book

balance of $2.4 million. What will be its bank and book balances as soon as it writes a check for $1.1 million to pay its fuel bill? A) $2.4 million; $1.3 million B) $2.4 million; $2.4 million C) $1.3 million; $2.4 million D) $1.3 million; $1.3 million E) $1.85 million; $1.85 million

47) During the month, May Electric receives four checks in the amounts of $100, $325, $200,

and $500, respectively. They are delayed for 1.6 days, 2.1 days, 2.6, and 1 day, respectively. What is the average daily collection float? Assume a 30-day month. A) $74.93 B) $63.80 C) $62.08 D) $59.47 E) $68.15

48) The Mesa Bank is offering your firm the free use of their lockbox services. They estimate

that you can reduce your average mail time by 2 days and they can save you a combined clearing and processing time of 1.5 days by putting the checks into the clearing system sooner. Your firm receives 320 checks a day with an average value of $2,500 each. The current T-Bill rate is .015 percent per day. Assume a 365-day year. What is the annual amount of income your firm can earn if it installs this service? A) $15,300 B) $14,800 C) $16,400 D) $153,300 E) $148,700

49) Prime Bank is offering your company the use of their lockbox services. They estimate that

you can reduce your average mail time by 1.5 days and they can save you a combined clearing and processing time of 1 day by putting the checks into the clearing system sooner. Your firm receives 198 checks a day with an average value of $2,300 each. The current TBill rate is .011 percent per day. Assume a 365-day year. Prime Bank will charge your firm an annual fee of $27,500 plus $.20 per check. What is the annual net savings from installing this system? A) $4,115.36 B) $3,480.00 C) $2,816.00 D) $3,756.78 E) $4,108.29

50) Community Financial provides lockbox services. They estimate that your firm can reduce its

average collection mail time by 1.6 days and the clearing and processing time by 1.2 days by implementing their system. Your firm receives 74 checks a day with an average value of $9,750 each. The current T-Bill rate is .014 percent per day. Assume a 365-day year. What is the net amount of annual income your firm can earn if it installs this service at an annual cost of $48,000? A) $65,675.00 B) $62,640.00 C) $56,408.17 D) $55,232.22 E) $58,746.20

51) Center Bank provides lockbox services. They estimate that you can reduce your average mail

time by 2.2 days and your combined clearing and processing time by .75 days by implementing their system. Your firm receives 65 checks a day with an average value of $298 each. The current T-Bill rate is .01 percent per day. Assume a 365-day year. The bank will charge your firm $.15 per check. What is the annual net savings from installing this system? A) $1,215.84 B) −$1,022.15 C) $548.32 D) −$1,473.09 E) $718.28

52) Uptown Bank provides lockbox services. They estimate that you can reduce your average

mail time by 1.6 days and your combined clearing and processing time by .5 days by implementing their system. Your firm receives 654 checks a day with an average value of $975 each. The current T-Bill rate is .009 percent per day. Assume a 365-day year. The bank will charge your firm $.17 per check. What is the net present value from installing this system? A) $105,215.84 B) $100,022.15 C) $98,548.32 D) $103,731.67 E) $102,718.28

53) The net float of a firm is made up of disbursement float and collection float. Identify and

describe the components of both disbursement and collection float.

54) Explain repurchase agreements and the role they can play in a firm’s everyday operations.

55) Explain why money market preferred stock appeals to corporations.

Answer Key Test name: Chapter 27(1) 1) D 2) B 3) C 4) D 5) D 6) D 7) A 8) B 9) A 10) E 11) C 12) D 13) C 14) B 15) D 16) E 17) A 18) C 19) B 20) C 21) C 22) D 23) C 24) B 25) E 26) B 27) D 28) C 29) B 30) B 31) A 32) E 33) A 34) A 35) E 36) C 37) B

38) D 39) A 40) D 41) A 42) D 43) B 44) C 45) A 46) A 47) C 48) D 49) D 50) D 51) D 52) D 53) Essay 54) Essay 55) Essay

Student name: 1) At the beginning of the day, a company had a ledger balance and available balance of $3,860.

During the day, the company wrote three checks for $310, $675, and $935. The company also deposited checks for $465 and $890. What is the company's collection float? A) $565 B) $1,355 C) $3,275 D) $2,505 E) $1,920

2) On an average day, a company writes 61 checks worth a total of $8,250 that clear in 2.75

days. The company also collects 73 checks worth a total of $10,590 that clear in 2.25 days. What is the company's average collection float? A) $18,840 B) $22,688 C) $8,250 D) $10,590 E) $23,828

3) Madison Corner writes 30 checks a day for an average amount of $497 each. These checks

generally clear the bank 3 days after they are written. In addition, the firm generally receives 67 checks with an average amount of $562 each. Deposited amounts are available after an average of 2.5 days. What is the amount of the firm's collection float? A) $94,135 B) $14,910 C) $37,654 D) $49,405 E) $44,730

4) At the beginning of the day, a company has a cash balance of $11,300 and no float. During

the day, the company wrote three checks for $610, $945, and $1,310. The company also deposited checks for $1,175 and $1,820. What is the company's disbursement float? A) $130 B) $5,860 C) $2,865 D) $2,995 E) $8,305

5) On an average day, a company writes 40 checks worth a total of $5,975 that clear in 3.5 days.

The company also collects 62 checks worth a total of $8,040 that clear in 3 days. What is the company's average disbursement float? A) $5,975 B) $24,120 C) $8,040 D) $16,080 E) $20,913

6) Marston Corporation writes 49 checks a day for an average amount of $482 each. These

checks generally clear the bank 3 days after they are written. In addition, the firm generally receives 61 checks with an average amount of $565 each. Deposited amounts are available after an average of 2.5 days. What is the firm's disbursement float? A) $23,618 B) $70,854 C) $15,309 D) $86,163 E) $34,465

7) On a typical day, a company writes 49 checks worth a total of $8,750 that clear in 3.25 days.

The company also collects 61 checks worth a total of $9,990 that clear in 2.75 days. Is this a collection or disbursement float? What is the amount of the float? A) A disbursement float of $965 B) A disbursement float of $1,240 C) A collection float of $1,122 D) A collection float of $1,240 E) A collection float of $965

8) On a typical day, a company writes 79 checks worth a total of $10,680 that clear in 2.25

days. The company also collects 92 checks worth a total of $14,740 that clear in 1.75 days. Is this a collection or disbursement float? What is the float value? A) A disbursement float of $4,060 B) A disbursement float of $1,765 C) A collection float of $1,765 D) A collection float of $4,060 E) A collection float of $1,922

9) Ellcrys Corporation writes 55 checks a day for an average amount of $473 each. These

checks generally clear the bank 3.25 days after they are written. In addition, the firm generally receives 52 checks with an average amount of $526 each. Deposited amounts are available after an average of 2.75 days. Is this a disbursement or collection float? What is the value of the float? A) A collection float of $9,331 B) A disbursement float of $7,184 C) A collection float of $11,126 D) A disbursement float of $9,331 E) A disbursement float of $11,126

10) Shannara Manufacturing writes 28 checks a day for an average amount of $489 each that

generally clear 2.5 days after they are written. In addition, the firm generally receives 36 checks each day with an average amount of $550 each that are available after 2 days. Is this a collection or disbursement float? What is the amount of the float? A) A collection float of $7,165 B) A collection float of $5,370 C) A disbursement float of $7,165 D) A disbursement float of $5,370 E) A collection float of $6,264

11) Hoyes Lumber generally receives three checks per month. A check for $12,320 clears in 4

days, a check for $6,850 clears in 3 days, and a check for $8,010 clears in 2 days. Assuming 30 days in each month, what is the average daily float? A) $302.00 B) $906.00 C) $2,464.33 D) $2,861.67 E) $2,679.33

Answer Key Test name: Chapter 27(2) 1) B 2) E 3) A 4) C 5) E 6) B 7) A 8) C 9) D 10) B 11) D

Chapter 28: 1) Selling goods and services on credit is: A) an investment in a customer. B) never necessary unless customers cannot pay for the goods. C) a decision independent of customers. D) permissible only if your bank lends the money. E) never a wise decision.

2) When one firm grants credit to another firm, a(n) _ A) account receivable; consumer credit. B) credit due; an installment note. C) account receivable; trade credit. D) trade receivable; an installment note. E) trade receivable; a secured loan.

is created, which is called:

3) The average is called the average collection period. A) time necessary to collect a credit sale B) number of customers per day who charge their purchases C) time for a credit customer to return to make a second purchase D) number of times a credit customer charges a purchase during a year E) number of items purchased in each credit transaction

4) The three components of credit policy are: A) collection policy, credit analysis, and interest rate determination. B) collection policy, credit analysis, and terms of the sale. C) collection policy, interest rate determination, and repayment analysis. D) credit analysis, repayment analysis, and terms of the sale. E) interest rate determination, repayment analysis, and terms of sale.

5) Credit analysis is best described as the process of: A) collecting an accounts receivable. B) determining the optimal credit terms. C) establishing the length of the credit period. D) setting the amount of discount to be granted. E) determining the probability that a customer will not pay.

6) Seasonal dating is used to promote sales during the off-season. This process involves: A) extending the credit period until after the season ends. B) extending both the discount period and the credit period by two months. C) accepting orders early but withholding shipment until the peak season. D) accepting orders early but dating the invoice when the goods are actually shipped. E) dating an invoice at a later date than when the goods are shipped.

7) If a customer is extended credit terms of 1/5, net 15, it means the customer has been granted

a: A) B) C) D) E)

1/5 percent discount for paying within 15 days. five percent discount for paying the next day. total credit period of 20 days. credit period of 10 days. one percent discount for paying within five days.

8) The credit period begins on the: A) shipping date. B) purchase order date. C) shipping arrival date. D) order process date. E) invoice date.

9) On June 1, a firm invoices a customer and offers terms of 2/10 net 30. The customer: A) must pay a penalty of 2/10 of one percent if payment is made later than July 1. B) must pay a penalty of 10 percent if payment is made later than 2 days after July 1. C) receives a discount of 2 percent if payment is made at least 10 days prior to July 1. D) receives a discount of 2 percent if payment is made on June 1 and pays a penalty of

10 percent if payment is made after July 1. E) receives a discount of 2 percent if payment is made within 10 days.

10) The length of the credit period offered by a firm is influenced by all of the following factors

except the: A) level of consumer demand. B) buyer’s operating cycle. C) standardization of the goods being sold. D) FTC guidelines for trade credit. E) customer type.

11) Seasonal dating of accounts receivable: A) is used by all firms that grant credit. B) sets the first date of the relevant season as the final due date for an invoice for

seasonal goods. C) sets a relevant seasonal date as the invoice date for an earlier order. D) refers to firms that invoice every quarter for sales made in the prior three months. E) requires all purchasers of seasonal goods to have their purchases paid by the end of the prior season.

12) With regard to considerations firms use when establishing a credit policy, which one of the

following statements is false? A) A firm that supplies a perishable product will tend to offer restrictive credit terms. B) A firm whose customers are in a high-risk business will tend to offer restrictive credit terms. C) Lengthening the credit period effectively reduces the price paid by the customer. D) Small accounts, associated with firms that find it difficult to acquire a line of credit, tend to receive longer credit periods. E) Larger accounts tend to receive more favorable credit terms.

13) The upper limit to the credit period is best expressed as the length of the: A) seller’s operating cycle. B) seller’s cash cycle. C) seller’s payables period. D) buyer’s operating cycle. E) buyer’s cash cycle.

14) Cash discounts: A) increase the amount of credit offered. B) increase profit margins on sales. C) speed up the collection of receivables. D) were first offered in the early 1900s. E) are a cost-free means of increasing sales.

15) With an open account the formal instrument of credit is the: A) purchase order. B) invoice. C) promissory note. D) banker’s acceptance. E) secured loan document.

16) Which one of the following statements is true regarding promissory notes? A) Most trade credit arrangements use promissory notes. B) Promissory notes are used when firms do not anticipate a problem with collections. C) Promissory notes usually involve no cash discount. D) A promissory note must be signed and delivered prior to goods being shipped. E) Promissory notes are used for small orders only.

17) A commercial draft typically: A) specifies the payment amount and payment due date. B) specifies that the purchaser use the seller’s bank as the guarantor. C) requires payment prior to the delivery of the goods. D) is signed upon delivery of the goods. E) involves a lien on the purchasers’ current assets.

18) Which one of the following statements is false? A) Commercial drafts represent a way to obtain a credit commitment from a customer

before the goods are delivered. B) When a banker’s acceptance is discounted in the secondary market it becomes a commercial note. C) Sight drafts require immediate payment. D) Banker’s acceptances arise when a bank guarantees payment on a commercial draft. E) A commercial draft becomes a trade acceptance once the buyer accepts the draft and promises to pay.

19) Which one of the following statements accurately describes a characteristic of a conditional

sales contract? A) The seller retains legal ownership until the buyer completes payment for the goods. B) The buyer is compensated for its opportunity costs. C) The seller receives a prepayment in full. D) The invoice is paid in one lump sum at the end of the credit period. E) The ownership of the goods changes to the buyer immediately upon delivery.

20) The net credit period for a company with terms of 3/10, net 60 is: A) 3 days. B) 10 days. C) 20 days. D) 6 days. E) 60 days.

21) The decision to grant credit should consider all the following except the: A) delay in revenues from granting credit. B) immediate costs of granting credit. C) probability of nonpayment. D) cost of short-term borrowing. E) fixed costs incurred during the credit period.

22) When analyzing the NPV of a decision to switch from a cash-only sales policy to a credit

policy with an early payment discount, a firm is least likely to consider the: A) size of the discount. B) length of the credit period. C) firm’s variable costs. D) expected change in sales. E) fixed salaries of the sales force.

23) When analyzing the decision to change the cash discount policy, a firm should select the

policy that has the: A) highest order size. B) lowest variable cost per unit. C) lowest NPV. D) highest NPV. E) lowest cash discount.

24) An analyst has graphed the costs of granting credit relative to the amount of credit extended.

The optimal credit amount is determined by the point that: A) minimizes the total cost curve. B) maximizes the carrying costs associated with granting credit. C) maximizes the opportunity costs associated with granting credit. D) minimizes the carrying costs of granting credit. E) minimizes the opportunity costs of granting credit.

25) Determining the optimal credit policy is based on a trade-off between the carrying costs of

granting credit and the: A) lost profits from refusing credit. B) cash flows delayed from granting credit. C) opportunity cost of the delayed payments. D) variable costs associated with the delayed payments. E) present value of uncollected sales.

26) One key reason for establishing a captive finance company is the: A) reduction of legal restrictions on the amount of debt that can be incurred. B) increased opportunities for internal sales. C) lower level of required financial insurance. D) anticipated decrease in accounts receivable. E) expected decrease in the cost of the debt required to finance receivables.

27) All the following resources are sources of credit information about a customer except: A) the customer’s financial statements. B) credit reports. C) the customer’s current payment history with the seller. D) the amount of goods the customer desires to purchase. E) banks.

28) Because the credit decision usually includes riskier customers, the decision should adjust for

this by: A) determining the probability of nonpayment and reducing the expected cash flows

accordingly. B) discounting the net cash flows at a lower discount rate. C) discounting the cash inflows at a higher discount rate. D) increasing the variable cost per unit. E) decreasing the variable cost per unit.

29) All the following items are one of the “five Cs of credit” except: A) capability. B) capacity. C) capital. D) character. E) conditions.

30) Which one of the following statements is false? A) An aging schedule includes only overdue accounts. B) Aging schedules are used to monitor accounts receivable. C) If sales are seasonal, the percentages shown on an aging schedule will vary during the

year. D) Collection efforts may involve legal action. E) Investments in accounts receivable equal average daily sales times average collection period.

31) During the process of collecting accounts receivable, a firm can perform all the following

actions except: A) send a delinquency letter of past due status to the customer. B) make personal contact by telephone. C) employ a collection agency. D) take legal action against the customer as necessary. E) forcibly remove property from the buyer’s premises.

32) Windshield glass purchased by an automaker and sitting on a shelf ready for use is classified

as: A) B) C) D) E)

finished goods inventory. raw materials. assembly materials. work-in-progress. partial-goods inventory.

33) Which one of the following statements is correct? A) Finished goods are classified as a commodity. B) Work-in-progress may have less resell value than the individual component parts did. C) Raw materials that are considered to be a commodity are generally illiquid. D) Raw materials consist of only those goods that are found in nature. E) Finished goods are highly liquid because they are completed.

34) All of the following items are carrying costs of inventory except: A) storage costs. B) insurance. C) restocking costs. D) theft. E) the opportunity cost of capital.

35) The basic assumption of the ABC approach to inventory management is that: A) inventory should be divided dependent on the type of cash or credit sale anticipated. B) most items are ordered, stocked, and sold in a relatively short period of time. C) firms should receive a customer’s order before incurring inventory costs. D) a small portion of inventory represents a large portion of inventory costs. E) firms should always be consistent in the amount of inventory ordered.

36) At the optimal inventory level, the: A) inventory is held to its daily minimum level. B) inventory is maintained at a level equal to one week’s production needs. C) carrying costs equal the restocking costs. D) inventory opportunity costs are zero. E) shortage costs are eliminated.

37) The EOQ model considers all the following factors except the: A) cost of the inventory. B) carrying cost. C) fixed cost of an order. D) restocking cost. E) annual sales units.

38) The EOQ model assumes inventory: A) is held at a constant level. B) is sold at a steady rate until it is depleted. C) will be available just as it is needed for production. D) has seasonal fluctuations. E) can be delivered immediately upon order.

39) The minimum level of inventory a firm wants to keep on hand at all times is referred to as: A) the base level. B) safety stock. C) the opportunity cost. D) the reorder point. E) keiretsu.

40) The total restocking cost is calculated as: A) Fixed cost per order × Number of orders. B) Order size × Variable cost per unit. C) Carrying costs + Fixed costs. D) Number of orders × Variable cost per unit. E) Fixed cost per unit × Average inventory.

41) The reorder point considers all the following factors except the: A) safety stock. B) variable costs per unit. C) delivery time. D) minimum desired inventory level. E) rate of sales.

42) The first step in materials requirements planning is to establish the: A) desired minimum raw materials inventory level. B) finished goods inventory level. C) cost of each order. D) delivery time required for each type of raw material. E) value of each inventory item as a percent of total inventory.

43) For a JIT inventory system to be efficient, the: A) inventory must have an independent demand. B) firm’s suppliers must be able to deliver goods quickly upon order. C) managers must limit production each day to a set quantity. D) firm must be a reseller of goods, not a manufacturer. E) supplying firm must be a subsidiary of the ordering firm.

44) Shahzur Restaurant Group has an account receivable balance of $573,600 and the average

collection period is 24 days. What are the firm’s credit sales per day? A) $37,716.16 B) $23,900.00 C) $87,235.00 D) $15,271.97 E) $65,931.03

45) Reddy Plumbing Supply has accounts receivable of $1,876,000 and average daily credit sales

of $63,970. The firm offers credit terms of 2/10, net 30. On average, what is the firm’s accounts receivable period? A) 29.33 days B) 80.35 days C) 12.45 days D) 146.63 days E) 34.10 days

46) If 34 percent of customers pay on Day 10 and the remainder pay, on average, on Day 28,

what is the average collection period? A) 19.72 days B) 20.08 days C) 21.88 days D) 18.47 days E) 22.09 days

47) Torres Resurfacing mailed an invoice today in the amount of $1,268 with terms of 2/7 net 30.

What is the cost of credit to the customer if the customer pays on the last day of the credit period? Assume a 365-day year. A) 41.02% B) 39.62% C) 37.80% D) 37.56% E) 39.40%

48) Sway Tailors currently has credit terms of net 30, an average collection period of 29 days,

and average receivables of $211,410. The firm estimates that if it offered terms of 2/10, net 30 that 45 percent of its customers would pay on Day 10 with the remainder paying on average in 32 days. How much cash could the company free up from its accounts receivables if it switched its credit policy? A) $38,762 B) $50,301 C) $64,219 D) $58,336 E) $65,009

49) Saavedra Upholstery sold $22,500 of merchandise on credit yesterday. They sent the invoice

to the customer today with the terms of 3/10 net 40. This particular customer typically pays on the net date. What is the effective rate of interest the customer is paying by not taking the discount? Assume a 365-day year. A) 42.31% B) 44.86% C) 39.27% D) 40.54% E) 45.38%

50) Alphonso’s has an all-cash policy and sells 50 units per month at $920 a unit. The variable

cost is $700 a unit. Should the firm grant 30 days of credit, it expects its sales would rise to 60 units without changes to price or cost per unit. The monthly required return is .75 percent. What is the NPV of switching to a credit policy? A) $266,667 B) $346,333 C) $366,667 D) $240,333 E) $258,778

51) Assume Atlantic Fish sells 3,200 pounds of fish per month at a price of $2.90 a pound. The

variable cost per pound is $2.22. Currently, the firm has a cash-only sales policy. The firm is considering changing to a net 30 credit policy. The monthly required return is 1.2 percent. What does the new level of sales need to be to break even on the switch? A) 3,219.40 pounds B) 3,489.67 pounds C) 3,370.44 pounds D) 170.44 pounds E) 119.40 pounds

52) Velez Company sells 2,600 units per month for cash at a price of $299 a unit and a variable

cost of $187 a unit. The firm estimates it can increase its sales by 200 units per month if it switches to a net 30 credit policy while keeping its price and costs at their current levels. If the monthly cost of capital is .85 percent, what is the NPV of switching? A) $1,590,005 B) $1,394,008 C) $1,211,036 D) $1,820,494 E) $2,006,413

53) Dourian Supply has been approached by a new customer who has asked the firm to extend

credit for 30 days on a one-time purchase of $499. The firm's required return on receivables is 1.8 percent per month and the variable cost of the desired item is $327. What is the NPV of granting credit if the firm estimates the probability of default is 15 percent? A) $62.93 B) $108.40 C) $89.65 D) $94.15 E) $76.67

54) Harbin, Incorporated, is willing to offer credit on a one-time purchase provided the NPV of

the transaction is at least $50 at a required monthly return of 2 percent. Assume a potential sale has a sales price of $248 and a variable cost of $164. What is the maximum probability of default that will result in an acceptable offer? A) 32.55% B) 29.62% C) 11.98% D) 10.02% E) 18.50%

55) Jackson Lumber assumes new customers will default 8 percent of the time, but if they don’t

default, they will become repeat customers who always pay their bills. Assume the average sale is $383 with a variable cost of $260, and a monthly required return of 1.65 percent. What is the NPV of extending credit for one month to a new customer? A) $5,589.09 B) $6,103.47 C) $6,598.18 D) $5,748.09 E) $6,858.18

56) Monroy Custom Fixtures is a new firm that sells a product with a variable cost of $62 a unit.

The firm has a monthly required return of 1.8 percent. The firm wants to offer all new customers 30 days of credit and expects that if it does so, that 12 percent will default on payment while the others become repeat customers. What is the minimum price the firm could charge to break even on an NPV basis? A) $82.15 B) $74.09 C) $63.27 D) $98.14 E) $78.40

57) Tiny Home Goods, Incorporated, orders 15,000 units at a time and sells 413,600 units per

year 15,000. The cost of placing an order is $32.60. What is the firm’s annual total restocking cost? A) $126.87 B) $118.23 C) $845.81 D) $898.89 E) $767.52

58) The total cost of holding inventory at Irrinki Irrigation is $9,600 when its order sizes are

optimized. If the firm places 68 orders per year, what is the fixed cost per order? A) $141.18 B) $282.35 C) $70.83 D) $35.42 E) $70.59

59) Skyward Climbing has total annual sales of 438,000 units, a carrying cost per unit of $2.67

per year, and restocking costs of $48 per order. What is the EOQ? A) 4,203 units B) 3,824 units C) 3,968 units D) 4,126 units E) 4,511 units

60) Romero Products has total annual sales of 846,000 units, a carrying cost per unit of $1.64 per

year, and restocking costs of $31 per order. Each inventory item has an average cost of $2.39. What is the average dollar value of the firm's inventory if it always orders the most economical quantity? A) $6,758 B) $7,008 C) $7,409 D) $6,218 E) $6,411

61) Identify several factors that affect the length of the credit period and provide an explanation

of each.

62) Green Garden is a cash-only company. The company is considering switching to a 30-day

credit policy with no discounts. What factors should the firm consider before making the switch?

63) Uptown Markets recently did an analysis of its credit policy and considered several different

options. Once the analysis was completed and reviewed, the firm adopted the most optimal policy. The president then stated: “Now, that’s done. So we don’t ever have to go through that process again.” Do you agree? Justify your answer.

64) There are generally considered to be five key factors that should be evaluated when trying to

determine if a customer will pay. Write five questions that a credit manager should answer when reviewing a credit application that would address these factors.

65) Explain how inventory is managed under an ABC inventory system.

66) Explain the purpose of a safety stock and how this relates to reorder points.

Answer Key Test name: Chapter 28 1) A 2) C 3) A 4) B 5) E 6) E 7) E 8) E 9) E 10) D 11) C 12) D 13) D 14) C 15) B 16) C 17) A 18) B 19) A 20) E 21) E 22) E 23) D 24) A 25) A 26) E 27) D 28) A 29) A 30) A 31) E 32) B 33) B 34) C 35) D 36) C 37) A

38) B 39) B 40) A 41) B 42) B 43) B 44) B 45) A 46) C 47) C 48) B 49) B 50) D 51) C 52) D 53) C 54) C 55) C 56) C 57) D 58) E 59) C 60) A 61) Essay 62) Essay 63) Essay 64) Essay 65) Essay 66) Essay

Chapter 29: 1) One company wishes to acquire another. Which one of the following events does not require

a formal vote by the shareholders of the acquired firm? A) A merger B) An acquisition of stock C) A horizontal acquisition of assets D) A consolidation E) A vertical acquisition of assets

2) Firm A and Firm B join to create Firm AB. This is an example of a(n): A) tender offer. B) acquisition of assets. C) acquisition of stock. D) consolidation. E) merger.

3) Suppose Walmart and Target were to merge. Ignoring potential antitrust problems, this

merger would be classified as a(n): A) horizontal merger. B) vertical merger. C) conglomerate merger. D) tax inversion merger. E) equity carve-out merger.

4) Suppose that General Motors makes an offer to acquire General Mills. Ignoring potential

antitrust problems, this merger would be classified as a(n): A) monopolistic merger. B) horizontal merger. C) vertical merger. D) conglomerate merger. E) equity carve-out merger.

5) Suppose that Apple acquired a manufacturer of microcrystal screen protectors. This merger

would be classified as a: A) monopolistic merger. B) vertical merger. C) conglomerate merger. D) horizontal merger. E) spin-off.

6) A

takes place when a dissident group solicits votes in an attempt to replace existing management. A) tender offer B) shareholder derivative action C) proxy contest D) management freeze-out E) shareholder's revenge

7) If All-Star Fuel, a chain of gasoline stations, acquires Mid-States Refining, a refiner of oil

products, the transaction would be an example of a: A) conglomerate acquisition. B) white knight. C) vertical acquisition. D) going-private transaction. E) horizontal acquisition.

8) A(n)

occurs when the officers of a firm purchase all the equity shares, and the shares of the firm are delisted and are no longer publicly available. A) consolidation B) vertical acquisition C) proxy contest D) going-private transaction E) equity carve-out

9) A(n)

occurs when all publicly owned stock in a firm is replaced with 100 percent equity ownership by a private group. A) tender offer B) proxy contest C) going-private transaction D) acquisition E) consolidation

10) The complete absorption of one company by another, wherein the acquiring firm retains its

identity and the acquired firm ceases to exist as a separate entity, is called a: A) merger. B) consolidation. C) tender offer. D) spin-off. E) divestiture.

11) A merger in which an entirely new firm is created and both the acquired and acquiring firms

cease to exist is called a: A) divestiture. B) consolidation. C) tender offer. D) spin-off. E) conglomeration.

12) A public offer by one firm to directly buy the shares of another firm is called a: A) merger. B) consolidation. C) tender offer. D) spin-off. E) divestiture.

13) The acquisition of a firm in the same industry as the bidder is called a A) conglomerate B) forward C) backward D) horizontal E) vertical

_ acquisition.

14) The acquisition of a firm involved with a different stage of the production process than the

bidder is called a A) conglomerate B) forward C) backward D) horizontal E) vertical

acquisition.

15) The acquisition of a firm whose business is not related to that of the bidder is called a

acquisition. A) conglomerate B) forward C) backward D) horizontal E) vertical

16) An attempt to gain control of a firm by soliciting a sufficient number of stockholder votes to

replace the current board of directors is called a: A) tender offer. B) proxy contest. C) going-private transaction. D) leveraged buyout. E) consolidation.

17) Which one of the following statements concerning mergers and acquisitions is correct? A) Generally, two-thirds of the shareholders in each firm must approve a merger. B) Acquisitions always result in at least one firm being dissolved. C) The net present value of an acquisition should have no bearing on whether or not the

acquisition occurs. D) Acquisitions of assets are generally quite simple and inexpensive from a legal and accounting perspective. E) At least one-half of the shareholders must vote to approve an acquisition of stock.

18) In a merger the: A) legal status of both the acquiring firm and the target firm is terminated. B) acquiring firm retains its name and legal status. C) acquiring firm acquires the assets but not the liabilities of the target firm. D) stockholders of the target firm have little, if any, say as to whether or not the merger

occurs. E) target firm always continues to exist as a subsidiary of the acquiring firm.

19) When a furniture manufacturer acquires a forestry firm it is making a A) horizontal B) longitudinal C) conglomerate D) vertical E) complementary resources

acquisition.

20) If Microsoft were to acquire an airline, the acquisition would be classified as a

acquisition. A) horizontal B) longitudinal C) conglomerate D) vertical E) complementary resources

21) Which one of the following combinations of firms would benefit the most through the use of

complementary resources? A) A ski resort and a travel trailer sales outlet B) A golf resort and a ski resort C) A hotel and a home improvement center D) A swimming pool distributor and a kitchen designer E) A fast food restaurant and a dry cleaner

22) Which one of the following is most likely a good candidate for an acquisition that could

benefit from the use of complementary resources? A) A sports arena that is home only to an indoor hockey team B) A hotel in a busy downtown business district of a major city C) A day care center located near a major route into the main business district of a large city D) An amusement park located in a centralized Florida location E) A fast food restaurant located near a major transportation hub

23) The value of a target firm to the acquiring firm is equal to the: A) value of the target firm as a separate entity plus the synergy derived from the

acquisition. B) purchase cost of the target firm. C) value of the merged firm minus the value of the target firm as a separate entity. D) purchase cost plus the incremental value derived from the acquisition. E) incremental value derived from the acquisition.

24) The positive incremental net gain associated with the combination of two firms through a

merger or acquisition is called: A) the agency conflict. B) goodwill. C) the merger cost. D) the consolidation effect. E) synergy.

25) All the following represent potential gains from an acquisition except: A) the replacement of ineffective managers. B) lower costs per unit produced. C) an increase in production size such that diseconomies of scale are realized. D) increased asset utilization. E) spreading of overhead costs.

26) The shareholders of a target firm benefit the most when: A) an acquiring firm has the better management team and replaces the target firm’s

managers. B) the management of the target firm is more efficient than the management of the acquiring firm which replaces them. C) the management of both the acquiring firm and the target firm are as equivalent as possible. D) their current management team is kept in place even though the managers of the acquiring firm are more suited to manage the target firm’s situation. E) their management team is technologically knowledgeable yet ineffective.

27) A proposed acquisition may create synergy by doing all the following except: A) increasing the market power of the combined firm. B) improving the distribution network of the acquiring firm. C) reducing the acquiring firm’s distribution costs. D) reducing the utilization of the acquiring firm’s assets. E) providing the combined firm with a strategic advantage.

28)

can provide a potential tax gain from an acquisition. A reduction in the level of debt An increase in surplus funds The combining of multi-state operations A decreased use of leverage Increased diseconomies of scale

A) B) C) D) E)

29) The synergy created by an acquisition could result from all the following except: A) revenue enhancements. B) cost reductions. C) increased debt capacity. D) decreased cash flows. E) increased efficiency.

30) Assume two firms are at their maximum level of debt. How could a merger between these

firms create synergy based on debt capacity? A) By increasing firm size B) By lowering risk C) By lowering taxes D) By lowering the tax shield E) They can’t.

31) Assume a well-established firm is operating at high levels of efficiency and profitability. A

group of recent college graduates recently opened a new firm in the same industry. The wellestablished firm might be interested in acquiring the new firm primarily to: A) reduce economies of scale. B) use the established firm’s tax losses. C) transfer technology knowledge. D) obtain the new firm’s surplus funds. E) control the production of purchased component parts.

32) The IRS is most likely to disallow an acquisition if it: A) moves the foreign operations of the acquired firm to the U.S. B) is totally financed with debt. C) is designed primarily to reduce federal taxes. D) is designed to transfer technology in a tax-free transfer. E) allows shareholders to avoid currently realizing their gains from a stock acquisition.

33) If an acquisition does not create value, then the: A) earnings per share of the acquiring firm must be the same both before and after the

acquisition. B) earnings per share can change but the stock price of the acquiring company should remain constant. C) price per share of the acquiring company should increase because of the growth of the firm. D) earnings per share will most likely increase while the price-earnings ratio remains constant. E) price-earnings ratio should remain constant regardless of any changes in the earnings per share.

34) For the acquiring firm, diversification: A) will automatically produce gains. B) will reduce both risk and debt capacity. C) may or may not provide financial benefits. D) will provide risk reduction for all shareholders’ portfolios. E) may result in a risk-free firm.

35) Assume a merger of two levered firms produced no synergy. In this case, the: A) acquiring firm's shareholders would neither gain nor lose any value. B) bondholders would probably benefit at shareholders' expense. C) diversification effect would only benefit the acquired firm's shareholders. D) combined shareholders would benefit at the expense of all debt holders. E) shareholders and bondholders would fail to realize any benefits or losses.

36) Assume a merger of two unlevered firms produced no synergy. In this case: A) the acquiring firm’s shareholders would gain and the acquired firm's shareholders

would lose. B) the shareholders of both firms would realize equal gains. C) the diversification effect would only benefit the acquired firm’s shareholders. D) the acquired firm's shareholders would gain at the expense of the acquiring firm's shareholders. E) all shareholders would fail to realize any benefits.

37) In a merger or acquisition, a firm should be acquired if it: A) generates a positive net present value to the shareholders of the acquiring firm. B) is a firm in the same line of business in which the acquirer has expertise. C) is a firm in a totally different line of business which will diversify the firm. D) pays a large dividend which will provide a cash pass through to the acquirer. E) increases the firm’s market share.

38) When evaluating an acquisition, an analyst should: A) concentrate on book values and ignore market values. B) focus on the total cash flows of the merged firm. C) include synergies. D) ignore any one-time acquisition fees or transaction costs. E) ignore any potential changes in management.

39) The Williams Act requires Schedule 13D be filed with the SEC within

days of obtaining

percent holding in a target firm’s stock. A) 5; 10 B) 10; 5 C) 15; 5 D) 5; 15 E) 15; 10

40) A tender offer generally offers a price that is

the current market price for a

number

of shares. A) equal to; minimum B) above; minimum C) above; maximum D) below; maximum E) equal to; maximum

41) Assume an acquiring firm obtained control of a target firm through a tender offer. This group

is now proposing a merger, which is generally referred to as a: A) proxy fight. B) street sweep. C) waning motion. D) toehold. E) cleanup merger.

