Corporate Finance 9th Edition [Canadian Edition] Test Bank by Ace Test Banks

Corporate Finance 9th Edition [Canadian Edition] by Ross, Westerfield, Jaffe, Jordan, Driss Test Bank

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) The balance sheet is made up of what five key components: 1) ______ A) fixed assets, current liabilities, long term debt, tangible current assets and shareholders' equity. B) intangible fixed assets, current liabilities, long term debt, net income and current assets. C) fixed assets, long term debt, current assets, current liabilities and shareholders' equity. D) current assets, fixed assets, long term debt, shareholders equity and retained earnings. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 01-01 What is Corporate Finance? Source : Chapter 01 Test Bank > TB 01-01 The balance sheet is made up of what five ke...

2) In terms of the balance sheet model of the firm, the value of the firm in financial markets is

equal to: 2) ______ A) tangible fixed assets plus intangible fixed assets. B) sales minus costs. C) cash inflow minus cash outflow. D) the value of the debt plus the value of the equity. E) the value of the debt minus the value of the equity. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 01-01 What is Corporate Finance? Source : Chapter 01 Test Bank > TB 01-02 In terms of the balance sheet model of the f...

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3) Inventory is a component of: 3) ______ A) current assets. B) current liabilities. C) equity. D) fixed assets. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 01-01 What is Corporate Finance? Source : Chapter 01 Test Bank > TB 01-03 Inventory is a component of:

4) Using the balance sheet model of the firm, finance may be thought of as analysis of three

primary subject areas. Which of the following groups correctly lists these three areas? 4) ______ A) Capital budgeting, capital structure, net working capital. B) Capital budgeting, capital structure, security marketing. C) Capital budgeting, net working capital, tax analysis. D) Capital budgeting, tax analysis, security marketing. E) Net working capital, tax analysis, security marketing. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 01-01 What is Corporate Finance? Source : Chapter 01 Test Bank > TB 01-04 Using the balance sheet model of the firm, f...

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5) Which of the following is not considered one of the basic questions of corporate finance? 5) ______ A) What long-lived assets should the firm invest? B) How much inventory should the firm hold? C) How can the firm raise cash for required capital expenditures? D) How should the short-term operating cash flows be managed? E) What amount of long term debt and equity should the company issue to the market in

the following years? Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 01-01 What is Corporate Finance? Source : Chapter 01 Test Bank > TB 01-05 Which of the following is not considered one...

6) The need to manage net working capital arises because: 6) ______ A) financial management is naturally broken into those areas. B) shareholders want to ensure they receive dividend payments. C) there is a mismatch between the timing of cash inflows and cash outflows. D) the sum of current assets and current liabilities usually is zero. E) the capital structure pie is limited in size. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 01-01 What is Corporate Finance? Source : Chapter 01 Test Bank > TB 01-06 The need to manage net working capital arise...

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7) Which one of these is a cash outflow from a corporation? 7) ______ A) sale of an asset B) dividend payment C) sale of common stock D) issuance of debt E) profit retained by the firm Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 01-01 What is Corporate Finance? Source : Chapter 01 Test Bank > TB 01-07 Which one of these is a cash outflow from a ...

8) Which one of these is a cash inflow to a corporation? 8) ______ A) Purchase of a long-term asset B) Repurchase of shares C) Collection of account receivables D) Reduction of accounts payables Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 01-01 What is Corporate Finance? Source : Chapter 01 Test Bank > TB 01-08 Which one of these is a cash inflow to a cor...

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9) In the managerial structure of the corporation the two officers and their responsibilities that

report directly to the Chief Financial Officer are: 9) ______ A) the credit manager who handles accounts receivable and the tax manager who

minimizes tax payments. B) the personnel manager who manages salaries and compensation and the production operations manager who manages facility operations. C) the treasurer who is responsible handling cash flow and making financial decisions and the tax manager who minimizes tax payments. D) the controller who manages the accounting function and the treasurer who is responsible handling cash flow and making financial decisions. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 01-01 What is Corporate Finance? Source : Chapter 01 Test Bank > TB 01-09 In the managerial structure of the corporati...

10) Value is created and recognized over time if: 10) ______ A) cash raised is invested in the investment activities of the firm. B) funds are raised in the capital markets. C) cash paid to shareholders and bondholders, is greater than cash raised in the financial

markets. D) management pursues activities to reduce taxes to zero. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 01-01 What is Corporate Finance? Source : Chapter 01 Test Bank > TB 01-10 Value is created and recognized over time if...

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11) Time preference refers to the fact that: 11) ______ A) corporations match current assets with current liabilities to minimize the short-term

financing cost. B) corporations match both current and long-term assets with current and long-term liabilities to minimize the change of bankruptcy. C) investors prefer current cash flows to future cash flows. D) investors seek to time cash flows to minimize tax liabilities. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 01-01 What is Corporate Finance? Source : Chapter 01 Test Bank > TB 01-11 Time preference refers to the fact that:

12) A corporate security can be viewed as a contingent claim on the firm's value. This means

that: 12) ______ A) debt holders will receive their payoff from the firm based on their fixed claim or the

firm's value if less than the fixed claim. B) debt holders will receive the maximum between the firm's value and the fixed claim. C) no payoff will be made to the debtholders unless the firm's value is greater than the fixed claim of the debt. D) no debt payoff will be made if there is an equity payoff. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 01-02 The Balance-Sheet Model of the Firm Source : Chapter 01 Test Bank > TB 01-12 A corporate security can be viewed as a cont...

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13) If a firm has debt outstanding, the shareholders contingent claim payoff is: 13) ______ A) equal to the promised payment to the debtholders B) equal to the firm's value minus the fixed debt payment, if the residual value is

positive. C) equal to the firm value minus the fixed debt payment, whether it is positive or negative. D) equal to the debt payment plus the residual value of the firm. E) equal to the payment provided by the stockholders when the equity was issued Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 01-02 The Balance-Sheet Model of the Firm Source : Chapter 01 Test Bank > TB 01-13 If a firm has debt outstanding, the sharehol...

14) The Simple Corporation has outstanding obligation to the Complex Corporation of $250. It is

year-end and the total cash flow of Simple from all sources is $325. The contingent payoff to the debtholders and the equity shareholders is: 14) ______ A) $250; $325. B) $75; $250. C) $250; $75. D) $325; $250. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 01-02 The Balance-Sheet Model of the Firm Source : Chapter 01 Test Bank > TB 01-14 The Simple Corporation has outstanding oblig...

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15) The general partner(s) in a general partnership agree to share work, costs and profits and

losses. Each partner: 15) ______ A) has liability only up to the amount of their investment. B) has liability for the debts of the partnership. C) has liability only if it is formally documented. D) never has any liability but the limited partners do. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 01-03 Capital Structure Source : Chapter 01 Test Bank > TB 01-15 The general partner(s) in a general partners...

16) In a general partnership, the general partners have _____ liability and have _____ control

over day-to-day operations. 16) ______ A) limited; no B) unlimited; total C) limited; total D) unlimited; no E) no; total Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 01-03 Capital Structure Source : Chapter 01 Test Bank > TB 01-16 In a general partnership, the general partne...

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17) The ultimate control of a corporation lies in the hands of the corporate: 17) ______ A) board of directors. B) shareholders C) CEO of the firm D) chairman of the board E) government Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 01-03 Capital Structure Source : Chapter 01 Test Bank > TB 01-17 The ultimate control of a corporation lies i...

18) The division of profits and losses among the members of a partnership is formalized in the: 18) ______ A) indemnity clause B) indenture contract C) statement of purpose D) partnership agreement Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 01-03 Capital Structure Source : Chapter 01 Test Bank > TB 01-18 The division of profits and losses among the...

19) The cheapest business entity to form is typically the: 19) ______ A) limited liability company. B) joint stock company. C) general partnership. D) limited partnership. E) sole proprietorship. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 01-03 Capital Structure Source : Chapter 01 Test Bank > TB 01-19 The cheapest business entity to form is typi...

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20) The Splitz Corporation has borrowed $5 million in debt with a promise to repay $5.5 million

in one year. The corporation had 10 million shares outstanding worth $2 each at the time of the borrowing. Splitz earns $6 million during the year. What is the debtholder's contingent claim; how much do the debtholders receive; and, how much do the equity holders receive? 20) ______ A) $5.5 million; $6 million; $20 million B) $5 million; $5.5 million; $0 C) $5 million; $5.5 million; $20 million D) $5.5 million; $5.5 million; $0.5 million Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 01-03 Capital Structure Source : Chapter 01 Test Bank > TB 01-20 The Splitz Corporation has borrowed...

21) The Splitz Corporation has borrowed $5 million in debt with a promise to repay $5.5 million

in one year. The corporation had 10 million shares outstanding worth $2 each at the time of the borrowing. Splitz earns $5 million during the year. What is the debtholder's contingent claim; how much does the debtholder receive; and, how much do the equity holders receive? 21) ______ A) $5 million; $5.5 million; $20 million B) $5.5 million; $5 million; $0 C) $5 million; $-0.5 million; $20 million D) $-0.5 million; $5 million; $0 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 01-03 Capital Structure Source : Chapter 01 Test Bank > TB 01-21 The Splitz Corporation has borrowed...

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22) Corporate securities are contingent claims because: 22) ______ A) they don't represent a direct claim on the firm. B) the firm may be bought out. C) the securities value is derived from the total value of the firm. D) book value can be negative. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 01-02 The Balance-Sheet Model of the Firm Source : Chapter 01 Test Bank > TB 01-22 Corporate securities are contingent claims b...

23) If a firm promised a payment to the debtholders greater than the firm's value, then: 23) ______ A) the firm will be broke and the debtholder will receive the firm's value. B) the debtholders receive the promised payment while the shareholders pay the

difference between the firm's value and the payment to the debtholders. C) the firm's value will be shared between equity and debtholders and shareholders according to the payment promised by the firm. D) the shareholders will get nothing from the firm. E) the firm would be broke, the debtholder will receive the firm's value, and the shareholders with get nothing. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 01-02 The Balance-Sheet Model of the Firm Source : Chapter 01 Test Bank > TB 01-23 If a firm promised a payment to the debthold...

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24) Agency costs as the sum costs of: 24) ______ A) monitoring costs of the shareholders and the residual loss of wealth due to divergent

management behavior. B) the costs of implementing control devices and the monitoring costs of the shareholders. C) the costs of implementing control devices and the residual loss of wealth due to divergent management behavior. D) the set-of-contracts needed to structure the firm and residual wealth. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 01-04 The Financial Manager Source : Chapter 01 Test Bank > TB 01-24 Agency costs as the sum costs of:

25) Which one of these best fits the description of an agency cost? 25) ______ A) increasing the dividend payments 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 Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 01-04 The Financial Manager Source : Chapter 01 Test Bank > TB 01-25 Which one of these best fits the description...

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26) Agency costs refer to: 26) ______ A) the total dividends paid to stockholders over the lifetime of a firm. B) the costs that result from default and bankruptcy of a firm. C) corporate income subject to double taxation. D) the costs of any conflicts of interest between stockholders and management. E) the total interest paid to creditors over the lifetime of the firm. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 01-04 The Financial Manager Source : Chapter 01 Test Bank > TB 01-26 Agency costs refer to:

27) Managerial goals may differ from those of the shareholders. It is noted that managers may: 27) ______ A) have a preference for expense consumption. B) be motivated by controlling sufficient resources to stay in business. C) avoid the control of the capital market and rely on internally generated funds. D) be wanted to depend on external parties. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 01-04 The Financial Manager Source : Chapter 01 Test Bank > TB 01-27 Managerial goals may differ from those of th...

28) What is the primary goal of the corporation? 28) ______ A) Maximize the pay and compensation of employees and managers of the firm. B) Maximize the value of the stockholders as they are the owners of the corporation. C) Minimize the wealth of the shareholders and maximize the wealth of managers. D) Maximize the societal value to minimize governmental interference. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 01-04 The Financial Manager Source : Chapter 01 Test Bank > TB 01-28 What is the primary goal of the corporation?

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29) Financial markets are composed of: 29) ______ A) capital markets and equity markets. B) capital markets and debt markets. C) capital markets and money markets. D) equity markets and money markets. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 01-05 Identification of Cash Flows Source : Chapter 01 Test Bank > TB 01-29 Financial markets are composed of:

30) The primary market is defined as: 30) ______ A) the market for insured securities. B) the market for new issues. C) the market for securities of the largest firms. D) the over-the-counter market. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 01-05 Identification of Cash Flows Source : Chapter 01 Test Bank > TB 01-30 The primary market is defined as:

31) Which one of the following is a primary market transaction? 31) ______ A) A dealer selling shares of stock to an individual investor. B) A dealer buying newly issued shares of stock from a corporation. C) An individual investor selling shares of stock to another individual. D) A bank selling shares of a medical firm to an individual. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 01-05 Identification of Cash Flows Source : Chapter 01 Test Bank > TB 01-31 Which one of the following is a primary mark...

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SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 32) Flea Fall Inc., a maker of dog flea collars, paid $125,000 cash for inventory on January 1, 2014. On December 31, 2014, the company's sales total $147,000 of which $117,000 has been collected. If inventory represents Flea Falls only cost, calculate the firms accounting profit as well as its cash flow as of December 31.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 01-01 What is Corporate Finance? Source : Chapter 01 Test Bank > TB 01-32 Flea Fall Inc., a maker of dog flea collars,...

33) The Harlow Corporation has promised to pay its debtholders an amount of $2,700 over the

next year. The firm's shareholders hold claim to whatever is left after the debtholders' claims have been satisfied. Calculate Harlow's debt and equity level if its assets total $1,100 at the end of the year. Recalculate for asset levels of $2,200 and $6,000.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 01-01 What is Corporate Finance? Source : Chapter 01 Test Bank > TB 01-33 The Harlow Corporation has promised to pay i...

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34) A financial manager's most important job is to create value from capital budgeting, financing,

and liquidity activities. Explain how financial managers create value.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 01-01 What is Corporate Finance? Source : Chapter 01 Test Bank > TB 01-34 A financial managers most important...

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

Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 01-01 What is Corporate Finance? Source : Chapter 01 Test Bank > TB 01-35 List and briefly describe the three basic ar...

36) The decision to incorporate must consider the fact that earnings will be taxed at both the

corporate and personal levels. Since this is disadvantageous, provide three reasons why one may want to incorporate.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 01-03 Capital Structure Source : Chapter 01 Test Bank > TB 01-36 The decision to incorporate must consider th...

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37) How can shareholders attempt to control managerial behavior to match shareholder interest?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 01-04 The Financial Manager Source : Chapter 01 Test Bank > TB 01-37 How can shareholders attempt to control mana...

38) Do you think agency problems arise in sole proprietorships and/or partnerships?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 01-04 The Financial Manager Source : Chapter 01 Test Bank > TB 01-38 Do you think agency problems arise in sole p...

39) If the corporate form of business organization has so many advantages over the sole

proprietorship, why is it so common for small businesses to initially be formed as sole proprietorships?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 01-03 Capital Structure Source : Chapter 01 Test Bank > TB 01-39 If the corporate form of business organizati...

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40) One thing lenders sometimes require when loaning money to a small corporation is an

assignment of the common stock as collateral on the loan. Then, if the business fails to repay its loan, the ownership of the stock certificates can be transferred directly to the lender. Why might a lender want such an assignment? What advantage of the corporate form of organization comes into play here?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 01-03 Capital Structure Source : Chapter 01 Test Bank > TB 01-40 One thing lenders sometimes require when loa...

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Answer Key Test name: Chapter 01 1) C 2) D

the value of the debt plus the value of the equity. 3) A 4) A 5) B

How much inventory should the firm hold? 6) C 7) B 8) C 9) D 10) C

cash paid to shareholders and bondholders, is greater than cash raised in the financial markets. 11) C

investors prefer current cash flows to future cash flows. 12) A

debt holders will receive their payoff from the firm based on their fixed claim or the firm's value if less than the fixed claim. 13) B

equal to the firm's value minus the fixed debt payment, if the residual value is positive. 14) C 15) B 16) B 17) B 18) D 19) E 20) D 21) B 22) C 23) E

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A and D are correct. A. the firm will be broke and the debtholder will receive the firm's value. D. the shareholders will get nothing from the firm. 24) B 25) D 26) D 27) C 28) B 29) C 30) B 31) B 32) Short Answer

Accounting Profit = Sales - Cost ($147,000 - $125,000 = $22,000) Cash Flow = Cash Inflow - Cash Outflow ($117,000 - $125,000 = $8,000) 33) Short Answer

If assets total $1,100: Value of Debt = $1,100, Value of Equity = $0 If assets total $2,200: Value of Debt = $2,200, Value of Equity = $0 If assets total $6,000: Value of Debt = $2,700, Value of Equity = $3,300 34) Short Answer

Buy assets that generate more than their cost. Sell financial securities that raise more cash than they cost. Minimize cash payouts to non-investors, ie., taxes to governments. 35) Short Answer

The three areas are: 1. Capital budgeting: The financial manager tries to identify investment opportunities that are worth more to the firm than they cost to acquire. 2. Capital structure: This refers to the specific mixture of current and long-term debt and equity a firm uses to finance its operations. 3. Working capital management: This refers to a firm's short-term assets and short-term liabilities. Managing the firm's working capital is a day-to-day activity that ensures the firm has sufficient resources to continue its operations and avoid costly interruptions. 36) Short Answer

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Easier access to capital markets. Retention of funds for reinvestment opportunities. Market pricing and trading of securities. 37) Short Answer

Vote for directors with shareholder's interest to select management. Provide incentive contracts; performance shares or options. Outside threat of takeover, (Board should not be willing to launch poison pills.) Managerial labor market. 38) Short Answer

Agency conflicts typically arise when there is a separation of ownership and management of a business. In a sole proprietorship and a small partnership, such separation is not likely to exist to the degree it does in a corporation. However, there is still potential for agency conflicts. For example, as employees are hired to represent the firm, there is once again a separation of ownership and management. 39) Short Answer

A significant advantage of the sole proprietorship is that it is cheap and easy to form. If the sole proprietor has limited capital to start with, it may not be desirable to spend part of that capital forming a corporation. Also, limited liability for business debts may not be a significant advantage if the proprietor has limited capital, most of which is tied up in the business anyway. Finally, for a typical small business, the heart and soul of the business is the person who founded it, so the life of the business may effectively be limited to the life of the founder during its early years. 40) Short Answer

In the event of a loan default, a lender may wish to liquidate the business. Often it is time consuming and difficult to take title of all of the business assets individually. By taking control of the stock, the lender is able to sell the business simply by reselling the stock in the business. This illustrates the ease of transfer of ownership of a corporation.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) The Statement of Financial Position is based on which following equality: 1) ______ A) Fixed Assets = (Stockholder's equity + Current Assets) B) Assets = (Liabilities + Stockholder's equity) C) Assets = (Current Long Term Debt + Retained earnings) D) Fixed Asset = (Liabilities + Stockholder's equity) Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 02-01 The Statement of Financial Position Source : Chapter 02 Test Bank > TB 02-01 The Statement of Financial Position is based...

2) Assets are listed on the Statement of Financial Position in order of: 2) ______ A) decreasing liquidity. B) increasing liquidity. C) increasing size. D) relative life. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 02-01 The Statement of Financial Position Source : Chapter 02 Test Bank > TB 02-02 Assets are listed on the Statement of Financ...

3) Of the following assets, which is the generally the least liquid? 3) ______ A) Marketable securities. B) Cash. C) Inventory. D) Accounts receivable. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 02-01 The Statement of Financial Position Source : Chapter 02 Test Bank > TB 02-03 Of the following assets, which is the genera...

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4) Which one of these accounts is classified as a current asset on the balance sheet? 4) ______ A) intangible asset B) accounts payable C) preferred stock D) inventory E) net plant and equipment Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 02-01 The Statement of Financial Position Source : Chapter 02 Test Bank > TB 02-04 Which one of these accounts is classified as...

5) Accounting liquidity is defined as: 5) ______ A) the amount of cash the firm has. B) the turnover ratio. C) the ability of the assets to generate income. D) the ease and quickness with which assets can be converted to cash. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 02-01 The Statement of Financial Position Source : Chapter 02 Test Bank > TB 02-05 Accounting liquidity is defined as:

6) Net working capital is defined as: 6) ______ A) current assets plus fixed assets. B) current assets plus stockholders' equity. C) fixed assets minus long-term liabilities. D) total assets minus total liabilities. E) current assets minus current liabilities. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 02-03 Debt versus Equity Source : Chapter 02 Test Bank > TB 02-06 Net working capital is defined as:

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7) Fixed assets can be either tangible or intangible. Intangible assets are: 7) ______ A) property, plant and equipment. B) those that can be converted to cash in the normal course of business. C) those that can be very valuable, although they have no physical presence, such as

trademarks or patents. D) those that are highly liquid. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 02-01 The Statement of Financial Position Source : Chapter 02 Test Bank > TB 02-07 Fixed assets can be either tangible...

8) Intangible fixed assets would include: 8) ______ A) building. B) machinery. C) trademarks. D) equipment. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 02-01 The Statement of Financial Position Source : Chapter 02 Test Bank > TB 02-08 Intangible fixed assets would include:

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9) The primary distinction between tangible and intangible assets is that: 9) ______ A) intangible assets have a physical existence while tangible assets do not. B) intangible assets do not have a physical existence while tangible assets do. C) since tangible assets do not have a physical existence they do not show up on the

balance sheet. D) since intangible assets do not have a physical existence they do not show up on the balance sheet. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 02-01 The Statement of Financial Position Source : Chapter 02 Test Bank > TB 02-09 The primary distinction between tangible and...

10) The earnings before interest and taxes, EBIT, on the income statement, provides results on: 10) ______ A) the post financing effect on the earnings capability of the firm. B) the operating income for the period. C) the gross margin of the firm. D) the extraordinary items of the firm for the period. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 02-01 The Statement of Financial Position Source : Chapter 02 Test Bank > TB 02-10 The earnings before interest and...

11) In the Statement of Financial Position assets are: 11) ______ A) all relatively illiquid. B) listed at current market value. C) listed at market value as of the most recent fiscal year. D) listed at the historical cost. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 02-01 The Statement of Financial Position Source : Chapter 02 Test Bank > TB 02-11 In the Statement of Financial Position asset...

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12) Under IFRS the value of all the firm's assets are reported at: 12) ______ A) Carrying value or market value. B) Book value or liquidation value. C) Market value or Carrying value. D) Book value or Carrying value. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 02-02 Liquidity Source : Chapter 02 Test Bank > TB 02-12 Under IFRS the value of all the...

13) Which of the following remarks concerning the income statement is NOT true? 13) ______ A) It measures performance over a specific period of time. B) It determines after-tax income of the firm. C) It includes deferred taxes. D) It does not include depreciation. E) It treats interest as an expense or revenue. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 02-02 Liquidity Source : Chapter 02 Test Bank > TB 02-13 Which of the following remarks concerning th...

14) For a firm with long-term debt, net income is equal to: 14) ______ A) Pretax income - Interest expense - Taxes. B) Dividends + Addition to retained earnings. C) EBIT - Taxes. D) Taxes + Addition to retained earnings. E) Operating income × (1 - Marginal tax rate). Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 02-02 Liquidity Source : Chapter 02 Test Bank > TB 02-14 For a firm with long-term debt, net income i...

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15) Noncash items refer to: 15) ______ 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 Statement of Financial Position other than cash on hand. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 02-02 Liquidity Source : Chapter 02 Test Bank > TB 02-15 Noncash items refer to:

16) According to IFRS, revenue is recognized as income when: 16) ______ A) a contract is signed to perform a service or deliver a good. B) the transaction is complete and the goods or services delivered. C) payment is received. D) income taxes are paid. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 02-02 Liquidity Source : Chapter 02 Test Bank > TB 02-16 According to IFRS, revenue is recognized as ...

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17) The TimeNow Corporation had 2020 fixed assets of $1345, current assets of $260, current

liabilities of $180 and shareholder's equity of $775. What was the net working capital for TimeNow in 2020? 17) ______ A) $260. B) $180. C) $80. D) $390. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 02-03 Debt versus Equity Source : Chapter 02 Test Bank > TB 02-17 The TimeNow Corporation had 2020 fixed asset...

18) The TimeNow Corporation had 2020 fixed assets of $1,345, current assets of $260, current

liabilities of $180 and shareholder's equity of $775. The 2021 fixed assets were $1,300, current assets of $220, current liabilities of $300, long-term liabilities of $390 and shareholder's equity of $750. What was the change (in dollars) in net working capital for TimeNow in 2020? 18) ______ A) $80. B) $20. C) $60. D) $160. E) $0 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 02-03 Debt versus Equity Source : Chapter 02 Test Bank > TB 02-18 The TimeNow Corporation had 2020 fixed asset...

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19) Which of the following is not included in the computation of operating cash flow? 19) ______ A) Earnings before interest and taxes. B) Interest paid. C) Depreciation. D) Current taxes. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 02-04 Value versus Cost Source : Chapter 02 Test Bank > TB 02-19 Which of the following is not included in th...

20) ______ refers to the firm's dividend payments less any net new equity raised. 20) ______ A) Operating cash flow B) Capital spending C) Net working capital D) Cash flow from creditors E) Cash flow to shareholders Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 02-04 Value versus Cost Source : Chapter 02 Test Bank > TB 02-20 ______ refers to the...

21) Net capital spending is equal to: 21) ______ A) net additions to Net Working Capital. B) the net change in fixed assets. C) net income plus depreciation. D) total cash flow to shareholders less interest and dividends paid. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 02-03 Debt versus Equity Source : Chapter 02 Test Bank > TB 02-21 Net capital spending is equal to:

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22) What is the effect on the Net Working Capital if the corporation decides to increase its

investment in inventory and pay for it with cash? 22) ______ A) Increase in NWC. B) Decrease in NWC. C) Depends on the amount of the investment. D) No effect. E) Depends on the amount of cash. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 02-03 Debt versus Equity Source : Chapter 02 Test Bank > TB 02-22 What is the effect on the Net Working Capita...

23) Which of the following is not a use of Net Working Capital? 23) ______ A) Retirement of long-term debt. B) Dividends. C) Sale of equity. D) Acquisition of fixed assets. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 02-03 Debt versus Equity Source : Chapter 02 Test Bank > TB 02-23 Which of the following is not a use of Net W...

24) Cash flow to shareholder is defined as: 24) ______ A) total cash flow from the firm plus cash flow to the bondholders. B) repurchases of equity less cash dividends paid plus new equity sold. C) cash flow from operations less cash flow to creditors. D) cash dividends plus repurchases of equity minus new equity sold. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 02-04 Value versus Cost Source : Chapter 02 Test Bank > TB 02-24 Cash flow to shareholder is defined as:

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25) For any individual period the firm cash flows are a circular flow of funds, this means: 25) ______ A) That the firm's cash flows are always invested in fixed assets. B) that the firm's cash flows are always in a spiral away from it. C) that firm's cash flows must be spent externally to be reinvested in the economy. D) that all cash flows generated by the firm must equal the cash flows paid to the

creditors and shareholders. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 02-04 Value versus Cost Source : Chapter 02 Test Bank > TB 02-25 For any individual period the firm cash flow...