42) A change in the corporate charter making it more difficult for the firm to be acquired by

increasing the percentage of shareholders that must approve a merger offer is called a: A) supermajority amendment. B) standstill agreement. C) greenmail provision. D) poison pill amendment. E) white knight provision.

43) Assume Paige Software just made a tender offer to purchase shares of its own stock. This

offer was made to all its shareholders except for the largest outside shareholder. This offer is referred to as a(n): A) limited recapitalization. B) white knight offer. C) exclusionary self-tender. D) asset restructuring. E) greenmail offer.

44) A contract wherein the bidding firm agrees to limit its holdings in the target firm is called a: A) supermajority amendment. B) standstill agreement. C) greenmail provision. D) poison pill amendment. E) white knight provision.

45) The payments made by a firm to repurchase shares of its outstanding stock from an

individual investor in an attempt to eliminate a potentially unfriendly takeover attempt are referred to as: A) a golden parachute. B) standstill payments. C) greenmail. D) a poison pill. E) a white knight.

46) A tactic designed to make unfriendly takeover attempts financially unappealing, if not

impossible, is called: A) a golden parachute. B) a standstill agreement. C) greenmail. D) a poison pill. E) a white knight.

47) Generous compensation packages paid to a firm’s top managers in the event of a takeover are

referred to as: A) golden parachutes. B) poison puts. C) white knights. D) shark repellents. E) bear hugs.

48) A friendly suitor that a target firm turns to as an alternative to a hostile bidder is called a: A) golden suitor. B) poison put. C) white knight. D) shark repellent. E) crown jewel.

49) A classified board is: A) a communication network that identifies firms that are willing to be acquired. B) the inclusion of a supermajority provision to prevent a small number of directors from

exerting total control over the board’s decisions. C) a board on which only a portion of the directors are elected in any one year. D) a communication network that distributes resumes for potential board candidates. E) a listing of criteria that a firm is seeking for a targeted purchase.

50) All the following will tend to discourage a takeover except: A) a supermajority provision. B) the hoarding of cash. C) an exclusionary self-tender offer. D) a leveraged recapitalization. E) the divestiture of key assets.

51)

In a tax-free acquisition, the shareholders of the target firm: A) receive income that is considered to be tax-exempt. B) gift their shares to a tax-exempt organization and therefore have no taxable gain. C) are viewed as having exchanged their shares. D) sell their shares to a qualifying entity thereby avoiding both income and capital gains taxes. E) sell their shares at cost thereby avoiding the capital gains tax.

52) Which one of the following statements is correct? A) If an acquisition is made with cash, then the cost of that acquisition is dependent upon

the acquisition gains. B) Acquisitions made by exchanging shares of stock are normally taxable transactions. C) Shareholders of the acquired firm must immediately realize capital gains/losses in a cash acquisition. D) Shareholders of the acquired firm are generally indifferent between a cash or a stock transaction. E) Acquisitions based on legitimate business purposes are not taxable transactions regardless of the means of financing used.

53) In a taxable transaction,: A) the acquiring firm has no immediate tax effects but gains valuable future depreciation

tax benefits on the marked up assets. B) the shareholders of both firms realize immediate capital gains. C) acquiring firms generally do not write up the assets of the acquired firm. D) the assets of both the acquiring and acquired firms are written up to their current market values. E) shares of the acquiring firm are exchanged for the target firm’s shares.

54) The purchase accounting method for mergers requires that: A) the excess of the purchase price over the fair market value of the target firm be

recorded as a one-time expense on the income statement of the acquiring firm. B) goodwill be amortized on a yearly basis. C) the equity of the acquiring firm be reduced by the excess of the purchase price over the fair market value of the target firm. D) the assets of the acquired firm be recorded at their fair market value on the balance sheet of the acquiring firm. E) the excess amount paid for the target firm be recorded as a tangible asset on the books of the acquiring firm.

55) A going-private transaction in which a large percentage of the money used to buy the

outstanding stock is borrowed is called a: A) tender offer. B) proxy contest. C) merger. D) leveraged buyout. E) consolidation.

56) The two sources of value created by an leverage buyout are: A) the tax benefit of debt and increased sales. B) lower tax and interest payments. C) lower interest expenses and increased efficiency. D) increased efficiency and the interest tax shield. E) lower taxes and lower dividends.

57) The sale of stock in a wholly owned subsidiary via an initial public offering is called a: A) split-up. B) carve-out. C) counter-tender offer. D) white knight gift. E) spin-off.

58) Which one of the following events is least associated with takeovers? A) Leveraged buyouts B) Management buyouts C) Proxy contests D) Acquisition of assets E) Spin-offs

59) A firm may want to divest itself of some of its assets for all the following reasons except to: A) raise cash. B) eliminate unprofitable operations. C) eliminate some recently acquired assets. D) cash in on profitable operations. E) eliminate some synergy.

60) Which one of the following statements is correct? A) A carve-out generates cash for the parent firm. B) A split-up frequently follows a spin-off. C) A carve-out is a specific type of acquisition. D) A spin-off involves an initial public offering. E) A divestiture means that the original firm ceases to exist.

61) When shares in a subsidiary are distributed to the existing stockholders of the parent

company, the transaction is called a(n): A) lockup transaction. B) bear hug. C) equity carve-out. D) spin-off. E) split-up.

62) Alpha Corporation has a market value of $520 and Gamma Corporation has a market value

of $285. If the two firms were to merge, their estimated combined value would be $950. What is the estimated synergy of the merger? A) $160 B) $175 C) $153 D) $145 E) $180

63) Alpha Corporation has a market value of $650 while Gamma Corporation has a market value

of $1,100. The two firms are merging and expect the combined firm to have a market value of $1,890. If the current Alpha shareholders obtain $750 of equity in the new firm, how much synergy was allocated to the Gamma shareholders? A) $0 B) $20 C) $25 D) $15 E) $40

64) Alpha Corporation is planning on merging with Gamma Corporation. Alpha will pay

Gamma’s stockholders the current value of their stock in shares of Alpha because no synergy will be created. Alpha currently has 4,000 shares of stock outstanding at a market price of $20 per share. Gamma has 1,500 shares outstanding at a price of $15 per share. What is the value of the merged firm? A) $102,500 B) $110,000 C) $82,500 D) $90,000 E) $74,545

65) Alpha Corporation is planning on merging with Gamma Corporation. Alpha will pay

Gamma’s stockholders in shares of Alpha an amount equal to the current value of their stock plus $120, which equals one-half of the synergy. Alpha currently has 4,000 shares of stock outstanding at a market price of $21 per share. Gamma has 1,200 shares outstanding at a price of $10 per share. What is the value of the merged firm? A) $88,120 B) $96,240 C) $96,000 D) $84,120 E) $92,360

66) Paola’s has a market value of $2,700 and believes that if it acquires Tyler’s in a stock

transaction, the expected synergy of $150 will result in the combined new firm being worth $4,500. If Paola’s wants to keep 70 percent of the synergy for itself, what should be the value of the stock it issues to Tyler’s? A) $1,950 B) $1,650 C) $1,695 D) $1,905 E) $1,755

67) Alpha Industries has agreed to merge with Gamma Corporation in exchange for receiving

shares in the combined firm equal to Alpha’s current market value. There are two economic scenarios with equal probabilities of occurrence that must be considered. The market value of Alpha will be either $45 per share or $30 per share, depending on the economic state. Similarly, the market value of Gamma will be either $75 or $50 per share. What value per share will the original Gamma shareholders receive in the combined firm assuming no synergy is created by the merger? A) $63.50 B) $54.25 C) $56.00 D) $57.75 E) $62.50

68) Advance Wear is merging with Swish. Advance Wear has debt with a face value of $80 and

Swish has debt with a face value of $40. Swish’ stockholders will receive stock in the combined firm in an amount equal to the standalone market value of Swish. The premerger values of the firms given two economic states with equal probabilities of occurrence are as follows: Premerger Values: Advance Wear

Stage 1

Stage 2

Market Value

Assets Debt Equity Swish

$ 160 80 80

$ 40 40 0

$ 100 60 40

Assets Debt Equity

$ 20 20 0

$ 80 40 40

$ 50 30 20

If the merger provides no synergy, what will be the gain or loss to the current shareholders of Advance Wear? A) −$10 B) $0 C) −$5 D) $5 E) $10

69) Golden’s is merging with Rosa’s. Golden’s has debt with a face value of $80 and Rosa’s has

debt with a face value of $50. The premerger values of the firms given two economic states with equal probabilities of occurrence are as follows: Premerger Values: Golden’s

Stage 1

Stage 2

Market Value

Assets Debt Equity Rosa’s

$ 130 80 50

$ 50 50 0

$ 90 65 25

Assets Debt Equity

$ 30 30 0

$ 90 50 40

$ 60 40 20

If the merger provides no synergy, and if Rosa’s stockholders receive stock in the combined firm in an amount equal to the standalone value of Rosa’s, what will be the combined gain or loss to the bondholders of these two firms? A) $0 B) $25 C) −$5 D) $5 E) $10

70) Romero’s is being acquired by A Squad for $90,000 cash. The acquisition is being financed

internally from retained earnings. Romero’s currently has 3,000 shares of stock outstanding at a price of $24 per share. A Squad has 10,000 shares outstanding with a market value of $48 per share. The acquisition will create $4,000 of synergy. What is the value of A Squad after the acquisition? A) $541,000 B) $466,000 C) $423,000 D) $506,000 E) $481,000

71) The market values of Alpha Corporation and Gamma Corporation are $2,500 and $900,

respectively. Assume Alpha acquires Gamma at a cost of $1,000 and the transaction creates $100 in synergy. What would be the NPV of this acquisition to Alpha? A) $50 B) $100 C) $125 D) $150 E) $0

72) Cassandra’s has 6,100 shares outstanding at a market price per share of $24. Adrian’s has

3,500 shares outstanding at a market price of $56 per share. Neither firm has any debt. Adrian’s is acquiring Cassandra’s for $155,000 in cash. The synergy of the acquisition is $22,500. What is the value of Cassandra’s to Adrian’s? A) $155,000 B) $132,500 C) $168,900 D) $158,200 E) $146,400

73) Becca Dental and Grin Dental are both all-equity firms. Becca has 2,500 shares outstanding

at a market price of $28 per share. Grin has 2,500 shares outstanding at a price of $41 per share. Grin is acquiring Becca for $72,000 in cash. The synergy of the acquisition is $3,500. What is the value of Becca to Grin? A) $66,500 B) $70,000 C) $36,000 D) $73,500 E) $79,500

74) Alpha Corporation and Gamma Corporation are both all-equity firms. Alpha has 1,750 shares

outstanding at a market price of $20 per share while Gamma has 2,500 shares outstanding at a price of $28 per share. Alpha is acquiring Gamma for $75,000 in cash. The incremental value of the acquisition is $8,000. What is the net present value to Alpha of acquiring Gamma? A) $2,000 B) $3,000 C) $6,000 D) $4,000 E) $8,000

75) Alpha Corporation is acquiring Gamma Corporation for $40,000 in cash. Alpha has a current

market value of $66,000 while Gamma’s current market value is $38,000. The synergy value from the acquisition is $2,500. What is the value of Alpha after the acquisition? A) $108,500 B) $68,500 C) $45,000 D) $66,500 E) $106,500

76) Alpha is acquiring Gamma for $22,500 in cash. Alpha has 2,300 shares of stock outstanding

at a market value of $26 per share. Gamma has 1,200 shares of stock outstanding at a market price of $17 per share. Neither firm has any debt. The net present value of the acquisition is $1,900. What is the price per share of Alpha after the acquisition? A) $26.00 B) $28.25 C) $26.83 D) $25.17 E) $26.50

77) Alto and Solo are all-equity firms. Alto has 2,400 shares outstanding at a market price of $24

per share. Solo has 4,000 shares outstanding at a price of $17 per share. Solo is acquiring Alto for $63,000 in cash. The synergy value of the acquisition is $5,500. What is the net present value of acquiring Alto to Solo? A) $100 B) $400 C) $1,200 D) $2,400 E) $5,500

78) Principal is acquiring Secondary Companies for $38,000 in cash. Principal has 4,500 shares

of stock outstanding at a market price of $31 per share. Secondary has 1,600 shares of stock outstanding at a market price of $22 per share. Neither firm has any debt. The net present value of the acquisition is $2,400. What is the price per share of Principal after the acquisition? A) $31.00 B) $30.78 C) $31.53 D) $32.10 E) $31.94

79) Firm X is being acquired by Firm Y for $35,000 cash which is being provided by retained

earnings. The synergy of the acquisition is $5,000. Firm X has 2,000 shares of stock outstanding at a price of $16 per share. Firm Y has 10,200 shares of stock outstanding at a price of $46 per share. What is the value of Firm Y after the acquisition? A) $534,750 B) $471,200 C) $435,000 D) $468,900 E) $535,500

80) Western has a market value of $950 with 50 shares outstanding and a price per share of $19.

Eastern has a market value of $3,000 with 120 shares outstanding and a price per share of $25. Eastern is acquiring Western by exchanging 40 of its shares for all 50 of Western's shares. What is the cost of the merger to Eastern's stockholders if the merger creates $200 of synergy? A) $1,333.33 B) $1,225.00 C) $1,037.50 D) $1,000.00 E) $950.00

81) Firm A has a market value of $6,000 with 150 shares outstanding and a price per share of

$40. Firm B has a market value of $800 with 40 shares outstanding and a price per share of $20. Firm A is acquiring Firm B by exchanging 25 of its shares for all 40 of Firm B’s shares. Assume the merger creates $500 of synergy. What will be the value of Firm B’s shareholders’ stake in the merged firm? A) $800 B) $1,021.30 C) $1,050.00 D) $1,042.86 E) $1,000.00

82) Firm X has a market value of $8,400 with 120 shares outstanding and a price per share of

$70. Firm Y has a market value of $2,000 with 100 shares outstanding and a price per share of $20. Firm X is acquiring Firm Y by exchanging 30 of its shares for all 100 of Firm Y’s shares. Assume the merger creates $400 of synergy. What will be the value of Firm A’s shareholders’ stake in the merged firm? A) $8,080 B) $9,200 C) $8,820 D) $8,640 E) $9,050

83) Firm A is planning on merging with Firm B. Firm A currently has 2,300 shares of stock

outstanding at a market price of $20 per share. Firm B has 750 shares outstanding at a price of $15 per share. The merger will create $200 of synergy. How many of its shares should Firm A offer in exchange for all of Firm B's shares if it wants its acquisition cost to be $12,000? A) 598 B) 607 C) 600 D) 584 E) 593

84) Firm X is planning on merging with Firm Y. Firm X currently has 3,500 shares of stock

outstanding at a market price of $25 per share. Firm Y has 400 shares outstanding at a price of $22 per share. The merger will create $500 of synergy. How many of its shares should Firm X offer in exchange for all Firm Y's shares if it wants its acquisition cost to be $9,000? A) 408 B) 359 C) 409 D) 360 E) 375

85) Firm K is planning on merging with Firm L. Firm K currently has 5,500 shares of stock

outstanding at a market price of $28 per share. Firm L has 500 shares outstanding at a price of $16 per share. The merger will create $600 of synergy. Firm K plans to offer a sufficient number of its shares to acquire Firm L at an acquisition cost of $8,200. How many total shares will be outstanding in the merged firm? A) 5,608 B) 5,792 C) 5,749 D) 5,760 E) 5,775

86) Rudy’s and Blackstone are all-equity firms. Rudy’s has 1,200 shares outstanding at a market

price of $36 per share. Blackstone has 2,500 shares outstanding at a price of $38 per share. Blackstone is acquiring Rudy’s for $48,000 in cash. What is the merger premium per share? A) $4.00 B) $4.25 C) $6.50 D) $8.00 E) $14.00

87) New England Fisheries (NEF) has 18,000 shares outstanding at a market price per share of

$14. Maryland Fish Markets (MFM) has 7,000 shares outstanding at a market price of $21 per share. Neither firm has any debt. MFM is acquiring NEF for $275,000 in cash. What is the merger premium per share? A) $1.43 B) $1.28 C) $.81 D) $1.04 E) $2.07

88) Turner’s has $3.8 million in net working capital. The firm has fixed assets with a book value

of $48.6 million and a market value of $54.2 million. Martin & Sons is buying Turner’s for $61.5 million in cash. The acquisition will be recorded using the purchase accounting method. What is the amount of goodwill that Martin & Sons will record on its balance sheet as a result of this acquisition? A) $0 B) $3.5 million C) $6.6 million D) $7.2 million E) $9.1 million

89) Describe the three basic legal procedures that one firm can use to acquire another and briefly

discuss the advantages and disadvantages of each.

90) The empirical evidence strongly indicates that the stockholders of the target firm realize

wealth gains while the stockholders in the acquiring firm gain little, if anything, from an acquisition. Although there exists no definitive answer as to why this is the case, several possible explanations have been proposed. List and explain three possible explanations for the minimal returns to the acquiring firm’s stockholders.

91) Sometimes the management of a target firm fights a takeover attempt even when that attempt

appears to be in the best interest of the shareholders. Why would management take this stance?

92) Explain the purpose of a standstill agreement and the basics of how it works.

93) Assume one firm acquires another in an all-cash transaction. Explain why the acquiring firm

generally carries the acquired fixed assets on their books at the pre-acquisition book values rather than writing those assets up to their current market values, which they are allowed to do.

Answer Key Test name: Chapter 29 1) B 2) D 3) A 4) D 5) B 6) C 7) C 8) D 9) C 10) A 11) B 12) C 13) D 14) E 15) A 16) B 17) A 18) B 19) D 20) C 21) B 22) A 23) A 24) E 25) C 26) A 27) D 28) C 29) D 30) B 31) C 32) C 33) B 34) C 35) B 36) E 37) A

38) C 39) B 40) C 41) E 42) A 43) C 44) B 45) C 46) D 47) A 48) C 49) C 50) B 51) C 52) C 53) C 54) D 55) D 56) D 57) B 58) E 59) E 60) A 61) D 62) D 63) E 64) A 65) B 66) C 67) E 68) A 69) B 70) B 71) E 72) C 73) D 74) B 75) D 76) C 77) A

78) C 79) B 80) C 81) D 82) D 83) B 84) B 85) B 86) A 87) B 88) B 89) Essay 90) Essay 91) Essay 92) Essay 93) Essay

Chapter 30: 1) Which one of the following circumstances is the best indication that a firm is experiencing

financial distress? A) Some of the firm's cash customers begin to charge their purchases. B) The market value of the firm's stock declines by 10 percent in line with the market. C) The firm's operating cash flow is repeatedly insufficient to pay current obligations. D) The firm's cash distributions are eliminated and replaced with stock repurchases. E) The firm's accounts payable turnover rate increases.

2) Insolvency can be defined as: A) not having cash. B) having less cash than the firm needs for one year. C) an inability to pay one’s debts. D) an inability to increase one’s debts. E) the present value of payments being less than assets.

3) Stock-based insolvency is a(n): A) income statement measurement. B) balance sheet measurement. C) book value measurement only. D) both an income statement measurement and a book value measurement. E) both a balance sheet and a book value measurement.

4) Flow-based insolvency is defined as a(n): A) balance sheet measurement. B) negative equity position. C) negative cash flow in any one period. D) negative net profit for the year. E) insufficient operating cash flow to meet current obligations.

5) Periods of financial distress are most associated with: A) continued increases in earnings. B) steady growth. C) dividend reductions. D) increasing growth rates. E) decreasing production costs.

6) A firm has several options available to it in times of financial distress. The firm may: A) reduce capital and R & D spending. B) raise new funds by selling securities or major assets. C) file for bankruptcy. D) negotiate with lenders. E) take any or all of the other actions.

7) Rather than failing, many firms can actually benefit from financial distress by: A) re-evaluating their core operations and restructuring their assets. B) selectively ceasing payment on some of their outstanding debts. C) filing for Chapter 7 bankruptcy. D) liquidating. E) increasing their debt load.

8) Both A) B) C) D) E)

are two primary methods of financial restructuring. a private workout and a Chapter 7 bankruptcy a Chapter 7 and a Chapter 11 bankruptcy replacing debt with equity and a private workout a private workout and a Chapter 11 bankruptcy a stock repurchase and a Chapter 11 bankruptcy

9) Firms are least likely to deal with financial distress by: A) selling major assets. B) merging with another firm. C) issuing new securities. D) exchanging debt for equity. E) acquiring a competitor.

10) Financial distress is least likely to lead to: A) asset restructuring. B) financial restructuring. C) liquidation. D) increasing dividends. E) issuing new shares.

11) A Chapter 7 bankruptcy involves all of the following except: A) filing a petition in federal court. B) issuing new equity securities to current shareholders. C) the appointing of a bankruptcy trustee. D) administration costs. E) distribution of liquidation proceeds.

12) APR, as it relates to the liquidation of a firm, means the rules of: A) absolute profitability. B) arbitration priority. C) absolute priority. D) arbitration profitability. E) automatic profitability.

13) The difference between liquidation and reorganization is that a: A) reorganization terminates all operations of the firm, while a liquidation only

terminates non-profitable operations. B) liquidation terminates all operations immediately, while a reorganization terminates operations over two, or more years. C) liquidation terminates all operations and a reorganization maintains the option of the firm as a going concern. D) liquidation deals with net working capital, while a reorganization deals with longterm liabilities. E) liquidation must occur outside of bankruptcy, while a reorganization involves the bankruptcy process.

14) The major difference between Chapter 7 and Chapter 11 proceedings is that: A) liquidation occurs in Chapter 11 but reorganization is the objective under Chapter 7. B) there is no priority of claims under Chapter 11. C) liquidation automatically occurs in Chapter 7 but may or may not occur under

Chapter 11. D) no administrative or legal costs are incurred under Chapter 7. E) Chapter 11 is voluntary and Chapter 7 is involuntary.

15) A firm in financial distress that reorganizes through the bankruptcy process: A) will continue to operate as a going concern throughout the entire process. B) must have the reorganization plan approved by only its primary creditor. C) cannot issue new securities to either creditors or shareholders. D) must file a reorganization plan within 90 days of filing the bankruptcy petition. E) must abide by the Section 363 provisions of Chapter 11.

16) A corporation is adjudged bankrupt under Chapter 7. Based on APR, shareholders receive

payment, if funds are remaining, after: A) the bankruptcy administrator but before the creditors. B) secured creditors but before unsecured creditors. C) unsecured creditors but before the IRS. D) the employees but before the IRS. E) all other parties have been paid.

17) From highest to lowest, APR ranks the claims in a bankruptcy liquidation in the following

order: A) administrative expenses, wages, government taxes, secured creditors, unsecured

creditors, and stockholders. B) administrative expenses, wages, government taxes, stockholders, secured creditors, and unsecured creditors. C) wages, administrative expenses, secured creditors, unsecured creditors, government taxes, and stockholders. D) wages, administrative expenses, secured creditors, unsecured creditors, stockholders, and government taxes. E) government taxes, administrative expenses, wages, secured creditors, unsecured creditors, and stockholders.

18) Section 363 as it relates to a bankruptcy filing: A) works like an auction to speed up the bankruptcy process. B) establishes the bankruptcy judge as the assignor of all bankruptcy assets. C) permits creditors to force a firm into an involuntary bankruptcy. D) allows creditors to submit a reorganization plan. E) requires all employee wages and benefits be paid prior to creditors.

19) Chapter 11 of the Federal Bankruptcy Reform Act of 1978: A) was replaced by Section 363 in 2009. B) was expanded to allow liquidations in 2010 as a result of the financial crisis of 2008. C) underwent a major revision in 2011. D) was amended in 2005 by the Bankruptcy Abuse Prevention and Consumer Protection

Act. E) has never been revised or amended.

20) Which one of the following statements correctly identifies a condition which must be met for

creditors to force a firm into involuntary bankruptcy? A) The creditors that represent 30 percent or more of the firm’s debt must agree on a plan prior to filing the involuntary petition. B) The firm must be at least 120 days delinquent in its debt payments. C) At least one-third of a firm’s known creditors must participate in the filing. D) If there are more than a dozen creditors, then at least three with claims totaling $13,475 or more must participate in the filing. E) Any individual creditor that is owed $5,000 or more can file an involuntary petition regardless of the number of total creditors.

21) In a Chapter 11 bankruptcy, a class of creditors is considered to have accepted the

bankruptcy plan when: A) two-thirds of the class in dollar amount agree. B) at least 51 percent of the class in number agree. C) at least 90 percent of the members of the class agree. D) at least 51 percent of the class in dollar amount and two-thirds of the class in number agree. E) one-half of the class in number and two-thirds of the class in dollar amount agree.

22) Private workouts generally: A) represent 75 percent of all financial restructurings. B) lead to lower stock price increases than formal bankruptcy reorganizations. C) exchange current financial securities for new securities. D) are more costly than formal bankruptcies. E) increase management salaries and provide employment guarantees.

23) Key reasons why a firm would choose a formal bankruptcy over a private workout include all

the following except the: A) issuance of debtor-in-possession debt. B) tax treatment of tax loss carryforwards. C) tax treatment of debt forgiveness. D) ability to issue new debt that is senior to all prior debts. E) higher priority given to the existing stockholders.

24) Which one of the following circumstances is most likely to protect an individual creditor's

interests in a formal bankruptcy proceeding? A) The bankrupt firm’s financial structure may be complicated with several groups and types of creditors. B) The indirect costs of bankruptcy may result in lost revenues and poor maintenance. C) The bankruptcy administrative costs may be high due to the length and complexity of the process. D) The absolute priority rule can be violated. E) The creditor may hold liens on specific assets.

25) Prepackaged bankruptcies: A) generally benefit only the bankrupt firm. B) require creditor approval within 7 days of filing. C) are a combination of a private workout and legal bankruptcy. D) were replaced by Section 363 provisions. E) must result in a full liquidation.

26) In a prepackaged bankruptcy, the firm: A) reaches an agreement with its creditors prior to filing the bankruptcy petition. B) exchanges all debt securities with equity securities. C) pays all its secured creditors and exchanges the unsecured debt securities with equity. D) must agree with the bankruptcy plan submitted to it by its creditors. E) prearranges an auction that will liquidate the firm within one month of the legal

filing.

27) Credit scoring models are used by lenders to determine: A) the best discount to offer each customer. B) the appropriate price to charge each customer. C) the optimal debt-equity ratio for the firm. D) a borrower’s credit risk. E) the percentage of their loan that will be repaid in a bankruptcy.

28) Altman initially developed the Z-score model for publicly traded manufacturing firms. Using

financial statement data and multiple discriminant analysis, he found that: A) in actual use, a Z-score greater than 2.99 implies bankruptcy within one year. B) in actual use, a Z-score greater than 1.81 implied a 90 percent chance of bankruptcy within one year. C) in actual use, a Z-score of less than 1.81 would predict bankruptcy within one year. D) in actual use, a Z-score less than 2.99 meant nonbankruptcy within one year. E) the lower the score the lower the chance of pending bankruptcy.

29) The key intuition of a Z-score model like Altman’s is that: A) only publicly traded firms can be evaluated. B) one will be just as well off by guessing on default rates. C) all corporations will default at least once. D) financial profiles of bankrupt and nonbankrupt firms are very different one year prior

to bankruptcy. E) privately traded firms disclose better financial information to lenders.

30) Altman’s revised model for private firms and nonmanufacturers predicts bankruptcy when

the computed value is: A) negative. B) less than 1.23. C) greater than 1.0 and less than 1.23. D) greater than 2.50. E) greater than 2.90.

31) Margo Imports is being liquidated. The firm owes $830,000 to its mortgage holder, and

$128,000 to its other secured creditors. In addition, the firm owes $329,000 to its unsecured creditors. The total sum for wage and benefit payments, consumer claims, and the administrative costs of liquidation amount to $330,000. The firm owes no taxes. The building, which is mortgaged, just netted $794,000 after selling costs. The remaining assets have yielded $467,000 in net proceeds. How much will the unsecured creditors receive for each dollar they are owed? A) $.027 B) $.025 C) $.333 D) $1.00 E) $.533

32) Espinosa Art Gallery is being liquidated. The building has been sold for a net of $840,000

but the mortgage due is $954,000. The remaining assets were sold with net proceeds of $173,000. Administrative costs, wages and benefits, and consumer claims equal $156,000. The firm also owes $61,000 in taxes. The secured claims total $53,000 and the unsecured claims are $173,000. What percentage of their total claims will the secured creditors be paid? A) 11.2% B) 8.8% C) 0% D) 41.2% E) 39.1%

33) Yellaratu Group is reorganizing and has presented a proposal based on a going-concern value

of $3 million after reorganization costs and delinquent wages, benefits, and taxes. The proposed financial structure is $680,000 in new mortgage debt, $320,000 in subordinated debt, and $2,000,000 in new equity. Secured creditors currently have a mortgage lien for $2.5 million on the factory and the unsecured creditors’ claims total $1.3 million. How much of the new debt and equity securities should the secured creditors receive? A) $1.8 million B) $2.5 million C) $3.0 million D) $.68 million E) $3.0 million

34) Shoe Shine has proposed a reorganization plan based on a going-concern value of $1.3

million after court costs and delinquent wages and taxes. The proposed financial structure is $400,000 in new mortgage debt, $200,000 in subordinated debt, and $700,000 in new equity. Secured creditors currently have a mortgage lien for $600,000 and the unsecured creditors are owed $950,000. What should the unsecured creditors receive if the reorganization plan is approved? A) $700,000 in equity securities B) $200,000 in subordinated debt and $700,000 in equity securities C) $950,000 in new equity securities D) 61.3 percent of the new mortgage debt, 61.3 percent of the subordinated debt, and 61.3 percent of new equity E) 82.6 percent of the subordinated debt and 82.6 percent of new equity

35) Pizza Planet has an estimated going-concern value of $2.5 million. The firm’s bankruptcy

reorganization plan consists of $750,000 in new mortgage debt, $250,000 in subordinated debt, and $1,500,000 in new equity. Currently the firm has a mortgage of $1,060,000, other secured debt of $90,000, and unsecured debt of $1,370,000 million. According to the APR, what will the stockholders receive if they currently have 2 million shares with a par value of $1 each? A) $1,000,000 in new equity B) $500,000 in new equity C) $500,000 in a combination of new debt and equity securities D) $0 E) $400,000 in new equity

36) The Launchpad is being liquidated. The administrative costs of liquidation, taxes, and wage

payments are expected to be $450,000. Secured creditors have a mortgage lien for $1.4 million on the real estate which was just liquidated and netted proceeds of $1.2 million. The other secured creditors have submitted claims totaling $274,000 and the unsecured submitted claims are $323,000. The remaining assets are expected to net $475,000. What payout should the unsecured creditors expect per each $1 claim? A) $.13 B) $0 C) $.08 D) $.06 E) $.02

37) Sunshine Products is being liquidated. The real estate has been sold and there is a remaining

mortgage balance of $126,000 after applying the sale proceeds. The other assets were just auctioned off and netted $418,000 after liquidation costs, wages, and taxes. The remaining secured creditors submitted claims totaling $362,000 and the unsecured creditor claims are $211,000. The secured creditors will receive per $1 claim and the unsecured creditors will receive per $1 claim. A) $1; $.1309 B) $.98; $0 C) $1; $.1662 D) $1; $.2654 E) $1; $.0678

38) Parade Corporation is experiencing financial distress. The estimated “going concern” value

of the firm is $3.2 million. The senior debt claim is on all fixed assets. The balance sheet of the firm has current assets of $1.1 million, fixed assets of $2.9 million, senior debt of $2.2 million, and subordinated debt of $1.8 million, with the remainder allocated to stockholders’ equity. Assume the firm files for formal bankruptcy and sells the firm for the estimated “going concern” value and nets 92 percent of that amount after administrative costs, wages, and taxes are paid. What amount will be distributed to the subordinated debtholders? A) $709,000 B) $721,000 C) $744,000 D) $811,000 E) $687,000

39) There are a number of ways firms can deal with financial distress. Identify at least 5 of these.

40) Financial distress may benefit firms if it prompts them to “restructure their assets”. Explain

what this means and how it can be beneficial.

41) Why would a firm’s creditors voluntarily agree to a prepackaged reorganization that offers

those creditors less than they are owed?

Answer Key Test name: Chapter 30 1) C 2) C 3) B 4) E 5) C 6) E 7) A 8) C 9) E 10) D 11) B 12) C 13) C 14) C 15) A 16) E 17) A 18) A 19) D 20) D 21) E 22) C 23) E 24) E 25) C 26) A 27) D 28) C 29) D 30) B 31) B 32) C 33) B 34) A 35) D 36) B 37) C

38) C 39) Essay 40) Essay 41) Essay

Chapter 31: 1) A(n)

is security issued in the United States that represents shares of a foreign stock and allows that stock to be traded in the United States. A) American depository receipt B) Yankee bond C) Yankee stock D) Eurostock E) foreign obligation trust certificate

2) The

is the implicit exchange rate between two currencies when both are quoted in a third currency. A) open exchange rate B) cross-rate C) backward rate D) forward rate E) interest rate

3) Money deposited in a financial center outside the country whose currency is involved is

called: A) B) C) D) E)

a foreign depository receipt. an international exchange certificate. an American depository receipt. Eurocurrency. Eurodollars.

4) The rate most international banks charge one another for overnight Eurodollar loans is the: A) Eurodollar yield to maturity. B) London Interbank Offered Rate. C) Paris Opening Interest Rate. D) United States Treasury bill rate. E) international prime rate.

5) The cross-rate is: A) the inverse of the direct rate. B) an implicit rate based on two currencies and their individual relationships with a third

currency. C) the rate converting the direct rate into the indirect rate. D) the average of the spot and forward rates. E) the link between the spot and forward rates.

6) A major network for foreign transactions called

is operated by a Belgian non-

profit cooperative. A) EURX B) BELX C) SWIFT D) LIBOR E) GLOBEX

7) Triangle arbitrage can occur when the

between two currencies is not

the ratio of

the two direct rates. A) cross-rate; equal to B) spot rate; equal to C) cross-rate; less than D) spot rate; less than E) cross-rate; greater than

8) When the euro is quoted as $1.866, this quote is a(n): A) triangle rate. B) indirect rate. C) direct rate. D) cross-rate. E) inverse rate.

9) When the Mexican peso is quoted as Ps19.9812, this quote is a(n): A) indirect rate. B) direct rate. C) cross-rate. D) triangle rate. E) linear rate.

10) What kind of trade involves agreeing today on an exchange rate for settlement in 90 days? A) Spot trade B) Market trade C) Forward trade D) Triangle trade E) Complex trade

11) The foreign exchange market is where: A) one country’s stocks are exchanged for another’s. B) one country’s bonds are exchanged for another’s. C) one country’s currency is traded for another’s. D) international banks make loans to one another. E) international businesses finalize import/export relationships with one another.

12) The price of one country’s currency, expressed in terms of another country’s currency, is

called the: A) absolute currency rate. B) cross inflation rate. C) depository rate. D) exchange rate. E) foreign interest rate.

13) An agreement to trade currencies based on the exchange rate set today, for settlement within

two business days is called a(n) A) swap B) option C) futures D) forward E) spot

trade.

14) Currencies that are exchanged today without any prior arrangement are exchanged at the: A) spot rate. B) forward rate. C) triangle rate. D) LIBOR. E) discounted rate.

15) An agreement to exchange currencies at some moment in the future, using an exchange rate

agreed upon today is called a A) spot B) forward C) swap D) floating E) triangle

trade.

16) Which one of the following statements is true? A) The exchange markets are limited to the currencies of highly developed countries. B) Importers and exporters are key players in the foreign exchange market. C) The trading floor of the foreign exchange market is located in London, England. D) Foreign exchange rates are set by the governments of each country issuing a currency. E) The foreign exchange market is the world’s smallest financial market.

17) Triangle arbitrage: A) no longer exists due to the advanced electronic communications used in today’s

markets. B) applies only to forward exchange rates. C) helps keep the currency market in equilibrium. D) opportunities can only be found in the spot market. E) involves only currencies other than the U.S. dollar.

18) Assume the euro is selling in the spot market for $1.19. Simultaneously, in the 3-month

forward market the euro is selling for $1.21. Which one of the following statements correctly describes this situation? A) The spot market is out of equilibrium. B) The forward market is out of equilibrium. C) The dollar is selling at a premium relative to the euro. D) The euro is selling at a premium relative to the dollar. E) The euro is less expensive in the forward market.

19) Suppose the spot exchange rate is $1 = £.7230 and the 1-month forward rate is $1 = £.7229.

Given this, you know the: A) U.S. inflation rate is higher than the U.K.’s. B) U.S. nominal interest rate is higher than the U.K.’s. C) pound is selling at a discount. D) U.S. real risk-free interest rate is higher than the U.K.’s. E) pound is selling at a premium.

20) Which one of following statements is false? A) Importers are participants in the foreign exchange market. B) The foreign exchange market is an over-the-counter market. C) There are no speculators in the foreign exchange market. D) Exporters are participants in the foreign exchange market. E) Portfolio managers are participants in the foreign exchange market.

21) Suppose the one-year forward rate is £.7118. Given no arbitrage opportunities, this implies

that traders expect the spot rate to be: A) £.7118 in one year. B) greater than £.7118 in one year. C) less than £.7118 in one year. D) greater than or equal to £.7118 in one year. E) less than or equal to £.7118 in one year.

22) If a foreign currency is selling at a discount relative to the dollar then the: A) foreign currency is cheaper in the spot market than it is in the forward market. B) cross-rate is cheaper than the direct rate. C) foreign currency is cheaper in the forward market than it is in the spot market. D) direct rate is cheaper than the indirect rate. E) settled rate is less than the spot rate.

23) Spot trades must be settled: A) on the trade date. B) within one business day. C) within two business days. D) within three business days. E) within one week of the trade date.

24) Assuming exchange rates are quoted as units of foreign currency per dollar, which one of the

following statements is correct? A) When the dollar strengthens, it takes more dollars to obtain one unit of a foreign currency. B) If the U.S. inflation rate is lower than the inflation rate in Canada, then the U.S. dollar will depreciate relative to the Canadian dollar. C) When a foreign currency appreciates in value it strengthens relative to the dollar. D) As the U.S. dollar strengthens, one British pound will purchase more U.S. dollars. E) The exchange rate is unaffected by differences in the inflation rates of the two countries.

25) The idea that a specific hamburger should cost the same regardless of where it is purchased

or the currency used to pay it is referred to as: A) the unbiased forward rates condition. B) uncovered interest rate parity. C) the international Fisher effect. D) absolute purchasing power parity. E) interest rate parity.

26) “The change in exchange rates is determined by the difference in the inflation rates of the

two countries.” This statement expresses the concept of: A) absolute purchasing power parity. B) relative purchasing power parity. C) the international Fisher effect. D) unbiased forward rates. E) interest rate parity.

27) For absolute purchasing power parity to hold: A) transaction costs must be observable. B) interest rates must be uniform on a nominal basis. C) inflation rates must be uniform in all markets. D) tariffs must be imposed on all imported goods. E) products must be identical in all markets.

28) The symbol “S0” represents the: A) spot exchange rate expressed in dollars per unit of foreign currency. B) forward rate expressed in foreign currency units per dollar. C) profit that can be realized on a triangle arbitrage. D) spot rate in foreign currency units per dollar. E) forward rate expressed in dollars per unit of foreign currency.

29) Absolute purchasing power parity is most likely to exist for: A) a 4-door Ford vehicle. B) a loaf of white bread. C) a 2-bedroom home. D) a new watch. E) an ounce of silver.

30) The forward rate is most likely to equal the spot rate when: A) the real rate of interest is declining. B) the inflation rates in the two countries are equal. C) purchasing power parity exists. D) the real rates of interest in the two countries are equal. E) inflation rates are historically high.

31) Which one of the following concepts states that real rates are equal across countries? A) Uncovered interest parity B) Relative purchasing power parity C) Unbiased forward rates D) Absolute purchasing power parity E) International Fisher effect

32) The symbol “RFC” represents the foreign country’s: A) forward nominal market interest rate. B) real risk-free interest rate. C) real market interest rate. D) forward real market interest rate. E) nominal risk-free interest rate.

33) Covered interest arbitrage involves: A) two spot rates. B) two forward rates. C) both a spot rate and a forward rate. D) a single exchange at the current exchange rate. E) a single exchange at a spot rate that exists in the future.

34)

holds because of the possibility of covered interest arbitrage. A) Uncovered interest parity B) Interest rate parity C) The international Fisher effect D) Unbiased forward rates E) Purchasing power parity

35) The condition stating that the interest rate differential between two countries is

approximately equal to the percentage forward premium or discount is called: A) the unbiased forward rates condition. B) uncovered interest rate parity. C) the international Fisher effect. D) purchasing power parity. E) interest rate parity.

36) The condition stating that the current forward rate is an unbiased predictor of the future spot

exchange rate is called: A) the unbiased forward rates condition. B) uncovered interest rate parity. C) the international Fisher effect. D) purchasing power parity. E) interest rate parity.

37) The condition stating that the expected percentage change in the exchange rate is equal to the

difference in interest rates between the countries is called: A) the unbiased forward rates condition. B) uncovered interest parity. C) the international Fisher effect. D) purchasing power parity. E) interest rate parity.

38) Interest rate parity: A) eliminates covered interest arbitrage opportunities. B) exists when spot rates are equal for multiple countries. C) means that the nominal risk-free rate of return must be the same across countries. D) exists when the spot rate is equal to the futures rate. E) eliminates exchange rate fluctuations.

39) The unbiased forward rate is a: A) condition where a future spot rate is equal to the current spot rate. B) guarantee of a future spot rate at one point in time. C) condition where the spot rate is expected to remain constant over a period of time. D) relationship between the future spot rate of two currencies at an equivalent point in

time. E) predictor of the future spot rate at the equivalent point in time.

40) The international Fisher effect states that A) spot B) one-year future C) nominal D) inflation E) real

rates are equal across countries.

41) The home currency approach: A) discounts all a project’s foreign cash flows using the current spot rate. B) employs uncovered interest parity to project future exchange rates. C) computes the net present value (NPV) of a project in the foreign currency and then

converts that NPV into U.S. dollars. D) utilizes the international Fisher effect to compute the NPV of foreign cash flows in the foreign currency. E) utilizes the international Fisher effect to compute the relevant exchange rates needed to compute the NPV of foreign cash flows in U.S. dollars.

42) The home currency approach: A) generally produces more reliable results than those found using the foreign currency

approach. B) requires an applicable exchange rate for every time period for which there is a cash flow. C) uses the current risk-free nominal rate to discount all the cash flows related to a project. D) stresses the use of the real rate of return to compute the net present value (NPV) of a project. E) converts the foreign-denominated NPV into the dollar-denominated NPV.

43) The foreign currency approach to capital budgeting analysis: A) is computationally harder to use than the home currency approach. B) utilizes the uncovered interest parity relationship. C) computes the NPV in both the foreign and the domestic currency. D) is solely dependent upon purchasing power parity. E) produces superior results as compared to the home currency approach.

44) Remitting funds to a parent firm from a foreign subsidiary is referred to as: A) recommitting. B) reshipping. C) repatriating. D) reminding. E) reshaping.

45) Which one of the following factors does not tend to hinder funds from foreign subsidiaries

being remitted to their home country parent firm? A) Foreign exchange remittance controls B) Repatriation taxes C) Active exchange rate market D) Blocking controls E) Expropriation taxes

46) An international firm that imports raw materials can reduce its

exposure to

rate

risk by entering into a forward contract. A) long-term; inflation B) short-term; inflation C) short-run; exchange D) long-run; exchange E) total; interest

47) The changes in the relative economic conditions between countries are referred to as the: A) international Fisher effect. B) international exchange rate effect. C) translation exposure to exchange rate risk. D) long-run exposure to exchange rate risk. E) the interest rate parity risk.

48) Which one of the following statements is correct? A) Borrowing money in the country in which operations are located reduces long-run

exchange rate risk. B) Accounting translation gains are recorded on the income statement as other income. C) In multidivisional firms, exchange rate risk should be managed at the division level. D) The usage of forward rates can help reduce the long-run exposure to exchange rate risk. E) Unexpected changes in economic conditions are classified as short-run exposure to exchange rate risk.

49) Financial Accounting Standards Board Statement No. 52 requires that most assets and

liabilities be translated at the current exchange rate. Translation gains and losses are recorded: A) in the shareholders' equity section of the balance sheet. B) as a normal income item on the income statement. C) as an extraordinary item on the income statement. D) as a footnote to the financial statements. E) only on income tax returns.

50) A foreign subsidiary can remit funds to the parent firm in all the following ways except by

means of: A) dividends. B) management fees for central services. C) royalties on the use of trade names. D) royalties on the use of patents. E) nationalization.

51) All the following are political risks associated with international investing except: A) nationalization. B) decreasing consumer demand. C) blocking of funds. D) tax law changes. E) contract abrogation.

52) Monies earned by foreign subsidiaries that have not yet been taxed under U.S. law can be

used to: A) purchase U.S. government bonds. B) purchase U.S. stocks. C) pay dividends. D) invest in new capital overseas. E) invest in new U.S. plants and equipment.

53) The Tax Cut and Jobs Act of 2017 allows untaxed foreign profits that are held as cash or as

securities to be: A) used to purchase U.S. fixed assets after a one-time tax of 8 percent. B) repatriated at a one-time tax rate of 15.5 percent. C) returned to the U.S. at the new corporate tax rate of 15 percent. D) repatriated at a one-time tax rate of 8 percent. E) returned to the U.S. as tax-free income.

54) How many euros can you get for $2,500 if the USD equivalent is 1.2195? A) €2,147.08 B) €2,050.02 C) €2,309.11 D) €3,048.75 E) €2,921.00

55) Sowmiya is planning a trip to Australia. The hotel will cost A$215 per night for ten nights.

She expects to spend another A$2,500 for meals, tours, souvenirs, and so forth. How much will this trip cost her in U.S. dollars if the USD equivalent is .7412? A) $6,273.61 B) $3,446.58 C) $3,317.54 D) $1,623.61 E) $2,901.43

56) A firm intends to import $65,000 worth of rugs from India. How many rupees does the firm

need to pay for this purchase if one rupee is worth $.0137? A) Rs4,744,526 B) Rs891 C) Rs62,903 D) Rs64,110 E) Rs21,077

57) Assume $1 will buy Can$1.2562 while $1.1860 will buy €1. What is the Can$/€ exchange

rate? €1 = A) Can$.9441 B) Can$.9349 C) Can$1.0592 D) Can$1.4899 E) Can$1.2161

58) Assume that ¥106.83 equals $1. Also assume that SKr8.2941 equals $1. How many Japanese

yen can you acquire in exchange for 5,000 Swedish krona? A) ¥388.19 B) ¥314.77 C) ¥41,710.99 D) ¥56,756.67 E) ¥64,401.20

59) You just returned from some extensive traveling. You started your trip with $10,000 in your

pocket. You spent 1.32 million pesos in Chile where Ps1 = $.001642. You spent Ps36,000 in Uruguay where Ps1 = $.03526. Then on the way home, you spent Ps29,000 in Mexico where $1 = Ps18.8709. How many dollars did you have left by the time you returned to the U.S.? A) $3,889.07 B) $4,001.84 C) $4,110.27 D) $5,026.44 E) $4,299.03

60) Assume the official USD equivalent of one Canadian dollar is .7813 and the USD equivalent

of the U.K. pound is 1.3699. Further assume you have 100 pounds and have been offered Can$180 for them. If you use triangle arbitrage and the entire £100, you can earn a profit of: A) £1.56. B) £2.66. C) £.87. D) £1.09. E) £2.03.

61) Zanir has been offered Can$1.75 for £1. How much profit can she earn on a triangle arbitrage

if the official rate is $1 = Can$1.2834 and the USD equivalent of £1 is $1.3699? Assume she currently has $100 in cash. A) $.46 B) $.73 C) $1.09 D) $1.37 E) $.57

62) Assume you can exchange $1 for £.7347 today. Assume that last week, £1 was worth

$1.3613. If you had converted £100 into dollars last week and then exchanged your dollars back into pounds today, you would now have a: A) profit of $.048. B) loss of $. 42. C) profit of £.101. D) loss of $.068. E) profit of £.015.

63) Assume today you can exchange $100 for either Can$128 or Ps1,892. Also assume that last

year, $100 was worth Can$126 or Ps1,847. Which one of the following statements is correct given this information? A) $100 invested in Canadian dollars last year would now be worth Ps1,824.09. B) $100 invested in Mexican pesos last year would now be worth $98.47. C) $100 invested in Mexican pesos last year would now be worth $101.63. D) $100 invested in Canadian dollars last year would now be worth $99.52. E) $100 invested in Canadian dollars last year would now be worth Ps1,862.44.

64) The cell phone you want to buy costs $699 in the U.S. If absolute purchasing power parity

exists, and if the exchange rate is €1= $1.1860, the same cell phone will cost Germany. A) €612.13 B) €1,206.25 C) €1,696.71 D) €829.01 E) €589.38

65) Assume the cost of a nice dinner in a restaurant in Singapore costs S$75. Also assume S$1 =

$.7445 and €1 = $1.1860. How much will the identical meal cost in euros if absolute purchasing power parity exists? A) €100.74 B) €88.95 C) €47.08 D) €66.22 E) €119.48

66) Assume $1 = ¥106.83 = £.7309. If a TV in London costs £430, what will that identical TV

cost in Tokyo if absolute purchasing power parity exists? A) ¥32,411.02 B) ¥34,666.67 C) ¥62,849.77 D) ¥58,001.28 E) ¥82,880.09

67) Assume the spot market exchange rate for $1 is currently A$1.3512. Also assume the

expected inflation rate is 2.6 percent in Australia compared to the U.S. rate of 3.2 percent. What is the expected exchange rate one year from now if relative purchasing power parity exists? A) A$1.3431 B) A$1.3572 C) A$1.3863 D) A$1.2967 E) A$1.3944

68) Assume the spot rate of $1 is £.7230. Also assume the expected inflation rate in the U.K. is

2.8 percent while the U.S. inflation rate is 3.6 percent. What is the expected exchange rate two years from now if relative purchasing power parity exists? A) £.9841 B) £.7115 C) £.7346 D) £.7058 E) £.4982

69) Assume the current spot rate is Can$1.2803 and the one-year forward rate is Can$1.2745.

Also assume the nominal risk-free rate in Canada is 4.8 percent while it is 4.2 percent in the U.S. Using covered interest arbitrage, you can earn a profit of for every $1 invested over the next year. A) $.0163 B) $.0108 C) −$.0040 D) −$.0088 E) −$.0840

70) Assume the current spot rate is Can$1.2811 and the one-year forward rate is Can$1.2767.

Also assume the nominal risk-free rate in Canada is 3.2 percent while the U.S. rate is 3.5 percent. Using covered interest arbitrage you can earn an extra profit of for every $1 invested over the next year. A) $.0018 B) $.0015 C) $.0011 D) $.0006 E) $.0002

71) Assume the spot rate for the Japanese yen currently is ¥106.83 per dollar while the one-year

forward rate is ¥107.20. Also assume a risk-free asset in Japan is currently earning 4.6 percent. If interest rate parity holds, approximately what rate can you earn on a one-year riskfree U.S. security? A) 4.24% B) 5.08% C) 4.62% D) 4.78% E) 4.96%

72) Assume the spot rate for the British pound currently is £.7287 per dollar and the one-year

forward rate is £.7304. A risk-free asset in the U.S. is currently earning 3 percent. If interest rate parity holds, approximately what rate can you earn on a one-year risk-free British security? A) 3.16% B) 3.03% C) 2.92% D) 2.84% E) 3.24%

73) Assume a risk-free asset in the U.S. is currently yielding 2.7 percent while a Canadian risk-

free asset is yielding 2.8 percent and the current spot rate is Can$1.2849 = $1. What is the approximate 6-month forward rate if interest rate parity holds? A) Can$1.2855 B) Can$1.2838 C) Can$1.2843 D) Can$1.2862 E) Can$1.2836

74) Suppose the spot rate on the Indian rupee is Rs65.2203, the risk-free nominal rate in the U.S.

is 4.6 percent, and the Indian risk-free nominal rate is 6.2 percent. Which one of the following one-year forward rates best establishes the approximate interest rate parity condition? A) Rs64.1768 B) Rs66.2638 C) Rs62.8840 D) Rs63.0733 E) Rs67.8420

75) Suppose the spot rate on the Canadian dollar is C$1.2797. Also assume the risk-free nominal

rate in the U.S. is 3.8 percent while it is only 3.3 percent in Canada. Which one of the following three-year forward rates best establishes the approximate interest rate parity condition? A) C$1.2733 B) C$1.2606 C) C$1.2861 D) C$1.2990 E) C$1.1918

76) You are considering a project in Norway with an initial cost of NKr135,000. The project is

expected to return a one-time payment of NKr200,000 at the end of Year 5. Assume the riskfree rate of return is 2.6 percent in the U.S. and 3.1 percent in Norway. Assume the inflation rate is 1.6 percent in the U.S. and 2.3 percent in Norway. Lastly, assume the current exchange rate is $1 = NKr7.9271. Approximately how much will the payment at the end of 5 Years be worth in U.S. dollars? A) $24,609 B) $24,108 C) $26,472 D) $25,870 E) $26,006

77) You are expecting a payment of Can$138,000 two years from now. Assume the risk-free rate

of return is 2.7 percent in Canada and 3.1 percent in the U.S. Also assume the current exchange rate is Can$1.2903 = $1. Approximately how much will the payment two years from now be worth in U.S. dollars? A) $108,319 B) $106,101 C) $107,813 D) $107,381 E) $108,169

78) Assume the current spot rate for the Norwegian krone is $1 = NKr7.9323, the expected

inflation rate in Norway is 2.1 percent and 1.2 percent in the U.S. Also assume a risk-free asset in the U.S. is yielding 3.7 percent. What nominal risk-free rate of return should you expect on a Norwegian security? A) 2.9% B) 4.6% C) 4.2% D) 3.1% E) 3.8%

79) Assume the current spot rate for the Norwegian krone is $1 = NKr7.93, the expected inflation

rate in Norway is 2.4 percent while it is 2.6 percent in the U.S. Also assume a risk-free asset in the U.S. is yielding 4.5 percent. What real rate of return should you expect on a risk-free Norwegian security? A) 4.3% B) 4.7% C) 1.9% D) 2.1% E) 2.4%

80) Assume the expected inflation rate in Finland is 2 percent while it is 4 percent in the U.S.

Also assume a risk-free asset in the U.S. is yielding 4.5 percent. What nominal rate of return should you expect on a risk-free Finnish security? A) 2.0% B) 1.5% C) 3.0% D) 2.5% E) 4.0%

81) Assume the expected inflation rate in Switzerland is 2.2 percent while it is 1.6 percent in the

U.S. Also assume a risk-free asset in the U.S. is yielding 3.7 percent. What real rate of return should you expect on a risk-free Swiss security? A) 2.0% B) 2.1% C) 3.0% D) 3.5% E) 3.1%

82) A Canadian project has an initial cost of Can$1.8 million and is expected to produce cash

inflows of Can$710,000 per year for 3 years after which time it will be worthless. Assume the expected inflation rate in Canada is 4 percent while it is only 3 percent in the U.S. The applicable interest rate in Canada is 8 percent. Assume the current spot rate is C$1 = $.78. What is the net present value of this project in Canadian dollars using the foreign currency approach? A) Can$33,974.02 B) Can$32,790.05 C) Can$29,738.86 D) Can$28,721.40 E) Can$30,751.18

83) Global Markets wants to invest in a riskless project in Sweden. The project has an initial cost

of SKr2.3 million and is expected to produce cash inflows of SKr850,000 per year for 3 years. The project will be worthless after the first 3 years. Assume the expected inflation rate in Sweden is 2.6 percent while it is 3.2 percent in the U.S. Also assume a risk-free security is paying 5.9 percent in the U.S. and the current spot rate is $1 = SKr8.31. What is the net present value of this project in Swedish krona using the foreign currency approach? Assume the international Fisher effect applies. A) SKr1,856.07 B) SKr1,809.85 C) SKr1,969.10 D) SKr1,978.67 E) SKr2,028.18

84) A project has an initial cost of £1.2 million and expected cash inflows of £400,000,

£500,000, and £600,000 for Years 1 to 3, respectively. Assume the current spot rate is £.73 and the nominal risk-free returns are 4 percent in the U.K. and 3 percent in the U.S. If uncovered interest rate parity exists, what is the net present value of this project in U.S. dollars using the home currency approach? Assume the project’s U.S. discount rate is 12 percent. A) −$56,359 B) −$104,040 C) −$71,067 D) $26,422 E) $92,009

85) A project has an initial cost of £80,000 and is expected to return £10,000 the first year,

£40,000 the second year, and £50,000 the third and final year. Assume the current spot rate is £.75. Also assume the nominal risk-free return is 3 percent in the U.K. and 5 percent in the U.S. The return relevant to the project is 7.8 percent in the U.K. and 8.1 percent in the U.S. Assume uncovered interest rate parity exists. What is the net present value of this project in U.S. dollars using the home currency approach? A) $9,787 B) $11,002 C) $10,312 D) $10,511 E) $9,514

86) Explain the difference between a spot trade and a forward trade as they relate to currencies.

87) What is triangle arbitrage?

88) How well do you think relative purchasing power parity and uncovered interest parity

behave? That is, do you think it's possible to forecast the expected future spot exchange rate accurately? What complications might you run into?

89) What is required for absolute purchasing power parity to hold? Do you think absolute PPP

would hold in the case where a shoe retailer in the U.S. sits directly across the border from a shoe retailer in Canada? How about Houston, Texas, and London, England?

90) Describe the foreign currency and home currency approaches to capital budgeting. Which is

better? Which approach would you recommend a U.S. firm use? Justify your answer.

Answer Key Test name: Chapter 31(1) 1) A 2) B 3) D 4) B 5) B 6) C 7) A 8) C 9) A 10) C 11) C 12) D 13) E 14) A 15) B 16) B 17) C 18) D 19) E 20) C 21) A 22) C 23) C 24) C 25) D 26) B 27) E 28) D 29) E 30) B 31) E 32) E 33) C 34) B 35) E 36) A 37) B

38) A 39) E 40) E 41) B 42) B 43) C 44) C 45) C 46) C 47) D 48) A 49) A 50) E 51) B 52) D 53) B 54) B 55) B 56) A 57) D 58) E 59) D 60) B 61) A 62) E 63) E 64) E 65) C 66) C 67) A 68) B 69) B 70) D 71) A 72) E 73) A 74) B 75) B 76) A 77) C

78) B 79) C 80) D 81) B 82) C 83) B 84) A 85) E 86) Essay 87) Essay 88) Essay 89) Essay 90) Essay

Student name: 1) The exchange rate is 1.29 Swiss francs per dollar. How many U.S. dollars are needed to

purchase 10,000 Swiss francs? A) $7,047.22 B) $10,325.97 C) $13,170.00 D) $7,751.94 E) $10,325.97 F) $12,900.00

2) The exchange rate is .7655 U.S. dollars per Brazilian real. How many U.S. dollars are needed

to purchase 7,800 Brazilian reals? A) $8,080.16 B) $9,263.11 C) $5,970.90 D) $10,189.42 E) $6,240.90

3) You are planning a trip to the United Kingdom and expect that you will spend 3,600 pounds.

How much will your spending be in U.S. dollars if the exchange rate is .7521 pounds per dollar? A) $2,977.56 B) $4,351.45 C) $2,707.56 D) $4,786.60 E) $3,747.08

4) You just returned from a trip to Italy and have 710 euros remaining. How many dollars will

you receive when you return home if the exchange rate is .9165 euros per U.S dollar? A) $680.36 B) $650.72 C) $774.69 D) $820.26 E) $748.81

5) Your German friend has decided to come visit you in the U.S. You estimate the cost of her

trip will be $3,300. What is the cost of her trip in euros if the U.S. dollar equivalent of the euro is 1.1390? A) €2,897.28 B) €2,744.79 C) €3,758.70 D) €2,997.18 E) €3,529.35

6) You can exchange $1 for either .9135 euro or .7245 British pounds. What is the cross-rate in

terms of pounds per euro? A) £.6618/€ B) £1.1639/€ C) £.7931/€ D) £.7050/€ E) £1.2609/€

7) You can exchange $1 for either Can$1.1423 or ¥121.21. What is the cross-rate between the

Canadian dollar and Japanese yen? A) Can$94.3204/¥ B) Can$.0087/¥ C) Can$.0094/¥ D) Can$106.1105/¥ E) Can$138.4582/¥

8) Currently, you can purchase either 124 Canadian dollars or 11,525 Japanese yen per $100.

What is the yen/Canadian dollar cross-rate? A) ¥92.9435/Can$ B) ¥.0108/Can$ C) ¥.0134/Can$ D) ¥98.1071/Can$ E) ¥.0099/Can$

9) The spot rate for the British pound is £.7169 = $1 and the Canadian dollar is Can$1.0717 =

$1. What is the £/Can$ cross-rate? A) £.6175/Can$ B) £.8362/Can$ C) £1.4949/Can$ D) £.6689/Can$ E) £1.5780/Can$

10) Currently, you can exchange $1 for either ¥106.29 or €.7580 in New York. In Tokyo, the

exchange rate is ¥/€.0074. If you have $1,400, how much profit can you earn with triangle arbitrage? A) $52.72 B) $48.67 C) $55.50 D) $65.90 E) $58.58

11) The exchange rates in New York for $1 are Can$1.1133 or £.7417. In Toronto, Can$1 will

buy £.6750. How much profit can you earn on $16,500 using triangle arbitrage? A) $217.51 B) $205.43 C) $228.96 D) $200.78 E) $271.89

12) Your favorite running shoes cost $100 in the U.S. while the identical shoes cost Can$120.90

in Canada. According to absolute purchasing power parity, what is the Can$/$ exchange rate? A) Can$.8271/$ B) Can$.8631/$ C) Can$1.2090/$ D) Can$1.2574/$ E) Can$1.2954/$

13) A ski resort hotel room in Switzerland costs SF320. A ski resort hotel room in Colorado costs

$345. Assuming the slopes and hotel rooms are identical, what is the Swiss franc/U.S. dollar exchange rate? A) SF.9275/$ B) SF1.0781/$ C) SF.9938/$ D) SF1.1250/$ E) SF.9646/$

14) A set of golf clubs costs $1,275 in the United States. The current exchange rate is $1.3664/£.

Assuming absolute purchasing power parity holds, what is the price of the clubs in Scotland? A) £970.43 B) £1,742.16 C) £999.76 D) £933.11 E) £1,655.05

15) The current spot rate between the pound and dollar is £.7544/$. The expected inflation rate in

the U.S is 2.23 percent and the expected inflation rate in the U.K. is 2.73 percent. Assuming relative purchasing power parity holds, what will the exchange rate be next year? A) £.7582/$ B) £.7918/$ C) £.7885/$ D) £.7506/$ E) £.7885/$

16) The current spot rate between the euro and dollar is €1.0927/$. The annual inflation rate in

the U.S is expected to be 2.73 percent and the annual inflation rate in euroland is expected to be 2.23 percent. Assuming relative purchasing power parity holds, what will the exchange rate be in two years? A) €1.0764/$ B) €1.0872/$ C) €1.0818/$ D) €1.0982/$ E) €1.1037/$

17) The annual inflation rate in the U.S is expected to be 1.94 percent and the annual inflation

rate in Poland is expected to be 4.55 percent. The current spot rate between the zloty and dollar is Z4.1196/$. Assuming relative purchasing power parity holds, what will the exchange rate be in four years? A) Z4.3374/$ B) Z4.5668/$ C) Z3.7061/$ D) Z4.4507/$ E) Z3.8054/$

18) The spot rate between Canada and the U.S. is Can$1.2383/$, while the one-year forward rate

is Can$1.2384/$. The risk-free rate in Canada is 2.84 percent and risk-free rate in the United States is 2.55 percent. How much in profit can you earn on $10,000 utilizing covered interest arbitrage? A) $24.65 B) $22.54 C) $33.56 D) $29.83 E) $28.17

19) The spot rate between the U.K. and the U.S. is £.7614/$, while the one-year forward rate is

£.7540/$. The risk-free rate in the U.K. is 4.59 percent and risk-free rate in the United States is 2.74 percent. How much in profit can you earn on $11,000 utilizing covered interest arbitrage? A) $276.86 B) $253.13 C) $103.15 D) $316.41 E) $91.68

20) The one-year forward rate for the Swiss franc is SF1.1361/$. The spot rate is SF1.1491/$.

The interest rate on a risk-free asset in Switzerland is 2.35 percent. If interest rate parity exists, what is the one-year risk-free rate in the U.S.? A) 1.19% B) 2.82% C) 3.52% D) 3.30% E) 3.08%

21) The spot rate between the Japanese yen and the U.S. dollar is ¥108.52/$, while the one-year

forward rate is ¥108.77/$. The one-year risk-free rate in the U.S. is 2.99 percent. If interest rate parity exists, what is the one-year risk-free rate in Japan? A) 2.41% B) 2.87% C) 3.23% D) 2.75% E) 2.58%

22) Assume interest rate parity holds. The one-year risk-free rate in the U.S. is 4.34 percent and

the one-year risk-free rate in Japan is 4.69 percent. The spot rate between the Japanese yen and the U.S. dollar is ¥115.17/$. What is the one-year forward exchange rate? A) ¥114.78/$ B) ¥118.40/$ C) ¥117.43/$ D) ¥115.56/$ E) ¥115.17/$

23) The one-year risk-free rate in the U.S. is 5.30 percent and the one-year risk-free rate in

Mexico is 7.96 percent. The one-year forward rate between the Mexican peso and the U.S. dollar is MXN12.444/$. What is the spot exchange rate? Assume interest rate parity holds. A) MXN14.007/$ B) MXN12.758/$ C) MXN14.977/$ D) MXN12.444/$ E) MXN12.137/$

24) A U.S. firm has total assets valued at €806,000 located in Germany. This valuation did not

change from last year. Last year, the exchange rate was €.9464/$. Today, the exchange rate is €.8985/$. By what amount did these assets change in value on the firm's U.S. financial statements? A) −$38,607.40 B) −$45,402.29 C) $38,607.40 D) $45,402.29 E) $0

25) Last year, the Mexican peso/U.S. dollar exchange rate was MXN13.2636/$. Today, the

exchange rate is MXN15.1975/$. A U.S. firm has total assets worth MXN13,470,000 located in Mexico that did not change in value over the year. What was the change in the value of the assets in dollars on the company's U.S. balance sheet? A) $0 B) −$112,880.26 C) −$129,231.40 D) $129,231.40 E) $112,880.26

Answer Key Test name: Chapter 31(2) 1) D 2) C 3) D 4) C 5) A 6) C 7) C 8) A 9) D 10) A 11) A 12) C 13) A 14) D 15) A 16) C 17) B 18) E 19) D 20) C 21) C 22) D 23) B 24) D 25) C

Alternative Investments: 1) A portfolio manager who adds commodities to a portfolio of traditional investments is most

likely seeking to: A) both increase expected returns and decrease portfolio variance. B) decrease portfolio variance only. C) increase expected returns only.

2) A Hong Kong hedge fund was valued at HK$400 million at the end of last year. At year's end

the value before fees was HK$480 million. The fund charges 2 and 20. Management fees are calculated on end- of-year values. Incentive fees are independent of management fees and calculated using no hurdle rate. The previous year the fund’s net return was 2.5%. The annualized return for the last two years is closest to: A) 8.1%. B) 13.6%. C) 7.9%.

3) A Canadian hedge fund has a value of C$100 million at the beginning of the year. The fund

charges a 2% management fee based on assets under management at the beginning of the year and a 20% incentive fee with a 10% hard hurdle rate. Incentive fees are calculated net of management fees. The value at the end of the year before fees is C$112 million. The net return to investors is closest to: A) 10%. B) 9%. C) 8%.

4) For a given set of underlying real estate properties, the type of real estate index that is most

likely to have the lowest standard deviation is a(n): A) REIT trading price index. B) appraisal index. C) repeat sales index.

5) An example of a relative value hedge fund strategy is: A) convertible arbitrage. B) merger arbitrage. C) market neutral.

6) A hedge fund that charges an incentive fee on all profits, but only if the fund's rate of return

exceeds a stated benchmark, is said to have a: A) hard hurdle rate. B) high water mark. C) soft hurdle rate.

7) A hedge fund has a 2-and-20 fee structure, based on beginning-of-period assets, with a soft

hurdle rate of 5%. Incentive fees are calculated before management fees. An endowment invests $60.0 million in the hedge fund. The value of the endowment's investment, before fees, decreases to $56.2 million after one year and increases to $58.0 million the next year. In the second year the endowment will be charged management and incentive fees closest to: A) $1.10 million. B) $1.70 million. C) $1.15 million.

8) Relatively infrequent valuations of private equity portfolio companies most likely cause: A) correlations of fund returns with equity returns to be biased downward. B) standard deviations of fund returns to be biased upward. C) average fund returns to be biased upward.

9) Adjusted funds from operations (AFFO) is best described as an estimate of a real estate

investment trust's: A) free cash flow. B) net operating income. C) operating cash flow.

10) To exit an investment in a portfolio company through a trade sale, a private equity firm sells: A) the portfolio company to one of the portfolio company’s competitors. B) shares of a portfolio company to the public. C) the portfolio company to another private equity firm.

11) If a commodity futures market is in backwardation: A) the futures price is of the commodity is higher than the spot price. B) a long futures position will have a negative roll yield. C) the commodity has a high convenience yield.

Answer Key Test name: Alternative Investments 1) B 2) C 3) A 4) B 5) A 6) C 7) B 8) A 9) A 10) A 11) C

Corporate Finance: 1) The before-tax cost of debt for Hardcastle Industries, Incorporated is currently 8.0%, but it

will increase to 8.25% when debt levels reach $600 million. The debt-to-total assets ratio for Hardcastle is 40% and its capital structure is composed of debt and common equity only. If Hardcastle changes its target capital structure to 50% debt / 50% equity, which of the following describes the effect on the level of new investment at which the cost of debt will increase? The level will: A) decrease. B) change, but can either increase or decrease. C) increase.