26) Earnings per share is equal to: 26) ______ A) net income divided by the total number of shares outstanding. B) net income divided by the market price of the common stock. C) gross income multiplied by the par value of the common stock. D) operating income divided by the total dividend paid to common shareholders. E) net income divided by total shareholders' equity. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 02-04 Value versus Cost Source : Chapter 02 Test Bank > TB 02-26 Earnings per share is equal to:

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27) Dividends per share is equal to total annual dividends paid: 27) ______ A) divided by the par value of common stock. B) divided by the total number of shares outstanding. C) divided by total shareholders' equity. D) multiplied by the par value of the common stock. E) multiplied by the total number of shares outstanding. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 02-04 Value versus Cost Source : Chapter 02 Test Bank > TB 02-27 Dividends per share is equal to total annual...

28) Calculate net income based on the following information.

Sales = $250.00 Cost of goods sold = $160.00 Depreciation = $35.00 Interest paid = $20.00 Tax rate = 34% 28) ______ A) $23.10. B) $11.90. C) $35.00. D) $46.20. E) $36.30. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 02-04 Value versus Cost Source : Chapter 02 Test Bank > TB 02-28 Calculate net income based on the following ...

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29) The cash flow of the firm is defined as the cash flow of the assets. This cash flow must be

equal to: 29) ______ A) cash flow to equity minus cash flow to debtholders. B) cash flow to debtholders minus cash flow to equity. C) cash flow from changes in working capital plus cash flow to equity. D) cash flow to equity plus cash flow to debtholders. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 02-04 Value versus Cost Source : Chapter 02 Test Bank > TB 02-29 The cash flow of the firm is defined as the ...

30) When making financial decisions related to assets, you should: 30) ______ A) always consider market values. B) place more emphasis on book values than on market values. C) rely primarily on the value of assets as shown on the balance sheet. D) only consider market values if they are less than book values. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 02-04 Value versus Cost Source : Chapter 02 Test Bank > TB 02-30 When making financial decisions related to a...

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31) From the following income statement information, calculate Johnson's after-tax cash flow

from operations. Net sales = $2,500 Cost of goods sold = $1,050 Operating expenses = $490 Depreciation = $300 Tax rate = 34% 31) ______ A) $660.00 B) $990.00 C) $1257.00 D) $735.60 E) $1059.00 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 02-04 Value versus Cost Source : Chapter 02 Test Bank > TB 02-31 From the following income statement informat...

32) Over the year, the Rigem Co. had a cash flow from operations of $938 and a net capital

spending of $225. In addition, the firm's Net Working Capital increased by $73. What was Rigem's total cash flow? 32) ______ A) $1,236 B) $748 C) $640 D) $786 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 02-03 Debt versus Equity Source : Chapter 02 Test Bank > TB 02-32 Over the year, the Rigem Co. had a cash flow...

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33) The primary source of the firm's cash flow is usually: 33) ______ A) net income. B) tax credits. C) earnings before interest and depreciation minus taxes. D) capital spending after taxes. E) working capital requirements. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 02-04 Value versus Cost Source : Chapter 02 Test Bank > TB 02-33 The primary source of the...

34) Dorr Corp. had a ROA of 8%. Dorr's profit margin was 4% on sales of $250. What were total

assets? 34) ______ A) $125 B) $500 C) $30 D) $220 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 02-02 Liquidity Source : Chapter 02 Test Bank > TB 02-34 Dorr Corp. had a ROA...

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35) CHAMP Co. has a profit margin on sales of 4% and a ROE of 18%. If CHAMP's debt-to-

equity ratio is 0.8, what is the total asset turnover ratio? 35) ______ A) 2.500. B) 5.625. C) 2.000. D) 10.125. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 02-02 Liquidity Source : Chapter 02 Test Bank > TB 02-35 CHAMP Co. has a profit margin on sales of...

36) Donny Dell Inc. had a days in inventory of 5 (based on 365 days). The inventory turnover

was: 36) ______ A) 5 B) 60 C) 73 D) cannot be figured without the inventory value. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 02-02 Liquidity Source : Chapter 02 Test Bank > TB 02-36 Donny Dell Inc. had a days in inventory of 5...

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37) Donny Dell Inc. had a Days in Inventory (based on 365 Days in Period) of 5. The Cost of

Goods Sold was $4,526. The Net Working Capital was $70, and the Total Current Assets were $400. What is Donny Dell's Quick Ratio? 37) ______ A) 11.315 B) 1.024 C) 4.829 D) 14.00 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 02-02 Liquidity Source : Chapter 02 Test Bank > TB 02-37 Donny Dell Inc. had a Days in Inventory (bas...

38) Donny Dell Inc.'s Cost of Goods Sold was $4,526. The company had a Net Working Capital

of $70 and the Total Current Assets were $400. If the Inventory Turnover was 62, what is the Current Ratio of Donny Dell? 38) ______ A) 0.99 B) 1.01 C) 1.212 D) 0.89 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 02-02 Liquidity Source : Chapter 02 Test Bank > TB 02-38 Donny Dell Inc.&#39;s Cost of Goods Sold...

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39) Tan Co. had total operating revenues of $720 over the past year. During that time, average

receivables were $90. What was the average collection period (ACP) given a 365-day year? 39) ______ A) 8.00 days. B) 4.56 days. C) 40.97 days. D) 45.63 days. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 02-02 Liquidity Source : Chapter 02 Test Bank > TB 02-39 Tan Co. had total operating revenues of...

40) Mirotronic Co. has a receivables turnover of 4 times. Sales are $20,000. What is the

collection period? (Use 365 days in a year.) 40) ______ A) 91.25 days B) 90 days C) 1.37 days D) 21.92 days Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 02-02 Liquidity Source : Chapter 02 Test Bank > TB 02-40 Mirotronic Co. has a receivables turnover of...

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41) The Cliplink Company has an equity multiplier of 3.36. What are the debt ratio and debt to

equity ratio of Cliplink? 41) ______ A) 0.70, 2.36. B) 2.36, 0.70. C) 0.30, 0.70. D) cannot be calculated without values for debt or equity. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 02-02 Liquidity Source : Chapter 02 Test Bank > TB 02-41 The Cliplink Company has an equity multiplie...

42) The Hi-Lite Corp. had a profitable year, and its ROE was 14.4%. The company paid out

$1.20 of their earnings of $3.00 for the year. What is Hi-Lite's sustainable growth rate? 42) ______ A) 17.20% B) 8.64% C) 5.76% D) 43.20% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 02-02 Liquidity Source : Chapter 02 Test Bank > TB 02-42 The Hi-Lite Corp. had a profitable year, and...

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43) Sin Co. stock sells for $28.00 per share. The total market value of the equity is $40 million.

The market-to-book ratio is 7. What is the book value per share? 43) ______ A) $128.00. B) $196.00. C) $1.43. D) $4.00. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 02-02 Liquidity Source : Chapter 02 Test Bank > TB 02-43 Sin Co. stock sells for...

44) Assuming that the current ratio is currently 2. Which of the following actions will increase it? 44) ______ A) Purchasing inventory with cash. B) Purchasing inventory on short-term credit. C) Paying off a short-term bank loan with long-term debt. D) A customer paying an overdue bill. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 02-02 Liquidity Source : Chapter 02 Test Bank > TB 02-44 Assuming that the current ratio is currently...

45) Cos Co.'s after-tax net income was $120. Their interest paid was $50. Assume that the

corporate tax is 40%. What is Cos CO.'s interest coverage ratio? 45) ______ A) 6.7 B) 2.4 C) 1.4 D) 5.0 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 02-02 Liquidity Source : Chapter 02 Test Bank > TB 02-45 Cos Co.&#39;s after-tax net income was...

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46) The Hi-Lite Corp. paid out $1.20 of its earnings of $3.00 for the year. The market price of the

company's stock at year-end was $28. What was Hi-Lite's price-earnings ratio? 46) ______ A) 23.33 B) 9.33 C) 4.03 D) 12.10 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 02-02 Liquidity Source : Chapter 02 Test Bank > TB 02-46 The Hi-Lite Corp. paid out...

47) Logit Co. paid dividends of $400 and retained 33.33% of its earnings. The sales for the year

were $12,000, while the total assets were $10,000. What was the ROA? 47) ______ A) 5%. B) 6%. C) 10%. D) 12%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 02-02 Liquidity Source : Chapter 02 Test Bank > TB 02-47 Logit Co. paid dividends of...

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48) The Lo-Gro Co. in 2014 had equity of $15 million, net income of $1.8 million, of which 60%

was paid out as dividends. The sustainable growth rate for the Lo-Gro Co. is: 48) ______ A) 0.48%. B) 4.80%. C) 0.72%. D) 7.20%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 02-02 Liquidity Source : Chapter 02 Test Bank > TB 02-48 The Lo-Gro Co. in 2014 had equity of...

49) The Lo-Gro Co. in 2014 had equity of $15 million, net income of $1.8 million, of which 60%

was paid out as dividends. The ROE and retained earnings for the Lo-Gro Co. are: 49) ______ A) 7.2%; $720,000. B) 4.8%; $720,000. C) 12%; $1,080,000. D) 12%; $720,000. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 02-02 Liquidity Source : Chapter 02 Test Bank > TB 02-49 The Lo-Gro Co. in 2014 had equity of...

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50) Peggy Grey's Cookies has net income of $360. The firm pays out 40% of the net income to

its shareholders as dividends. During the year, the company sold $80 worth of common stock. What is the cash flow to stockholders? 50) ______ A) $64. B) $136. C) $144. D) $224. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 02-04 Value versus Cost Source : Chapter 02 Test Bank > TB 02-50 Peggy Grey&#39;s Cookies has net income...

51) Pete's Boats has beginning long-term debt of $180 and ending long-term debt of $210. The

beginning and ending total debt balances are $340 and $360, respectively. The interest paid is $20. What is the amount of the cash flow to creditors? 51) ______ A) -$10. B) $0. C) $10. D) $40. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 02-04 Value versus Cost Source : Chapter 02 Test Bank > TB 02-51 Pete&#39;s Boats has beginning long-term debt...

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SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 52) Discuss the difference between book values and market values on the Statement of Financial Position and explain which is more important to the financial manager and why.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 02-01 The Statement of Financial Position Source : Chapter 02 Test Bank > TB 02-52 Discuss the difference between book values a...

53) The Simmons Company reported retained earnings in 2016 of $4750. In 2017, Simmons

earned $1120 before taxes and paid a dividend of $730. Simmon's tax rate is 34%. What are Simmons' retained earnings?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 02-01 The Statement of Financial Position Source : Chapter 02 Test Bank > TB 02-53 The Simmons Company reported retained earnin...

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54) Pion Inc. reported current assets of $80 and fixed assets of $150 as of December 31. The

company, as of December 31, also reports current liabilities of $72 and long-term liabilities of $149. Calculate Pion's shareholder's equity.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 02-01 The Statement of Financial Position Source : Chapter 02 Test Bank > TB 02-54 Pion Inc. reported current assets of...

55) Grady's Candies paid a total of $32 million in dividends in 2017. In addition, the company

issued $22.5 million in new stock in that year. What was Grady's cash flow to stockholders in 2017?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 02-04 Value versus Cost Source : Chapter 02 Test Bank > TB 02-55 Grady&#39;s Candies paid a total of...

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56) Based on the following information, calculate stockholders' equity:

Cash = $5.00 Accounts payable = $12.00 Other current liabilities = $65.00 Accounts receivable = $20.00 Inventory = $50.00 Net fixed assets = $175.00 Long-term debt = $40.00

57) The Paymore Co. reported the following long-term liabilities and stockholder's equity for

2017: Long-term debt

$200

Preferred stock

$80

Common stock

$30

Retained earnings

$375

In 2017, Paymore earned $125 in net income and paid a $40 dividend. What is the 2017 total common shareholder equity figure?

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58) Qwerty, Inc 2017 Income Statement ($ in millions ) Net sales

$9,610

Less: cost of goods sold

6,310

Less: Depreciation

1,370

Earnings before interest and taxes

1,930

Less: Interest paid

630

Taxable Income

$1,300

Less: Taxes

455

Net income

$845

Qwerty, Inc Statement of Financial Position ($ in millions) 2016

2017

2016

2017

Cash

$310

$405

Accounts payable

$2,720

$2,570

Accounts rec.

2,640

3,055

Notes payable

100

Inventory

3,275

3,850

Total

$2,820

$2,570

Total

$6,225

$7,310

Long-term debt

7,875

8,100

Net fixed assets

10,960

10,670

Common stock

5,000

5,250

Retained earnings

1,490

2,060

Total liab. & equity

$17,185

$17,980

Total assets

$17,185

$17,980

What is the change in the net working capital from 2016 to 2017?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 02-03 Debt versus Equity Source : Chapter 02 Test Bank > TB 02-58 A table showing qwerty, inc 2017 income statement ($ in millions)&#8230;

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59) Qwerty, Inc 2017 Income Statement ($ in millions ) Net sales

$9,610

Less: cost of goods sold

6,310

Less: Depreciation

1,370

Earnings before interest and taxes

1,930

Less: Interest paid

630

Taxable Income

$1,300

Less: Taxes

455

Net income

$845

Qwerty, Inc Statement of Financial Position ($ in millions) 2016

2017

2016

2017

Cash

$310

$405

Accounts payable

$2,720

$2,570

Accounts rec.