2) An analyst gathered the following information about a capital budgeting project:

The proposed project cost $10,000. The project is expected to increase pretax net income and cash flow by $3,000 in each of the next eight years. The company has 50% of its capital in equity at a cost of 12%. The pretax cost of debt capital is 6%. The company’s tax rate is 33%. The project’s net present value is closest to: A) $1,551. B) $6,604. C) $7,240.

3) Which of the following stakeholders are most likely to benefit from a company’s growth and

excellent financial performance? A) Governments. B) Creditors. C) Customers.

4) Lincoln Coal is planning a new coal mine, which will cost $430,000 to build, with the

expenditure occurring next year. The mine will bring cash inflows of $200,000 annually over the subsequent seven years. It will then cost $170,000 to close down the mine over the following year. Assume all cash flows occur at the end of the year. Alternatively, Lincoln Coal may choose to sell the site today. What minimum price should Lincoln set on the property, given a 16% required rate of return? A) $376,872. B) $280,913. C) $325,859.

5) Which of the following statements about corporate governance is most accurate? Corporate

governance: A) best practices are essentially the same in developed economies. B) is defined in the same way in most countries. C) may be focused only on shareholder interests.

6) Arlington Machinery currently has assets on its balance sheet of $300 million that is financed

with 70% equity and 30% debt. The executive management team at Arlington is considering a major expansion that would require raising additional capital. Jeffery Marian, an analyst with Arlington Machinery, has put together the following schedule for the costs of debt and equity: Amount of New Debt After-tax Cost (in millions) of Debt $0 to $49 $50 to $99 $100 to $149

4.0% 4.2% 4.5%

Amount of New Equity (in millions)

Cost of Equity

$0 to $99 $100 to $199 $200 to $299

7.0% 8.0% 9.0%

In a presentation to Arlington’s executive management team, Marian makes the following statements: Statement 1: If we maintain our target capital structure of 70% equity and 30% debt, the breakpoint at which our cost of equity will increase to 9.0% is approximately $286 million in new capital. Statement 2: If we want to finance total assets of $600 million, our weighted average cost of capital (WACC) for the additional financing needed will be 7.56%. Marian’s statements are:

A) B) C)

Statement 1

Statement 2

Correct Incorrect Correct

Incorrect Incorrect Correct

A) Option A B) Option B C) Option C

7) The effect of a company announcement that they have begun a project with a current cost of

$10 million that will generate future cash flows with a present value of $20 million is most likely to: A) only affect value of the firm’s common shares if the project was unexpected. B) increase the value of the firm’s common shares by $20 million. C) increase value of the firm’s common shares by $10 million.

8) The following is a schedule of Tiger Company’s new debt and equity capital costs ($

millions): Amount of New Debt < $30 $30 − $60 > $60

After-tax Cost of Debt 3.5% 4.0% 4.7%

Amount of New Equity < $60 $60 − $90 > $90

Cost of Equity 8.5% 10.3% 12.5%

The company has a target capital structure of 30% debt and 70% equity. Tiger needs to raise an additional $135.0 million of capital for a new project while maintaining its target capital structure. The company’s second debt break point and its marginal cost of capital (MCC) are closest to:

Debt Break Point #2 A) B) C)

$200 million $100 million $200 million

MCC 8.4% 8.4% 10.0%

A) Option A B) Option B C) Option C

9) Ashlyn Lutz makes the following statements to her supervisor, Paul Ulring, regarding the

basic principles of capital budgeting: Statement 1: The timing of expected cash flows is crucial for determining the profitability of a capital budgeting project. Statement 2: Capital budgeting decisions should be based on the after-tax net income produced by the capital project. Which of the following regarding Lutz’s statements is most accurate? Statement 1

Statement 2

A) Incorrect B) Correct C) Correct A) Option A B) Option B C) Option C

Correct Correct Incorrect

10) The stakeholders most likely to be concerned with their legal liabilities are: A) directors. B) regulators. C) creditors.

11) Meredith Suresh, an analyst with Torch Electric, is evaluating two capital projects. Project 1

has an initial cost of $200,000 and is expected to produce cash flows of $55,000 per year for the next eight years. Project 2 has an initial cost of $100,000 and is expected to produce cash flows of $40,000 per year for the next four years. Both projects should be financed at Torch’s weighted average cost of capital. Torch’s current stock price is $40 per share, and next year’s expected dividend is $1.80. The firm’s growth rate is 5%, the current tax rate is 30%, and the pre-tax cost of debt is 8%. Torch has a target capital structure of 50% equity and 50% debt. If Torch takes on either project, it will need to be financed with externally generated equity which has flotation costs of 4%. Suresh is aware that there are two common methods for accounting for flotation costs. The first method, commonly used in textbooks, is to incorporate flotation costs directly into the cost of equity. The second, and more correct approach, is to subtract the dollar value of the flotation costs from the project NPV. If Suresh uses the cost of equity adjustment approach to account for flotation costs rather than the correct cash flow adjustment approach, will the NPV for each project be overstated or understated?

A) B) C) A) Option A B) Option B C) Option C

Project 1 NPV

Project 2 NPV

Understated Understated Overstated

Understated Overstated Overstated

12) Assume a firm uses a constant WACC to select investment projects rather than adjusting the

projects for risk. If so, the firm will tend to: A) reject profitable, low-risk projects and accept unprofitable, high-risk projects. B) accept profitable, low-risk projects and reject unprofitable, high-risk projects. C) accept profitable, low-risk projects and accept unprofitable, high-risk projects.

13) The debt of Savanna Equipment, Incorporated has an average maturity of ten years and a

BBB rating. A market yield to maturity is not available because the debt is not publicly traded, but the market yield on debt with similar characteristics is 8.33%. Savanna is planning to issue new ten-year notes that would be subordinate to the firm’s existing debt. The company’s marginal tax rate is 40%. The most appropriate estimate of the after-tax cost of this new debt is: A) More than 5.0%. B) Between 3.3% and 5.0%. C) 5.0%.

14) Hanson Aluminum, Incorporated is considering whether to build a mill based around a new

rolling technology the company has been developing. Management views this project as being riskier than the average project the company undertakes. Based on their analysis of the projected cash flows, management determines that the project’s internal rate of return is equal to the company’s marginal cost of capital. If the project goes forward, the company will finance it with newly issued debt with an after-tax cost less than the project’s IRR. Should management accept or reject this project? A) Accept, because the marginal cost of the new debt is less than the project’s internal rate of return. B) Reject, because the project reduces the value of the company when its risk is taken into account. C) Accept, because the project returns the company’s cost of capital.

15) The financial manager at Genesis Company is looking into the purchase of an apartment

complex for $550,000. Net after-tax cash flows are expected to be $65,000 for each of the next five years, then drop to $50,000 for four years. Genesis’ required rate of return is 9% on projects of this nature. After nine years, Genesis Company expects to sell the property for after-tax proceeds of $300,000. What is the respective internal rate of return (IRR) and net present value (NPV) on this project? A) 6.66%; −$64,170. B) 7.01%; −$53,765. C) 13.99%; $166,177.

16) A firm has $4 million in outstanding bonds that mature in four years, with a fixed rate of

7.5% (assume annual payments). The bonds trade at a price of $98 in the open market. The firm’s marginal tax rate is 35%. Using the bond-yield plus method, what is the firm’s cost of equity risk assuming an add-on of 4%? A) 13.34%. B) 12.11%. C) 11.50%.

17) The stakeholder theory of corporate governance is primarily focused on: A) the interests of various stakeholders rather than the interests of shareholders. B) increasing the value a company. C) resolving the competing interests of those who manage companies and other groups

affected by a company’s actions.

18) A company prepares a chart with the net present value (NPV) profiles for two mutually

exclusive projects with equal lives of five years. Project Jones and Project Smith have the same initial cash outflow and total undiscounted cash inflows, but 75% of the cash inflows for Project Jones occur in years 1 and 2, while 75% of the cash inflows for Project Smith occur in years 4 and 5. Which of the following statements is most accurate regarding these projects? A) Project Smith has a higher internal rate of return than Project Jones. B) There is a range of discount rates in which the company should choose Project Jones and a range in which it should choose Project Smith. C) There is a range of discount rates in which the optimal decision is to reject both projects.

19) Which of the following steps is least likely to be an administrative step in the capital

budgeting process? A) Forecasting cash flows and analyzing project profitability. B) Conducting a post-audit to identify errors in the forecasting process. C) Arranging financing for capital projects.

20) A North American investment society held a panel discussion on the topics of capital costs

and capital budgeting. Which of the following comments made during this discussion is the least accurate? A) Any given project’s NPV will decline when a breakpoint is reached. B) An increase in the after-tax cost of debt may occur at a break point. C) A project’s internal rate of return decreases when a breakpoint is reached.

21) Axle Corporation earned £3.00 per share and paid a dividend of £2.40 on its common stock

last year. Its common stock is trading at £40 per share. Axle is expected to have a return on equity of 15%, an effective tax rate of 34%, and to maintain its historic payout ratio going forward. In estimating Axle’s after-tax cost of capital, an analyst’s estimate of Axle’s cost of common equity would be closest to: A) 9.2%. B) 8.8%. C) 9.0%.

22) Stolzenbach Technologies has a target capital structure of 60% equity and 40% debt. The

schedule of financing costs for the Stolzenbach is shown in the table below: Amount of New Debt After-tax Cost (in millions) of Debt $0 to $199 $200 to $399 $400 to $599

4.5% 5.0% 5.5%

Amount of New Equity (in millions) $0 to $299 $300 to $699 $700 to $999

Cost of Equity

7.5% 8.5% 9.5%

Stolzenbach Technologies has breakpoints for raising additional financing at both: A) $400 million and $700 million. B) $500 million and $700 million. C) $500 million and $1,000 million.

23) An analyst with Laytech Corporation is evaluating two machines as possible replacements

for an existing stamping machine. He estimates that machine 1 has a cost of $5 million and that purchasing it would produce a profitability index of 1.20. He estimates that machine 2 has a cost of $6 million and that purchasing it would produce a profitability index of 1.17. Based on these estimates he should conclude that: A) machine 2 should be chosen. B) neither project is preferred to the other. C) machine 1 should be chosen.

24) Which of the following is most accurate for two independent projects with conventional cash

flows? A) An analyst will not encounter the problem of multiple IRRs. B) A firm that rations investment capital will choose the one with the higher NPV. C) The project with the higher IRR will also have the higher NPV.

25) Pfluger Company’s accounts payable department receives an invoice from a vendor with

terms of 2/10 net 30. If Pfluger pays the invoice on its due date, the cost of trade credit is closest to: A) 27.9%. B) 43.5%. C) 44.6%.

26) With sales of $45 million, the operating earnings of Poston Industries are $3.8 million. Fixed

operating costs are $4.2 million, net profit margin is 4.5%, and unit variable costs are $35.50. At the current level of sales, Poston’s degree of operating leverage is closest to: A) 1.2. B) 1.6. C) 2.1.

27) Randox Industries has the following investment policy statement: "In order to achieve the

safety and liquidity necessary in the investment of excess cash balances, the CFO or his designee may invest excess cash balances in 30-day U.S. Treasury bills, or in banker’s acceptances with maturities of less than 31 days or 30-day certificates of deposit, where the credit rating of the issuing bank is A+ or higher." This policy statement is: A) inappropriate because both banker’s acceptances and certificates of deposit are illiquid. B) inappropriate because it is too restrictive. C) appropriate because these are all safe, liquid securities.

28) An investment policy statement for a firm’s short-term cash management function would

least appropriately include: A) procedures to follow if the investment guidelines are violated. B) information on who is allowed to invest corporate cash. C) a list of permissible securities.

29) A firm is choosing among three short-term investment securities:

Security 1: A 30-day U.S. Treasury bill with a discount yield of 3.6%. Security 2: A 30-day banker’s acceptance selling at 99.65% of face value. Security 3: A 30-day time deposit with a bond equivalent yield of 3.65%. Based only on these securities’ yields, the firm would: A) prefer the time deposit. B) prefer the banker’s acceptance. C) prefer the U.S. Treasury bill.

30) Which of the following strategies is most likely to be considered good payables management? A) Paying trade invoices on the day they arrive. B) Taking trade discounts only if the firm’s annual return on short-term investments is

less than the discount percentage. C) Paying invoices on the last day to still get the supplier’s discount for early payment.

31) Which of the following is least likely an indicator of a firm’s liquidity? A) Cash as a percentage of sales. B) Amount of credit sales. C) Inventory turnover.

32) An appropriate cash management strategy for a company that has a seasonally high need for

cash prior to the holiday shopping season would least likely include: A) investing in U.S. Treasury notes at other times of the year because they are highly liquid. B) allowing short-term securities to mature without reinvestment. C) borrowing funds though a bank line of credit.

33) A firm has average days of receivables outstanding of 22 compared to an industry average of

29 days. An analyst would most likely conclude that the firm: A) has a lower cash conversion cycle than its peer companies. B) has better credit controls than its peer companies. C) may have credit policies that are too strict.

34) A banker’s acceptance that is priced at $99,145 and matures in 72 days at $100,000 has a(n): A) bond equivalent yield greater than its effective annual yield. B) money market yield greater than its discount yield. C) discount yield greater than its bond equivalent yield.

35) With respect to inventory management,: A) a decrease in a firm’s days of inventory on hand indicates better inventory

management and can lead to increased profits. B) an increase in days of inventory on hand can be the result of either good or poor inventory management. C) a firm with inventory turnover higher than the industry average can be expected to have better profitability as a result.

Answer Key Test name: Corporate Finance 1) A 2) A 3) A 4) B 5) C 6) C 7) A 8) C 9) C 10) A 11) C 12) A 13) A 14) B 15) B 16) B 17) C 18) C 19) C 20) C 21) A 22) C 23) A 24) A 25) C 26) C 27) B 28) C 29) B 30) C 31) B 32) A 33) C 34) B 35) B

Derivatives: 1) The process that ensures that two securities positions with identical future payoffs, regardless

of future events, will have the same price is called: A) the law of one price. B) arbitrage. C) exchange parity.

2) When interest rates and futures prices for an asset are uncorrelated and forwards are less

liquid than futures, it is most likely that the price of a forward contract is: A) equal to the price of a futures contract. B) greater than the price of a futures contract. C) less than the price of a futures contract.

3) An analyst determines that a portfolio with a 35% weight in Investment P and a 65% weight

in Investment Q will have a standard deviation of returns equal to zero. Investment P has an expected return of 8%. Investment Q has a standard deviation of returns of 7.1% and a covariance with the market of 0.0029. The risk-free rate is 5% and the market risk premium is 7%. If no arbitrage opportunities are available, the expected rate of return on the combined portfolio is closest to: A) 7%. B) 6%. C) 5%.

4) Which of the following is an example of an arbitrage opportunity? A) A stock with the same price as another has a higher rate of return. B) A portfolio of two securities that will produce a certain return that is greater than the

risk- free rate of interest. C) A put option on a share of stock has the same price as a call option on an identical share.

5) MBT Corporation recently announced a 15% increase in earnings per share (EPS) over the

previous period. The consensus expectation of financial analysts had been an increase in EPS of 10%. After the earnings announcement the value of MBT common stock increased each day for the next five trading days, as analysts and investors gradually reacted to the better than expected news. This gradual change in the value of the stock is an example of: A) efficient markets. B) inefficient markets. C) speculation.

6) The spot price of an asset is 62 and the risk-free rate is 2.5%. If the net cost of carry for the

asset over the next six months is −3 in present value terms, the no-arbitrage 6-month forward price is closest to: A) 66.6 B) 65.8 C) 59.7

7) It is possible to profit from arbitrage when there are no costs or benefits to holding the

underlying asset and the forward contract price is: A) greater than the present value of the spot price. B) less than the future value of the spot price. C) less than the present value of the spot price.

8) A net benefit from holding the underlying asset of a forward contract will: A) decrease the value of the forward contract at expiration. B) increase the value of the forward contract during its life. C) decrease the no-arbitrage forward price at initiation.

9) Bea Moran wants to establish a long derivatives position in a commodity she will need to

acquire in six months. Moran observes that the six-month forward price is 45.20 and the sixmonth futures price is 45.10. This difference most likely suggests that for this commodity: A) there is an arbitrage opportunity among forward, futures, and spot prices. B) futures prices are negatively correlated with interest rates. C) long investors should prefer futures contracts to forward contracts.

10) Derivatives valuation is based on risk-neutral pricing because: A) this method provides an intrinsic value to which investors apply a risk premium. B) the risk of a derivative is based entirely on the risk of its underlying asset. C) risk tolerances of long and short investors are assumed to offset.

11) Which of the following is the best interpretation of the no-arbitrage principle? A) The information flow is quick in the financial market. B) There is no way you can find an opportunity to make a profit. C) There is no free money.

12) Which of the following statements about arbitrage opportunities is most accurate? A) Engaging in arbitrage requires a large amount of capital. B) The market prices of two assets or portfolios that have the same future payoffs cannot

differ for protracted periods. C) Arbitrage is referred to as the law of one price.

13) The price of a pay-fixed receive-floating interest rate swap is: A) determined by expected future short-term rates. B) negative when floating rates are highly volatile. C) zero when floating rates and fixed rates are equal.

14) Compared to European put options on an asset, otherwise identical American put options on

the asset are most likely to be more valuable if: A) the asset value is significantly lower than the exercise price. B) the options are out-of-the-money. C) the asset pays dividends during the life of the option.

15) The calculation of derivatives values is based on an assumption that: A) arbitrage opportunities do not arise in real markets. B) arbitrage opportunities are exploited rapidly. C) investors are risk neutral.

16) For two European put options that differ only in their time to expiration, which of the

following is most accurate? The longer-term option: A) is worth at least as much as the shorter-term option. B) is worth more than the shorter-term option. C) can be worth less than the shorter-term option.

17) Which of the following portfolios has the same future cash flows as a protective put? A) Long call option, long risk-free bond, short the underlying asset. B) Long call option, long risk-free bond. C) Short call option, long risk-free bond.

18) For a European style put option: A) exercise value is equal to the underlying stock price minus its exercise price. B) intrinsic value is equal to its market price plus its exercise value. C) time value is equal to its market price minus its exercise value.

19) The time value of a European call option with 30 days to expiration will most likely be: A) less than the current option premium if the option is currently in-the-money. B) equal to the intrinsic value if the exercise price is greater than the current spot price. C) greater than the current option premium if the option is currently out-of-the-money.

20) The value of a European put option at expiration is most likely to be increased by: A) a lower risk-free interest rate. B) a higher exercise price. C) higher volatility of the underlying asset price.

21) Other things equal, a short put position would become more valuable as a result of an

increase in: A) the price of the underlying asset. B) the volatility of the price of the underlying asset. C) the time to expiration.

22) The time value of an option is most accurately described as: A) increasing as the option approaches its expiration date. B) the amount by which the intrinsic value exceeds the option premium. C) equal to the entire premium for an out-of-the-money option.

Answer Key Test name: Derivatives 1) B 2) A 3) C 4) B 5) B 6) B 7) B 8) C 9) B 10) B 11) C 12) C 13) A 14) A 15) B 16) C 17) B 18) C 19) A 20) B 21) A 22) C

Economics: 1) If money wages increase, other things equal, the most likely result is a: A) short-run inflationary gap. B) long-run inflationary gap. C) short-run recessionary gap.

2) When demand for a good is inelastic, a higher price will: A) have no impact on the demand for the good. B) lead to an increase in total expenditures for the good. C) fail to reduce the quantity demanded for the good.

3) Which of the following is least relevant when explaining why monopoly firms can earn

positive economic profits over the long term? A) The existence of economies of scale. B) Control over production input resources. C) The ability to use price discrimination.

4) A price index that is calculated using the current weights of the index’s basket of goods and

services is known as a: A) hedonic price index. B) chained price index. C) Laspeyres price index.

5) Which of the following is least accurate regarding the allocative efficiency associated with

price discrimination? Price discrimination: A) leads to production where the sum of consumer surplus and producer surplus is greater than it would be otherwise. B) results in gains to the discriminating firm by selling to consumers with relatively inelastic demand. C) leads to a decrease in allocative efficiency.

6) The current annual inflation rate, as measured by using the Consumer Price Index (CPI), is

best defined as: A) percentage change in the CPI from its base period. B) percentage change in the CPI from a year ago. C) increase in the CPI from a year ago.

7) Which of the following is least likely to be considered a reason why regulation of monopolies

is not effective? A) Regulators do not know the firm’s cost structure. B) Regulation shifts industry demand and increases prices. C) Regulation reduces the incentive for firms to reduce costs. Regulation is not associated with a shift in industry demand.

8) If the government is running a budget deficit, which of the following relationships are least

likely to occur in the economy at the same time?

A) B) C)

Exports relative to imports exports < imports exports < imports exports > imports

Savings relative to investment private savings > private investment private savings < private investment private savings < private investment

A) Option A B) Option B C) Option C

9) Which of the following is least accurate with regard to advertising for firms operating under

monopolistic competition? A) Advertising expenses are high relative to perfect competition and monopoly. B) Advertising may decrease average total cost. C) The increase to average total costs associated with advertising increases as output increases.

10)

In order for effective price discrimination to occur the seller must: A) maximize revenue by selling at the highest price possible. B) face a demand curve with a negative slope. C) have more than one identifiable group of customers with the same price elasticities of demand for the product.

11) Which of the following is least accurate regarding the relationship between price (P),

marginal revenue (MR), average total cost (ATC), and marginal cost (MC) at the profit maximizing output under monopoly? A) P = MR. B) MR = MC. C) MR < ATC.

12) Steve Walker, CFA, is attending an economics lecture, during which the lecturer makes the

following two statements about consumer price inflation: Statement 1: High-definition televisions are considerably more expensive than traditional models. This means consumers are spending more money per television unit, which represents a form of inflation. Statement 2: Employment contracts with automatic increases based on the Consumer Price Index fail to increase wages as much as the increase in the cost of living because of biases in the price index. Should Walker agree or disagree with these statements? Statement 1

Statement 2

Disagree Disagree Agree

Disagree Agree Agree

A) B) C) A) Option A B) Option B C) Option C

13) In a perfectly competitive industry, the short-run supply curve for the market is the: A) marginal cost curve above the average variable cost curve. B) sum of the individual supply curves for all firms in the industry. C) marginal cost curve above the average total cost curve.

14) If private saving equals private business investment, a trade surplus implies that there is: A) no fiscal surplus or deficit. B) a fiscal surplus. C) a fiscal deficit.

15) In the long-run, after all firms in a perfectly competitive industry have adopted new

technology, the: A) price will equal minimum average total cost. B) individual firm supply will increase as demand decreases. C) price will be set where average variable cost is equal to marginal revenue.

16) For price discrimination to work, the seller must face a market with all of the following

characteristics EXCEPT: A) a downward sloping demand curve. B) high barriers to entry. C) a way of preventing customers from purchasing the product at a lower price and reselling it at a higher price.

17) Which of the following amounts is least likely to be subtracted from gross domestic product

in order to calculate national income? A) Statistical discrepancy. B) Indirect business taxes. C) Capital consumption allowance.

18) Based on the concept of diminishing returns, as the quantity of output increases, the short-run

marginal costs of production eventually: A) rise at an increasing rate. B) fall at a decreasing rate. C) rise at a decreasing rate.

19) Manufacturing and trade sales are best described as a: A) leading indicator. B) lagging indicator. C) coincident indicator.

20) What is the relationship between price and marginal revenue for a price searcher? A) Marginal revenue = price. B) Marginal revenue < price. C) Marginal revenue > price.

21) When potential real GDP is less than actual real GDP, the economy is most likely

experiencing: A) underemployment. B) recession. C) inflation.

22) Even though the producer surplus increases under a monopoly scenario, relative to one of

perfect competition, the consumer surplus decreases by: A) an equal amount. B) a greater amount. C) a lesser amount.

23) If a fiscal budget deficit increases, which of the following factors must also increase if all

other factors are held constant? A) Trade surplus. B) Savings. C) Investment.

24) In the dominant firm model of oligopoly, it is least likely that one firm: A) has a significant cost advantage over its competitors. B) effectively sets the price in the market. C) is the innovation leader in product development.

25) The kinked demand model assumes that below the current price, the demand curve becomes: A) more elastic because competitors will decrease their prices. B) less elastic because competitors will decrease their prices. C) less elastic because competitors will not decrease their prices.

26) Consider the following statements:

Statement 1: “When oligopoly firms cheat on price fixing agreements, the result increases economic efficiency.” Statement 2: “Monopolistic competition is inefficient because a large deadweight loss from advertising and marketing costs is a characteristic of this form of competition.” With respect to these statements: A) both are correct. B) only one is correct. C) both are incorrect.

27) Assume that the market for paper supplies and the market for toothpicks have the following

characteristics: The Market for Paper Supplies is comprised of: A large number of independent sellers Differentiated products Low barriers to entry/exit A large number of independent sellers Homogeneous products No barriers to entry/exit A) decrease, and so will the quantity sold by Wudden Floss. B) increase, and the quantity sold by Wudden Floss will decrease. C) decrease, and Wudden Floss will sell nothing.

28) Average weekly initial claims for unemployment insurance are classified as a: A) coincident indicator. B) leading indicator. C) lagging indicator.

29) A company has estimated that the price elasticity of demand for its output is −1.1. If the

company increases the price of its product by 5%, it is most likely that: A) both total revenue and profits will decrease. B) total revenue will decrease but profits may increase. C) total revenue will increase but profits may decrease.

30) If domestic savings are insufficient to finance domestic private investment and exports are

greater than imports, it is most likely that the fiscal budget has: A) a deficit that is less than the trade surplus. B) a surplus that is greater than the trade surplus. C) a deficit that is greater than the trade surplus.

31) An economist calculates the following value:

National income + transfer payments to households − indirect business taxes − corporate income taxes − undistributed corporate profits The most appropriate term for the value she has calculated is: A) disposable income. B) GDP. C) personal income.

32) In the short run, will an increase in the money supply increase the price level and real output? A) Only one will increase in the short run. B) Both will increase in the short run. C) Neither will increase in the short run.

33) Which of the following events is most likely to increase short-run aggregate supply (shift the

curve to the right)? A) Inflation that results in an increase in goods prices. B) An increase in government spending intended to increase real output. C) High unemployment puts downward pressure on money wages.

34) With respect to the IS-LM model, a change in the price level will shift: A) the LM curve, but not the aggregate demand curve. B) the aggregate demand curve, but not the LM curve. C) both the LM and aggregate demand curves.

35) Compared to a competitive market result, a single-price monopoly will most likely: A) adopt a marginal cost pricing strategy, which will decrease consumer surplus. B) result in lower output, deadweight loss, and less producer and consumer surplus. C) result in a higher price, less consumer surplus, and more producer surplus.

36) The spot rate for Japanese yen per UK pound is 138.78. If the UK interest rate is 1.75% and

the Japanese interest rate is 1.25%, the 6-month no-arbitrage forward rate is closest to: A) 138.10 JPY/GBP. B) 138.44 JPY/GBP. C) 138.95 JPY/GBP.

37) The spot rate for Chinese yuan per Canadian dollar is 6.4440. If the Canadian interest rate is

2.50% and the Chinese interest rate is 3.00%, the 3-month no-arbitrage forward rate is closest to: A) 6.436 CNY/CAD. B) 6.475 CNY/CAD. C) 6.452 CNY/CAD.

38) If households are holding larger real money balances than they desire, which of the following

is least likely? A) The opportunity cost of holding money balances will decrease. B) The interest rate is higher than its equilibrium rate in the market for real money balances. C) The central bank must issue securities to absorb the excess money supply and establish equilibrium.

39) According to the quantity theory of money, if nominal GDP is $7 trillion, the price index is

150, and the money supply is $1 trillion, then the velocity of the money supply is closest to: A) 7.0. B) 10.5. C) 4.7.

40) The spot exchange rate for United States dollars per United Kingdom pound (USD/GBP) is

1.5775. If 30-day interest rates are 1.5% in the United States and 2.5% in the United Kingdom, and interest rate parity holds, the 30-day forward USD/GBP exchange rate should be: A) 1.5788. B) 1.5621. C) 1.5762.

41) Participants in foreign exchange markets that can be characterized as "real money accounts"

most likely include: A) insurance companies. B) hedge funds. C) central banks.

42) Which of the following relationships in regard to the quantity theory of money is least

accurate? A) Nominal GDP = Price × Money Supply. B) Nominal GDP = Money Supply × Velocity = Price × Real Output. C) Money × Velocity = Money Supply × Velocity.

43) In the context of the foreign exchange market, investment accounts are said to be leveraged if

they: A) buy currencies on margin. B) use derivatives. C) borrow and sell foreign currencies.

44) If a bank needs to borrow funds from the Federal Reserve to fund a temporary shortage in

reserves, it would borrow funds at the: A) prime rate. B) discount rate. C) federal funds rate.

45) Assuming the federal government maintains a balanced budget, the most likely effects of a

tax increase on government expenditures and real GDP are: Government Expenditures

Real GDP

Increase Increase Decrease

Increase Decrease Decrease

A) B) C) A) Option A B) Option B C) Option C

46) Spot and one-month forward exchange rates are as follows:

EUR/DEF EUR/GHI EUR/JKL

Spot

1-month forward

2.5675 4.3250 7.0625

2.5925 4.2800 7.0075

Based on these exchange rates, the EUR is closest to a 1-month forward: A) premium of 1% to the GHI. B) discount of 1% to the JKL. C) premium of 1% to the DEF.

47) Frequent changes in advertised prices are one of the costs of: A) unexpected inflation only. B) both expected and unexpected inflation. C) expected inflation only.

48) The exchange rate for Australian dollars per British pound (AUD/GBP) was 1.4800 five

years ago and is 1.6300 today. The percent change in the Australian dollar relative to the British pound is closest to: A) depreciation of 9.2%. B) appreciation of 10.1%. C) depreciation of 10.1%.

49) Which of the following statements about the demand and supply of money is most accurate?

People who are: A) buying bonds to reduce their money balances will increase the demand for bonds with an associated increase in interest rates. B) holding money when interest rates are lower will try to increase their money balances and, as a result, the supply of money increases. C) holding money when interest rates are higher will try to reduce their money balances and, as a result, the demand for money decreases.

50) The spot exchange rate for CHF/EUR is 0.8342 and the 1-year forward quotation is −0.353%.

The 1- year forward exchange rate for EUR/CHF is closest to: A) 1.2022. B) 0.8313. C) 1.2029.

51) Contractionary monetary policy is least likely to decrease consumption spending by

decreasing: A) the foreign exchange value of the currency. B) securities prices. C) expectations for economic growth.

52) Other things equal, a real exchange rate (stated as units of domestic currency per unit of

foreign currency) will decrease as a result of an increase in the: A) nominal exchange rate (domestic/foreign). B) domestic price level. C) foreign price level.

53) In the balance of payments accounts, goods and financial assets that migrants bring to a

country are included in the: A) financial account. B) capital account. C) current account.

54) If the money interest rate is measured on the y-axis and the quantity of money is measured on

the x- axis, the money supply curve is: A) vertical. B) downward sloping to the lower right. C) upward sloping to the upper right.

55) According to the Fisher effect, which of the following interest rates includes a premium for

the expected rate of inflation? A) Neither yields on short-term government debt nor yields on long-term corporate debt. B) Both yields on short-term government debt and yields on long-term corporate debt. C) Yields on long-term corporate debt, but not yields on short-term government debt.

56) A country is experiencing a core inflation rate of 7% during a recessionary period of real

GDP growth. If the central bank has a single mandate to achieve price stability and uses inflation targeting with an acceptable range of zero to 4%, its monetary policy response is most likely to decrease: A) the foreign exchange value of the country’s currency. B) short-term interest rates. C) GDP growth in the short run.

57) In 20X5, Carthage’s merchandise imports exceeded the value of its merchandise exports. In

this case, Carthage would most likely have which of the following? A) Current account surplus. B) Balance of trade surplus. C) Capital account surplus.

58) The least likely result of import quotas and voluntary export restraints is: A) a decrease in the quantity of imports of the product. B) increased revenue for the government. C) a shift in production toward higher-cost suppliers.

59) The USD/EUR spot exchange rate is 1.3500 and 6-month forward points are −75. The 6-

month forward exchange rate is: A) 1.3575, and the USD is at a forward discount. B) 1.3425, and the USD is at a forward discount. C) 1.3425, and the USD is at a forward premium.

60) Assume that the long-term equilibrium money market interest rate is 4% and the current

money market interest rate is 3%. At this current rate of 3%, there will be an excess: A) supply of money in the money market, and investors will tend to be net buyers of securities. B) demand for money in the money market, and investors will tend to be net buyers of securities. C) demand for money in the money market, and investors will tend to be net sellers of securities.

Answer Key Test name: Economics 1) C 2) B 3) C 4) B 5) C 6) B 7) B 8) C 9) C 10) B 11) A 12) A 13) B 14) B 15) A 16) B 17) B 18) A 19) C 20) B 21) C 22) B 23) B 24) C 25) B 26) B 27) C 28) B 29) B 30) B 31) C 32) B 33) C 34) A 35) C 36) B 37) C

38) C 39) A 40) C 41) A 42) A 43) B 44) B 45) A 46) A 47) B 48) A 49) C 50) C 51) A 52) B 53) B 54) A 55) B 56) C 57) C 58) B 59) C 60) C

Equity Investments: 1) Which of the following statements best describes the overreaction effect? A) Low returns over a three-year period are followed by high returns over the following

three years. B) High returns over a one-year period are followed by low returns over the following three years. C) High returns over a one-year period are followed by high returns over the following year.

2) Equal weighting is the most common weighting methodology for indexes of which of the

following types of assets? A) Hedge funds. B) Equities. C) Fixed income securities.

3) Which of the following option positions is said to be a long position? A) Writer of a put option. B) Buyer of a put option. C) Writer of a call option.

4) An investor bought a stock on margin. The margin requirement was 60%, the current price of

the stock is $80, and the stock price was $50 one year ago. If margin interest is 5%, how much equity did the investor have in the investment at year-end? A) 73.8%. B) 60.6%. C) 67.7%.

5) Peg Fisk, CFA, states that two of the objectives of market regulation which CFA Institute

attempts to address are minimum standards of competence among investment professionals and ease of performance evaluation for investors. Fisk is accurate with regard to: A) only one of these objectives B) both of these objectives. C) neither of these objectives.

6) The idea that uninformed traders, when faced with unclear information, observe the actions

of informed traders to make decisions, is referred to as: A) narrow framing. B) herding behavior. C) information cascades.

7) Which of the following statements least likely describes the role of a portfolio manager in

perfectly efficient markets? Portfolio managers should: A) quantify client's risk tolerance, communicate portfolio policies and strategies, and maintain a strict buy and hold policy avoiding any changes in the portfolio to minimize transaction costs. B) construct diversified portfolios that include international securities to eliminate unsystematic risk. C) construct a portfolio that includes financial and real assets.

8) Which of the following conditions is most likely necessary for capital to be allocated to its

most valuable uses? A) There are no barriers to the flow of complete information to the financial markets. B) Investors are well informed about the risk and return of various investments. C) Financial markets are frictionless (i.e., free of taxes or transactions costs).

9) The value of a total return index: A) may increase at either a faster or slower rate than the value of a price return index

with the same constituent securities and weights. B) can be calculated by multiplying the beginning value by the geometrically linked series of periodic total returns. C) is determined by the price changes of the securities that constitute the index.

10) Which of the following statements about indexes is CORRECT? A) An equal weighted index assumes a proportionate market value investment in each

company in the index. B) A market weighted series must adjust the denominator to reflect stock splits in the sample over time. C) A price-weighted index assumes an equal number of shares (one of each stock) represented in the index.

11) If the momentum effect persists over time, it would provide evidence against which of the

following forms of market efficiency? A) Weak form only. B) Both weak form and semi strong form. C) Semi strong form only.

12) Which of the following statements concerning market efficiency is least accurate? A) Tests of the semi-strong form of the EMH require that security returns be risk-

adjusted using a market model. B) Market efficiency assumes that individual market participants correctly estimate asset prices. C) If weak-form market efficiency holds, technical analysis cannot be used to earn abnormal returns over the long-run.

13) An analyst with Guffman Investments has developed a stock selection model based on

earnings announcements made by companies with high P/E stocks. The model predicts that investing in companies with P/E ratios twice that of their industry average that make positive earnings announcements will generate significant excess return. If the analyst has consistently made superior risk-adjusted returns using this strategy, which form of the efficient market hypothesis has been violated? A) Strong, semi strong, and weak forms. B) Weak form only. C) Semi strong and strong forms only.

14) A stock's price currently is $100. An analyst forecasts the following for the stock:

The normalized trailing price earnings (P/E) ratio will be 12×. The stock is expected to pay a $5 dividend this coming year on projected earnings of $10 per share. If the analyst were to buy and hold the stock for the year, the projected rate of return based on these forecasts is closest to: A) 15%. B) 25%. C) 20%.

15) A firm has a constant growth rate of 7% and just paid a dividend of $6.25. If the required rate

of return is 12%, what will the stock sell for two years from now based on the dividend discount model? A) $133.75. B) $149.80. C) $153.13.

16) Which of the following industries is most likely to operate in a fragmented market? A) Pharmaceuticals. B) Oil services. C) Confections.

17) When constructing a peer group of firms, an analyst should least appropriately consider the

firms’: A) industry classification. B) cost structures. C) business cycle sensitivity.

18) In a period when U.S. equity prices are increasing and the U.S. dollar is depreciating, which

of the following investors in U.S. equities is most likely to earn the highest return in the investor's local currency? A) U.S. investor who reinvests dividends. B) Non-U.S. investor who reinvests dividends. C) Non-U.S. investor who does not reinvest dividends.

19) Assume a company has earnings per share of $5 and pays out 40% in dividends. The

earnings growth rate for the next 3 years will be 20%. At the end of the third year the company will start paying out 100% of earnings in dividends and earnings will increase at an annual rate of 5% thereafter. If a 12% rate of return is required, the value of the company is closest to: A) $102.80. B) $92.90. C) $55.70.

20) Given the following estimated financial results for the next period, value the stock of

FishnChips, Incorporated, using the infinite period dividend discount model (DDM). Sales of $1,000,000. Earnings of $150,000. Total assets of $800,000. Equity of $400,000. Dividend payout ratio of 60.0%. Average shares outstanding of 75,000. Real risk free interest rate of 4.0%. Expected inflation rate of 3.0%. Expected market return of 13.0%. Stock Beta at 2.1. The per share value of FishnChips stock is approximately: (Note: Carry calculations out to at least 3 decimal places.) A) $17.91. B) $26.86. C) $30.89.

21) Because of dividend displacement of earnings, the net effect on firm value of increasing the

dividend payout ratio is: A) to increase firm value. B) indeterminate. C) to decrease firm value.

22) The experience curve, which illustrates the cost per unit relative to output: A) slopes upward. B) slopes downward. C) slopes upward in the early years and downward in the later years.

23) Which of the following is least likely a reason the price to cash flow (P/CF) model has grown

in popularity? A) CFs are used extensively in valuation models. B) CFs are more easily estimated than future dividends. C) CFs are generally more difficult to manipulate than earnings. CFs are not easier to estimate than dividends.

24) Declining prices that result from the development of substitute products are most likely to

characterize an industry in the: A) shakeout stage. B) mature stage. C) decline stage.

25) Use the following information and the multi-period dividend discount model to find the value

of Computech’s common stock. Last year’s dividend was $1.62. The dividend is expected to grow at 12% for three years. The growth rate of dividends after three years is expected to stabilize at 4%. The required return for Computech’s common stock is 15%. Which of the following statements about Computech's stock is least accurate? A) At the end of two years, Computech's stock will sell for $20.69. B) The dividend at the end of year three is expected to be $2.28. C) Computech's stock is currently worth $17.46.

26) What value would be placed on a stock that currently pays no dividend but is expected to

start paying a $1 dividend five years from now? Once the stock starts paying dividends, the dividend is expected to grow at a 5 percent annual rate. The appropriate discount rate is 12 percent. A) $9.08. B) $14.29. C) $8.11.

27)

Which of the following is least likely an advantage of using price/sales (P/S) multiple? A) P/S multiples provide a meaningful framework for evaluating distressed firms. B) P/S multiples are not as volatile as P/E multiples and hence may be more reliable in valuation analysis. C) P/S multiples are more reliable because sales data cannot be distorted by management.

28) Industry analysis is most likely to provide an analyst with insight about a company's: A) pricing power. B) financial performance. C) competitive strategy.

29) Yong Kim, CFA, buys a preferred stock that has a 6% dividend yield (defined as the ratio of

the preferred dividend to the market price of the preferred stock). One year later, Kim sells the stock when it is selling at a 5% dividend yield. The preferred stock pays a fixed annual dividend, which Kim received right before selling. What rate of return did Kim realize on his investment? A) 26%. B) 14%. C) 20%.

30) A conglomerate is in the following lines of business, with segment revenue as a percentage

of total revenue: 30% banking, 30% automobiles, 25% apparel, and 15% heavy machinery. Based on the Global Industry Classification Standard, the sector classification for this company is most likely: A) industrials. B) financial services. C) consumer discretionary.

Answer Key Test name: Equity Investments 1) A 2) A 3) B 4) A 5) B 6) C 7) A 8) B 9) B 10) C 11) B 12) B 13) C 14) B 15) C 16) B 17) C 18) A 19) A 20) B 21) B 22) B 23) B 24) C 25) C 26) A 27) C 28) A 29) A 30) C

Ethical and Professional Standards: 1) An analyst finds a stock that has had a low beta given its historical return, but its total risk

has been commensurate with its return. When writing a research report about the stock for clients with well- diversified portfolios, according to Standard V(B), Communication with Clients and Prospective Clients, the analyst needs to mention: A) the relationship of the historical beta and return only. B) the relationship of the historical total risk to return only. C) both the historical beta and total risk and return.

2) Jan Hirsh, CFA, is employed as manager of a college endowment fund. The college’s board

of directors has recently voted to consider divesting from companies located in a country that has a poor civil rights record. Hirsh has personal investments in several firms in the country. Hirsh needs to: A) disclose her ownership in the stocks to her supervisor only. B) do nothing since the board has not made a decision yet. C) disclose her ownership in the stocks to both her supervisor and the board.

3) An analyst meets with a new client. During the meeting, the analyst sees that the new client’s

portfolio is heavily invested in one over-the-counter stock. The analyst has been following the stock and thinks it will perform well in the long run. The analyst arranges through a brokerage firm to simultaneously sell a large number of shares of the stock via a series of cross trades from the new client’s portfolio to various existing clients. He arranges the trades to be executed at a price that approximates the current market price. This action is: A) not in violation of the Standards. B) a violation of Standard III(B), Fair Dealing. C) a violation of Standard III(A), Loyalty, Prudence, and Care.

4) Carol Hull, CFA, is an investment advisor whose prospective client, Frank Peters, presents

special requirements. To construct an investment policy statement for Peters, Hull inquires about Peters’ investment experience, risk and return objectives, and financial constraints. Peters states that he has a great deal of investment experience in the capital markets and does not wish to answer questions about his tolerance for risk or his other holdings. Under Standard III(C), Suitability, Hull: A) may accept Peters’ account but may only manage his portfolio to a benchmark or index. B) must decline to enter into an advisory relationship with Peters. C) is permitted to manage Peters’ account without any knowledge of his risk preferences.

5) Michael Malone, CFA, is an investment analyst for a large brokerage firm in New York who

covers the airlines industry. After hours in his personal time, Malone maintains an online blog on which he expresses his personal opinions about various investment opportunities, including, but not limited to, the airlines industry. On his blog, he posts a very negative investment opinion about WestAir stock. Malone knows that WestAir's stock will be downgraded to a “sell” by his firm next week. Malone has most likely violated: A) violated Standard IV(A) Loyalty. B) Standard VI(B) Priority of Transactions. C) violated Standard II(A) Material Nonpublic Information.

6) Which of the following actions would be a violation of the Standard VII(A) Conduct as

Participants in CFA Institute Programs? A) Misrepresenting information on the Professional Conduct Statement. B) Using the CFA designation without submitting a Professional Conduct Statement and paying annual dues. C) Exaggerating the implications of holding the CFA designation.

7) Which of the following statements is least accurate regarding being a part of Standard III(B),

Fair Dealing? A) At the same time notify clients for whom an investment is suitable of a new investment recommendation. B) Shorten the time between decision and dissemination. C) Maintain a list of clients and their holdings.

8) Francisco Perez, CFA, CPA, is a portfolio manager for an investment advisory firm. Due to

the prominence of his position, he is often invited to attend free marketing and educational events hosted by firms which seek to inform the investment community about their investment processes. One such firm, Unlimited Horizons, has invited Perez to attend free educational events which qualify for Continuing Education credits which could help Perez maintain his CPA designation. Perez should most likely: A) decline to attend the event as it could result in a violation of Standard I(A) "Knowledge of the Law." B) accept the invitation as no cash compensation is involved and the primary intent is to educate and inform the investment community. C) decline to attend the event as it could result in a violation of Standard I(B) "Independence and Objectivity."

9) Lucy Ackert and Chris Brown prepared the following information to be included in the

promotional materials of their employer, Lofton Securities. Lucy Ackert is one of five CFAs at Lofton Securities. She satisfied all requirements for the CFA designation in 1998. Chris Brown holds a CFA Level I designation, which he passed in 2001. He is registered to take the next scheduled Level II examination. Are the promotional materials prepared by Ackert and Brown fully consistent with the Standards of Professional Conduct? A) Ackert: No. Brown: Yes. B) Ackert: Yes. Brown: No. C) Ackert: No. Brown: No.

10) Victor Logan is a portfolio manager for McCoy Advisors, and Jack Brisco is the Director of

Research for McCoy. Brisco has developed a proprietary model that has been thoroughly researched and is known throughout the industry as the McCoy model. The model is purely quantitative and screens stocks into buy, hold, and sell categories. The basic philosophy of the model is thoroughly explained to clients. Brisco frequently alters the model based on rigorous research—an aspect that is well explained to clients, although the specific alterations are not continually disclosed. Portfolio managers then make specific sector and security holding decisions, purchasing only securities that are indicated as "buys" by the model. Logan has conducted very thorough research on his own, using the same process that Brisco uses to validate his findings. Logan feels the model is missing some key elements that would further reduce the list of acceptable securities to purchase, however, Brisco has refused to look at Logan's research. Frustrated by this, Logan applies his own version of the model, with the justification that he is still only purchasing securities on the buy list. Because of the conflict with Brisco, he does not disclose the use of the model to anyone at McCoy or to clients. Which of the following statements regarding Logan and Brisco is CORRECT? Logan is: A) not violating the Standards by applying his version of the model, but is violating the Standards by not disclosing it to clients. Brisco is not violating the Standards. B) violating the Standards by applying his version of the model and by not disclosing it to clients. Brisco is violating the Standards by failing to consider Logan's research. C) violating the Standards by applying his version of the model and by not disclosing it to clients. Brisco is not violating the Standards.

11) Sometimes a CFA Institute member simply feels a law has been violated by his firm, and

sometimes the member knows a law has been violated. Which of the following pairs of guidelines is CORRECT with respect to the first step a member should take in each case? The member should first contact: A) the firm's counsel if he feels a law has been violated and the SEC if he knows a law has been violated. B) his supervisor in the firm if he feels a law has been violated and contact the firm's counsel if he knows a law has been violated. C) the firm's counsel if he feels a law has been violated and contact his supervisor if he knows a law has been violated.

12) Amanda Brad, CFA, is a security analyst at UpTrend, Incorporated During a routine visit to a

beauty salon, she learns that a major cosmetic company, Lorean, is expected to present a revolutionary formula for facial cream. Brad buys Lorean stock for her portfolio and prepares a special report on the company. Brad also makes a call to Hillary Lang, another security analyst at UpTrend, to inform her about the news. Lang starts trading on her clients’ portfolios. Brad’s report states that given the on-going research activity at Lorean within the last months, investors can expect some successful new products and a sharp increase in the price of the stock. Lang’s actions: A) violate the Standard of Objectivity and Independence. B) violate the Standards because she trades on inside information. C) violate the Standard of Fair Dealing.

13) An analyst preparing a report needs to cite which of the following? A) A recent quote from the Federal Reserve Chairman. B) The individual who developed a chart from the same firm. C) Estimates of betas provided by Standard & Poor's.

14) Sue Parsons, CFA, works full-time as an investment advisor for the Malloy Group, an asset

management firm. To help pay for her children’s college expenses, Parsons wants to engage in independent practice in which she would advise individual clients on their portfolios. She would conduct these investment activities only on weekends. She is currently only in the preparation stage and has not started independent practice yet. Which of the following statements about Standard IV(A), Loyalty to Employer, is most accurate? Standard IV(A): A) does not require Parsons to notify Malloy of preparing to undertake independent practice under the current conditions. B) requires Parsons to obtain written consent from both Malloy and the persons from whom she undertakes independent practice. C) requires Parsons to notify Malloy in writing about her intention to undertake an independent practice.

15) A CFO who is a CFA Institute member is careful to make his press releases—some of them

containing material and previously undisclosed information—clear and understandable to his readers. While writing a new release, he often has his current intern proofread rough drafts. He also sends electronic copies to his brother, an English teacher, to get suggestions concerning style and grammar. With respect to Standard II(A), Material Nonpublic Information, the CFO is: A) not in violation of the Standard. B) violating the standard by either showing the pre-release version to his intern or sending it to his brother. C) only in violation by e-mailing the pre-release version to his brother but not the intern, because the intern is in essence an employee of the firm.

16) An analyst who is a CFA Institute member receives an invitation from a business associate’s

firm to spend the weekend in a high-quality resort. In order to abide by the Standards, the analyst should (may): A) do both of the actions listed here. B) obtain written consent from his supervisor if the offer is contingent on achieving a target investment return. C) refuse the invitation if the associate is from a firm he analyzes for his employer.

17) One year ago, Karen Jason left the employment as a portfolio manager of Howe Advisors.

The departure was contentious and both parties threatened legal action. As a result, both parties signed a settlement in which Jason was paid a pro rated bonus, but agreed not to work on the portfolios of any existing Howe client for two years. The terms of the agreement were that both parties agreed to keep all aspects of the agreement confidential, including the fact that there was hostility surrounding the departure. Jason now works for Torre Advisors, who has the Stein Company as a new client. At the time Jason left Howe, Stein was a client of Howe, although Jason did not personally work on the Stein portfolio. Jason's supervisor at Torre wants Jason to work on the Stein portfolio. Jason should: A) inform her supervisor that she cannot work on the portfolio because of a legal agreement, but cannot tell him why. B) work on the portfolio because she did not personally work on the portfolio when she was at Howe. C) inform her supervisor that she cannot work on the portfolio because of a non-compete agreement.

18) Nick O'Donnell, CFA, unsuspectingly joins the research team at Wickett & Company, an

investment banking firm controlled by organized crime. None of the managers at Wickett are CFA Institute members. Because of his tenuous situation at Wickett, O'Donnell begins making preparations for independent practice. He knows he will be terminated if he informs management at Wickett that he is preparing to leave. Consequently, he determines that "if he can just hang on for one year, he will likely have a client base sufficient for him to strike out on his own." This action is: A) a violation of his duty to disclose conflicts to his employer. B) not a violation of his duty to employer. C) a violation of his fiduciary duties.

19) Gordon McKinney, CFA, works in the trust department of a bank. The bank's trust account

holds a large block of a particular company. McKinney learns that this company is going to buy back one million shares at a 15% premium to the market price on a first-come-firstserved basis. McKinney immediately tells his mother-in-law to tender her shares but waits until the end of the day to tender the trust's shares. McKinney has most likely violated: A) Standard VI(B), Priority of Transactions. B) Standard IV(A), Loyalty to Employer. C) Standard II(A), Material Nonpublic Information.

20) A stockbroker who is a member of CFA Institute has a part-time housekeeper who also

works for the CEO of Festival, Inc. One day the housekeeper mentions to the broker that she saw the CEO of Festival having a conversation at his home with John Tater, who is a nationally known corporate lawyer and consultant. The stockbroker is restricted from trading on this information: A) for both of the reasons listed here. B) only if the broker knows that the meeting is non-public information. C) if the housekeeper says the meeting concerned a tender offer and the broker knows that it is non-public information.

21) In accordance with Standard III (A) Loyalty, Prudence and Care, which of the following

statements is not a required or recommended action? A) Submit to clients, at least quarterly, itemized statements detailing all of the period’s transactions. B) Vote all proxies on behalf of clients in a responsible manner. C) Utilize client brokerage to the sole benefit of the client.

22) Regarding (1) not voting all client proxies, and (2) using a directed brokerage arrangement, a

member would violate the Standards by: A) engaging in neither of these practices. B) using a directed brokerage arrangement. C) not voting all proxies for client stocks.

23) Denise Weaver is a portfolio manager who manages a mutual fund and has pension clients.

When Weaver receives a proxy for stock in the mutual fund, she gives it to Susan Griffith, her administrative assistant, to complete. When the proxy is for a stock owned in a pension plan, she asks Griffith to send the proxy on to the sponsor of the pension fund. Weaver has: A) violated the Standards by her policy on mutual fund and pension fund proxies. B) violated the Standards by her policy on mutual fund proxies, but not her policy on pension fund proxies. C) not violated the Standards.

24) Liam McCoy has lunch with a wealthy client whose portfolio he manages. McCoy advises

the client to double his current position in the JKM Corporation due to an anticipated increase in sales. In accordance with Standard (V) Investment Analysis, Recommendations and Actions, when McCoy returns to his office he should: A) document the details of the conversation with the client with regard to his investment recommendation. B) verify the suitability of the investment recommendation before placing the client’s order. C) identify other clients for whom JKM may be a suitable investment and notify them immediately of his recommendation.

25) Rhonda Meyer, CFA, is preparing a research report on Moon Ventures, Incorporated In the

course of her research she learns the following: Moon had its credit rating downgraded by a prominent rating agency 3 years ago due to sales pressure in the industry. The rating was restored 3 months later when the pressure resolved. Moon’s insider trading has been substantial over the last 3 months. Holdings of Moon shares by officers, directors, and key employees were reduced by 50% during that period. In Meyer’s detailed report making a buy recommendation for Moon, both the credit rating downgrade and the insider trading were omitted from the report. Meyer has: A) not violated the Code and Standards in her report. B) violated the Code and Standards by not including the insider trading information in her report. C) violated the Code and Standards by not including the insider trading information and by not including the credit rating downgrade in her report.

26) Member compliance on issues relating to corporate governance or to soft dollars is primarily

addressed by the Standard concerning: A) Disclosure of Conflicts to Clients and Prospects. B) Loyalty, Prudence, and Care. C) Disclosure of Referral Fees.

27) Steve Jones is a portfolio manager for Gregg Advisors. Gregg has developed a proprietary

model that has been thoroughly researched and is known throughout the industry as the Gregg model. The model is purely quantitative and screens stocks into buy, hold, and sell categories. The basic philosophy of the model is thoroughly explained to clients. The director of research frequently alters the model based on rigorous research—an aspect that is well explained to clients, although the specific alterations are not continually disclosed. Portfolio managers then make specific sector and security holding decisions, purchasing only securities that are indicated as "buys" by the model. Jones thoroughly understands the model and uses it with all of his clients. Jones is: A) violating the Standards in purchasing stocks without a thorough research basis and in not disclosing all alterations of the model to clients. B) not violating the Standards either in purchasing stocks without a thorough research basis or in not disclosing all alterations of the model to clients. C) violating the Standards in not disclosing all alterations of the model to clients, but not in purchasing stocks without a thorough research basis.

28) A code of ethics: A) provides the public with assurance of a minimum level of ethical behavior. B) should not be used for marketing purposes. C) may be rules-based or principles-based.

29) Lynne Jennings is a chemical industry research analyst for a large brokerage company. That

industry is currently seeing an increase in mergers and acquisitions. While flying through Chicago, Jennings sees several senior officers who she knows are from the largest and fourth largest chemical companies walk into a conference room. She concludes that negotiations for an acquisition might be taking place. Jennings: A) may not act or cause others to act on this information. B) should inform her compliance officer that she has material nonpublic information on firms she covers. C) may use this information to support an investment recommendation.

30) Joni Black, CFA, works for a portfolio management firm. Black is a partner of the firm and is

primarily responsible for managing several large pension plans. Black has just finished a research report in which she recommends Zeta Corporation as a “Strong Buy.” Her rating is based on solid management in a growing and expanding industry. She just handed the report to the marketing department of the firm for immediate dissemination. Upon returning to her desk she notices a news flash by CNN reporting that management for Zeta Corporation is retiring. Black wishes she did not recommend Zeta Corporation as a “Strong Buy,” but believes the corporation is still a good investment regardless of the management. What course of action for Black is best? Black: A) should revise the recommendation based on this new information. B) should report the new information to her immediate supervisor so that they can determine whether or not the marketing department should send out the report as written. C) may send out the report as written as long as a follow up is disseminated within a reasonable amount of time reflecting the changes in management.

31) Recommended procedures to comply with the Standard concerning priority of transactions

are least likely to include: A) limited front-running by employees. B) disclosure to clients of the firm’s policies in regard to personal investing. C) blackout periods.

32) An analyst finds a stock with historical returns that are not correlated with interest rate

changes. The analyst writes a report for his clients that have large allocations in fixed-income instruments and emphasizes the observed lack of correlation. He feels the stock would be of little value to investors whose portfolios are composed primarily of equities. The clients with allocations of fixed income instruments are the only clients to see the report. According to Standard V(B), Communication with Clients and Prospective Clients, the analyst has: A) not violated the Standard. B) violated the Standard concerning fair dealings with all clients. C) violated the article in the Standard concerning facts and opinions.

33) Patricia Hoolihan is an individual investment advisor who uses mutual funds for her clients.

She typically chooses funds from a list of 40 funds that she has thoroughly researched. The Burns, a married couple that are a client, asked her to consider the Hawkeye fund for their portfolio. Hoolihan had not previously considered the fund because when she first conducted her research three years ago, Hawkeye was too small to be considered. However, the fund has now grown in value, and cursory research uncovers no fundamental flaws with the fund. She puts the fund in the Burns' portfolio but not in any of her other clients' portfolios. The fund ends up being the best performing fund on her list. Hoolihan has: A) violated the Standards by not having a reasonable and adequate basis for making the recommendation. B) not violated the Standards. C) violated the Standards by not dealing fairly with clients.

34) Which of the following statements about a code of ethics is most accurate? A code of ethics: A) must include rules-based standards of conduct. B) does not need to include standards of conduct. C) must include principles-based standards of conduct.

35) An analyst has found an investment with what appears to be a great return-to-risk ratio. The

analyst double-checks the data for accuracy, keeps careful records, and is careful to not make any misrepresentations as he simultaneously sends an e-mail to all his clients with a “buy” recommendation. According to Standard V(A), Diligence and Reasonable Basis, the analyst has: A) fulfilled all obligations. B) violated the Standard if he does not verify whether the investment is appropriate for all the clients. C) violated the Standard by communicating the recommendation via e-mail.

36) Abner Flome, CFA, is writing a research report on Paulsen Group, an investment advisory

firm. Flome’s brother-in-law holds shares of Paulsen stock. Flome has recently interviewed for a position with Paulsen and expects a second interview. According to the Standards, Flome’s most appropriate action is to disclose in the research report: A) his brother-in-law’s holding of Paulsen stock and that he is being considered for a job at Paulsen. B) that he is being considered for a job at Paulsen. C) his brother-in-law’s holding of Paulsen stock.

37) Lance Tuipulotu, CFA, manages investments for 400 individuals and families and often finds

his resources stretched. When his largest investors petition him to include a 5% to 7% allocation of noninvestment-grade bonds in their portfolios, he decides he needs additional help to meet the request. He considers various independent advisors to use as submanagers, but determines that the most qualified advisors would be too expensive. Reasoning that a lower-cost provider would enable him to pass the savings along to his clients, he chooses that provider to invest the new bond allocation. Tuipulotu has violated: A) Both Standard III(C) Suitability and Standard V(A) Diligence and Reasonable Basis. B) Standard III(C) Suitability by failing to consider the appropriateness of the noninvestment-grade bonds. C) Standard V(A) Diligence and Reasonable Basis by letting fee structure determine the selection of the submanager.

38) Cynthia Abbott, a CFA charterholder, is preparing a research report on Boswell Company for

her employer, Capital Asset Management. Bob Carter, president of Boswell, invites Abbott and several other analysts to visit his company and offers to pay her transportation and lodging. Abbott pays for her own transportation and lodging, but while visiting the company, accepts an item of small value from Carter. Abbott does not disclose this gift to her supervisor at Capital when she returns. In the course of the company visit, Abbott overhears a conversation between Carter and his chief financial officer that the company’s earnings per share (EPS) are expected to be $1.10 for the next quarter. Abbott was surprised that this EPS is substantially above her initial earnings estimate of $0.70 per share. Without further investigation, Abbott decides to include the $1.10 EPS in her research report on Boswell. Using the high EPS positively affects her recommendation of Boswell. Which of the following statements about whether Abbott violated Standard V(A), Diligence and Reasonable Basis and Standard I(B), Independence and Objectivity is CORRECT? Abbott: A) violated Standard V(A) but she did not violate Standard I(B). B) did not violate Standard V(A) but she violated Standard I(B). C) violated both Standard V(A) and Standard I(B).

39) Ken James has been an independent financial advisor for 15 years. He received his CFA

Charter in 1993, but did not feel it helped his business, so he let his dues lapse this year. He still has several hundred business cards with the CFA designation printed on them. His promotional materials state that he received his CFA designation in 1993. James: A) must cease distributing the cards with the CFA designation, but can continue to use the existing promotional materials. B) must cease distributing the cards with the CFA designation and the existing promotional materials. C) can continue to use the existing promotional materials, and can use the cards until his supply runs out—his new cards cannot have the designation.

40) An investment advisor goes straight from a research seminar to a meeting with a prospective

new client with whom she has never been in contact. The advisor is very excited about the information she just received in the seminar and begins showing the prospect the new ideas her firm is coming up with. This is most likely a violation of: A) both of these. B) Standard III(C), Suitability. C) Standard III(B), Fair Dealing.

41) Lee Hurst, CFA, is an equity research analyst who has recently left a large firm to start

independent practice. He is able to re-create several of his previous recommendation reports, based on his clear recollection of supporting documentation he compiled at his previous employer. He publishes the reports and obtains several new clients. Hurst is most likely: A) in violation of Standard V(C) Record Retention. B) in violation of Standard V(A) Diligence and Reasonable Basis. C) not in violation of any Standard.

42) Martin Tripp, CFA, is vice-president of the equity department at Walker Financial, a large

money management firm. Of the twenty analysts in his department for whom he has supervisory responsibility, eight are subject to CFA Institute Standards of Professional Conduct. Tripp believes that he cannot personally evaluate the conduct of the twenty analysts on a continuing basis. Therefore, he plans to delegate some of his supervisory duties to Sarah Green, who is subject to the Standards, and some to Bob Brown, who is not subject to the Standards. According to CFA Institute Standards of Professional Conduct, which of the following statements about Tripp's ability to delegate supervisory duties is most accurate? A) Tripp may delegate some or all of his supervisory duties only to Green because she is subject to the Standards. B) Tripp may not delegate any of his supervisory duties to either Green or Brown. C) Tripp may delegate some or all of his supervisory duties to Brown, even though Brown is not subject to the Standards.

43) Andy Rock, CFA, is an analyst at Best Trade Company The company is going to announce a

sell recommendation on Biomed stock in one hour. Rock was a member of the team who reached the decision on Biomed. Rock’s wife has an account at Best Trade Comapany that contains Biomed stock. According to the Code and Standards, trading on Rock’s wife’s account can begin: A) only after the recommendation is announced to the general public. B) as soon as the information is disseminated to all clients. C) only after Rock, as a beneficial owner, has given an appropriate amount of time for clients and his employer to act.

44) Jacob Allen, CFA, decides he could make more money if he started his own company. Which

of the following steps would most likely violate Standard IV(A) Loyalty? A) Using his notes from prior research of a firm in a creating a new research report on the firm, after leaving his current employer. B) Soliciting, without written permission from his current employer, the business of former clients after he leaves his current employer. C) Renting space for his new company and interviewing several candidates for the position of manager at the new company.

45) An analyst has several groups of clients who are categorized according to their specific

needs. Compared to research reports distributed to all of the clients, reports for a specific group: A) may generally exclude more basic facts. B) will not be allowed because it violates the Standard III(B), Fair Dealing. C) will definitely include more basic facts.

46) Ron Vasquez is registered to sit for the Level II CFA exam. Unfortunately, Vasquez has

failed the exam the past two years. In his frustration, Vasquez posted the following comment on a popular internet bulletin board: “I believe that CFA Institute is intentionally limiting the number of charterholders in order to increase its cash flow by continuing to fail candidates. Just look at the pass rates.” Which of the following statements regarding Vasquez’s conduct is most accurate? Vasquez is: A) in violation of both Standard I(D) Misconduct and Standard VII(A) Conduct as Participants in CFA Institute Programs. B) not in violation of Standard I(D) Misconduct or Standard VII(A) Conduct as Participants in CFA Institute Programs C) in violation of Standard VII(A) Conduct as Participants in CFA Institute Programs, but not in violation of Standard I(D) Misconduct.

47) Judy Gonzales is a portfolio manager with Brenly Capital and works on Johnson Company's

account. Brenly has a policy against accepting gifts over $25 from clients. The Johnson portfolio has a fantastic year, and in appreciation, the pension fund manager sent Gonzales a rare bottle of wine. Gonzales should: A) inform her supervisor in writing that she received additional compensation in the form of the wine. B) return the bottle to the client explaining Brenly's policy. C) present the bottle of wine to her supervisor.

48) Rey Sanchez, CFA, covers the specialty chemical industry for Rock Advisory Associates.

Until today he has had a buy recommendation on ChemStar, and many of the firm’s customers have purchased shares based upon his recommendation. The firm’s client accounts are divided into two fundamental categories: trading and buy-and-hold accounts. The firm holds discretionary trading authority over the trading accounts, but not the buy-and-hold accounts. Sanchez has recently come to believe that the fundamentals are changing for the worse at ChemStar, and is preparing a sell recommendation. He calls a meeting of the firm’s portfolio managers with accounts holding ChemStar and tells them of the pending release of the sell recommendation. On this basis, the portfolio managers sell all positions in the discretionary accounts but not in the buy-and-hold accounts. Sanchez completes and mails the report to all clients two days later, and, shortly thereafter, many of the buy-and-hold accounts sell their ChemStar positions. With regard to these actions, Sanchez is: A) not in violation of the Standard on Fair Dealing; the portfolio managers are in violation of the Standard on Fair Dealing. B) in violation of the Standard on Fair Dealing; the portfolio managers are in violation of the Standard on Fair Dealing. C) in violation of the Standard on Fair Dealing; the portfolio managers are not in violation of the Standard on Fair Dealing.

49) Steve Phillips is the new director of equity research for a brokerage company. He receives a

call from a reporter at the Financial News, a weekly publication that comes out on Mondays. The reporter explains the relationship she had with his predecessor. They would share information that they both learned on stocks—the former director would benefit the company's clients by news he obtained from the reporter in exchange for information he gave to her. The former director could ask her not to publish any information he gave her until after a certain date, ensuring that the brokerage clients would be informed before the publication date. After the conversation, Phillips called the former director, who confirmed that the reporter was trustworthy with respect to honoring the agreement for delaying publication until clients have been informed. Philips should: A) only disclose research that has already been disseminated to clients, as long as the reporter is providing valuable information of her own. B) disclose research not yet disclosed to clients, as long as the reporter promises not to publish the information until after all clients have received the research, and the reporter provides valuable information of her own. C) not disclose any research even after it has been disseminated to clients regardless of the value of the information that the reporter may have.

50) Preston Partners is an investment management firm that adopted the Code and Standards as

part of its policy manual. Gerald Smithson, CFA, has recently added the stock of Utah Biochemical Company and Norgood PLC to all his client's investment portfolios. Shortly afterwards Utah Biochemical and Norgood announced a merger that increased the share price of both companies. Smithson contends he saw the president of Utah Biochemical dining with the chairman of Norgood, but did not overhear their conversation. Smithson researched both companies extensively and determined that each company was a good investment. He put in a block trade for shares in each company. Preston's policies were not clear in this area as he allocated the shares by starting with his largest client accounts and working down to the small accounts. Some of Smithson's clients were very conservative personal trust accounts, others were pension funds who had aggressive investment objectives. Which standard was NOT broken? A) Standard III(C)—Suitability. B) Standard V(A)—Diligence and Reasonable Basis. C) Standard IV(C)—Responsibilities of Supervisors.

51) Jason Blackwell, CFA, works as an investment manager for Mega Capital, a large

multinational brokerage firm. Mega Capital is based in a country whose applicable law is stricter than the CFA Institute Code and Standards, but does business with clients in a country whose applicable law is less strict than the Code and Standards. Blackwell decides to follow the requirements of the Code and Standards for clients in the less strict country, which is sufficient to also comply with that less-strict country’s local laws. While Blackwell is still employed at Mega, Lego Associates verbally asks Blackwell to review client portfolios during evenings and weekends for a fee. Blackwell gets written consent from his immediate supervisor at Mega to undertake this independent activity for a one-month trial basis. Which of the following statements about Blackwell’s actions involving Standard I, Professionalism, and Standard IV(A), Loyalty is most accurate? Blackwell: A) violated Standard I but did not violate Standard IV(A). B) violated both Standard I and Standard IV(A). C) did not violate either Standard I or Standard IV(A).

52) Which of the following statements regarding allocating trades is CORRECT? It is

permissible under the Standards to allocate trades: A) on a pro-rata basis over all suitable accounts. B) based upon any method the firm deems suitable so long as the allocation procedure has been disclosed to all clients. C) based upon compensation arrangements.