2,640

3,055

Notes payable

100

Inventory

3,275

3,850

Total

$2,820

$2,570

Total

$6,225

$7,310

Long-term debt

7,875

8,100

Net fixed assets

10,960

10,670

Common stock

5,000

5,250

Retained earnings

1,490

2,060

Total liab. & equity

$17,185

$17,980

Total assets

$17,185

$17,980

What is the cash flow of the firm for 2017?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 02-04 Value versus Cost Source : Chapter 02 Test Bank > TB 02-59 A table showing qwerty, inc 2017 income statement ($ in millions)&#8230;

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Answer Key Test name: Chapter 02 1) B 2) A 3) C 4) D 5) D 6) E 7) C 8) C 9) B 10) B 11) D

listed at the historical cost. 12) D 13) D 14) B

Dividends + Addition to retained earnings. 15) D 16) B 17) C 18) D

In 2020 Wc = $260-$180 = $80 In 2021 WC = $220-$300 = -$80 Change in WC = $80-(-$80) = $160. 19) B 20) E 21) B 22) D

No effect. 23) C

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24) D 25) D

that all cash flows generated by the firm must equal the cash flows paid to the creditors and shareholders. 26) A

net income divided by the total number of shares outstanding. 27) B 28) A 29) D 30) A 31) D 32) C 33) C 34) A 35) A

ROE = NP/EQUITY = 0. 18 = 0. 04/EQUITY = 0. 22222 D/E = 0. 8 D = 0. 1776 Total Assets = 0. 2222 + 0. 1776 = 0. 39996 EM = 0. 39996/0. 2222 = 1. 8 AT = 0. 18/(1. 8 X 0. 04) = 2. 5. 36) C 37) B 38) C

CURRENT LIABILITIES = $400-$70 = $330 CURRENT RATIO = $400/$300 = 1. 212. 39) D 40) A 41) A 42) B 43) D 44) C

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45) D 46) B

P/E RATIO = MPS/EPS = $28/$3 = 9. 33 TIMES. 47) B 48) B 49) D 50) A

Cash flow to stockholders =.40($360) - $80 = $64. 51) A

Cash flow to creditors = $20 - ($210 - $180) = -$10. 52) Short Answer

The accounts on the Statement of Financial Position are generally carried at historical cost, not market values. Although the book value of current assets and current liabilities may closely approximate market values, the same cannot be said for the rest of the Statement of Financial Position accounts. Ultimately, the financial manager should focus on the firm's stock price, which is a market value measure. Hence, market values are more meaningful than book values. 53) Short Answer

$4750 + $1120(1 -.34) - $730 = $4759.20 54) Short Answer

($80 + $150) - ($72 + $149) = $9 55) Short Answer

$32 - ($22.5) = ($9.5) 56) Short Answer

($5 + $20 + $50 + $175) - ($12 + $65 + $40) = $133 57) Short Answer

$30 + $375 + $125 - $40 = $490 58) Short Answer

($7,310 - $2,570) - ($6,225 - $2,820) = $1,335 59) Short Answer

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Change in net working capital = ($75 + $502 + $640 - $405) - ($70 + $563 + $662 - $390) = $93 Net capital spending = $1,413 - $1,680 + $210 = -$57 Earnings before interest and taxes = $785 - $460 - $210 = $115 Taxable income = $115 - $35 = $80 Taxes = .35($80) = $28 Operating cash flow = $115 + $210 - $28 = $297 Cash flow of the firm = $297 - (-$93) - (-$57) = $447

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Financial planning is concerned with the basic policy elements of: 1) ______ A) investment decision, decisions on the amount of cash payments to shareholders, and the decision of which investment banker to choose. B) the method of raising capital, investment decisions, and the level of growth to attain. C) investment decisions, degree of financial leverage, and the decision on the amount of cash payments to shareholders. D) degree of financial leverage, level of growth to attain, and investment decisions. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 03-01 What is Financial Planning? Source : Chapter 03 Test Bank > TB 03-01 Financial planning is concerned with the bas...

2) One key reason a long term financial plan is developed is that: 2) ______ A) the plan determines your financial policy. B) the plan determines your investment policy. C) there are direct connections between achievable corporate growth and the financial

plan. D) there is unlimited growth possible in a well-developed financial plan. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 03-01 What is Financial Planning? Source : Chapter 03 Test Bank > TB 03-02 One key reason a long term financial plan is...

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3) The process of combining smaller projects into a large budget for planning purposes is

called: 3) ______ A) aggregation. B) consolidation. C) accumulation. D) capital allocation. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 03-01 What is Financial Planning? Source : Chapter 03 Test Bank > TB 03-03 The process of combining smaller projects in...

4) Projected future financial statements are called: 4) ______ A) plug statements. B) pro forma statements. C) reconciled statements. D) aggregated statements. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 03-02 A Financial Planning Model: The Ingredients Source : Chapter 03 Test Bank > TB 03-04 Projected future financial statements are ca...

5) An example of an economic assumption would be: 5) ______ A) growth in sales. B) growth in the capital spending requirement. C) a plug variable. D) change in interest rates. E) growth in dividends. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 03-02 A Financial Planning Model: The Ingredients Source : Chapter 03 Test Bank > TB 03-05 An example of an economic assumption would b...

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6) The current accounts receivable is $45,000 and directly proportional to total sales. If the

company expects a 5% increase in sales for next year, the forecast accounts receivable will be: 6) ______ A) $47,250. B) $40,500. C) $49,950. D) impossible to calculate without last year's credit sales. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 03-03 The Percentage of Sales Method Source : Chapter 03 Test Bank > TB 03-06 The current accounts receivable is...

7) Financial planning models frequently assume that many variables are proportional to: 7) ______ A) economic growth. B) industry growth. C) interest rates. D) company sales. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 03-02 A Financial Planning Model: The Ingredients Source : Chapter 03 Test Bank > TB 03-07 Financial planning models frequently assume ...

8) The addition to retained earnings for the financial planning period is equal to: 8) ______ A) Net Income + Taxes - Dividends. B) Net Income - Dividends. C) Net income + Depreciation - Dividends. D) Sales - Dividend. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 03-03 The Percentage of Sales Method Source : Chapter 03 Test Bank > TB 03-08 The addition to retained earnings for the fi...

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9) If forecasted net income is $3,600, the expected dividend is $1,098 and the tax rate is 34%,

what is the retention ratio? 9) ______ A) 0.300 B) 0.198 C) 0.802 D) 0.695 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 03-03 The Percentage of Sales Method Source : Chapter 03 Test Bank > TB 03-09 If forecasted net income is ...

10) If a firm holds the dividend payout, the debt to equity ratio and outstanding shares constant,

while maintaining income and assets proportional to sales, the plug variable is: 10) ______ A) short term debt. B) retained earnings. C) sustainable growth. D) long term debt. E) accounts receivable. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Hard Topic : 03-03 The Percentage of Sales Method Source : Chapter 03 Test Bank > TB 03-10 If a firm holds the dividend payout, the deb...

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11) The external funds needed (EFN) equation projects the addition to retained earnings as: 11) ______ A) Net Profit Margin × Δ Sales. B) Net Profit Margin × Δ Sales × (1 - d). C) Net Profit Margin × Projected sales × (1 - d). D) Projected sales × (1 - d). E) Net Profit Margin × Projected sales. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 03-03 The Percentage of Sales Method Source : Chapter 03 Test Bank > TB 03-11 The external funds needed (EFN) equation pro...

12) Growth can be reconciled with the goal of maximizing firm value: 12) ______ A) because greater growth always adds to value. B) because growth must be an outcome of decisions that maximize value. C) because growth and wealth maximization are the same. D) because growth of any type cannot decrease value. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 03-04 The Statement of Comprehensive Income Source : Chapter 03 Test Bank > TB 03-12 Growth can be reconciled with the goal of ma...

13) Sustainable growth is defined as the level of growth than a firm can: 13) ______ A) maintain if it stays in the same business. B) maintain if it does not change the accounting relationships or capital structure. C) maintain if the net working capital is increased. D) maintain if the sales force grows at the rate of inflation. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 03-04 The Statement of Comprehensive Income Source : Chapter 03 Test Bank > TB 03-13 Sustainable growth is defined as the level o...

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14) The most recent financial statements for REM Co. are shown below. Statement of Financial Position Income Statement with Statement of Comprehensive Income Sales

$480

Costs

240

Taxes

Net income

$180

Assets

Total

$1,440

1,440

Debt

$600

Equity

672

Total

$1,440

Assets and costs are proportional to sales. Debt is not. A dividend of $90 was paid. REM wishes to maintain a constant payout to net income. Next year's sales are expected to be $480. What is the EFN (external funds needed)? 14) ______ A) $240.00 B) $132.00 C) $60.00 D) $168.00 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 03-03 The Percentage of Sales Method Source : Chapter 03 Test Bank > TB 03-14 The most recent financial statements for REM...

15) A firm has a fixed debt-to-equity ratio and dividend policy. Assets and net income are

proportional to sales, and new equity will not be issued. Which of the following statements is most correct? 15) ______ A) Almost any growth rate is theoretically possible. B) Only one growth rate is possible. C) The firm cannot grow. D) The firm's growth rate must be less than some maximum. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 03-04 The Statement of Comprehensive Income Source : Chapter 03 Test Bank > TB 03-15 A firm has a fixed debt-to-equity ratio and ...

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16) In estimating the pro-forma statement of financial position, projected retained earnings are

computed as present retained earnings plus: 16) ______ A) projected retained earnings and cash dividends. B) projected retained earnings plus debt. C) projected retained earnings plus assets. D) projected net income minus cash dividends. E) projected net income earnings minus debt. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 03-03 The Percentage of Sales Method Source : Chapter 03 Test Bank > TB 03-16 In estimating the pro-forma statement of fin...

17) In the financial planning model, external funds needed (EFN) is equal to: 17) ______ A) assets less (liabilities - equity). B) assets less (liabilities + equity). C) (assets + liabilities) less equity. D) (assets + equity) less liabilities. E) assets less equity. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 03-03 The Percentage of Sales Method Source : Chapter 03 Test Bank > TB 03-17 In the financial planning model, external fu...

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18) The most recent financial statements for Matrix Chip are shown below. Statement of Comprehensive Income Sales

$880

Costs

626

Taxes

Net income

$204 Statement of Financial Position

Current assets

$200

Current liabilities

$400

Fixed assets

2000

Long-term dept

700

Equity

1100

$2200

Assets, costs, and current liabilities are proportional to sales. Matrix Chip maintains a constant 50% dividend payout. No external financing is possible. What is the maximum percentage increase in sales that can be sustained? 18) ______ A) 5.55% B) 8.14% C) 5.667% D) 22.72% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 03-04 The Statement of Comprehensive Income Source : Chapter 03 Test Bank > TB 03-18 The most recent financial statements for Mat...

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19) The sustainable growth rate will be equivalent to the internal growth rate when: 19) ______ A) a firm has no debt. B) the growth rate is positive. C) the plowback ratio is positive but less than 1. D) a firm has a debt-equity ratio exactly equal to 1. E) net income is greater than zero. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 03-04 The Statement of Comprehensive Income Source : Chapter 03 Test Bank > TB 03-19 The sustainable growth rate will be equivale...

20) A firm's planning model has assets and cash proportional to sales. The firm maintains a

constant dividend payout ratio and a constant debt to equity ratio. Keying in on the asset to sales ratio, the firm's sustainable growth is ______ and the asset to sales ratio is ______. 20) ______ A) higher; higher B) higher; lower C) lower; lower D) constant; higher E) constant; lower Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 03-04 The Statement of Comprehensive Income Source : Chapter 03 Test Bank > TB 03-20 A firms planning model has assets and cash

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21) Altering the inputs to a financial plan by changing one of the assumptions at a time is called: 21) ______ A) a redundancy check. B) a pro forma evaluation. C) goal seeking. D) sensitivity analysis. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 03-01 What is Financial Planning? Source : Chapter 03 Test Bank > TB 03-21 Altering the inputs to a financial plan by c...

22) The maximum rate at which a firm can grow while maintaining a constant debt-equity ratio is

best defined by its: 22) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 03-04 The Statement of Comprehensive Income Source : Chapter 03 Test Bank > TB 03-22 The maximum rate at which a firm can grow wh...

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23) It is easier to evaluate a firm using its financial statements when the firm: 23) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 03-04 The Statement of Comprehensive Income Source : Chapter 03 Test Bank > TB 03-23 It is easier to evaluate a firm using its fi...

24) Which of the following will increase sustainable growth? 24) ______ A) Buy new assets. B) Decrease debt. C) Increase profit margin. D) Increase dividend payout ratio. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 03-04 The Statement of Comprehensive Income Source : Chapter 03 Test Bank > TB 03-24 Which of the following will increase sustain...

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25) Assuming the following ratios are constant, what is the sustainable growth rate? Total assets/sales

1.0

Net income/sales

0.1

Debt/equity

0.3

Dividends/net income

0.4 25) ______

A) 6.67% B) 5.13% C) 4.06% D) 8.46% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 03-04 The Statement of Comprehensive Income Source : Chapter 03 Test Bank > TB 03-25 Assuming the following ratios are constant, ...

26) A firm wishes to maintain a growth rate of 10% per year and a debt-to-equity ratio of 1/2.

The dividend payout is .2, and the ratio of total assets to sales is constant at 1.2. What must the profit margin be? 26) ______ A) 10.00% B) 9.09% C) 11.11% D) 8.00% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 03-04 The Statement of Comprehensive Income Source : Chapter 03 Test Bank > TB 03-26 A firm wishes to maintain a growth rate of 1...