53) Paul Drake is employed by a company to provide investment advice to participants in the

firm's 401(k) plan. Company stock is one of the investment options in the plan. Drake feels that the stock is too risky for employees to own in their 401(k) plan and starts advising them to pull out of the stock. The Treasurer of the company calls Drake and tells him that he will be fired if he continues making such advice because he is violating his fiduciary duty to the company. Drake should: A) continue to advise employees to sell their stock. B) make sell recommendations but point out that the company Treasurer has a differing and valid point of view. C) tell employees that he cannot provide advice on company stock because of a conflict of interest.

54) Paul Thomas, CFA, is designing a new layout for research reports his firm writes and issues

on individual stocks. In his design, Thomas includes a stock chart on the first page of each report. He does not reference that the charts are copied from the Standard & Poor's web site. Thomas has: A) violated CFA Institute Standards of Professional Conduct because he did not state the source of the charts. B) violated CFA Institute Standards of Professional Conduct because he did not make sure that the information in these charts is accurate. C) not violated CFA Institute Standards of Professional Conduct because these charts are widely available over the Internet.

55) Klaus Gerber, CFA, is a regular contributor to the Internet site WizeGuy. This past week

Gerber has been incorrectly quoted as recommending that investors buy shares in Bradford, Incorporated. He is unaware that this message has been placed on the site as the quote was placed as a prank by an unknown source. This is the third time this has happened over the past month and each time the stock being mentioned moved in price according to the buy or sell recommendation. Fritz Fox, CFA, maintains and updates the WizeGuy site and has learned how to determine if the quotes being attributed to Gerber are actually valid. Several days later, he observes an investment recommendation, posted on the site, to buy Gresham, Incorporated. The investment recommendation is purported to be from Gerber, but Fox actually knows it to be bogus. He immediately sells 1,000 Gresham short and e-mails Gerber to inform him of the bogus recommendation. Gerber immediately issues a rebuttal, and Gresham falls by 14%. Fox's action is: A) not in violation of the Code and Standards. B) a violation of the Standard concerning use of material nonpublic information. C) a violation of the Standard concerning fiduciary duties.

56) Caroline Turner, an analyst for Lansing Asset Management, just completed an investment

report in which she recommends changing a “buy” to a “sell” for Gallup Company. Her supervisor at Lansing approves of the change in recommendation. Turner wonders about whether she needs to disseminate this investment recommendation to Lansing’s clients and if so, how to distribute this information. According to CFA Institute Standards of Professional Conduct, Turner is: A) not required to disseminate the change of recommendation from a buy to a sell because the change is not material. B) required to disseminate the change in a prior investment recommendation to all clients and customers on a uniform basis. C) required to design an equitable system to disseminate the change in a prior investment recommendation.

57) Fern Baldwin, CFA, as a representative for Fernholz Investment Management, is

compensated by a base salary plus a percentage of fees generated. In addition, she receives a quarterly performance bonus on a particular client’s fee if the client’s account increases in value by more than 2 points over a benchmark index. Baldwin had a meeting with a prospect in which she described the firm’s investment approach but did not disclose her base salary, percentage fee, or bonus. Baldwin has: A) not violated the Standards because there is no conflict of interest with a potential prospect in the employment arrangements. B) violated the Standards by not disclosing her salary, fee percentage, and performance bonus. C) violated the Standards by not disclosing her performance bonus.

58) The CFA Institute Professional Conduct Program may impose sanctions on: A) CFA charterholders, member firms, and candidates for the CFA designation. B) CFA charterholders and candidates for the CFA designation. C) CFA charterholders only.

59) An analyst belongs to a nationally recognized charitable organization, which requires dues

for membership. The analyst has worked out a deal where he provides money management advice in lieu of paying dues. Which of the following must the analyst do? A) Must treat the charitable organization as his employer. B) Resign from the position because the relationship is a conflict with the Standards. C) Nothing since he is not an employee of the charitable organization.

60) Bjorn Sandvik, CFA, completes a research report with a buy recommendation for Acorn

Properties. In the early afternoon, Sandvik e-mails this recommendation to his clients who had responded to his request that they provide Sandvik with their e-mail addresses. Later that afternoon, the printed recommendation is forwarded to the postal service for normal delivery to all customers, who receive the mailing 1 to 3 days later. Sandvik has: A) violated the Code and Standards by sending the e-mail recommendation to only some of his clients. B) not violated the Code and Standards because he acted fairly in disseminating research information to his clients. C) violated the Code and Standards by sending the e-mail recommendation in advance of the printed report.

61) A profession is most accurately described as an occupational group that requires its members

to: A) put client interests first. B) have specialized expert knowledge. C) abide by a code of ethical conduct.

62) Which of the following is least likely to be a reason for imposing a suspension on a member

or candidate? A) Discussing a question from the CFA exams on social media. B) Misdemeanor charge for possession of narcotics. C) Failing to return the annual professional conduct statement.

63) John Hill, CFA, has been working for Advisors, Incorporated, for eight years. Hill is about to

start his own money management business and has given his two-week notice of his resignation from Advisors. A few days before his resignation takes effect, a former client of Advisors calls Hill at his home about his new firm. The former client says that he is very happy that Hill is leaving Advisors because now he and Hill can resume a professional relationship. The client says that he would never become a client of Advisors again. Hill promises to call the client back after he has left Advisors. Hill does not tell his employer about the call. Hill has most likely: A) not violated the Standards. B) violated the Standard concerning loyalty to employer. C) violated the Standard concerning disclosure of conflicts.

64) Nancy McCoy, CFA, is preparing a report on Gourmet Food Mart. As part of her research,

she contacts the company’s contractors, suppliers, and competitors. McCoy is told by the CEO of a major produce vendor that he is about to file a lawsuit against Gourmet Food Mart, seeking significant damages. McCoy incorporates this information into her research report, which projects a decline in profitability for Gourmet Food Mart due to the impending litigation. According to the CFA Institute Standards of Professional Conduct, McCoy: A) has not violated any Standard. B) has violated the Standards by disseminating confidential information. C) has violated the Standards by utilizing material nonpublic information.

65) The following information pertains to the Galaxy Trust, a trust established by Stephen P.

House and managed by Gamma Investment LLC: At the time the trust was established House provided $5 million in cash to fund the trust, but Gamma was aware that 93% of his personal assets were in the form of Oracle stock. Gamma has been asked to view his funds and the trust as a single entity for planning purposes, since House’s will stipulates that all of his estate will pass to the trust upon his death. The investment policy statement, developed in September 1996, stipulates that the trust should maintain a short position in Oracle stock and use the proceeds to diversify the trust more adequately. House was able to sell all of his Oracle shares back to the corporation in January 1999 for cash. The policy statement redrawn in September 1999 continues to stipulate that the trust hold a short position in Oracle stock. House has given the portfolio manager in charge of the trust an all expenses paid vacation package anywhere in the world each year at Christmas. The portfolio manager has reported this fact in writing to his immediate supervisor at Gamma. Which of the following is most correct? The investment manager is: A) in violation of the Code and Standards by not properly updating the investment policy statement in light of the change in the circumstances but is not in violation with regard to the acceptance of the gift from House. B) in violation of the Code and Standards by not properly updating the investment policy statement in light of the change in the circumstances and is in violation with regard to the acceptance of the gift from House. C) not in violation of the Code and Standards for not properly updating the investment policy statement in light of the change in the circumstances and is not in violation with regard to the acceptance of the gift from House.

66) Bob Hatfield, CFA, has his own money management firm with two clients. The accounts of

the two clients are equal in value. It is Hatfield’s opinion that interest rates will fall in the near future. Based upon this, Hatfield begins increasing the bond allocation of each portfolio. In order to comply with Standard V(B), Communication with Clients and Prospective Clients, the analyst needs to: A) inform the clients of the change and tell them it is based upon an opinion and not a fact. B) perform both of these functions. C) make sure that the change is identical for both clients.

67) Bill Valley has been working for Advisors, Incorporated, for several years, and he just joined

CFA Institute. Valley’s sister just received a large bonus in the form of stock options in Zephyr, Incorporated. Valley’s sister knows nothing about financial assets and offers Valley a week at her holiday home each year in exchange for Valley monitoring Zephyr and the value of her stock options. In order to comply with the Code and Standards, Valley needs to inform Advisors of: A) both the use of the holiday home and his sister's options. B) the compensation in the form of the use of the holiday home only. C) nothing since no money is involved and it is a favor for a family member.

68) Roger Smith, CFA, has been invited to join a group of analysts in touring the riverboats of

River Casino Corporation. For the tour, River Casino has arranged chartered flights from casino to casino since commercial flight schedules are not practical for the group’s time schedule. River Casino has also arranged to pay for the analysts’ lodging for the three nights of the tour. According to CFA Institute Standards of Professional Conduct, Smith: A) is required to pay for his flight and lodging. B) may accept the arrangements as they are. C) may accept the flight but is required to pay for his lodging.

69) Fred Dean, CFA, has just taken a job as trader for LPC. One of his first assignments is to

execute the purchase of a block of East Street Industries. While working with East Street on an assignment for his previous employer, he learned that East Street’s sales have weakened and will likely be significantly below the LPC analyst’s estimate, but no public announcement of this has been made. Which of the following actions would be the most appropriate for Dean to take according to the Standards? A) Contact East Street’s management and urge them to make the information public and make the trade if they refuse. B) Post the information about the drop in sales on an internet bulletin board to achieve public dissemination and inform his supervisor of the posting. C) Request that the firm place East Street’s stock on a restricted list and decline to make any trades of the company’s stock.

70) Graham Carson, CFA, is an investment advisor to Ron Grayson, a client with moderate risk

tolerance and an investment horizon of 15 years. Grayson calls Carson to complain about two stocks in his account that have performed poorly. He feels that one stock was too risky for him as it paid no dividend and had a beta of 1.4. The other stock had a beta of 0.9 and paid a dividend of 3%, but financial regulators have indicated that the firm’s reported earnings were incorrectly stated. Based on this information, Carson has most likely: A) not violated the Standards. B) violated both the Standard on suitability and the Standard on diligence and reasonable basis. C) violated only the Standard on suitability.

71) Fran Lester, CFA, works for a broker based in a country in which participation in any IPO is

permitted with her employer’s permission. She lives and works in a country that has no restrictions on her participation in IPOs. If Lester’s firm is distributing shares of an oversubscribed IPO through the office Lester works in, can Lester receive shares in the IPO? A) Yes, because the applicable law is that of her home country. B) No, not under any circumstances. C) Yes, but she must obtain permission from her employer.

72) Recommended procedures to comply with the Standard related to fair dealing are most likely

to include: A) publishing personnel guidelines for pre-dissemination that prohibit those who know about a pending recommendation from discussing or acting on it. B) simultaneously informing all investment representatives in the firm about pending recommendation changes. C) requiring investment committee approval for all recommendation changes.

Answer Key Test name: Ethical and Professional Standards 1) A 2) B 3) A 4) C 5) A 6) A 7) A 8) C 9) C 10) A 11) C 12) C 13) A 14) A 15) B 16) A 17) A 18) B 19) A 20) C 21) B 22) A 23) A 24) A 25) B 26) B 27) B 28) C 29) C 30) A 31) A 32) A 33) A 34) B 35) A 36) B 37) A

38) A 39) A 40) A 41) A 42) C 43) B 44) A 45) A 46) B 47) B 48) B 49) A 50) B 51) A 52) A 53) A 54) A 55) B 56) C 57) C 58) B 59) A 60) B 61) B 62) B 63) A 64) C 65) A 66) A 67) A 68) B 69) A 70) A 71) B 72) A

Financial Reporting and Analysis: 1) Which of the following is a company least likely required to present according to

International Accounting Standard (IAS) No. 1? A) Statement of changes in owners’ equity. B) A summary of accounting policies. C) Disclosures of material events.

2) According to IFRS guidance for management’s commentary, addressing the company’s key

relationships is: A) neither recommended nor required. B) required. C) recommended.

3) Selected information from Able Company’s financial activities is as follows:

Net Income was $720,000. 1,000,000 shares of common stock were outstanding on January 1. 1,000 shares of 8%, $1,000 par value preferred shares were outstanding on January 1. The tax rate was 40%. The average market price per share for the year was $20. 6,000 shares of 3%, $500 par value preferred shares, convertible into common shares at a rate of 40 common shares for each preferred share, were outstanding for the entire year. Able’s basic and diluted earnings per share (EPS) are closest to:

A) B) C)

Basic EPS

Diluted EPS

$0.64 $0.55 $0.55

$0.64 $0.52 $0.55

A) Option A B) Option B C) Option C

4) A company has the following sequence of events regarding their stock:

One million shares outstanding at the beginning of the year. On June 30th, they declared and issued a 10% stock dividend. On September 30th, they sold 400,000 shares of common stock at par. Basic earnings per share at year-end will be computed on how many shares? A) 1,200,000. B) 1,000,000. C) 1,100,000.

5) Books Forever, Incorporated, uses short-term bank debt to buy inventory. Assuming an

initial current ratio that is greater than 1, and an initial quick (or acid test) ratio that is less than 1, what is the effect of these transactions on the current ratio and the quick ratio? A) Both ratios will decrease. B) Neither ratio will decrease. C) Only one ratio will decrease.

6) David Chance, CFA, is analyzing Grow Corporation. Chance gathers the following

information: Net cash provided by operating activities Net cash used for fixed capital investments Cash paid for interest Income before tax Income tax expense Net income

$ 3,500 $ 727 $ 195 $ 4,400 $ 1,540 $ 2,860

Grow’s free cash flow to the firm (FCFF) isclosest to: A) $2,900. B) $2,260. C) $2,640.

7) The following footnote appeared in Crabtree Company’s 20X7 annual report:

“On December 31, 20X7, Crabtree recognized a restructuring charge of $20 million, of which $5 million was for severance pay for employees who will be terminated in 20X8 and $15 million was for land that became permanently impaired in 20X7.” Based only on these changes, Crabtree’s net profit margin and fixed asset turnover ratio (using year- end financial statement values) in 20X8 as compared to 20X7 will be: Net profit margin A) B) C) A) Option A B) Option B C) Option C

Lower Higher Higher

Fixed asset turnover Higher Unchanged Higher

8) Do the following characteristics have to be met in order to classify a liability as current on

the balance sheet? Characteristic #1 – Settlement is expected within one year or operating cycle, whichever is less. Characteristic #2 – Settlement will require the use of cash within one year or operating cycle, whichever is greater. Characteristic #1 A) B) C) A) Option A B) Option B C) Option C

No Yes No

Characteristic #2 No No Yes

9) Which of the following transactions would least likely be reported in the cash flow statement

as investing cash flows? A) Sale of held-to-maturity securities for cash. B) Purchase of plant and equipment used in the manufacturing process with financing provided by the seller. C) Principal payments received from loans made to others.

10) During 2007, Brownfield Incorporated purchased $140 million of inventory. For the year just

ended, Brownfield reported cost of goods sold of $130 million. Inventory at year-end was $45 million. Calculate inventory turnover for the year. A) 2.89. B) 3.25. C) 3.71.

11)11) McQueen Corporation prepared the following common-size income statement for the year ended December 31, 20X7: Sales 100% Cost of goods sold 60% Gross profit 40%

For 20X7, McQueen sold 250 million units at a sales price of $1 each. For 20X8, McQueen has decided to reduce its sales price by 10%. McQueen believes the price cut will double unit sales. The cost of each unit sold is expected to remain the same. Calculate the change in McQueen’s expected gross profit for 20X8 assuming the price cut doubles sales. A) $80 million increase. B) $50 million increase. C) $150 million increase.

12) What would be the impact on a firm’s return on assets ratio (ROA) of the following

independent transactions, assuming ROA is less than one? Transaction #1 – A firm owned investment securities that were classified as available-forsale and there was a recent decrease in the fair value of these securities. Transaction #2 – A firm owned investment securities that were classified as trading securities and there was recent increase in the fair value of the securities. Transaction #1

Transaction #2

Higher Higher Lower

Lower Higher Higher

A) B) C) A) Option A B) Option B C) Option C

13) A segment of a common-size balance sheet for Olsen Company in its most recent year shows

the following data: Common stock Additional paid-in capital Preferred stock

1% 19% 15%

How should an analyst most appropriately interpret these data? A) Proceeds from the issuance of common stock are 20% of total assets. B) Shareholders’ equity is 35% of total assets. C) Preferred stock is 15% of shareholders’ equity.

14) Orange Company’s net income for 2004 was $7,600,000 with 2,000,000 shares outstanding.

The average share price in 2004 was $55. Orange had 10,000 shares of eight percent $1,000 par value convertible preferred stock outstanding since 2003. Each preferred share was convertible into 20 shares of common stock. Orange Company’s diluted earnings per share (Diluted EPS) for 2004 is closest to: A) $3.80. B) $3.45. C) $3.40.

15) In converting a statement of cash flows from the indirect to the direct method, which of the

following adjustments should be made for a decrease in unearned revenue when calculating cash collected from customers, and for an inventory writedown (when market value is less than cost) when calculating cash payments to suppliers? Cash collections from customers:

Cash payments to suppliers

A) Add decrease in unearned revenue Subtract an inventory writedown Add an inventory writedown B) Subtract decrease in unearned revenue Subtract an inventory writedown C) Subtract decrease in unearned revenue A) Option A B) Option B C) Option C

16) In preparing its cash flow statement for the year ended December 31, 20x4, Giant

Corporation collected the following data: Gain on sale of equipment

$ 6,000

Proceeds from sale of equipment

10,000

Purchase of Zip Company bonds for Amortization of bond discount

180,000

Dividends paid

(75,000)

Proceeds from sale of Treasury stock

(maturity value $200,000)

2,000

38,000

In its December 31, 20x4, statement of cash flows, under U.S. GAAP, what amounts should Giant report as net cash used in investing activities and net cash used in financing activities? Investing Activities A) B) C)

$178,000 $170,000 $170,000

Financing Activities −$37,000 $37,000 −$38,000

A) Option A B) Option B C) Option C

17) According to International Financial Reporting Standards, how do cash dividends received

from trading securities and financial securities measured at fair value through OCI affect net income? Trading securities

Fair value through OCI

No effect Increase Increase

Increase No effect Increase

A) B) C) A) Option A B) Option B C) Option C

18) The following data pertains to the Sapphire Company:

Net income equals $15,000. 5,000 shares of common stock issued on January 1st. 10% stock dividend issued on June 1st. 1,000 shares of common stock were repurchased on July 1st. 1,000 shares of 10%, $100 par preferred stock each convertible into 8 shares of common were outstanding the whole year. What is the company’s diluted earnings per share (EPS)? A) $2.50. B) $1.00. C) $1.15.

19) Duster Company reported the following financial information at the end of 2007: in millions Unearned revenue Common stock at par Capital in excess of par Accounts payable Treasury stock Retained earnings Accrued expenses Accumulated other comprehensive loss Long-term debt

$ 240 30 440 1,150 2,000 5,160 830 210 1,570

Calculate Duster’s liabilities and stockholders’ equity as of December 31, 2007. Liabilities A) $3,790 million B) $3,550 million C) $3,790 million A) Option A B) Option B C) Option C

Stockholders' equity $3,420 million $7,840 million $7,420 million

20) Matrix, Incorporated’s common size income statement for the years ended December 31,

20X1 and 20X2 included the following information (percent of net sales): 20X1

20X2

Sales Cost of Goods Sold

100 (55) 45

100 (60) 40

Selling General & Administrative Depreciation

(5) (7)

(5) (8)

(15)

(6)

(7)

Interest Expense

Income Tax Expense

Analysis of this data indicates that from 20X1 to 20X2: A) the effective tax rate increased. B) interest expense per dollar of sales declined. C) cost of goods sold increased.

21) Convenience Travel Corporation’s financial information for the year ended December 31,

20X4 included the following: Property Plant & Equipment Accumulated Depreciation

$15,000,000 9,000,000

The only asset owned by Convenience Travel in 20X5 was a corporate jet airplane. The airplane was being depreciated over a 15-year period on a straight-line basis at a rate of $1,000,000 per year. On December 31, 20X5 Convenience Travel sold the airplane for $10,000,000 cash. Net income for the year ended December 31, 20X5 was $12,000,000. Based on the above information, and ignoring taxes, what is cash flow from operations (CFO) for Convenience Travel for the year ended December 31, 20X5? A) $8,000,000. B) $11,000,000. C) $13,000,000.

22) Joplin Corporation reports the following in its year-end financial statements:

Net income of $43.7 million. Depreciation expense of $4.2 million. Increase in accounts receivable of $1.5 million. Decrease in accounts payable of $2.3 million. Increase in capital stock of $50 million. Sold equipment with a book value of $7 million for $15 million after-tax. Purchased equipment for $35 million. Joplin’s free cash flow to the firm (FCFF) is closest to: A) $66 million. B) $24 million. C) $16 million.

23) What is the appropriate measurement basis for equipment used in the manufacturing process? A) Historical cost B) Fair value C) Lower of cost or net realizable value

24) Financial information for Jefferson Corporation for the year ended December 31st, was as

follows: Sales Purchases Inventory at Beginning Inventory at Ending Accounts Receivable at Beginning Accounts Receivable at Ending Accounts Payable at Beginning Accounts Payable at Ending Other Operating Expenses Paid

$ 3,000,000 1,800,000 500,000 800,000 300,000 200,000 100,000 100,000 400,000

Based upon this data and using the direct method, what was Jefferson Corporation’s cash flow from operations (CFO) for the year ended December 31st? A) $1,200,000. B) $900,000. C) $800,000.

25) A firm’s balance sheet prepared under IFRS is least likely to include: A) market value of inventory. B) fair value of firm PPE. C) market value of the firm’s equity.

26) Is an acquisition of treasury stock or a loss from the write-down of inventory under the

lower-of-cost-or- market rule included in comprehensive income? Inventory write-down A) B) C) A) Option A B) Option B C) Option C

No No Yes

Acquisition of treasury stock No Yes No

27) To convert an indirect statement of cash flows to a direct basis, the analyst would: A) reduce cost of goods sold by any decreases in inventory. B) increase cost of goods sold by any depreciation that was included. C) reduce cost of goods sold by any decreases in accounts payable.

28) A company reports a gain of €100,000 on the sale of an asset and a loss of €100,000 due to

foreign currency translation adjustment. Which of these items will be included in the company’s comprehensive income? A) Only one of these items is included in comprehensive income. B) Both of these items are included in comprehensive income. C) Neither of these items is included in comprehensive income.

29) An analyst compiled the following information for Universe, Incorporated for the year ended

December 31, 20X4: Net income was $850,000. Depreciation expense was $200,000. Common stock was sold for $100,000. Preferred stock (eight percent annual dividend) was sold at par value of $125,000. Common stock dividends of $25,000 were paid. Preferred stock dividends of $10,000 were paid. Equipment with a book value of $50,000 was sold for $100,000. Using the indirect method and assuming U.S. GAAP, what was Universe Incorporated’s cash flow from operations (CFO) for the year ended December 31, 20X4? A) $1,000,000. B) $1,050,000. C) $1,015,000.

30) Wells Incorporated reported the following common size data for the year ended December

31, 20X7: Income Statement Sales Cost of goods sold Operating expenses Interest expense Income Statement Income tax Net income Balance sheet

% 100.0 58.2 30.2 0.7 % 5.7 5.2 %

Cash Accounts receivable Inventory Net fixed assets Total assets

4.8 14.9 49.4 30.9 100.00

% Accounts payable Accrued liabilities Long-term debt Common equity Total liabilities & equity

15.0 13.8 23.2 48.0 100.0

For 20X6, Wells reported sales of $183,100,000 and for 20X7, sales of $215,600,000. At the end of 20X6, Wells’ total assets were $75,900,000 and common equity was $37,800,000. At the end of 20X7, total assets were $95,300,000. Calculate Wells’ current ratio and return on equity ratio for 20X7. A) B) C)

Current ratio

Return on equity

2.4 4.6 2.4

24.5% 25.2% 26.8%

A) Option A B) Option B C) Option C

31) The following information is for Trotters Diversified as of year-end:

Average common shares outstanding of 5.0 million. Average market price for common stock of $35.00 per share. Net income of $9.0 million. Common stock dividends paid of $1.2 million. Tax rate of 40%. 500,000 shares of cumulative convertible preferred stock with $30 par value and 10% dividend. Each preferred share is convertible into 5 common shares. Preferred dividends of $1.5 million were paid. 10,000 convertible $1,000 par bonds with a 6.0% coupon, each convertible into 8 shares of common stock. 400,000 stock options with an exercise price of $32.00 per share. All of these securities were outstanding for the full year. Diluted EPS for Trotters Diversified is closest to: A) $1.19. B) $1.23. C) $1.50.

32) For the year ended December 31, 2007, Challenger Company reported the following

financial information: Revenue Cost of goods sold Cash operating expenses Depreciation expense Tax expense

$ 100,000 (40,000) (20,000) (5,000) (3,000) $ 32,000 $ 7,500 $ 2,500 $ 3,000 $ 1,000

Net income Increase in accounts receivable Decrease in inventory Increase in short-term notes payable Decrease in accounts payable

Calculate cash flow from operating activities using the direct method and the indirect method. A) B) C)

Direct method

Indirect method

$34,000 $31,000 $31,000

$34,000 $34,000 $31,000

A) Option A B) Option B C) Option C

33) Galaxy, Incorporated’s U.S. GAAP balance sheet as of December 31, 20X4 included the

following information (in $):

Accounts Payable Dividends Payable Common Stock Retained Earnings

12-31-X3

12-31-X4

300,000 200,000 1,000,000 700,000

500,000 300,000 1,000,000 1,000,000

Galaxy’s net income in 20X4 was $800,000. What was Galaxy’s cash flow from financing (CFF) in 20X4? A) −$300,000. B) −$500,000. C) −$400,000.

34) Darth Corporation’s most recent income statement shows net sales of $6,000, and Darth’s

marginal tax rate is 40%. Cash expenses reported were $3,200. In addition, depreciation expense was reported at $800. A further examination of the most recent balance sheets reveals that accounts receivable during that period increased by $1,000. The cash flow from operating activities reported by Darth should be: A) $2,200. B) $1,000. C) $1,200.

35) Galaxy Corporation manufactures custom motorcycles. Galaxy finances the motorcycles over

36 months for customers who make a minimum down payment of 10%. Historically, Galaxy has experienced bad debt losses equal to 1% of sales. Galaxy also provides a 24 month unlimited warranty on all new motorcycles. In the past, warranty expense has averaged 3% of sales. Ignoring taxes, how does the recognition of bad debt expense and warranty expense at the time of sale affect Galaxy’s liabilities? Bad debt expense

Warranty expense

No effect No effect Increase

No effect Increase No effect

A) B) C) A) Option A B) Option B C) Option C

36) A 12 percent $100,000 convertible bond was issued on October 1, 2004. It is dilutive and can

be converted into 18,000 shares. The effective income tax rate for the year was 40%. What adjustments should be made to calculate diluted earnings per share? Interest added to the numerator Shares added to the denominator A) B) C)

$3,000 $3,000 $1,800

18,000 4,500 4,500

A) Option A B) Option B C) Option C

37) Holden Company’s fixed asset footnote included the following:

During 20X7, Holden sold machinery for a gain of $100,000. The machinery had an original cost of $500,000 and its accumulated depreciation was $240,000. At the end of 20X7, Holden purchased machinery at a cost of $1,000,000. Holden paid $400,000 cash. The balance was financed by the seller at 8% interest. Depreciation expense was $2,080,000 for the year ended 20X7. Calculate Holden’s cash flow from investing activities for the year ended 20X7. A) $300,000 outflow. B) $40,000 outflow. C) $360,000 inflow.

38) A company reports the following unusual events:

Loss on discontinued operations. Restructuring and severance costs applicable to asset sales. Plant shutdown costs. Which of these items would most likely be considered nonrecurring and included in operating income? A) Loss on discontinued operations and restructuring and severance costs applicable to asset sales. B) Restructuring and severance costs applicable to asset sales and plant shutdown costs. C) Loss on discontinued operations and plant shutdown costs.

39) Red Oak Corporation is a furniture manufacturer located in Canada. Red Oak is financed

with a combination of debt and equity. The debt consists of unsecured zero-coupon bonds that mature in 20 years. For income tax purposes, interest on the bonds is deductible when accrued. Red Oak’s equity consists of common stock and preferred stock. No dividends have ever been paid on Red Oak’s common stock; however, dividends are paid quarterly to the preferred shareholders. Should the accrued interest on the zero-coupon bonds and the dividends paid to the preferred shareholders be reported as a nonoperating component of Red Oak’s net income? Accrued interest A) B) C) A) Option A B) Option B C) Option C

Preferred dividends

Yes Yes No

Yes No Yes

40) Selected information from Feder Corporation’s financial activities for the year is as follows:

Net income was $7,650,000. 1,100,000 shares of common stock were outstanding on January 1. The average market price per share was $62. Dividends were paid during the year. The tax rate was 40%. 10,000 shares of 6% $1,000 par value preferred shares convertible into common shares at a rate of 20 common shares for each preferred share were outstanding for the entire year. 70,000 options, which allow the holder to purchase 10 shares of common stock at an exercise price of $50 per common share, were outstanding the entire year. Feder Corporation’s diluted earnings per share (EPS) was closest to: A) $5.32. B) $5.87. C) $4.91.

41) Consider the following:

Statement #1: One approach to presenting a common-size cash flow statement is to express each inflow of cash as a percentage of total cash inflows and each outflow of cash as a percentage of total cash outflows. Statement #2: Expressing each line item of the cash flow statement as a percentage of revenue is useful in forecasting future cash flows. Which of these statements regarding a common-size cash flow statement is (are) CORRECT? A) Only statement #1 is correct. B) Both statements are correct. C) Only statement #2 is correct.

42) Statement #1 – As compared to the price-to-earnings ratio, the price-to-cash flow ratio is

easier to manipulate because management can easily control the timing of the cash flows. Statement #2 – A firm with earnings per share of $2 is more profitable than a firm with earnings per share of $1. With respect to these statements: A) both are incorrect. B) both are correct. C) only one is correct.

43) A common-size cash flow statement is least likely to provide payments to employees as a

percentage of: A) total cash outflows for the period. B) revenues for the period. C) operating cash flow for the period.

44) The First National Bank is a commercial bank that specializes in consumer financing,

particularly automobile loans. The majority of the loans are funded from customer deposits. In addition, the bank purchases various investment securities with available cash. The investments are debt securities and have an average maturity date of less than 30 days. Should First National Bank report the interest received from the consumer loans and the interest received from the investment securities as an operating or as a nonoperating component in its year-end income statement? Consumer loans

Investment securities

Nonoperating Operating Operating

Operating Nonoperating Operating

A) B) C) A) Option A B) Option B C) Option C

45) Young Distributors, Incorporated issued convertible bonds two years ago, and those bonds

are the only potentially dilutive security Young has issued. In 20X5, Young’s basic earnings per share (EPS) and diluted EPS were identical, but in 20X4 they were different. Which of the following factors is least likely to explain the difference between basic and diluted EPS? The: A) bonds were antidilutive in 20X5 but not in 20X4. B) bonds were redeemed by Young Distributors at the beginning of 20X5. C) average market price of Young common stock increased in 20X5.

46) Selected financial information gathered from the Matador Corporation follows:

Average debt Average equity Return on assets Quick ratio Sales Cost of goods sold

2007

2006

2005

$ 792,000 $ 215,000 5.9%

$ 800,000 $ 294,000 6.6%

$ 820,000 $ 364,000 7.2%

0.3 $ 1,650,000 $ 1,345,000

0.5 $ 1,452,000 $ 1,176,000

0.6 $ 1,304,000 $ 1,043,000

Using only the data presented, which of the following statements ismost correct? A) Gross profit margin has improved. B) Leverage has declined. C) Return on equity has improved.

47) A firm has a cash conversion cycle of 80 days. The firm's payables turnover goes from 11 to

12, what happens to the firm's cash conversion cycle? It: A) may shorten or lengthen. B) lengthens. C) shortens.

48) An analyst compiled the following information from Hampshire, Incorporated’s financial

activities in the most recent year: Net income was $2,800,000. 100,000 shares of common stock were outstanding on January 1. The average market price per share for the year was $250. 10,000 shares of 6%, $1,000 par value preferred shares were outstanding the entire year. 10,000 warrants, which allow the holder to purchase 10 shares of common stock for each warrant held at a price of $150 per common share, were outstanding the entire year. 30,000 shares of common stock were issued on September 1. Hampshire, Incorporated’s diluted earnings per share are closest to: A) $14.67. B) $18.38. C) $20.00.

49) Selected information from Gerrard, Incorporated’s financial activities in the most recent year

was as follows: Net income was $330,000. The tax rate was 40%. 700,000 shares of common stock were outstanding on January 1. The average market price per share for the year was $6. Dividends were paid during the year. 2,000 shares of 8% $500 par value preferred shares, convertible into common shares at a rate of 200 common shares for each preferred share, were outstanding for the entire year. 200,000 shares of common stock were issued on March 1. Gerrard, Incorporated’s diluted earnings per share (diluted EPS) was closest to: A) $0.261. B) $0.289. C) $0.197.

50) 50. Which of the following statements about a firm with convertible preferred stock

outstanding is most accurate? A) If diluted EPS is less than basic EPS then the convertible preferred is said to be antidilutive. B) Diluted EPS is calculated with net income minus preferred dividends in the numerator. C) If diluted and basic EPS are equal, the firm must report both basic and diluted EPS.

51) Barracuda Corporation, a U.S. corporation, owns a subsidiary located in Germany. The

German subsidiary’s financial statements are maintained in euros. If the euro recently appreciated relative to the U.S. dollar, how would the unrealized translation gain affect Barracuda’s retained earnings and total stockholders’ equity? Retained earnings A) B) C) A) Option A B) Option B C) Option C

No effect No effect Increase

Total stockholders' equity No effect Increase Increase

52) The “All Faiths” church is building a new church for $2 million on land acquired several

years ago. The contractor estimates the cost at $1.3 million and the project is to be completed over a 2-year period with the payments split evenly between the 2 years. During the first year, the total costs incurred were $700,000. During the second year the contractor experienced cost overruns and costs incurred were $1.0 million. How much revenue and income should the contractor recognize in the second year of the project?

A) B) C)

Revenue

Income

$ 923,077 $ 1,076,923 $ 1,000,000

−$ 76,923 $ 376,923 $ 0

A) Option A B) Option B C) Option C

53) Jodi Lein, small business consultant, is currently working with RJ Landscaping, a sole

proprietorship. She is trying to educate the owner on the importance of monitoring cash flows. Operating information as of the end of the most recent month appears below: Cash from sale of truck of $7,000. Cash salaries paid of $17,000. Cash from customers of $45,000. Depreciation expense of $5,500. Interest on bank line of credit of $1,000. Cash paid to suppliers of $22,000. Other cash expenses, including rent, of $6,300. No taxes due. Using this information and U.S. GAAP, what is the cash flow from operations for the month? A) −$1,300. B) $11,200. C) −$300.

54) Which costs are least likely to be reported as an expense in the current accounting period? A) Period costs. B) Loan interest that has not yet been paid. C) Costs of producing inventory.