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27) A firm wishes to maintain a growth rate of 12% per year and a dividend payout of 10%. The

ratio of total assets to sales is constant at 1.5, and the profit margin is 10%. What must be the debt-to-equity ratio? 27) ______ A) 0.52 B) 0.67 C) 0.79 D) 0.84 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 03-04 The Statement of Comprehensive Income Source : Chapter 03 Test Bank > TB 03-27 A firm wishes to maintain a growth rate of 1...

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

income, then the: 28) ______ A) fixed assets will have to increase at the same rate, regardless of the current capacity

level. 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 03-04 The Statement of Comprehensive Income Source : Chapter 03 Test Bank > TB 03-28 If a firm bases its growth projection on the...

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29) Marcie's Mercantile wants to maintain its current dividend policy, which is a payout ratio of

40%. 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 Marcie's can grow is equal to: 29) ______ A) 40% of the internal rate of growth. B) 60% of the internal rate of growth. C) the internal rate of growth. D) the sustainable rate of growth. E) 60% of the sustainable rate of growth. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 03-04 The Statement of Comprehensive Income Source : Chapter 03 Test Bank > TB 03-29 Marcies Mercantile wants to maintain its

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 30) Why is it important for managers to understand the importance of both the internal and the sustainable rates of growth?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 03-04 The Statement of Comprehensive Income Source : Chapter 03 Test Bank > TB 03-30 Why is it important for managers to understa...

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31) State the assumptions that underlie the sustainable growth rate and interpret what the

sustainable growth rate means.

32) The most recent financial statements for Valley View Distributors are: Statement of Comprehensive Income Sales

$3200

Costs

2600

Net income

$600

Statement of Financial Position Assets

Total

$3600

ST. Debt

$192

LT. Debt

$1248

Equity

2160

Total

$3600

Assets, short term debt and costs are proportional to sales. Long term debt is not. Dividends are 20%. Next year's sales are projected to be $3,600. What is external funds needed (EFN)?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 03-03 The Percentage of Sales Method Source : Chapter 03 Test Bank > TB 03-32 The most recent financial statements for Val...

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33) The most recent financial statements for Nosa Co. are: Statement of Comprehensive Income Sales

$500

Costs

400

Taxes

Net income

$50 Statement of Financial Position

Current assets

$200

Current liabilities

$400

Fixed assets

2000

Long-term dept

700

Equity

1100

$2200

Assets, costs, and current liabilities are proportional to sales. Long-term debt is not. Nosa maintains a constant 50% dividend payout. Next year's sales are projected to be $540. What is the EFN (external funds needed)?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 03-03 The Percentage of Sales Method Source : Chapter 03 Test Bank > TB 03-33 The most recent financial statements for Nos...

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34) The most recent financial statements for Quik-chip Co. are: Statement of Comprehensive Income Sales

$320

Costs

260

Taxes

Net income

$40 Statement of Financial Position

Working Capital

$400

Long-term dept

$820

Fixed assets

1650

Equity

1230

$2050

Assets and costs are proportional to sales. Quik-chip maintains a constant 30% dividend payout and a constant debt-to-equity ratio. What is the maximum sustainable increase in sales assuming no new equity?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 03-04 The Statement of Comprehensive Income Source : Chapter 03 Test Bank > TB 03-34 The most recent financial statements for Qui...

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35) Assuming the following ratios are constant, what is the sustainable growth rate? Sales/total assets

0.4

Net income/sales

0.1

Debt/Total Assets

0.2

Retained earnings/net income

0.6

36) A firm wishes to maintain a growth rate of 15% per year while maintaining a debt-to-equity

ratio of 1.0, a profit margin of 20% and a dividend payout of 60%. What level of asset efficiency must it achieve?

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37) A firm wishes to maintain a growth rate of 4% per year, a debt-to-equity ratio of.26, and a

dividend payout of 40%. If the profit margin is 10% and next year's sales are projected at $500, what is the total asset projection?

38) A firm follows the objective of maximizing sales growth. Is maximizing growth always

consistent with the shareholders' objective? Can a firm achieve this objective if it is at the desired level for the payout ratio, the debt to equity ratio and the asset structure?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 03-03 The Percentage of Sales Method Source : Chapter 03 Test Bank > TB 03-38 A firm follows the objective of maximizing s...

39) Suppose a firm calculates its external funding needs and finds that it is negative. What are the

firm's options in this case?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 03-04 The Statement of Comprehensive Income Source : Chapter 03 Test Bank > TB 03-39 Suppose a firm calculates its external fundi...

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Answer Key Test name: Chapter 03 1) 2) 3) 4) 5) 6) 7) 8) 9)

C C A B D A D B D b = 1-DPO 10) C 11) C 12) B

because growth must be an outcome of decisions that maximize value. 13) B 14) D

$1440 - $672 - $600 = $168 15) B 16) D 17) B 18) C

B = 0.5 ROE = 204/1800 = 0.1133 G = bxROE = 0.1133 X 0.5 5.667% 19) A 20) B 21) D 22) E 23) C

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24) C 25) D 26) B 27) C 28) D 29) D 30) Short Answer

One reason that causes firms to go out of business is the lack of external funding to support the growth of the firm. Understanding the implications of both the internal and sustainable growth rates can help management know when to limit firm growth such that the growth does not exceed the availability of the necessary financing to fund that growth. 31) Short Answer

The usual assumptions are: Costs and assets increase proportionately with sales. The dividend payout ratio remains at the same level. The current debt-equity ratio is optimal, and no new equity sales are possible. The sustainable growth rate is the maximum rate at which sales can increase with the restriction that no new equity sales are possible and long-term debt increases only in an amount such that the debt-equity ratio remains at the same level. 32) Short Answer

EFN = [3600/3200(400)] - [192/3200(400) - 600/3200(3600)(1 -.2)] = 450 - 24 - 540 = -114 33) Short Answer

Given the sales projection, Equity needs are up $144, plus a dividend of $27 must be paid. The new net income will cover $54 of their needed funds, leaving $117 as EFN. EFN = (2200/500)(40) - (400/500)(40) - (.5)(.1)(540) = 117. 34) Short Answer

2.334312% increase in sales is equivalent to a $7.47 dollar increase in sales. Apply the formula:

35) Short Answer

Growth Rate

36) Short Answer

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.15 = .15 = .16/(T -.16) T = 1.2267 Therefore TA turnover is.815 or must generate 81.5 cents worth of sales for each dollar in assets. 37) Short Answer

; X = 975.00 38) Short Answer

No, goals are not the same--shareholders wealth maximization is achieved through positive NPV investment. Increased sales do not necessarily mean increase value. - Fixed relationships only allow for a set growth rate. - If desired growth is different than sustainable growth then relationships must change. - Higher growth means more financing 39) Short Answer

With a negative external financing need, the firm has a surplus of funds that it can use to increase sales growth, reduce current liabilities, reduce long-term debt, buy back common stock, or increase dividends. If acceptable opportunities exist, the firm might also use the extra funds to add assets or increase sale growth.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Financial markets develop to accommodate ________ between individuals. 1) ______ A) trade and barter B) barter and lending C) borrowing and lending D) lending and trade Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 04-01 The Financial Market Economy Source : Chapter 04 Test Bank > TB 04-01 Financial markets develop to accommodate ___...

2) Which of the following is not true? 2) ______ A) Financial markets can be used to adjust consumption patterns over time. B) Corporate investment decisions have nothing to do with financial markets. C) Financial markets deal with cash flows over time. D) Investment decisions rely on the economic principles of financial markets. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 04-01 The Financial Market Economy Source : Chapter 04 Test Bank > TB 04-02 Which of the following is not true?

3) Components of a loan that is fully paid back are: 3) ______ A) the interest and financial market payments. B) the principle repayment and the down payment. C) the interest payment and principal repayment. D) the down payment and interest payment. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 04-01 The Financial Market Economy Source : Chapter 04 Test Bank > TB 04-03 Components of a loan that is fully paid back...

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4) A financial instrument that by its possession entitles the holder to receive the payments is

called: 4) ______ A) principal instruments. B) interest only instruments. C) registered instruments. D) bearer instruments. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 04-01 The Financial Market Economy Source : Chapter 04 Test Bank > TB 04-04 A financial instrument that by its possessio...

5) One of the functions of financial intermediaries is to make sure the market clears. This

means: 5) ______ A) setting the appropriate interest rates. B) recording the parties to the transactions. C) making sure the total amount to be lent equals the total amount to be borrowed. D) minimizing the spread between rates. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 04-01 The Financial Market Economy Source : Chapter 04 Test Bank > TB 04-05 One of the functions of financial intermedia...

6) If the amount of money lent equals the amount borrowed, then the market is cleared at: 6) ______ A) the equilibrium interest rate. B) the marginal rate of substitution. C) the crossover rate. D) the short term yield curve rate. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 04-01 The Financial Market Economy Source : Chapter 04 Test Bank > TB 04-06 If the amount of money lent equals the amoun...

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7) The ray that connects the maximum one can consume in Year 0 with the maximum one can

consume in Year 1 represents: 7) ______ A) all the investment possibilities and has a slope equal to (1 + r). B) all best consumption alternatives and has a slope equal to -(1 + r). C) all the savings choices and has a slope equal to 1. D) all the best consumption choices and has a slope equal to 1. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 04-02 The Anonymous Market Source : Chapter 04 Test Bank > TB 04-07 The ray that connects the maximum one can co...

8) An individual with no investment opportunities has an income of $15,000 in period 0 and an

income of $10,000 in period 1. If the interest rate is 7%, which of the following points is on the individual's consumption possibility line? 8) ______ A) $3,000 in period 0 and $21,215 in period 1. B) $4,000 in period 0 and $21,116 in period 1. C) $10,000 in period 0 and $15,350 in period 1. D) $16,000 in period 0 and $9,000 in period. E) $18,800 in period 0 and $6,200 in period 1. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 04-02 The Anonymous Market Source : Chapter 04 Test Bank > TB 04-08 An individual with no investment opportuniti...

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9) A lender with no investment opportunities has equal income in period 0 and period 1. Which

of the following correctly describes the consequence of an increase in the interest rate? 9) ______ A) Consumption in period 0 stays the same while consumption in period 1 decreases. B) Consumption in period 0 stays the same while consumption in period 1 increases. C) Consumption in period 0 increases while consumption in period 1 decreases. D) Consumption in period 0 decreases while consumption in period 1 stays the same. E) Consumption in period 0 decreases while consumption in period 1 increases Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 04-02 The Anonymous Market Source : Chapter 04 Test Bank > TB 04-09 A lender with no investment opportunities ha...

10) Which of the following conditions do not characterize perfect capital markets? 10) ______ A) Trading is costless; access to the financial markets is free. B) Information about borrowing and lending opportunities is readily available. C) There are many traders; no single trader can have a significant impact on market

prices. D) A few influential firms can control the financial market. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 04-03 Market Clearing Source : Chapter 04 Test Bank > TB 04-10 Which of the following conditions do not cha...

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11) The first basic principle of finance dictates that an individual will invest in a project if: 11) ______ A) they are made better off in the financial markets. B) they are unable to adjust their savings and consumption in the financial markets. C) the project is at least as desirable as what is available in the financial markets. D) the interest rate for borrowing and lending is not equal. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 04-04 Making Consumption Choices Over Time Source : Chapter 04 Test Bank > TB 04-11 The first basic principle of finance dictate...

12) You have an investment opportunity that requires $400,000. You have no funds available,

but you will have an income of $120,000 this year. The investment will have a net payoff of $33,000 at the end of the year. If the market rate is 7.5%, will you invest? 12) ______ A) No, because I need $280,000 more than I will have. B) Yes, because I will be $3,000 above my required return. C) No, because I only get $33,000 back on my $400,000. D) Yes, because the market rate is less than the borrowing rate. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 04-05 The Competitive Market Source : Chapter 04 Test Bank > TB 04-12 You have an investment opportunity that requ...

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13) The following statement: "the value of an investment to an individual is not dependent on

consumption preferences" is called the: 13) ______ A) marginal rate of substitution. B) separation theorem. C) value additivity principle. D) investor's dilemma. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 04-05 The Competitive Market Source : Chapter 04 Test Bank > TB 04-13 The following statement: "the value of an in...

14) An investment should be made in period 0 if: 14) ______ A) desired consumption in period 0 is less than income. B) desired consumption in period 1 is greater than income. C) return on the investment is greater than the interest rate. D) return on the investment is less than the interest rate. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 04-06 How Many Interest Rates Are There in a Competitive Market? Source : Chapter 04 Test Bank > TB 04-14 An investment should be made in period 0 if:

15) The consumption opportunity set moves further out when an investment is available because: 15) ______ A) the total number of alternatives are now greater. B) the investment is better than what is available in the market. C) the project rate of return is less than the market rate. D) the market rate is irrelevant to the investment choice. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 04-06 How Many Interest Rates Are There in a Competitive Market? Source : Chapter 04 Test Bank > TB 04-15 The consumption opportunity set moves furthe...

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16) The present value of future cash flows minus initial cost is called: 16) ______ A) the future value of the project. B) the net present value of the project. C) the equivalent sum of the investment. D) the initial investment risk equivalent value. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 04-06 How Many Interest Rates Are There in a Competitive Market? Source : Chapter 04 Test Bank > TB 04-16 The present value of future...

17) According to the net present value rule, an investment should be made if: 17) ______ A) the net present value has no risk. B) the net present value is greater than the cost of investment. C) the net present value is less than present value. D) the net present value is more desired than consumption. E) the net present value is positive. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 04-06 How Many Interest Rates Are There in a Competitive Market? Source : Chapter 04 Test Bank > TB 04-17 According to the net present value rule, an ...

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18) You have an investment opportunity available to you that requires $400,000. You have no

funds available, but you will have an income of $120,000 this year. The investment will have a payoff of $433,000 at the end of the year. If the market rate is 8.25%, what is the net present value? 18) ______ A) $33,000 B) $433,000 C) $0.00 D) $23,100 E) $30,485 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 04-06 How Many Interest Rates Are There in a Competitive Market? Source : Chapter 04 Test Bank > TB 04-18 You have an investment opportunity available...

19) Which of the following statements is true? 19) ______ A) Stockholders prefer corporations to make investments when the net present value is

positive. B) Stockholders prefer corporations to make investments only when the probability of loss is very low. C) Most corporate charters require a stockholder vote on decisions concerning large investment projects. D) Stockholders prefer corporations to make all investments with positive net incomes. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 04-07 The Basic Principle Source : Chapter 04 Test Bank > TB 04-19 Which of the following statements is true?

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20) An individual has $60,000 income in period 0 and $30,000 income in period 1. If the

individual desires to consume $19,000 in period 1, and the market interest rate is 8%, what is the maximum amount of consumption in period 0? 20) ______ A) $50,000 B) $70,185 C) $71,000 D) $61,880 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 04-05 The Competitive Market Source : Chapter 04 Test Bank > TB 04-20 An individual has $60,000 income...

21) An individual has an income of $35,000 in period 0 and $40,000 in period 1. An investment

opportunity that costs $10,000 in period 0 is worth $11,000 in period 1. What is the maximum possible consumption in period 0 if the individual consumes $50,000 in period 1 when the market rate of interest is 8%? 21) ______ A) $26,000 B) $26,667 C) $44,000 D) $44,720 E) $25,926 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 04-05 The Competitive Market Source : Chapter 04 Test Bank > TB 04-21 An individual has an income of...

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22) Shareholders of corporations generally do not vote on every investment decision but depend

on managers to maximize value by: 22) ______ A) choosing the highest net income projects. B) investing at the market rate of return. C) buying shares back from investors. D) following the NPV rule to choose investments. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 04-07 The Basic Principle Source : Chapter 04 Test Bank > TB 04-22 Shareholders of corporations generally do no...

23) Diagrams illustrating the consumption choices for a corporation show the two period trade-

off as originating in the northwest quadrant, or (-X, Y), because: 23) ______ A) corporations have a tendency to waste resources. B) unlike an individual, corporations have no consumption endowment. C) each investor cannot maximize their own consumption. D) people differ in tastes and preferences. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 04-07 The Basic Principle Source : Chapter 04 Test Bank > TB 04-23 Diagrams illustrating the consumption choice...

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24) Corporate managers can maximize shareholder wealth by choosing positive NPV projects

because: 24) ______ A) all investors have the same preferences. B) the unhappy shareholders can sell off shares. C) the separation theorem in financial markets states that all investors will be satisfied

with the same investment decision regardless of personal preferences. D) managers are wiser than shareholders regarding investments. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 04-07 The Basic Principle Source : Chapter 04 Test Bank > TB 04-24 Corporate managers can maximize shareholder ...

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 25) An individual has an income of $4,000 in period 0 and $0 in period 1. The individual has the potential investment opportunities given below: Project

Cost

Worth in Period 1

$1,500

$1,620

$2,000

$2,400

$1,000

$1,040

$700

$910

If the market interest rate is 11%, what is the optimal investment? What is maximum consumption in period 1 if the individual takes on the optimal set of investment projects and consumes all other period 0 income?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 04-02 The Anonymous Market Source : Chapter 04 Test Bank > TB 04-25 An individual has an income of...

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26) An individual has an income of $4,000 in period 0 and $0 in period 1. The individual has the

potential investment opportunities given below: Project

Cost

Worth in Period 1

$1,500

$1,620

$2,000

$2,400

$1,000

$1,040

$700

$910

Suppose that the market interest is 5%. What is the maximum possible consumption in period 1 if the individual takes on the optimal set of investment projects and consumes all other period 0 income?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 04-02 The Anonymous Market Source : Chapter 04 Test Bank > TB 04-26 An individual has an income of...

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27) An individual has an income of $4,000 in period 0 and $0 in period 1. The individual has the

potential investment opportunities given below: Project

Cost

Worth in Period 1

$1,500

$1,620

$2,000

$2,400

$1,000

$1,040

$700

$910

At what market rates of interest would make the individual indifferent between (1) all consumption in Period 0 and none in Period 1 and (2) no consumption in Period 0 and all consumption in Period 1?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 04-02 The Anonymous Market Source : Chapter 04 Test Bank > TB 04-27 An individual has an income of...

28) An individual has income of $20,000 in period 0 and $42,000 in period 1. An investment

opportunity that costs $15,000 in period 0 is worth $18,000 in period 1. The market interest rate is 6%. What is the maximum possible consumption in period 1 if the individual consumes $16,000 in period 0 and follows the NPV rule?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 04-02 The Anonymous Market Source : Chapter 04 Test Bank > TB 04-28 An individual has income of...

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29) An individual has income of $10,000 in period 0 and $25,000 in period 1. An investment

opportunity that costs $10,000 in period 0 is worth $10,500 in period 1. The market interest rate is 8%. What is the maximum possible consumption in period 1 if the individual consumes $20,000 in period 0 and the individual follows the NPV rule?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 04-02 The Anonymous Market Source : Chapter 04 Test Bank > TB 04-29 An individual has income of...

30) An individual has income of $15,000 in period 0 and $20,000 in period 1. An investment

opportunity that costs $10,000 in period 0 is worth $11,500 in period 1. The market interest rate is 8%. What is the maximum possible consumption in period 0 if the individual consumes $26,000 in period 1?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 04-02 The Anonymous Market Source : Chapter 04 Test Bank > TB 04-30 An individual has income of...

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31) A corporation has the following opportunity to invest in a project with a return of $42,000 in

one period. The current investment is $46,900. The financial market rate is 14%. Explain the investment choice the corporation should make. (Hint: Determine the NPV.)

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 04-07 The Basic Principle Source : Chapter 04 Test Bank > TB 04-31 A corporation has the following opportunity ...

32) A corporation has the following opportunity to invest in a project with a return of $42,000 in

one period. The current investment is $46,900. The financial market rate is 5%. Explain the investment choice the corporation should make. (Hint: Determine the NPV.)

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 04-07 The Basic Principle Source : Chapter 04 Test Bank > TB 04-32 A corporation has the following opportunity ...

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33) A corporation has the following opportunity to invest in a project with a return of $42,000 in

one period. The current investment is $46,900. If the corporation had cash on hand of $25,000 before raising any capital for the investment and the financial market rate is 9%. How much will the current shareholders earn.?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 04-07 The Basic Principle Source : Chapter 04 Test Bank > TB 04-33 A corporation has the following opportunity ...

34) If the corporation had cash on hand of $25,000 before raising any capital for the investment

and the financial market rate is 9%. Explain the investment choice the corporation should make. (Hint: Determine the NPV.)

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 04-07 The Basic Principle Source : Chapter 04 Test Bank > TB 04-34 If the corporation had cash on hand of...

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35) The separation theorem in financial markets is fundamental to allowing managers to

maximize all shareholders wealth. Explain the separation theorem and how the financial markets provide for all different types of investors.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 04-05 The Competitive Market Source : Chapter 04 Test Bank > TB 04-35 The separation theorem in financial markets ...

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Answer Key Test name: Chapter 04 1) 2) 3) 4) 5) 6) 7) 8)

C B C D D A B C Consumption at period 0, $10,000, $5000 will be saved for consumption at period 1. Consumption at period 1 = $5,000 * (1 + 7%) + $10,000 = $15,350. 9) E 10) D 11) C 12) B

$400,000 * (1 + 7.5%) = $430,000, thus the required payoff is $30,000. 13) B 14) C 15) B 16) B 17) E 18) C

-$400,000 + $433,000/(1 + 8.25%) = $0.00. 19) A 20) B

= $60,000 + ($30,000 - $19,000)/(1 + 8%) = $70,185. 21) E 22) D 23) B 24) C 25) Short Answer

Invest $2,000 in project B and $700 in D. Period 1 consumption is $2,400 + $910 = $3,310

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26) Short Answer

Invest $1,500 in project A, $2,000 in B, and $700 in D. Period 1 consumption is $1,620 + $2,400 + $910 = $4,930 27) Short Answer

Determine rates of return; A:8%, B:20%, C:4% and D:30%. Therefore, all consumption in Period 0 market rate must be greater than 30%. For all Period 1 consumption market rate must be less than 4%. (For simplicity assumes one would look only at the investment decision.) 28) Short Answer

Individual must borrow $11,000 from period 1 income which comes at a cost of $11,000 (1.06) = $11,660. Therefore, max period 1 dollars is: $42,000 - $11,660 + $18,000 = $48,340 29) Short Answer

The individual will turn down the investment opportunity. Also, the individual must borrow $10,000 from period which comes at a cost of $10,000 (1.08) = $10,800. Therefore, maximum period 1 dollars is: $25,000 - $10,800 = $14,200 30) Short Answer

Maximum consumption in period 1 is the sum of the following amounts: a) $5,000 of period 0 income. b) Period 1 available income of $20,000 + $11,500 - 26,000 = $5,500. The present value of $5,500 is $5,500/(1.08) = $5,092.59 Sum of a and b = $10,092.59 31) Short Answer

NPV = -42,000 + (46,900/1.14) = -42,000 + 41.140.35 = -859.65. Do not invest. 32) Short Answer

NPV = -42,000 + (46,900/1.05) = -42,000 + 44,666.67 = 2,666.67. Do invest. 33) Short Answer

NPV = -42,000 + (46,900/1.09) = -42,000 + 43,027.52 = 1,027.52 New lender receive 17,000 * 1.09 = 18,530 in Period 1 leaving $28,370 to the current shareholders for a 28370/25000 - 1 = .1348 return (13.48%). 34) Short Answer

NPV = -42,000 + (46,900/1.09) = -42,000 + 43,027.52 = 1,027.52 = 1,642. Do invest.

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35) Short Answer

• Investors have different utility • Evaluates investment decisions by the market rate • Separates consumption from investment decisions

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) The time value of money concept can be defined as: 1) ______ A) the time in your life when you receive an inheritance. B) the relationship between money spent versus money received. C) the relationship between a dollar to be received in the future and a dollar today. D) the relationship of interest rate stated and amount paid. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 05-01 The One-Period Case Source : Chapter 05 Test Bank > TB 05-01 The time value of money concept can be defin...

2) The compound value is defined as: 2) ______ A) the value of a dollar received tomorrow. B) the value of a sum after investing over one or more periods. C) the value of a sum today to received in the future. D) the rate of growth in a sum today. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 05-01 The One-Period Case Source : Chapter 05 Test Bank > TB 05-02 The compound value is defined as:

3) Present value may be defined as: 3) ______ A) future cash flows discounted to the present. B) official prescribed price. C) present cash flows compounded into the future. D) the average of the bid and asked price. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 05-01 The One-Period Case Source : Chapter 05 Test Bank > TB 05-03 Present value may be defined as:

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4) Find the present value of $5,325.00 to be received in one period if the rate is 6.5%. 4) ______ A) $5,000.00 B) $5,071.43 C) $5,671.13 D) $5,591.25 Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 05-01 The One-Period Case Source : Chapter 05 Test Bank > TB 05-04 Find the present value of...

5) The present value of future cash flows minus initial cost is called: 5) ______ A) the future savings of the project. B) the net present value of the project. C) the equivalent sum of the investment. D) the initial investment risk equivalent value. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 05-01 The One-Period Case Source : Chapter 05 Test Bank > TB 05-05 The present value of future cash flows minus...

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6) What is the future value of the following cash flows at the end of year 3 if the interest rate is

6%? The cash flows occur at the end of each year. Year 1

Year 2

Year 3

$5,180

$9,600

$2,250 6) ______

A) $15,916.78 B) $18,109.08 C) $18,246.25 D) $19,341.02 E) $19,608.07 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-02 The Multiperiod Case Source : Chapter 05 Test Bank > TB 05-06 What is the future value of the following ca...

7) Discounting cash flows involves: 7) ______ A) reducing cash flows that occur beyond 10 years in the future. B) discounting expected cash flows beyond a certain number of years in the future,

which varies with the riskiness of the project. C) reducing expected cash flows to achieve certainty equivalence. D) reducing the value of future cash flows to reflect the time value of money. E) taking the cash discount offered on trade merchandise. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 05-02 The Multiperiod Case Source : Chapter 05 Test Bank > TB 05-07 Discounting cash flows involves:

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8) Beatrice invests $1,000 in an account that pays 4% simple interest. How much more could

she have earned over a five-year period if the interest had compounded annually? 8) ______ A) $15.45 B) $15.97 C) $16.65 D) $17.09 E) $21.67 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 05-02 The Multiperiod Case Source : Chapter 05 Test Bank > TB 05-08 Beatrice invests $1,000 in an account that p...

9) In the equation, NPV = -Cost + PV, the term Cost is the: 9) ______ A) current value of the commitment fee today. B) current value of the terminal cash flow. C) initial cash outflow. D) present value of the variable costs. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 05-02 The Multiperiod Case Source : Chapter 05 Test Bank > TB 05-09 In the equation, NPV = -Cost + PV, the term ...

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10) If you have a choice to earn simple interest on $10,000 for three years at 8% or compound

interest at 7.5% for three years which one will pay more and by how much? 10) ______ A) Simple interest by $1,500. B) Compound interest by $22.97. C) Compound interest by $150.75. D) Simple interest by $150.00. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 05-02 The Multiperiod Case Source : Chapter 05 Test Bank > TB 05-10 If you have a choice to earn simple interest...