55) Determine the cash flow from operations given the following table. Item Cash payment of dividends Sale of equipment Net income Purchase of land Increase in accounts payable Sale of preferred stock Increase in deferred taxes Profit on sale of equipment

Amount $ 30 $ 25 $ 25 $ 15 $ 20 $ 25 $ 5 $ 15

A) $20. B) $45. C) $35.

56) For a manufacturing company reporting under U.S. GAAP, interest received is most likely

reported as: A) an investing cash flow and as non-operating income. B) an operating cash flow but as non-operating income. C) both an operating cash flow and operating income.

57) Which costs are least likely to be reported as an expense in the current accounting period? A) Period costs. B) Loan interest that has not yet been paid. C) Costs of producing inventory.

58) A U.S. GAAP reporting company invests $50 million in a bond portfolio yielding 4% with

an average maturity of seven years. After one year, interest rates have fallen by 50 basis points. The company will report the highest retained earnings if the securities in the portfolio are classified as: A) trading securities. B) available-for-sale. C) held-to-maturity.

59) From Thorpe Company’s cash flow statement, an analyst discovers that during the most

recent period Thorpe spent $2 million on what the firm describes as “investment in capital improvements.” If the analyst believes this expenditure will not give Thorpe any enduring benefit beyond the current period, the most appropriate adjustment is to: A) decrease both CFO and CFI. B) increase CFO and decrease CFI. C) decrease CFO and increase CFI.

60) A common-size cash flow statement is least likely to show each cash inflow as a percentage

of: A) revenue. B) total cash flows. C) all cash inflows.

61) Which of the following items would affect owners’ equity and also appear on the income

statement? A) Unrealized gains and losses on available-for-sale securities. B) Dividends paid to shareholders. C) Unrealized gains and losses on trading securities.

62) The revaluation model for investment property is permitted under: A) both IFRS and U.S. GAAP. B) neither IFRS nor U.S. GAAP. C) IFRS, but not U.S. GAAP.

63) Train, Incorporated’s cash flow from operations (CFO) in 20X8 was $14 million. Train paid

$8 million cash to acquire a franchise at the beginning of 20X8 that was expensed in 20X8. If Train had elected to amortize the cost of the franchise over eight years, 20X8 cash flow from operations (CFO) would have been: A) $21 million. B) $14 million. C) $22 million.

64) A manufacturing firm shuts down production at one of its plants and offers the facility for

rent. Based on the market for similar properties, the firm determines that the fair value of the plant is €500,000 more than its carrying value. If this firm uses the cost model for plant and equipment and the fair value model for investment property, should it recognize a gain on its income statement? A) No, because the firm must continue to use the cost model for valuation of this asset. B) Yes, because the plant will be reclassified as investment property. C) No, because the increase in value does not reverse a previously recognized loss.

65) A firm acquires investment property for €3 million and chooses the fair value model for

financial reporting. In Year 1 the market value of the investment property decreases by €150,000. In Year 2 the market value of the investment property increases by €200,000. On its financial statements for Year 2, the firm will recognize a: A) €150,000 increase in shareholders’ equity. B) €200,000 gain on its income statement. C) €150,000 gain on its income statement and a €50,000 revaluation surplus in shareholders’ equity.

66) For a company which owns a majority of the equity of a subsidiary, whether to create a

deferred tax liability for undistributed profits from the subsidiary depends on an “indefinite reversal criterion” under: A) U.S. GAAP, but not IFRS. B) both IFRS and U.S. GAAP. C) IFRS, but not U.S. GAAP.

67) Diabelli Incorporated is a manufacturing company that is operating at normal capacity levels.

Which of the following inventory costs is most likely to be recognized as an expense on Diabelli’s financial statements when the inventory is sold? A) Selling cost. B) Administrative overhead. C) Allocation of fixed production overhead.

68) Christophe Incorporated is an electronics manufacturing firm. It owns equipment with a tax

basis of $800,000 and a carrying value of $600,000 as the result an impairment charge. It also has a tax loss carryforward of $300,000 that is expected to be utilized within the next year or two. The tax rate on these items is 40% but the tax rate will decrease to 35%. Which of the following is closest to the effect on the income statement of the change in tax rate? A) Decrease income tax expense by $5,000. B) Increase income tax expense by $5,000. C) Increase income tax expense by $25,000.

69) A tax rate that has been substantively enacted is used to determine the balance sheet values of

deferred tax assets and deferred tax liabilities under: A) both IFRS and U.S. GAAP. B) IFRS only. C) U.S. GAAP only.

70) A company issues 5% semiannual coupon, 3-year, $1,000 par value bonds on January 1,

20X0, when the market interest rate is 13.3%. The sale proceeds are $800. Under the effective interest rate method, what amount of interest expense per $1,000 par value will the company record for the year ending December 31, 20X1? A) $106.40. B) $116.29. C) $66.29.

71) For a firm that uses the cost basis for valuing its long-lived assets, fair value is a

consideration when calculating a gain or loss on: A) selling an asset. B) abandoning an asset. C) exchanging an asset.

72) The inventory turnover ratio and the number of days in inventory are least likely used to

evaluate the: A) age of a firm's inventory. B) effectiveness of a firm's inventory management. C) stability of a firm's inventory levels.

73) Which of the following statements regarding the disclosure of deferred taxes in a company’s

balance sheet is most accurate? A) Current deferred tax liability and noncurrent deferred tax asset are netted, resulting in the disclosure of a net noncurrent deferred tax liability or asset. B) There should be a combined disclosure of all deferred tax assets and liabilities that are likely to reverse in the current period. C) Deferred tax assets and liabilities are classified as noncurrent.

74) Which set of accounting standards requires firms to disclose estimated amortization expense

for the next five years on intangible assets? A) U.S. GAAP. B) Both IFRS and U.S. GAAP. C) IFRS.

75) Which of the following factors is least likely to cause a difference between a firm’s effective

tax rate and statutory rate? A) Tax credits. B) Non-deductible expenses. C) Deductible expenses.

76) When bonds are issued at a premium: A) earnings of the firm increase over the life of the bond as the bond premium is

amortized. B) coupon interest paid decreases each period as bond premium is amortized. C) earnings of the firm decrease over the life of the bond as the bond premium is amortized.

77) Under which financial reporting standards is the full amount of a deferred tax asset shown on

the balance sheet, regardless of its probability of being realized fully? A) IFRS, but not U.S. GAAP. B) U.S. GAAP, but not IFRS. C) Neither IFRS nor U.S. GAAP.

78) Barber Incorporated, which uses LIFO inventory accounting under U.S. GAAP, sells DVD

recorders. On October 14, it purchased a large number of recorders at a cost of $90 each. Due to an oversupply of recorders remaining in the marketplace due to lower than anticipated demand during the Christmas season, the selling price at December 31 is $80 and the replacement cost is $73. The normal profit margin is 5 percent of the selling price and the selling costs are $2 per recorder. What is the value of the recorders on December 31? A) $78. B) $73. C) $74.

79) Selected information from the financial statements of Salvo Company for the years ended

December 31, 20X3 and 20X4 is as follows (in $ millions):

Sales Cost of Goods Sold Gross Profit Cost of Franchise Other Expenses Net Income Cash Accounts Receivable Inventory Property, Plant & Equipment (net) Total Assets Accounts Payable Long-term Debt Common Stock Retained Earnings Total Liabilities and Equity

20X3

20X4

$ 21 (8) 13 (6) (6) $ 1 $ 4 6 9 12 $ 31 $ 7 10 8 6 $ 31

$ 23 (9) 14 0 (6) $ 8 $ 5 5 7 15 $ 32 $ 5 5 8 14 $ 32

If Salvo had amortized the cost of the franchise acquired in 20X3 over six years instead of expensing it, Salvo’s return on average total equity for 20X4 would have beenclosest to: A) 31.1%. B) 35.6%. C) 38.9%.

80) Under U.S. GAAP, a lessee must recognize a balance sheet liability for: A) finance leases, but not operating leases. B) operating leases, but not finance leases. C) both finance leases and operating leases.

81) Cushinson Corporation had a beginning inventory of $9,500 (250 units) and made three

inventory purchases during the fiscal year:

3/1/X6 7/1/X6 9/1/X6

Purchases

Units Total Cost

400 450 550

$ 14,800 $ 14,850 $ 15,950

The company began operations on Jan. 1, 20X6. Costing uses the LIFO method of determining cost of goods sold. First year sales were 1,300 units. Themost likely effects of using LIFO inventory costing as compared to FIFO in Cushinson’s 20X6 financial statements are: A) lower net income; lower working capital. B) higher net income; higher working capital. C) higher net income; lower working capital.

82) A reconciliation of beginning and ending carrying values for each class of property, plant,

and equipment is required for firms reporting under: A) U.S. GAAP. B) both U.S. GAAP and IFRS. C) IFRS.

83) An IFRS-reporting firm reclassifies a building it owns from “owner-occupied” to “investment

property.” The fair value of the building is greater than its carrying value. Under the fair value model for investment property, the firm will recognize a gain: A) in other comprehensive income but not on the income statement. B) only if it reverses a previously recognized loss. C) equal to the difference between fair value and carrying value.

84) Alter Incorporated determines that it has $35,000 of accounts receivable outstanding at the

end of 20X8. Based on past experience, it recognizes an allowance for bad debt equal to 10% of its credit sales. The tax base of Alter’s accounts receivable at the end of 20X8 is closest to: A) $35,000. B) $31,500. C) $3,500.

85) A bond is issued at the end of the year 20X0 with an 8% semiannual coupon rate, 5 years to

maturity, and a par value of $1,000. The bond's yield at issuance is 10%. Using the effective interest method, if the yield has decreased to 9% at the end of the year 20X1, the balance sheet liability for the bond is closest to: A) $967. B) $935. C) $923.

86) A company purchases a new pizza oven for $12,675. It will work for 5 years and have no

salvage value. The company will depreciate the oven over 5 years using the straight-line method for financial reporting, and over 3 years for tax reporting. If the tax rate for years 4 and 5 changes from 41% to 31%, the deferred tax liability as of the end of year 3 is closest to: A) $1,040. B) $2,080. C) $1,570.

87) The effect of an inventory writedown on a firm’s return on assets (ROA) is most accurately

described as: A) higher ROA in the current period and lower ROA in later periods. B) lower ROA in the current period and higher ROA in later periods. C) lower ROA in the current period and no effect on ROA in later periods.

88) Selected information from Jenner, Incorporated’s financial statements for the year ended

December 31 included the following (in $): Cash Accounts Receivable

$ 200,000 300,000

Inventory Property, Plant & Equipment Total Assets

1,500,000 11,000,000

LIFO Reserve at January 1 LIFO Reserve at December 31 Net Income (after 40% tax rate)

400,000

13,000,000

Accounts Payable Deferred Tax Liability Long-term Debt Common Stock Retained Earnings Total Liabilities & Equity

$ 300,000 600,000 8,100,000 2,200,000 1,800,000 $ 13,000,000

600,000 800,000

Jenner uses the last in, first out (LIFO) inventory cost flow assumption. If Jenner had used first in, first out (FIFO), return on total equity would: A) increase to 21.1%. B) decrease to 18.3%. C) increase to 23.0%.

89) Selected financial data from Krandall, Incorporated’s balance sheet for the year ended

December 31 was as follows (in $): Cash Accounts Receivable

$ 1,100,000 300,000

Inventory Property, Plant & Equipment Total Assets

2,400,000 8,000,000

LIFO Reserve at January 1 LIFO Reserve at December 31

11,800,000

Accounts Payable Deferred Tax Liability Long-term Debt Common Stock Retained Earnings Total Liabilities & Equity

$ 400,000 700,000 8,200,000 1,000,000 1,500,000 11,800,000

600,000 900,000

Krandall uses the last in, first out (LIFO) inventory cost flow assumption. The tax rate is 40%. If Krandall used first in, first out (FIFO) instead of LIFO and paid any additional tax due, its assets-to-equity ratio would beclosest to: A) 3.73 B) 4.06 C) 4.18

90) A health care company purchased a new MRI machine on 1/1/X3. At year-end the company

recorded straight-line depreciation expense of $75,000 for book purposes and accelerated depreciation expense of $94,000 for tax purposes. Management estimates warranty expense related to corrective eye surgeries performed in 20X3 to be $250,000. Actual warranty expenses of $100,000 were incurred in 20X3 related to surgeries performed in 20X2. The company’s tax rate for the current year was 35%, but a tax rate of 37% has been enacted into law and will apply in future periods. Assuming these are the only relevant entries for deferred taxes, the company’s recorded changes in deferred tax assets and liabilities on 12/31/X3 are closest to:

A) B) C)

DTA

DTL

$52,500 $55,500 $55,500

$6,650 $6,650 $7,030

A) Option A B) Option B C) Option C

91) U.S. GAAP least likely requires property, plant, and equipment to be tested for impairment: A) when events indicate the firm may not recover the asset’s carrying value. B) when an asset is reclassified as held-for-sale. C) at least annually.

92) Moore Limited uses the LIFO inventory cost flow assumption. Its cost of goods sold in 20X8

was $800. A footnote in its financial statements reads: “Using FIFO, inventories would have been $70 higher in 20X8 and $80 higher in 20X7.” Moore’s COGS if FIFO inventory costing were used in 20X8 is closest to: A) $730. B) $790. C) $810.

93) Using the lower of cost or market principle under U.S. GAAP, if the market value of

inventory falls below its historical cost, the minimum value at which the inventory can be reported in the financial statements is the: A) net realizable value minus selling costs. B) market price minus selling costs minus normal profit margin. C) net realizable value.

94) Enduring Corporation operates in a country where net income from sales of goods are taxed

at 40%, net gains from sales of investments are taxed at 20%, and net gains from sales of used equipment are exempt from tax. Installment sale revenues are taxed upon receipt. For the year ended December 31, 2004, Enduring recorded the following before taxes were considered: Net income from the sale of goods was $2,000,000, half was received in 2004 and half will be received in 2005. Net gains from the sale of investments were $4,000,000, of which 25% was received in 2004 and the balance will be received in the 3 following years. Net gains from the sale of equipment were $1,000,000, of which 50% was received in 2004 and 50% in 2005. On its financial statements for the year ended December 31, 2004, Enduring should apply an effective tax rate of: A) 26.67% and increase its deferred tax liability by $1,000,000. B) 22.86% and increase its deferred tax liability by $1,000,000. C) 22.86% and increase its deferred tax asset by $1,000,000.

95) Capitalizing interest costs related to a company’s construction of assets for its own use is

required by: A) U.S. GAAP only. B) IFRS only. C) both IFRS and U.S. GAAP.

96) A U.S. company uses the LIFO method to value its inventory for their income tax return. For

its financial statements prepared for shareholders, the company may: A) use the FIFO method, but must disclose a LIFO reserve. B) only use the LIFO method. C) use any other inventory method under generally accepted accounting principles (GAAP).

97) Novak, Incorporated owns equipment with a historical cost of $20,000, a useful life of 5

years, and an estimated salvage value of $5,000. Using the double declining balance method, depreciation expense in Year 3 for this equipment is: A) $3,000.00 B) $2,200.00 C) $2,880.00

98) A company redeems $10,000,000 of bonds that it issued at par value for 101% of par or

$10,100,000. In its statement of cash flows, the company will report this transaction as a: A) $10,100,000 CFO outflow. B) 10,100,000 CFF outflow. C) $10,000,000 CFF outflow and $100,000 CFO outflow.

99) For a lessor that reports under U.S. GAAP, a lease is classified as an operating lease if: A) ownership risks are not substantially transferred to the lessee. B) the fair value of the asset is greater than the sum of the lease payments and the asset’s

expected residual value. C) it cannot be classified as a sales-type lease or a direct financing lease.

100)

A firm has deferred tax assets of $315,000 and deferred tax liabilities of $190,000. If the tax rate increases, adjusting the value of the firm's deferred tax items will: A) have no effect on income tax expense. B) decrease income tax expense. C) increase income tax expense.

101)

For a firm financed with common stock and long-term fixed-rate debt, an analyst should most appropriately adjust which of the following items for a change in market interest rates? A) Cash flow from financing. B) Interest paid. C) Debt-to-equity ratio.

102)

On December 31, 20X3 Okay Company issued 10,000 $1000 face value 10-year, 9% bonds to yield 7%. The bonds pay interest semi-annually. On its financial statements (prepared under U.S. GAAP) for the year ended December 31, 20X4, the effect of this bond on Okay's cash flow from operations is: A) −$755,735. B) −$900,000. C) −$700,000.

103)

A U.S. GAAP firm writes down inventory to net realizable value. In the period of the writedown, what is the most likely effect on cost of goods sold? A) No effect. B) Increase. C) Decrease.

104)104) A company issues an annual-pay bond with the following characteristics: Face value $ 67,831 Maturity Coupon

4 7%

Market interest rates

years

What is the unamortized discount at the end of the first year? A) $1,209. B) $1,750. C) $499.

105)

Deferred tax items should be measured based on the: A) tax rate that will apply when the temporary difference reverses. B) firm’s effective tax rate at the time when the temporary difference reverses. C) statutory tax rate at the time when the temporary difference is recognized.

106)

A company acquires an intangible asset for $100,000 and expects it to have a value of $20,000 at the end of its 5-year useful life. If the company amortizes the asset using the double-declining balance method, amortization expense in year 4 of the asset’s useful life is closest to: A) $8,640. B) $6,910. C) $1,600.

107)

In analyzing disclosures related to the financing liabilities of a company, which of the following disclosures would be least helpful to the analyst? A) The present value of the future bond payments discounted at the coupon rate of the bonds. B) The interest expense for the period as provided on the income statement or in a footnote. C) Filings with the Securities and Exchange Commission (SEC) that disclose all outstanding securities and their features.

Dubois Company bought land for company use five years ago for €2 million and presents its balance sheet value as €2.2 million. If the fair value of the land decreases to €1.8 million, Dubois will: A) decrease shareholders’ equity by €400,000 but will not recognize a loss. B) recognize a loss of €400,000 and decrease shareholders’ equity by €200,000. C) recognize a loss of €200,000 and decrease shareholders’ equity by €400,000.

108)

109)

Under IFRS, deferred tax assets and deferred tax liabilities are classified on the balance sheet as: A) either current or noncurrent items. B) noncurrent items. C) current items.

110)

Deferred taxes must be recognized for undistributed earnings from an investment in an associate firm under: A) neither IFRS nor U.S. GAAP. B) U.S. GAAP only. C) both IFRS and U.S. GAAP.

111)

Fred Company has a deferred tax liability of $1,200,000. If Fred’s tax rate increases from 30% to 40%, the impact of this tax rate change will: A) increase Fred’s income tax expense by $400,000. B) decrease Fred’s income tax expense by $120,000. C) increase Fred’s income tax expense by $120,000.

112)

Robbins, Incorporated, reports under IFRS and uses the effective interest rate method for valuing its bond liabilities. Robbins sells a 10-year, $100 million, 5% annual coupon bond issue for $98 million and paid $500,000 in issuance costs. Two years later, the bond liability Robbins will report on its balance sheet for this debt is closest to: A) $98.1 million. B) $98.0 million. C) $97.9 million.

113)

Which of the following is least likely required for a lease to be classified as a direct financing lease by the lessor under U.S. GAAP? A) The lease transfers substantially all the benefits and risks of ownership to the lessee. B) The sum of the lease payments and asset’s residual value is not less than the asset value. C) A third party guarantees the payment of the residual value of the lease to the lessor.

114)

Cody Scott would like to screen potential equity investments to identify value stocks and selects firms that have low price-to-sales ratios. Unfortunately, screening stocks based only on this criterion may result in stocks that have poor profitability or high financial leverage, which are undesirable to Scott. Which of the following filters could be added to the stock screen to best control for poor profitability and high financial leverage? Filter #1 – Include only stocks with a debt-to-equity ratio that is above a certain benchmark value. Filter #2 – Include only dividend paying stocks. Filter #3 – Include only stocks with an assets-to-equity ratio that is below a certain benchmark value. Filter #4 – Include only stocks with a positive return-on-equity. Poor profitability

High financial leverage

Filter #2 Filter #4 Filter #4

Filter #3 Filter #3 Filter #1

A) B) C) A) Option A B) Option B C) Option C

115)

Mechanisms that enforce discipline over financial reporting quality least likely include: A) government securities regulators. B) counterparties to private contracts. C) accounting standard-setting bodies.

116)

Portsmouth Industries has stated that in the market for their medical imaging product, their strategy is to grow their market share in the premium segment by leveraging their research and development capabilities to produce machines with greater resolution for the most challenging cases of spinal degeneration. An analyst examining their financials for subsequent periods would most likely conclude that they are successfully pursuing this strategy if she finds: A) increasing research and development expense and decreasing operating margins. B) an increase in revenue and operating margins. C) an increase in gross margins greater than the increase in operating margins.

117)

A significant increase in days payables above historical levels is most likely associated with: A) an unsustainable increase in reported earnings. B) an increase in net working capital. C) low quality of the cash flow statement.

118)

Baetica Company reported the following selected financial statement data for the year ended December 31, 20X7: in millions For the year ended December 31, 20X7: Sales Cost of goods sold Selling and administration expenses Depreciation Net income As of December 31, 20X7: Non-cash operating working capitala Cash balance a

% of Sales

$ 500 (300) (125) (50) $ 25

100% 60% 25% 10% 5%

$ 100 $ 35

20% N/A

Non-cash operating working capital = Receivables + Inventory − Payables

Baetica expects that sales will increase 20% in 20X8. In addition, Baetica expects to make fixed capital expenditures of $75 million in 20X8. Ignoring taxes, calculate Baetica’s expected cash balance, as of December 31, 2008, assuming all of the common-size percentages remain constant. A) $80 million. B) $30 million. C) $40 million.

119)

An analyst has decided to identify value stocks for investment by screening for companies with high book-to-market ratios and high dividend yields. A potential drawback of using these screens to find value stocks is that the firms selected may: A) be those that have significantly underperformed the market. B) be concentrated in specific industries. C) have unsustainable dividend payments.

120)

National Scooter Company and Continental Chopper Company are motorcycle manufacturing companies. National’s target market includes consumers that are switching to motorcycles because of the high cost of operating automobiles and they compete on price with other manufacturers. The average age of National’s customers is 24 years. Continental manufactures premium motorcycles and aftermarket accessories and competes on the basis of quality and innovative design. Continental is in the third year of a five-year project to develop a customized hybrid motorcycle. Which of the two firms would most likely report higher gross profit margin, and which firm would most likely report higher operating expense stated as a percentage of total cost? Higher gross profit margin A) B) C)

National Continental Continental

Higher percentage operating expense Continental National Continental

A) Option A B) Option B C) Option C

121)

The most likely problem with using financial statement ratios to screen for stocks to include in a portfolio is that: A) specific industries are often over-represented. B) firm characteristics are not identified well by financial statement measures. C) firms with undesirable characteristics will be included.

Answer Key Test name: Financial Reporting and Analysis 1) C 2) C 3) B 4) A 5) A 6) A 7) B 8) A 9) B 10) B 11) B 12) B 13) A 14) C 15) C 16) B 17) C 18) B 19) A 20) B 21) A 22) C 23) A 24) B 25) C 26) C 27) A 28) B 29) A 30) C 31) A 32) C 33) C 34) B 35) B 36) C 37) B

38) B 39) B 40) A 41) B 42) A 43) C 44) C 45) C 46) C 47) B 48) A 49) A 50) C 51) B 52) A 53) A 54) C 55) C 56) B 57) C 58) A 59) C 60) B 61) C 62) B 63) C 64) C 65) B 66) A 67) C 68) C 69) B 70) B 71) C 72) C 73) C 74) A 75) C 76) A 77) B

78) C 79) A 80) C 81) B 82) C 83) B 84) A 85) B 86) C 87) B 88) A 89) B 90) C 91) C 92) C 93) B 94) B 95) C 96) B 97) B 98) B 99) C 100) 101) 102) 103) 104) 105) 106) 107) 108) 109) 110) 111) 112) 113) 114) 115) 116) 117)

B C B B B A C A C B B A C A A C C C

118) 119) 120) 121)

B B C A

Fixed Income: 1) A 4 percent Treasury bond has 2.5 years to maturity. Spot rates are as follows: 6 month 2%

1 year 2.5%

1.5 years 3%

2 years 4%

2.5 years 6%

The note is currently selling for $976. Determine the arbitrage profit, if any, that is possible. A) $37.63. B) $43.22. C) $19.22.

2) An investor holds $100,000 (par value) worth of TIPS currently trading at par. The coupon

rate of 4% is paid semiannually, and the annual inflation rate is 2.5%. What coupon payment will the investor receive at the end of the first six months? A) $2,000. B) $2,025. C) $2,050.

3) Venenata Foods has a 10-year bond outstanding with an annual coupon of 6.5%. If the bond

is currently priced at $1,089.25, which of the following is closest to the semiannual-bond basis yield? A) 5.42%. B) 5.33%. C) 5.26%.

4) A yield curve for coupon bonds is composed of yields on bonds with similar: A) coupon rates. B) issuers. C) maturities.

5) In a commercial mortgage-backed security (CMBS), which of the following is an example of

CMBS- level call protection? A) Yield maintenance charges. B) Prepayment lockout. C) Residual tranche.

6) Which of the following statements about floating-rate notes is most accurate? A) Inverse floating-rate notes are attractive to investors who expect interest rates to rise,

while floating-rate notes are attractive to investors who expect interest rates to fall. B) The coupon payment on a floating-rate note at each reset date is typically based on LIBOR as of that date. C) Floating-rate notes have built-in floors, while inverse floating-rate notes have built-in caps.

7) The interest rate on excess reserves borrowed by one bank from another bank is most

accurately described as a(n): A) reserve swap rate. B) interbank lending rate. C) central bank funds rate.

8) The reference rate for a floating-rate note should least likely match the note’s: A) reset frequency. B) maturity. C) currency.

9) A covenant that requires the issuer not to let the insurance coverage lapse on assets pledged

as collateral is an example of a(n): A) negative covenant. B) affirmative covenant. C) inhibiting covenant.

10) Which of the following statements about U.S. Treasury Inflation Protection Securities (TIPS)

is most accurate? A) The inflation-adjusted principal value cannot be less than par. B) Adjustments to principal values are made annually. C) The coupon rate is fixed for the life of the issue.

11) A bond’s indenture least likely specifies the: A) source of funds for repayment. B) covenants that apply to the issuer. C) identity of the lender.

12) Allcans, an aluminum producer, needs to issue some debt to finance expansion plans, but

wants to hedge its bond interest payments against fluctuations in aluminum prices. Jerrod Price, the company’s investment banker, suggests a commodity index floater. This type of bond is least likely to provide which of the following advantages? A) Payment structure helps protect Allcan's credit rating. B) The bond's coupon rate is linked to the price of aluminum. C) Allows Allcans to set coupon payments based on business results.

13) Suppose that the six-month spot rate is equal to 7% and the two-year spot rate is 6%. The

one-and a half-year forward rate starting six months from now has to: A) be more than 6%. B) be less than 6%. C) lie between 6% and 7%.

14) A $1,000 par, semiannual-pay bond is trading for 89.14, has a coupon rate of 8.75%, and

accrued interest of $43.72. The flat price of the bond is: A) $935.12. B) $891.40. C) $847.69.

15) A five-year bond with a 7.75% semiannual coupon currently trades at 101.245% of a par

value of $1,000. Which of the following is closest to the current yield on the bond? A) 7.75%. B) 7.65%. C) 7.53%.

16) A waterfall structure is least likely describe: A) credit card ABS. B) auto loan ABS. C) agency RMBS.

17) Bond X is a noncallable corporate bond maturing in ten years. Bond Y is also a corporate

bond maturing in ten years, but Bond Y is callable at any time beginning three years from now. Both bonds carry a credit rating of AA. Based on this information: A) The zero-volatility spread of Bond X will be greater than its option-adjusted spread. B) Bond Y will have a higher zero-volatility spread than Bond X. C) The option adjusted spread of Bond Y will be greater than its zero-volatility spread.

18) A renegotiable mortgage has a fixed interest rate that: A) the borrower may change to a variable rate. B) changes to a different fixed rate during its life. C) changes to a variable rate during its life.

19) Which of the following statements concerning the support tranche in a planned amortization

class (PAC) CMO backed by agency RMBS is least accurate? A) If prepayments are too low to maintain the scheduled PAC payments, the shortfall is provided by the support tranche. B) The purpose of a support tranche is to provide prepayment protection for one or more PAC tranches. C) The support tranches are exposed to high levels of credit risk.

20) A repurchase agreement is described as a “reverse repo” if: A) the repurchase price is lower than the sale price. B) a bond dealer is the lender. C) collateral is delivered to the lender and returned to the borrower.

21) The one-year spot rate is 7.00%. One-year forward rates are 8.15% one year from today,

10.30% two years from today, and 12.00% three years from today. The value of a 4-year, 11% annual pay, $1,000 per bond is closest to: A) $1,052. B) $1,060. C) $984.

22) One of the primary benefits of securitization is that it: A) removes problem assets from the issuing firm’s balance sheet. B) improves the collectability of the loans that are securitized. C) improves the legal claims of the security holders to the loans that are securitized.

23) If yield to maturity and risk factors remain constant over the remainder of a coupon bond's

life, and the bond is trading at a discount today, it will have a: A) positive current yield and a capital gain. B) positive current yield, only. C) negative current yield and a capital gain.

24) Which of the following embedded bond options tends to benefit the borrower? A) Put option. B) Conversion option. C) Interest rate cap.

25) A 10-year spot rate is least likely the: A) yield-to-maturity on a 10-year zero-coupon bond. B) yield-to-maturity on a 10-year coupon bond. C) appropriate discount rate on the year 10 cash flow for a 20-year bond.

26) Austin Traynor is considering buying a $1,000 face value, semi-annual coupon bond with a

quoted price of 104.75 and accrued interest since the last coupon of $33.50. Ignoring transaction costs, how much will the seller receive at the settlement date? A) $1,081.00. B) $1,014.00. C) $1,047.50.

27) With respect to auto-loan backed ABS: A) the underlying loans are collateralized so no credit enhancement is necessary. B) all of them have some sort of credit enhancement. C) some of them have some sort of credit enhancement.

28) If a callable bond has an option-adjusted spread (OAS) of 75 basis points, this most likely

suggests: A) the bond has a zero-volatility spread greater than 75 basis points. B) the 75 basis points represent the investor’s compensation for credit risk, liquidity risk, and volatility risk. C) the implied cost of the call option is the bond’s nominal spread minus 75 basis points.

29) An investor most concerned with reinvestment risk would be least likely to: A) prefer a noncallable bond to a callable bond. B) eliminate reinvestment risk by holding a coupon bond until maturity. C) prefer a lower coupon bond to a higher coupon bond.

30) If the yield curve is downward-sloping, the no-arbitrage value of a bond calculated using spot

rates will be: A) greater than the market price of the bond. B) equal to the market price of the bond. C) less than the market price of the bond.

31) Medium-term notes (MTNs) most likely: A) have maturities between 2 and 10 years. B) are sold through an underwritten offering. C) have less liquidity than long-term bonds of the same issuer.

32) The bonds of Grinder Corporation trade at a G-spread of 150 basis points above comparable

maturity U.S. Treasury securities. The option adjusted spread (OAS) on the Grinder bonds is 75 basis points. Using this information, and assuming that the Treasury yield curve is flat: A) the zero-volatility spread is 225 basis points. B) the option cost is 75 basis points. C) the zero-volatility spread is 75 basis points.

33) An annual-pay, 4% coupon, 10-year bond has a yield to maturity of 5.2%. If the price of this

bond is unchanged two years later, its yield to maturity at that time is: A) greater than 5.2%. B) 5.2%. C) less than 5.2%.

34) A five-year corporate bond and its benchmark government bond had the following yields

over a one- month period:

Corporate bond yield Government bond yield

Beginning of Month

End of Month

6.75% 4.25%

7.00% 4.75%

Over this month, the price of the corporate bond most likely experienced: A) unfavorable macroeconomic factors and favorable microeconomic factors. B) unfavorable macroeconomic and microeconomic factors. C) favorable macroeconomic factors and unfavorable microeconomic factors.

35) Which of the following is least likely an advantage of estimating the duration of a bond

portfolio as a weighted average of the durations of the bonds in the portfolio? A) It is easier to calculate than the alternative. B) It can be used when the portfolio contains bonds with embedded options. C) It is theoretically more sound than the alternative.

36) An investor buys a bond that has a Macaulay duration of 3.0 and a yield to maturity of 4.5%.

The investor plans to sell the bond after three years. If the yield curve has a parallel downward shift of 100 basis points immediately after the investor buys the bond, her annualized horizon return is most likely to be: A) less than 4.5%. B) greater than 4.5%. C) approximately 4.5%.

37) The factors that must be considered when estimating the credit risk of a bond include: A) the bond rating, the recovery rate, and the yield volatility. B) only the bond rating and the recovery rate. C) only the bond rating.

38) Which of the following will be the greatest for a putable bond at relatively high yields? A) Modified duration of the bond ignoring the option. B) Macaulay duration of the bond ignoring the option. C) Effective duration of the bond.

39) The factors that must be considered when estimating the credit risk of a bond include: A) the bond rating, the recovery rate, and the yield volatility. B) only the bond rating and the recovery rate. C) only the bond rating.

40) Which of the following will be the greatest for a putable bond at relatively high yields? A) Modified duration of the bond ignoring the option. B) Macaulay duration of the bond ignoring the option. C) Effective duration of the bond.

41) Jane Walker has set a 7% yield as the goal for the bond portion of her portfolio. To achieve

this goal, she has purchased a 7%, 15-year corporate bond at a discount price of 93.50. What amount of reinvestment income will she need to earn over this 15-year period to achieve a compound return of 7% on a semiannual basis? A) $624. B) $574. C) $459.

42) An investor purchases a fixed coupon bond with a Macaulay duration of 5.3. The bond’s

yield to maturity decreases before the first coupon payment. If the YTM then remains constant and the investor sells the bond after three years, the realized yield will be: A) lower than the YTM at the date of purchase. B) equal to the YTM at the date of purchase. C) higher than the YTM at the date of purchase.

43) Steven Company has EBITDA/interest and debt-to-capital ratios that are both higher

compared to Joseph Company to a degree consistent with one level of issuer credit rating. Based only on this information, the credit rating of Steven is most likely to be: A) the same as Joseph. B) lower than Joseph. C) higher than Joseph.

44) All else being equal, which of the following bond characteristics will lead to lower levels of

coupon reinvestment risk for bonds that are held to maturity? A) Shorter maturities and higher coupon levels. B) Longer maturities and higher coupon levels. C) Shorter maturities and lower coupon levels.

45) In comparing the price volatility of putable bonds to that of option-free bonds, a putable bond

will have: A) more price volatility at higher yields. B) less price volatility at higher yields. C) less price volatility at low yields.

46) When using duration and convexity to estimate the effect on a bond’s value of changes in its

credit spread, an analyst should most appropriately use: A) the same method used when estimating the effect of changes in yield. B) Macaulay duration rather than modified duration. C) a convexity measure that has been adjusted for the bond’s credit risk.