11) The equation [Ct/(1 + r)t] provides: 11) ______ A) the compound value of a series of payments with a single interest rate. B) the compound value of a series of payments with a series of interest rates. C) the compound value of a single payment. D) the present value of a series of payments with a single interest rate. E) the present value of a single payment. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 05-02 The Multiperiod Case Source : Chapter 05 Test Bank > TB 05-11 The equation [Ct/(1 + r)t] provides:

12) The future value table provides the factors for the: 12) ______ A) compound interest rate for 1/N periods for a specified interest rate. B) compound value of a dollar for 1/N periods for a specified interest rates. C) single value of a dollar for N periods for a specified interest rate. D) simple interest rate for N periods. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-12 The future value table provides the factors ...

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13) Jim Mayer has deposited $7,000 in a guaranteed investment account with a promised rate of

7% compounded annually. He plans to leave it there for 4 full years when he will make a down payment on a car after graduation. How much of a down payment will he be able to make? 13) ______ A) $8,960.00 B) $1,960.00 C) $2,175.57 D) $9,175.57 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-02 The Multiperiod Case Source : Chapter 05 Test Bank > TB 05-13 Jim Mayer has deposited...

14) Which of the following statements is true? 14) ______ A) Regardless of the value of the interest rate, increasing the compounding frequency

will decrease the future value. B) Regardless of the value of the interest rate, increasing the compounding frequency will increase the future value. C) There is a relationship between the future value of investment and the effect of compounding frequency. At high interest rates, increases in compounding frequency will decrease the future value. D) There is a relationship between the future value of investment and the effect of compounding frequency. At low interest rates, increases in compounding frequency will decrease the future value. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-14 Which of the following statements is true?

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15) The discount rate is adjusted: 15) ______ A) upward to reflect higher risk and to increase the future cash flows. B) upward to reflect higher risk and to reduce the future cash flows. C) downward to reflect higher risk and to increase the future cash flows. D) downward to reflect higher risk and to reduce the future cash flows. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-15 The discount rate is adjusted:

16) The great grandparents of one of your classmates sold their factory to the government at the

beginning of 1898 for $150,000. If these proceeds had been invested at 6% from then until the end of 2020, what would the legacy to your classmate's family be worth at the end of 2020? (assume whole years). 16) ______ A) $183,403,163.02 B) $1,248,000.00 C) $91,701,581.51 D) $51,205,684.15 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-16 The great grandparents of one of your classm...

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17) The present value factor is: 17) ______ A) the dollar amount of the future value. B) the rate that equates the present value with the future value. C) the process of calculating future or present values. D) the value of $1 to be received in T periods at a given interest rate. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 05-02 The Multiperiod Case Source : Chapter 05 Test Bank > TB 05-17 The present value factor is:

18) Your parents are giving you $100 a month for four years while you are in college. At a 6%

annual discount rate, what are these payments worth to you when you first start college? 18) ______ A) $3,797.40 B) $4,167.09 C) $4,198.79 D) $4,258.03 E) $4,279.32 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-18 Your parents are giving you...

19) The equation (1 + (r/m))m-1 gives the: 19) ______ A) effective annual interest rate, and r is the stated annual interest rate. B) effective annual interest rate, and m is the number of years to maturity. C) stated annual interest rate, and r is the effective annual interest rate. D) stated annual interest rate, and m is the number of years to maturity. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-19 The equation (1 + (r/m))m-1 gives the:

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20) You have a sub-contracting job with a local manufacturing firm. Your agreement calls for

annual payments of $50,000 for the next five years. At a discount rate of 12%, what is this job worth to you today? 20) ______ A) $180,238.81 B) $201,867.47 C) $210,618.19 D) $223,162.50 E) $224,267.10 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-20 You have a sub-contracting job with a local ...

21) You have deposited $1,500 in an account that promises to pay 8% compounded quarterly for

the next five years. How much will you have in the account at the end? 21) ______ A) $1,598.33 B) $2,228.92 C) $2,203.99 D) $6,991.44 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-21 You have deposited $1,500 in...

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22) Which of the following amounts is closest to the end value of investing $9,000 for 7 years at

a continuously compounded rate of 11%? 22) ______ A) $18,685.44 B) $19,369.83 C) $15,930.00 D) $19,437.90 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-22 Which of the following amounts is closest to...

23) Which of the following amounts is closest to the end value of investing $3,000 for 3/4 years

at a continuously compounded rate of 12%? 23) ______ A) $3,163 B) $3,283 C) $3,263 D) $3,287 E) $3,317 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-23 Which of the following amounts is closest to...

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24) Your employer contributes $25 a week to your retirement plan. Assume that you work for

your employer for another twenty years and that the applicable discount rate is 5%. Given these assumptions, what is this employee benefit worth to you today? 24) ______ A) $13,144.43 B) $15,920.55 C) $16,430.54 D) $16,446.34 E) $16,519.02 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-24 Your employer contributes...

25) Which of the following amounts is closest to the end value of investing $5,000 for 14 months

at a stated annual interest rate of 6 percent compounded monthly? 25) ______ A) $5,352 B) $5,362 C) $5,350 D) $5,293 E) $6,183 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-25 Which of the following amounts is closest to...

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26) You are the beneficiary of a life insurance policy. The insurance company informs you that

you have two options for receiving the insurance proceeds. You can receive a lump sum of $50,000 today or receive payments of $641 a month for ten years. You can earn 6.5% on your money. Which option should you take and why? 26) ______ A) You should accept the payments because they are worth $56,451.91 today. B) You should accept the payments because they are worth $56,523.74 today. C) You should accept the payments because they are worth $56,737.08 today. D) You should accept the $50,000 because the payments are only worth $47,757.69 today. E) You should accept the $50,000 because the payments are only worth $47,808.17 today. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-26 You are the beneficiary of a life insurance ...

27) Which of the following amounts is closest to the end value of investing $10,000 for 1 1/2

years at a stated annual interest rate of 12% compounded quarterly? 27) ______ A) $11,800 B) $11,852 C) $11,941 D) $11,961 Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-27 Which of the following amounts is closest to...

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28) The present value table provides the factors for the: 28) ______ A) simple interest rate for N periods. B) discount value of a dollar for N periods for a specified interest rate. C) discount value of a dollar for 1/N periods for a specified interest rate. D) simple interest value of an investment for N periods. E) simple interest value of an investmentfor 1/N periods. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 05-02 The Multiperiod Case Source : Chapter 05 Test Bank > TB 05-28 The present value table provides the factors...

29) Which of the following amounts is closest to the end value of investing $7,500 for 2 1/2

years at an effective annual interest rate of 12.36%? Interest is compounded semiannually. 29) ______ A) $7,531 B) $8,427 C) $9,818 D) $9,469 E) $10,122 Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-29 Which of the following amounts is closest to...

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30) The present value of a set of cash flows is: 30) ______ A) the sum of the present value of the individual cash flows. B) the sum of individual cash flows which are then discounted. C) not equal to the sum of the present value of the individual cash flows. D) always greater than the present value of the investment. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 05-02 The Multiperiod Case Source : Chapter 05 Test Bank > TB 05-30 The present value of a set of cash flows is:

31) If the compound period is greater than one: 31) ______ A) the effective annual interest rate is always equal to the annual percentage rate. B) the effective annual interest rate is always less than the annual percentage rate. C) the effective annual interest rate is always greater than the annual percentage rate. D) the effective annual interest rate is never greater than the annual percentage rate. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-31 If the compound period is greater than one:

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32) A court settlement awarded an accident victim four payments of $50,000 to be paid at the

end of each of the next four years. Using a discount rate of 4%, calculate the present value of the annuity. 32) ______ A) $173,255 B) $178,495 C) $181,495 D) $184,095 E) $200,000 Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-32 A court settlement awarded an accident victi...

33) The interest rate charged per period multiplied by the number of periods per year is called the

_____ rate. 33) ______ A) effective annual B) annual percentage C) periodic interest D) compound interest Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-33 The interest rate charged per period multipl...

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34) Which one of the following statements concerning interest rates is correct? 34) ______ A) The stated rate is the same as the effective annual rate. B) An effective annual rate is the rate that applies if interest were charged annually. C) The annual percentage rate increases as the number of compounding periods per year

increases. D) Banks prefer more frequent compounding on their savings accounts. E) For any positive rate of interest, the effective annual rate will always exceed the annual percentage rate. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-34 Which one of the following statements concer...

35) Which of the following amounts is closest to the net present value of a project that

contributes $10,000 at the end of the first year and $5,000 at the end of the second year. The initial cost is $8,000 and the appropriate interest rate is 10%. 35) ______ A) $5,223 B) $5,951 C) $7,000 D) $21,223 E) $23,000 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-02 The Multiperiod Case Source : Chapter 05 Test Bank > TB 05-35 Which of the following amounts is closest to...

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36) What is the net present value of a project that contributes $25,000 at the end of the first year

and $12,000 at the end of the second year? The initial cost is $33,000. The appropriate interest rate is 7% for the first year and 10% for the second year. 36) ______ A) $1,579.44 B) $559.90 C) $281.85 D) -$2,148.26 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-02 The Multiperiod Case Source : Chapter 05 Test Bank > TB 05-36 What is the net present value of a project t...

37) The government imposed a fine on the Not-So-Legal Company. The fine calls for 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. The government has agreed to pay an annual interest of 3 percent on the held funds. How much will be donated to charity in two years? 37) ______ A) $475,000.00 B) $460,590.00 C) $447,174.76 D) $451,050.05 E) $474,407.70 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-02 The Multiperiod Case Source : Chapter 05 Test Bank > TB 05-37 The government imposed a fine on the Not-So-...

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38) What is the effective annual rate if a bank charges you 7.64% compounded quarterly? 38) ______ A) 7.79% B) 7.86% C) 7.95% D) 7.98% E) 8.01% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-38 What is the effective annual rate if a bank ...

39) You are to receive $75 per year indefinitely. The market rate of interest for these types of

payments is 8%. The price you would pay for this stream is: 39) ______ A) $9.38 B) $81.00 C) $93.75 D) $937.50 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-39 You are to receive...

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40) Aunt Clarisse has promised to leave you an annuity that will pay $60 next year and grow at

an annual rate of 4%. The payments are expected to go on indefinitely and the interest rate is 9%. What is the value of the growing perpetuity? 40) ______ A) $667 B) $693 C) $1,200 D) $1,248 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-40 Aunt Clarisse has promised to leave you an a...

41) Which of the following amounts is closest to the present value of a payment of $21,000 three

years from now if the effective annual interest rate is 4%? 41) ______ A) $18,669 B) $18,658 C) $19,218 D) $18,480 E) $17,951 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-02 The Multiperiod Case Source : Chapter 05 Test Bank > TB 05-41 Which of the following amounts is closest to...

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42) Thorton will receive an inheritance of $500,000 three years from now. Thorton's personal

discount rate corresponds to a 10% interest rate compounded semiannually. Which of the following values is closest to the amount that Thorton should accept today for the right to his inheritance? 42) ______ A) $373,108 B) $375,657 C) $665,500 D) $670,048 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-42 Thorton will receive an inheritance of...

43) A mortgage instrument pays $1.5 million at the end of each of the next two years. An

investor has an alternative investment with the same amount of risk that will pay interest at 8% compounded semiannually. Which of the following amounts is closest to what the investor should pay for the mortgage instrument? 43) ______ A) $1.28 million. B) $1.39 million. C) $2.67 million. D) $2.72 million. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-43 A mortgage instrument pays $1.5...

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44) An equal stream of payments that lasts forever is: 44) ______ A) a growing annuity. B) a zero-coupon bond. C) a perpetuity. D) valueless. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-44 An equal stream of payments that lasts forev...

45) An annuity: 45) ______ A) is a debt instrument that pays no interest. B) is a stream of payments that varies with current market interest. C) is a series of equal payments through time. D) has no value. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-45 An annuity:

46) A perpetuity differs from an annuity because: 46) ______ A) perpetuity payments vary with the rate of inflation. B) perpetuity payments vary with the market rate of interest. C) perpetuity payments are variable while annuity payments are constant. D) perpetuity payments never cease. E) annuity payments never cease. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-46 A perpetuity differs from an annuity because...

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47) An annuity factor: 47) ______ A) can be used to determine the present value of a level stream of payments. B) consists entirely of maturation and interest. C) is a variable that can never be greater than one. D) is any factor that affects the price of a bond. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-47 An annuity factor:

48) Charles Carr borrowed $3,500 to consolidate his debts. Since Charles had an excellent credit

rating, he was able to borrow at a 12% effective annual rate. Charles is required to make monthly payments. Charles will make equal payments for the next 36 months. Which one of the following values is closest to his monthly payments? 48) ______ A) $121 B) $122 C) $115 D) $118 E) $123 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-48 Charles Carr borrowed $3,500 to...

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49) Tina is able to pay $160 a month for five years for a car. If the interest rate is 4.9%, how

much can Tina afford to borrow to buy a car? 49) ______ A) $6,961.36 B) $8,499.13 C) $8,533.84 D) $8,686.82 E) $9,588.05 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-49 Tina is able to pay $160 a...

50) What is the present value of 10 payments of $500 each received every 24 months at a

discount rate of 12%? 50) ______ A) $1,840.93 B) $1,332.60 C) $2,825.11. D) $1,761.66 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-50 What is the present value of 10 payments of ...

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51) If a student borrows $20,000 to start a business as a 5 year, 10% loan, the annual payment is: 51) ______ A) $2,000.00 B) $3,275.95 C) $4,000.00 D) $5,275.95 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-51 If a student borrows $20,000...