47) Structural subordination means that a parent company’s debt: A) ranks pari passu with a subsidiary’s debt with respect to the subsidiary’s cash flows. B) has a higher priority of claims to a subsidiary’s cash flows than the subsidiary’s debt. C) has a lower priority of claims to a subsidiary’s cash flows than the subsidiary’s debt.

48) Duration and convexity are most likely to produce more accurate estimates of interest rate

risk when the term structure of yield volatility is: A) downward sloping. B) upward sloping. C) flat.

49) Holding other factors constant, the interest rate risk of a coupon bond is higher when the

bond's: A) yield to maturity is lower. B) coupon rate is higher. C) current yield is higher.

50) If the term structure of yield volatility slopes upward: A) short-term interest rates are less than long-term interest rates. B) long-term interest rates are more variable than short-term interest rates. C) forward interest rates are higher than spot interest rates.

51) An investment advisor states, “An investor’s annualized holding period return from investing

in a bond consists of three parts: the coupon interest payments, the return of principal, and any capital gain or loss that the investor realizes on the bond.” The advisor is: A) incorrect, because these are not the only sources of return from investing in a bond. B) incorrect, because an investor who holds a bond to maturity will not realize a capital gain or loss. C) correct.

52) All else equal, which of the following is least likely to increase the interest rate risk of a

bond? A) A longer maturity. B) A decrease in the YTM. C) Inclusion of a call feature.

Answer Key Test name: Fixed Income 1) C 2) B 3) C 4) B 5) C 6) C 7) C 8) B 9) B 10) C 11) C 12) C 13) B 14) B 15) B 16) C 17) B 18) B 19) C 20) B 21) B 22) C 23) B 24) C 25) B 26) A 27) B 28) A 29) B 30) B 31) C 32) B 33) A 34) A 35) C 36) C 37) B

38) B 39) B 40) B 41) B 42) C 43) A 44) C 45) B 46) A 47) C 48) C 49) A 50) B 51) A 52) C

Portfolio Management: 1) Portfolios that plot on the security market line in equilibrium: A) have only systematic (beta) risk. B) may be concentrated in only a few stocks. C) must be well diversified.

2) Which of the following statements regarding the covariance of rates of return is least

accurate? A) Covariance is positive if two variables tend to both be above their mean values in the same time periods. B) Covariance is not a very useful measure of the strength of the relationship between rates of return. C) If the covariance is negative, the rates of return on two investments will always move in different directions relative to their means.

3) All portfolios on the capital market line: A) contain different risky assets. B) are perfectly positively correlated. C) are unrelated except that they all contain the risk-free asset.

4) Which of the following statements about active and passive asset management is most

accurate? A) Active management may use fundamental analysis, technical analysis, or a “smart beta” approach to outperform a chosen benchmark. B) Active management has been gaining market share over time versus passive management. C) Passive management’s share of industry revenues is smaller than its share of assets under management.

5) When comparing portfolios that plot on the security market line (SML) to those that plot on

the capital market line (CML), a financial analyst would most accurately state that portfolios that lie on the SML: A) have only systematic risk, while portfolios on the CML have both systematic and unsystematic risk. B) are not necessarily well diversified, while portfolios on the CML are well diversified. C) are not necessarily priced at their equilibrium values, while portfolios on the CML are priced at their equilibrium values.

6) An investor with a buy-and-hold strategy who makes quarterly deposits into an account

should most appropriately evaluate portfolio performance using the portfolio’s: A) money-weighted return. B) geometric mean return. C) arithmetic mean return.

7) Three portfolios have the following expected returns and risk: Portfolio Expected return Jones 4% Kelly 6% Lewis 7%

Standard deviation 2% 5% 8%

A risk-averse investor choosing from these portfolios could rationally select: A) Jones or Kelly, but not Lewis. B) Jones, but not Kelly or Lewis. C) any of these portfolios.

8) An investor buys one share of stock for $100. At the end of year one she buys three more

shares at $89 per share. At the end of year two she sells all four shares for $98 each. The stock paid a dividend of $1.00 per share at the end of year one and year two. What is the investor’s time-weighted rate of return? A) 6.35%. B) 0.06%. C) 11.24%.

9) Charlie Smith holds two portfolios, Portfolio X and Portfolio Y. They are both liquid, well-

diversified portfolios with approximately equal market values. He expects Portfolio X to return 13% and Portfolio Y to return 14% over the upcoming year. Because of an unexpected need for cash, Smith is forced to sell at least one of the portfolios. He uses the security market line to determine whether his portfolios are undervalued or overvalued. Portfolio X's beta is 0.9 and Portfolio Y's beta is 1.1. The expected return on the market is 12% and the risk-free rate is 5%. Smith should sell: A) either portfolio X or Y because they are both properly valued. B) portfolio Y only. C) both portfolios X and Y because they are both overvalued.

10) When the market is in equilibrium, all: A) assets plot on the CML. B) investors hold the market portfolio. C) assets plot on the SML.

11) In equilibrium, an inefficient portfolio will plot: A) on the CML and below the SML. B) below the CML and below the SML. C) below the CML and on the SML.

12) According to the capital asset pricing model (CAPM): A) a stock with high risk, measured as standard deviation of returns, will have high

expected returns in equilibrium. B) an investor who is risk averse should hold at least some of the risk-free asset in his portfolio. C) all investors who take on risk will hold the same risky-asset portfolio.

13) On January 1, Jonathan Wood invests $50,000. At the end of March, his investment is worth

$51,000. On April 1, Wood deposits $10,000 into his account, and by the end of June, his account is worth $60,000. Wood withdraws $30,000 on July 1 and makes no additional deposits or withdrawals the rest of the year. By the end of the year, his account is worth $33,000. The time-weighted return for the year is closest to: A) 5.5%. B) 7.0%. C) 10.4%.

14) Which of the following statements about the efficient frontier is least accurate? A) The efficient frontier shows the relationship that exists between expected return and

total risk in the absence of a risk-free asset. B) Portfolios falling on the efficient frontier are fully diversified. C) Investors will want to invest in the portfolio on the efficient frontier that offers the highest rate of return.

15) A model that estimates expected excess return on a security based on the ratio of the firm’s

book value to its market value is best described as a: A) single-factor model. B) multifactor model. C) market model.

16) A portfolio’s excess return per unit of systematic risk is known as its: A) Treynor measure. B) Jensen’s alpha. C) Sharpe ratio.

17) An analyst wants to determine whether Dover Holdings is overvalued or undervalued, and by

how much (expressed as percentage return). The analyst gathers the following information on the stock: Market standard deviation = 0.70 Covariance of Dover with the market = 0.85 Dover’s current stock price (P0) = $35.00 The expected price in one year (P1) is $39.00 Expected annual dividend = $1.50 3-month Treasury bill yield = 4.50%. Historical average S&P 500 return = 12.0%. Dover Holdings stock is: A) overvalued by approximately 1.8%. B) undervalued by approximately 2.1%. C) undervalued by approximately 1.8%.

18) Which of the following is the most accurate description of the market portfolio in Capital

Market Theory? The market portfolio consists of all: A) risky assets in existence. B) risky and risk-free assets in existence. C) equity securities in existence.

19) Which of the following is least likely considered a source of systematic risk for bonds? A) Market risk. B) Purchasing power risk. C) Default risk.

20) A stock's abnormal rate of return is defined as the: A) expected risk-adjusted rate of return minus the market rate of return. B) actual rate of return less the expected risk-adjusted rate of return. C) rate of return during abnormal price movements.

21) Kendra Jackson, CFA, is given the following information on two stocks, Rockaway and

Bridgeport. Covariance between the two stocks = 0.0325 Standard Deviation of Rockaway’s returns = 0.25 Standard Deviation of Bridgeport’s returns = 0.13 Assuming that Jackson must construct a portfolio using only these two stocks, which of the following combinations will result in the minimum variance portfolio? A) 80% in Bridgeport, 20% in Rockaway. B) 50% in Bridgeport, 50% in Rockaway. C) 100% in Bridgeport.

22) Which of the following statements best describes an investment that is not on the efficient

frontier? A) The portfolio has a very high return. B) There is a portfolio that has a lower return for the same risk. C) There is a portfolio that has a lower risk for the same return.

23) According to the CAPM, a rational investor would be least likely to choose as his optimal

portfolio: A) a 100% allocation to the risk-free asset. B) a 130% allocation to the market portfolio. C) the global minimum variance portfolio.

24) James Franklin, CFA, has high risk tolerance and seeks high returns. Based on capital market

theory, Franklin would most appropriately hold: A) the market portfolio as his only risky asset. B) a high risk biotech stock, as it will have high expected returns in equilibrium. C) a high-beta portfolio of risky assets financed in part by borrowing at the risk-free rate.

25) All portfolios that lie on the capital market line: A) contain at least some positive allocation to the risk-free asset. B) contain the same mix of risky assets unless only the risk-free asset is held. C) have some unsystematic risk unless only the risk-free asset is held.

26) Which of the following pooled investment shares is least likely to trade at a price different

from its NAV? A) Exchange-traded fund shares. B) Closed-end mutual fund shares. C) Open-end mutual fund shares.

27) Smith has more steeply sloped risk-return indifference curves than Jones. Assuming these

investors have the same expectations, which of the following best describes their risk preferences and the characteristics of their optimal portfolios? Smith is: A) less risk averse than Jones and will choose an optimal portfolio with a lower expected return. B) more risk averse than Jones and will choose an optimal portfolio with a higher expected return. C) more risk averse than Jones and will choose an optimal portfolio with a lower expected return.

28) When a risk-free asset is combined with a portfolio of risky assets, which of the following is

least accurate? A) The standard deviation of the return for the newly created portfolio is the standard deviation of the returns of the risky asset portfolio multiplied by its portfolio weight. B) The variance of the resulting portfolio is a weighted average of the returns variances of the risk-free asset and of the portfolio of risky assets. C) The expected return for the newly created portfolio is the weighted average of the return on the risk-free asset and the expected return on the risky asset portfolio.

29) An investor buys a non-dividend paying stock for $100 at the beginning of the year with 50%

initial margin. At the end of the year, the stock price is $95. Deflation of 2% occurred during the year. Which of the following return measures for this investment will be greatest? A) Leveraged return. B) Real return. C) Nominal return.

30) Which of the following is not necessarily included in an investment policy statement? A) A benchmark against which to judge performance. B) An investment strategy based on the investor’s objectives and constraints. C) Procedures to update the IPS when circumstances change.

31) A head and shoulders pattern is most likely to precede a reversal in trend if: A) volume decreases between the left shoulder and the head, then increases between the

head and the right shoulder. B) the left shoulder, the head, and the right shoulder occur on increasing volume. C) the left shoulder, the head, and the right shoulder occur on decreasing volume.

32) Which of the following uses of data is most accurately described as curation? A) An analyst adjusts daily stock index data from two countries for their different market

holidays. B) A data technician accesses an offsite archive to retrieve data that has been stored there. C) An investor creates a word cloud from financial analysts’ recent research reports about a company.

33) The advantages of using technical analysis include: A) the incorporation of psychological reasons behind price changes. B) complete objectivity. C) ease in interpreting reasons behind stock price trends.

34) While assessing an investor’s risk tolerance, a financial adviser is least likely to ask which of

the following questions? A) “What rate of investment return do you expect?” B) “Is your home life stable?” C) “How much insurance coverage do you have?”

35) A government decides it will privatize vehicle registrations if the province’s auto insurance

companies can record and maintain ownership titles using distributed ledger technology. This application of distributed ledger technology is best characterized as: A) blockchain. B) tokenization. C) smart contracts.

36) The resistance level signifies the price at which a stock's supply would be expected to: A) cause the stock price to "break out". B) increase substantially. C) decrease substantially.

37) When performing strategic asset allocation, properly defined and specified asset classes

should: A) each contain assets that have a broad range of risk and expected return. B) have high returns correlations with other asset classes. C) approximate the investor's total investable universe as a group.

38) An endowment is required by statute to pay out a minimum percentage of its asset value each

period to its beneficiaries. This investment constraint is best classified as: A) unique circumstances. B) liquidity. C) legal and regulatory.

39) The manager of the Fullen Balanced Fund is putting together a report that breaks out the

percentage of the variation in portfolio return that is explained by the target asset allocation, security selection, and tactical variations from the target, respectively. Which of the following sets of numbers was the most likely conclusion for the report? A) 33%, 33%, 33%. B) 50%, 25%, 25%. C) 90%, 6%, 4%.

40) Based on a questionnaire about investment risk, an advisor concludes that an investor’s risk

tolerance is high, but based on an analysis of the client's income needs and time horizon, he concludes the investor's risk tolerance is low. The most appropriate action for the advisor is to: A) educate the client about investment risk and re-administer the questionnaire. B) emphasize bonds over stocks. C) emphasize stocks over bonds.

Answer Key Test name: Portfolio Management 1) B 2) C 3) B 4) C 5) B 6) B 7) C 8) B 9) B 10) C 11) C 12) C 13) C 14) C 15) A 16) A 17) A 18) A 19) C 20) B 21) C 22) C 23) C 24) A 25) B 26) C 27) C 28) B 29) B 30) C 31) C 32) A 33) A 34) A 35) B 36) B 37) C

38) C 39) C 40) B

Quantitative Methods: 1) A successful investor has decided to set up a scholarship fund for deserving students at her

alma mater. Her plan is for the fund to be capable of awarding $25,000 annually in perpetuity. The first scholarship is to be awarded and paid out exactly four years from today. The funds will be deposited into an account immediately and will grow at a rate of 4%, compounded semiannually, for the foreseeable future. How much money must the investor donate today to fund the scholarship? A) $528,150. B) $549,487. C) $574,253.

2) An investment manager has a pool of five security analysts he can choose from to cover three

different industries. In how many different ways can the manager assign one analyst to each industry? A) 60. B) 10. C) 125.

3) A company says that whether it increases its dividends depends on whether its earnings

increase. From this we know: A) P(dividend increase | earnings increase) is not equal to P(earnings increase). B) P(earnings increase | dividend increase) is not equal to P(earnings increase). C) P(both dividend increase and earnings increase) = P(dividend increase).

4) Determining the number of ways five tasks can be done in order, requires: A) only the factorial function. B) the permutation formula. C) the labeling formula.

5) Which of the following is an a priori probability? A) The probability the Fed will lower interest rates prior to the end of the year. B) For a stock, based on prior patterns of up and down days, the probability of the stock

having a down day tomorrow. C) On a random draw, the probability of choosing a stock of a particular industry from the S&P 500.

6) The probability of a new office building being built in town is 64%. The probability of a new

office building that includes a coffee shop being built in town is 58%. If a new office building is built in town, the probability that it includes a coffee shop is closest to: A) 58%. B) 37%. C) 91%.

7) A firm is going to create three teams of four from twelve employees. How many ways can

the twelve employees be selected for the three teams? A) 34,650. B) 495. C) 1,320.

8) The "likelihood" of an event occurring is defined as: A) an unconditional probability. B) a conditional probability. C) a joint probability.

9) Compute the present value of a perpetuity with $100 payments beginning four years from

now. Assume the appropriate annual interest rate is 10%. A) $1,000. B) $751. C) $683.

10) Nikki Ali and Donald Ankard borrowed $15,000 to help finance their wedding and reception.

The annual payment loan carries a term of seven years and an 11% interest rate. Respectively, the amount of the first payment that is interest and the amount of the second payment that is principal are approximately: A) $1,650; $1,702. B) $1,650; $1,468. C) $1,468; $1,702.

11) Marc Schmitz borrows $20,000 to be paid back in four equal annual payments at an interest

rate of 8%. The interest amount in the second year’s payment would be: A) $6038.40. B) $1116.90. C) $1244.90.

12) Natalie Brunswick, neurosurgeon at a large U.S. university, was recently granted permission

to take an 18-month sabbatical that will begin one year from today. During the sabbatical, Brunswick will need $2,500 at the beginning of each month for living expenses that month. Her financial planner estimates that she will earn an annual rate of 9% over the next year on any money she saves. The annual rate of return during her sabbatical term will likely increase to 10%. At the end of each month during the year before the sabbatical, Brunswick should save approximately: A) $3,505.00 B) $3,330.00 C) $3,356.00

13) A parking lot has 100 red and blue cars in it.

40% of the cars are red. 70% of the red cars have radios. 80% of the blue cars have radios. What is the probability that the car is red given that it has a radio? A) 47%. B) 28%. C) 37%.

14) Optimal Insurance is offering a deferred annuity that promises to pay 10% per annum with

equal annual payments beginning at the end of 10 years and continuing for a total of 10 annual payments. For an initial investment of $100,000, what will be the amount of the annual payments? A) $42,212. B) $38,375. C) $25,937.

15) The real risk-free rate can be thought of as: A) exactly the nominal risk-free rate reduced by the expected inflation rate. B) approximately the nominal risk-free rate plus the expected inflation rate. C) approximately the nominal risk-free rate reduced by the expected inflation rate.

16) A local loan shark offers 4 for 5 on payday. What it involves is that you borrow $4 from him

and repay $5 on the next payday (one week later). What would the stated annual interest rate be on this loan, with weekly compounding? Assuming 52 weeks in one year, what is the effective annual interest rate on this loan? Select the respective answer choices closest to your numbers. A) 25%; 300%. B) 1,300%; 10,947,544%. C) 25%; 1,300%.

17) At a charity fundraiser there have been a total of 342 raffle tickets already sold. If a person

then purchases two tickets rather than one, how much more likely are they to win? A) 0.50. B) 2.10. C) 1.99.

18) Consider the following set of stock returns: 12%, 23%, 27%, 10%, 7%, 20%,15%. The third

quartile is: A) 23%. B) 20.0%. C) 21.5%.

19) Jim Franklin recently purchased a home for $300,000 on which he made a down payment of

$100,000. He obtained a 30-year mortgage to finance the balance on which he pays a fixed annual rate of 6%. If he makes regular, fixed monthly payments, what loan balance will remain just after the 48th payment? A) $186,109. B) $192,444. C) $189,229.

20) The probability of each of three independent events is shown in the table below. What is the

probability of A and C occurring, but not B? Table 1: Event A B C

Probability of Occurrence 25% 15% 42%

A) 8.9%. B) 3.8%. C) 10.5%.

21) Which of the following statements about probability is most accurate? A) A conditional probability is the probability that two or more events will happen

concurrently. B) An outcome is the calculated probability of an event. C) An event is a set of one or more possible values of a random variable.

22) As the number of compounding periods increases, what is the effect on the EAR? EAR: A) increases at an increasing rate. B) does not increase. C) increases at a decreasing rate.

23) Elise Corrs, hedge fund manager and avid downhill skier, was recently granted permission to

take a 4 month sabbatical. During the sabbatical, (scheduled to start in 11 months), Corrs will ski at approximately 12 resorts located in the Austrian, Italian, and Swiss Alps. Corrs estimates that she will need $6,000 at the beginning of each month for expenses that month. (She has already financed her initial travel and equipment costs.) Her financial planner estimates that she will earn an annual rate of 8.5% during her savings period and an annual rate of return during her sabbatical of 9.5%. How much does she need to put in her savings account at the end of each month for the next 11 months to ensure the cash flow she needs over her sabbatical? Each month, Corrs should save approximately: A) $2,070. B) $2,080. C) $2,065.

24) Distribution X has a mean of 10 and a standard deviation of 20. Distribution Y is identical to

Distribution X in all respects except that each observation in Distribution Y is three times the value of a corresponding observation in Distribution X. The mean and standard deviation of Distribution Y are closest to:

A) B) C)

Mean

Standard deviation

30 10 30

20 60 60

A) Option A B) Option B C) Option C

25) Which of the following statements is least accurate regarding covariance? A) The covariance of a variable with itself is one. B) Covariance can only apply to two variables at a time. C) Covariance can exceed one.

26) If 10 equal annual deposits of $1,000 are made into an investment account earning 9%

starting today, how much will you have in 20 years? A) $42,165. B) $39,204. C) $35,967.

27) To compare the returns over the past three years on a mutual fund to the returns on a

certificate of deposit with annual compounding over the same period, an analyst is least likely to use the mutual fund’s annual: A) geometric mean return. B) arithmetic mean return. C) time-weighted return.

28) Selmer Jones has just inherited some money and wants to set some of it aside for a vacation

in Hawaii one year from today. His bank will pay him 5% interest on any funds he deposits. In order to determine how much of the money must be set aside and held for the trip, he should use the 5% as a: A) required rate of return. B) discount rate. C) opportunity cost.

29) Given the following table about employees of a company based on whether they are smokers

or nonsmokers and whether or not they suffer from any allergies, what is the probability of both suffering from allergies and not suffering from allergies? Table 2: Suffer from Allergies Smoker Nonsmoker Total

35 55 90

Don't Suffer from Allergies 25 185 210

Total 60 240 300

A) 1.00. B) 0.00. C) 0.50.

30) There is a 40% chance that an investment will earn 10%, a 40% chance that the investment

will earn 12.5%, and a 20% chance that the investment will earn 30%. What is the mean expected return and the standard deviation of expected returns, respectively? A) 17.5%; 5.75%. B) 15.0%; 7.58%. C) 15.0%; 5.75%.

31) An investor will receive an annuity of $5,000 a year for seven years. The first payment is to

be received 5 years from today. If the annual interest rate is 11.5%, what is the present value of the annuity? A) $23,185.00 B) $15,000.00 C) $13,453.00

32) Compute the standard deviation of a two-stock portfolio if stock A (40% weight) has a

variance of 0.0015, stock B (60% weight) has a variance of 0.0021, and the correlation coefficient for the two stocks is −0.35? A) 0.07%. B) 2.64%. C) 1.39%.

33) How much should an investor have in a retirement account on his 65th birthday if he wishes

to withdraw $40,000 on that birthday and each of the following 14 birthdays, assuming his retirement account is expected to earn 14.5%? A) $272,977. B) $234,422. C) $274,422.

34) Based on the annual returns on a stock index over the last ten years, the arithmetic mean

return is calculated as zero percent. It is most likely that the average compound rate of return for an investment in the index over that period is: A) positive. B) zero. C) negative.

35) Which of the following rules is used to calculate an unconditional probability? A) Addition rule. B) Total probability rule. C) Multiplication rule.

36) The probability of A is 0.4. The probability ofAC is 0.6. The probability of (B | A) is 0.5, and

the probability of(B | AC) is 0.2. Using Bayes’ formula, what is the probability of (A | B)? A) 0.125. B) 0.625. C) 0.375.

37) Which of the following is a joint probability? The probability that a: A) stock increases in value after an increase in interest rates has occurred. B) stock pays a dividend and splits next year. C) company merges with another firm next year.

38) What is the standard deviation of a portfolio if you invest 30% in stock one (standard

deviation of 4.6%) and 70% in stock two (standard deviation of 7.8%) if the correlation coefficient for the two stocks is 0.45? A) 6.83%. B) 0.38%. C) 6.20%.

39) If X and Y are independent events, which of the following is most accurate? A) P(X or Y) = P(X) + P(Y). B) P(X or Y) = (P(X)) × (P(Y)). C) P(X | Y) = P(X).

40) Shawn Choate wants to choose a variable of study that has the most desirable statistical

properties. The statistic he is presently considering has the following characteristics: The expected value of the sample mean is equal to the population mean. The variance of the sampling distribution is smaller than that for other estimators of the parameter. As the sample size increases, the standard error of the sample mean increases and the sampling distribution is centered more closely on the mean. Choate’s estimator is: A) unbiased and consistent. B) efficient and consistent. C) unbiased and efficient.

41) Which of the following could be the set of all possible outcomes for a random variable that

follows a binomial distribution? A) (1,2). B) (0, 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11). C) (-1, 0,1).

42) For a test of the equality of the mean returns of two non-independent populations based on a

sample, the numerator of the appropriate test statistic is the: A) larger of the two sample means. B) average difference between pairs of returns. C) difference between the sample means for each population.

43) The number of days a particular stock increases in a given five-day period is uniformly

distributed between zero and five inclusive. In a given five-day trading week, what is the probability that the stock will increase exactly three days? A) 0.600. B) 0.167. C) 0.333.

44) Which of the following statements about a confidence interval for a population mean is most

accurate? A) When a z-statistic is acceptable, a 95% confidence interval for a population mean is the sample mean plus-or-minus 1.96 times the sample standard deviation. B) If the population variance is unknown, a large sample size is required in order to estimate a confidence interval for the population mean. C) For a sample size of 30, using a t-statistic will result in a wider confidence interval for a population mean than using a z-statistic.

45) A stock price decreases in one period and then increases by an equal amount in the next

period. The investor calculates a holding period return for each period and calculates their arithmetic mean. The investor also calculates the continuously compounded rate of return for each period and calculates the arithmetic mean of these. Which of the arithmetic means will be greater? A) The mean of the continuously compounded returns. B) The mean of the holding period returns. C) Neither, because both will equal zero.

46) Suppose the mean debt/equity ratio of the population of all banks in the United States is 20

and the population variance is 25. A banking industry analyst uses a computer program to select a random sample of 50 banks from this population and compute the sample mean. The program repeats this exercise 1000 times and computes the sample mean each time. According to the central limit theorem, the sampling distribution of the 1000 sample means will be approximately normal if the population of bank debt/equity ratios has: A) any probability distribution. B) a normal distribution, because the sample is random. C) a Student's t-distribution, because the sample size is greater than 30.

47) For a certain class of junk bonds, the probability of default in a given year is 0.2. Whether

one bond defaults is independent of whether another bond defaults. For a portfolio of five of these junk bonds, what is the probability that zero or one bond of the five defaults in the year ahead? A) 0.4096. B) 0.7373. C) 0.0819.

48) A researcher is testing whether the average age of employees in a large firm is statistically

different from 35 years (either above or below). A sample is drawn of 250 employees and the researcher determines that the appropriate critical value for the test statistic is 1.96. The value of the computed test statistic is 4.35. Given this information, which of the following statements is least accurate? The test: A) indicates that the researcher is 95% confident that the average employee age is different than 35 years. B) indicates that the researcher will reject the null hypothesis. C) has a significance level of 95%.

49) Cumulative Z-Table z 1.2 1.3 1.4 1.5 1.6

0.04 0.8925 0.9099 0.9251 0.9382 0.9495

0.05 0.8944 0.9115 0.9265 0.9394 0.9505

0.06 0.8962 0.9131 0.9279 0.9406 0.9515

0.07 0.8980 0.9147 0.9292 0.9418 0.9525

0.08 0.8997 0.9162 0.9306 0.9429 0.9535

0.09 0.9015 0.9177 0.9319 0.9441 0.9545

Maria Huffman is the Vice President of Human Resources for a large regional car rental company. Last year, she hired Graham Brickley as Manager of Employee Retention. Part of the compensation package was the chance to earn one of the following two bonuses: if Brickley can reduce turnover to less than 30%, he will receive a 25% bonus. If he can reduce turnover to less than 25%, he will receive a 50% bonus (using a significance level of 10%). The population of turnover rates is normally distributed. The population standard deviation of turnover rates is 1.5%. A recent sample of 100 branch offices resulted in an average turnover rate of 24.2%. Which of the following statements ismost accurate? A) Brickley should not receive either bonus. B) For the 50% bonus level, the critical value is -1.65 and Huffman should give Brickley a 50% bonus. C) For the 50% bonus level, the test statistic is -5.33 and Huffman should give Brickley a 50% bonus.

50) A stock increased in value last year. Which will be greater, its continuously compounded or

its holding period return? A) Neither, they will be equal. B) Its continuously compounded return. C) Its holding period return.

51) Consider a random variable X that follows a continuous uniform distribution: 7 ≤ X ≤ 20.

Which of the following statements is least accurate? A) F(10) = 0.23 B) F(12 ≤ X ≤ 16) = 0.307. C) F(21) = 0.00.

52) A multivariate distribution is best defined as describing the behavior of: A) two or more independent random variables. B) two or more dependent random variables. C) a random variable with more than two possible outcomes.

53) A p-value of 0.02% means that a researcher: A) cannot reject the null hypothesis at either the 5% or 1% significance levels. B) can reject the null hypothesis at both the 5% and 1% significance levels. C) can reject the null hypothesis at the 5% significance level but cannot reject at the 1%

significance level.

54) Which of the following statements regarding the central limit theorem (CLT) is least

accurate? The CLT: A) holds for any population distribution, assuming a large sample size. 2 2 B) gives the variance of the distribution of sample means as σ /n, where σ is the population variance and n is the sample size. 2 C) states that for a population with mean µ and variance σ , the sampling distribution of the sample means for any sample of size n will be approximately normally distributed.

55) Which of the following statements about probability distributions is most accurate? A) A binomial distribution gives the probabilities only for whole number outcomes for a

random variable. B) A discrete uniform random variable has varying probabilities for each outcome that total to one. C) A continuous uniform distribution has a lower limit but no upper limit.

56) When sampling from a population, the most appropriate sample size: A) is at least 30. B) minimizes the sampling error and the standard deviation of the sample statistic around

its population value. C) involves a trade-off between the cost of increasing the sample size and the value of increasing the precision of the estimates.

57) A discount brokerage firm states that the time between a customer order for a trade and the

execution of the order is uniformly distributed between three minutes and fifteen minutes. If a customer orders a trade at 11:54 A.M., what is the probability that the order is executed after noon? A) 0.250. B) 0.750. C) 0.500.

58) In addition to the usual parameters that describe a normal distribution, to completely describe

10 random variables, a multivariate normal distribution requires knowing the: A) 10 correlations. B) 45 correlations. C) overall correlation.

59) Critical values from Student’s t-distribution for a two-tailed test at a 5%

significance level: df 28 29 30

2.048 2.045 2.042

A researcher wants to test a hypothesis that two variables have a population correlation coefficient equal to zero. For a sample size of 30, the appropriate critical value for this test is plus-or-minus: A) 2.048 B) 2.045 C) 2.042

60) What kind of test is being used for the following hypothesis and what would a z-statistic of

1.68 tell us about a hypothesis with the appropriate test and a level of significance of 5%, respectively? H0: B ≤ 0 HA: B > 0 A) Two-tailed test; fail to reject the null. B) One-tailed test; reject the null. C) One-tailed test; fail to reject the null.

61) Which of the following would least likely be categorized as a multivariate distribution? A) The returns of the stocks in the DJIA. B) The return of a stock and the return of the DJIA. C) The days a stock traded and the days it did not trade.

62) The sample mean is an unbiased estimator of the population mean because the: A) sample mean provides a more accurate estimate of the population mean as the sample

size increases. B) expected value of the sample mean is equal to the population mean. C) sampling distribution of the sample mean has the smallest variance of any other unbiased estimators of the population mean.

63) An analyst wants to determine whether the mean returns on two stocks over the last year

were the same or not. What test should she use, assuming returns are normally distributed? A) Chi-square test. B) Paired comparisons test. C) Difference in means test.

64) Which of the following is least likely a step in stratified random sampling? A) The sub-samples are pooled to create the complete sample. B) The size of each sub-sample is selected to be the same across strata. C) The population is divided into strata based on some classification scheme.

65) A range of estimated values within which the actual value of a population parameter will lie

with a given probability of 1 − α is a(n): A) α percent point estimate. B) (1 − α) percent confidence interval. C) α percent confidence interval.

66) The probability density function of a continuous uniform distribution is best described by a: A) line segment with a 45-degree slope. B) line segment with a curvilinear slope. C) horizontal line segment.

67) The standard normal distribution is most completely described as a: A) symmetrical distribution with a mean equal to its median. B) normal distribution with a mean of zero and a standard deviation of one. C) distribution that exhibits zero skewness and no excess kurtosis.

68) Mei Tekei just celebrated her 22nd birthday. When she is 27, she will receive a $100,000

inheritance. Tekei needs funds for the down payment on a co-op in Manhattan and has found a bank that will give her the present value of her inheritance amount, assuming an 8.0% stated annual interest rate with continuous compounding. Will the proceeds from the bank be sufficient to cover her down payment of $65,000? A) Yes, Tekei will receive $68,058. B) No, Tekei will only receive $61,878. C) Yes, Tekei will receive $67,028.

69) The variance of 100 daily stock returns for Stock A is 0.0078. The variance of 90 daily stock

returns for Stock B is 0.0083. Using a 5% level of significance, the critical value for this test is 1.61. The most appropriate conclusion regarding whether the variance of Stock A is different from the variance of Stock B is that the: A) variances are not equal. B) variances are equal. C) variance of Stock B is significantly greater than the variance of Stock A.

70) An article in a trade journal suggests that a strategy of buying the seven stocks in the S&P

500 with the highest earnings-to-price ratio at the end of the calendar year and holding them until March 20 of the following year produces significant trading profits. Upon reading further, you discover that the study is based on data from 1993 to 1997, and the earnings-toprice ratio is calculated using the stock price on December 31 of each year and the annual reported earnings per share for that year. Which of the following biases is least likely to influence the reported results? A) Time-period bias. B) Look-ahead bias. C) Survivorship bias.

71) An analyst conducts a two-tailed test to determine if mean earnings estimates are

significantly different from reported earnings. The sample size is greater than 25 and the computed test statistic is 1.25. Using a 5% significance level, which of the following statements is most accurate? A) To test the null hypothesis, the analyst must determine the exact sample size and calculate the degrees of freedom for the test. B) The analyst should reject the null hypothesis and conclude that the earnings estimates are significantly different from reported earnings. C) The analyst should fail to reject the null hypothesis and conclude that the earnings estimates are not significantly different from reported earnings.

72) The average return on small stocks over the period 1926-1997 was 17.7%, and the standard

deviation of the sample was 33.9%. Assuming returns are normally distributed, the 95% confidence interval for the return on small stocks next year is: A) −16.2% to 51.6%. B) −48.7% to 84.1%. C) 16.8% to 18.6%.

73) A sample of five numbers drawn from a population is (5, 2, 4, 5, 4). Which of the following

statements concerning this sample is most accurate? A) The mean of the sample is ∑X / (n − 1) = 5. B) The sample variance is: ∑(x1 − mean of the sample) 2 / (n − 1) = 1.5. C) The sampling error of the sample mean is equal to the standard error of the sample.

74) A test of a hypothesis that the means of two normally distributed populations are equal based

on two independent random samples: A) is done with a t-statistic. B) is a paired-comparisons test. C) is based on a chi-square statistic.

75) A cumulative distribution function for a random variable X is given as follows: x 5 10 15 20

F(x) 0.14 0.25 0.86 1.00

The probability of an outcome less than or equal to 10 is: A) 25%. B) 39%. C) 14%.

Answer Key Test name: Quantitative Methods 1) B 2) A 3) B 4) A 5) C 6) C 7) A 8) B 9) B 10) A 11) C 12) C 13) C 14) B 15) C 16) B 17) C 18) A 19) C 20) A 21) C 22) C 23) B 24) C 25) A 26) B 27) B 28) B 29) B 30) B 31) B 32) B 33) C 34) C 35) B 36) B 37) B

38) C 39) C 40) C 41) B 42) B 43) B 44) C 45) B 46) A 47) B 48) C 49) C 50) C 51) C 52) B 53) B 54) C 55) A 56) C 57) B 58) B 59) A 60) B 61) C 62) B 63) B 64) B 65) B 66) C 67) B 68) C 69) B 70) C 71) C 72) B 73) B 74) A 75) A