52) A "little seven" accounting firm offers to pay you a year-end bonus of $5,000 for 3 years if

you will accept employment with them and stay for the entire 3-year period. Which of the following amounts is closest to the present value of the bonus if the interest rate is 10%? 52) ______ A) $5,000. B) $11,270. C) $12,434. D) $15,000. E) $31,576. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-52 A "little seven" accounting firm offers to p...

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53) An S&L provides a loan with 15 yearly repayments of $8,000 with the first payment

beginning immediately. Which of the following amounts comes closest to the present value of the loan if the interest rate is 7%? 53) ______ A) $72,863. B) $77,964. C) $115,648. D) $120,000. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-53 An S&amp;L provides a loan with 15 yearly re...

54) Suzette is going to receive $10,000 today as the result of an insurance settlement. In addition,

she will receive $15,000 one year from today and $25,000 two years from today. She plans on saving all of this money and investing it for her retirement. If Suzette can earn an average of 11% on her investments, how much will she have in her account if she retires 25 years from today? 54) ______ A) $536,124.93 B) $541,414.14 C) $546,072.91 D) $570,008.77 E) $595,098.67 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-54 Suzette is going to receive...

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55) A sports team, to solve the salary cap problem, has offered a player a contract of $1 million a

year for the next season, with the payments growing at 7% per year for the next 25 years. The player believes the discount rate for such payments is 13%. What is the value today of taking this contract? 55) ______ A) $12,405,955.40 B) $16,666,666.67 C) $884,956.09 D) $5,824,965.76 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-55 A sports team, to solve the salary cap probl...

56) The Ajax Co. just decided to save $1,500 a month for the next five years as a safety net for

recessionary periods. The money will be set aside in a separate savings account which pays 3.25% interest compounded monthly. It deposits the first $1,500 in a month. If the company had wanted to deposit an equivalent lump sum today, how much would it have had to deposit? 56) ______ A) $82,964.59 B) $83,189.29 C) $83,428.87 D) $83,687.23 E) $84,998.01 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-56 The Ajax Co. just decided to save...

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57) As an excellent student in environmental ecology, you have been awarded the "Clean

Effluent Prize" by a state agency. You (or your estate) could receive $300 forever from the state or $400 for the next 25 years. Payments are to be received annually. If the market rate of interest is 6%, what is the value of the two options respectively? 57) ______ A) $30,000; $10,000.25 B) $5,000; $5,113.34 C) $10,000; $6,304.74 D) $2,500; $3,859.46 E) $6,666.67; $5,113.34 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-57 As an excellent student in environmental eco...

58) You are comparing two investment options. The cost to invest in either option is the same

today. Both options will provide you with $20,000 of income. Option A pays five annual payments starting with $8,000 the first year followed by four annual payments of $3,000 each. Option B pays five annual payments of $4,000 each. Which one of the following statements is correct given these two investment options? 58) ______ A) Both options are of equal value given that they both provide $20,000 of income. B) Option A is the better choice of the two given any positive rate of return. C) Option B has a higher present value than option A given a positive rate of return. D) Option B has a lower future value at year 5 than option A given a zero rate of return. E) Option A is preferable because it is an annuity due. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-58 You are comparing two investment options. Th...

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59) Alan Burnie has just started work and has been wanting to buy a sleek powerboat for some

time. Rather than purchase and finance now, he plans to save every three months and increase the deposits by 3% per annum as he expects raises at least that large. How much must the first deposit be if the boat costs $25,000 today and he expects to earn 10% on the money over the next five years? 59) ______ A) $1,501.56 B) $2,081.99 C) $1,561.49 D) $6,097.27 E) $2,359.82 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-59 Alan Burnie has just started work and has be...

60) Luis has a management contract that grants him a lump sum payment of $20 million is paid

upon the completion of his first five years of service. The company wants to set aside an equal amount of funds each year to cover this anticipated cash outflow. The company can earn 4.5 percent on these funds. How much must the company set aside each year for this purpose? 60) ______ A) $3,775,042.93 B) $3,798,346.17 C) $3,801,033.67 D) $3,655,832.79 E) $4,038,018.22 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-60 Luis has a management contract that grants h...

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

6.5 percent. One annuity will pay $2,000 annually, starting today, for 20 years. The second annuity will pay annually, starting one year from today, for 20 years. What is the annual payment for the second annuity? 61) ______ A) $2,225 B) $2,075 C) $2,000 D) $2,130 E) $2,405 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-61 You are comparing two annuities with equal p...

62) Kay owns two annuities that will each pay $500 a 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 annuities? 62) ______ A) $289.98 B) $265.42 C) $299.01 D) $308.00 E) $312.50 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-62 Kay owns two annuities that will each pay...

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63) The potential owner/managers of the yet-to-be-formed new In-Line Blade Company are

evaluating the prospects for the business. The new equipment is expected to be $5.5 million and has after-tax cash flows of $400,000 for the first two years, $750,000 in the next two years, and $1,200,000 thereafter indefinitely. The owners estimate that they require a 15% rate of return. What is the value of the In-Line Blade Company; should they go forward with the investment? 63) ______ A) $3,872,122; yes. B) $646,261.63; yes. C) -$2,000,000; no. D) $943,596; yes. E) $105,185; yes. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-05 Present Value and Discounting Source : Chapter 05 Test Bank > TB 05-63 The potential owner/managers of the yet-to-b...

64) The BobIU Computer Graphics Co. has just produced a new multimedia graphics chip which

will cost $6,000,000 this year to put into production. They anticipate net cash flows of $3 million next year, $2million, $1 million, $.5 million, $.25 million and then $0 over each of the following years. The two owners require a 15% return on their investment. The value of this investment to the firm is: 64) ______ A) $750,000.10 B) -$811,329.97 C) $556,462.71 D) $652,173.91 E) -$371,782.85 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 05-05 Present Value and Discounting Source : Chapter 05 Test Bank > TB 05-64 The BobIU Computer Graphics Co. has just pro...

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SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 65) Mr. Miser, who is 35 years old, has just inherited $11,000 and decides to use the windfall towards his retirement. He places the money in a bank, which promises a return of 6% per year until his planned retirement at age 65. If his funds earn 6% interest compounded annually, how much will he have at retirement? Repeat the analysis for both semi-annual and continuous compounding.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-65 Mr. Miser, who is 35 years old, has just inh...

66) An investment today of $3,300 is worth $10,000 in 8 years. At what rate has your investment

been growing (annually) over the 8 years?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 05-02 The Multiperiod Case Source : Chapter 05 Test Bank > TB 05-66 An investment today of...

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67) Joe, a freshman in college, needs $55,000 in 4 years to buy the car of his dreams. If his

investments earn 6% interest per year, how much must he invest today to have that amount at graduation? If he invested once a year for four years beginning today until the end of the 4 years how much must he invest?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-02 The Multiperiod Case Source : Chapter 05 Test Bank > TB 05-67 Joe, a freshman in college, needs...

68) Three factors affect the present value of an annuity. Explain what these three factors are and

discuss how an increase in each will impact the present value of the annuity.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 05-03 Future Value and Compounding Source : Chapter 05 Test Bank > TB 05-68 Three factors affect the present value of an...

69) Three factors affect the future value of an annuity. Explain what these three factors are and

discuss how an increase in each will impact the future value of the annuity.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-69 Three factors affect the future value of an ...

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70) As the winner of the Housecleaners sweepstakes, you are entitled to one of the following

prizes: A. $999,999 immediately. B. $100,000 per year forever. C. $180,000 per year for the next 10 years starting immediately. D. $400,000 payable every 2 years over 20 years. E. $39,000 next year growing by 6% forever. In terms of present values, which prize should be chosen if r = 9%?

71) Your aunt, in her will, left you the sum of $5,000 a year forever with payments starting

immediately. However, the news is better. She has specified that the amount should grow at 5% per year to maintain purchasing power. Given an interest rate of 12%, what is the PV of the inheritance?

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72) If you invest $100,000 today at 12% per year over the next 15 years, what is the most you

can spend in equal amounts out of the fund each year over that time?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-72 If you invest $100,000 today...

73) Tobi owns a perpetuity that will pay $1,500 a year, starting one year from now. He offers to

sell you all of the remaining payments after the next 25 payments have been paid. What price should you offer him for payments 26 onward if you desire a rate of return of 8 percent? What does your offer price illustrate about the value of perpetuities?

74) What is meant by "amortizing a loan"?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 05-04 The Power of Compounding: A Digression Source : Chapter 05 Test Bank > TB 05-74 What is meant by &#34;amortizing a loan&#34;?

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Answer Key Test name: Chapter 05 1) 2) 3) 4)

C B A A PV = $5,325. 00/(1 + 6. 5%) = $5,000. 00. 5) B 6) C

FV = $5,180*(1 + 6%)^2 + $9,600*(1 + 6%) + $2,250 = $18,246.25. 7) D 8) C

$1,000*(1 + 4%)^5 - $1000*(1 + 4%*5) = $16. 65. 9) C 10) B

Simple: $10,000*(1 + 8%*3) = $12,400. 00 Compound: 10000*(1 + 7. 5%)^3 = $12,422. 97. 11) E 12) C 13) D

$7,000*(1 + 7%)^4 = $9,175. 57. 14) B 15) A 16) A 17) D 18) D

= 100*(1-(1 + (6%/12))^(-12*4))/(6%/12) = $4,258. 03. 19) A

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20) A

PV = 50000*(1-(1 + 12%)^(-5))/12% = $180,238. 81. 21) B

PV = $1,500*(1+ (8%/4))^(4*5) = $2,228. 92. 22) D

FV = 9000*e^(7*11%) = $19,437. 90. 23) B

FV = 3000*EXP((3/4)*12%) = $3,282. 52. 24) C

PV = $25*(1-(1 + 5%/52)^(-52*20))/(5%/52) = $16,430. 54 25) B

FV = 5000*(1 + 6%/12)^(14). 26) A

Monthly Payments: PV = 641*(1-(1 + 6. 5%/12)^(-12*10))/(6. 5%/12) = $56,451. 91. 27) C

FV = 10000*(1 + 12%/4)^(1. 5*4) = $11,941. 28) B 29) E

FV = $7,500*(1 + 12. 36%/2)^(2. 5*2) = $10,122. 30) A 31) C 32) C

PV = 50000*(1-(1 + 4%)^(-4))/4% = $181,495. 33) B 34) B 35) A

NPV = -8000 + 10000/(1 + 10%) + 5000/(1 + 10%)^2 = $5,223.

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36) B

NPV = -33,000 + 25,000/(1 + 7%) + 12,000/((1 + 10%)*(1 + 7%)) = $559. 90. 37) B 38) B

EAR = +( 1 + 7. 64%/4)^4 - 1 = 7. 86%. 39) D

PV = $75/8% = $937. 50. 40) C

PV = $60/(9% - 4%) = $1,200. 41) A

PV = $21,000/(1 + 4%)^3 = $18,669. 42) A

PV = $500,000/(1 + 10%/2)^(2*3) = $373,108. 43) C

PV = $1. 5/(1 + 8%/2)^(2*1) + $1. 5/(1 + 8%/2)^(2*2) = $2. 67 Million. 44) C 45) C 46) D 47) A 48) C

A = 3500/((1-(1 + 12%/12)^(-36))/(12%/12)) = $ 116. 25 thus $115 is the closest. 49) B

PV = $160*(1-(1 + 4. 9%/12)^(-12*5))/(4. 9%/12) = $8,499. 13. 50) D 51) D

A = $20,000/((1-(1 + 10%)^(-5))/10%) = $5,275. 95. 52) C

PV = 5000*(1-(1 + 10%)^(-3))/10% = $12,434. 53) B

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PV = $8000*(1 + 7%)*(1-(1 + 7%)^(-15))/7% = $77,964. 54) E

FV = 10000*(1 + 11%)^25 + 15000*(1 + 11%)^24 + 25000*(1 + 11%)^23 = $595,098. 67. 55) A 56) A 57) B 58) B 59) B 60) D 61) D 62) A 63) B 64) B 65) Short Answer

$11,000(1.06)30 = $63,178.40 $11,000(1.03)60 = $64,867.63 $11,000. e(.06)(30) = $66,546.12 66) Short Answer

$10,000 = 3300(1 + r)8; 10,000/3300 = 3.0303 = (1 + r)8; 1 + r = 1.14864482 or 14.86%; PV = 3300, FV = 10,000 N = 8 PMT = 0 I/YR = ? = 14.86% 67) Short Answer

$55000/(1.06)4 = 43,565.15; $55,000/4.6371 = 11,860.86 68) Short Answer

The factors are the interest rate, payment amount, and the number of payments. An increase in the payment and number of payments will increase the present value, while an increase in the interest rate will decrease the present value. 69) Short Answer

The factors are the interest rate, payment amount, and number of payments. An increase in any of these three will increase the future value of the annuity. 70) Short Answer

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PV = $999,999 PV = $1,111,111 PV = $1,259,144 PV = $1,747,090 PV = $1,300,000 71) Short Answer

$5,000 + $5,000(1.05)/(.12 -.05) = $80,000 72) Short Answer

A = $100,000/((1-(1 + 12%)^(-15))/12%) = $14,682.42 73) Short Answer

Perpetuity value: PV = $1,500 /.08 = $18,750 Value of payments for first 25 years: PV = $1,500 × ({1 - [1 / (1 +.08)25]} /.08) = $16,012.16 Value of payments after the first 25 years: PV = $18,750 - 16,012.16 = $2,737.84 This can also be calculated as: PV = $18,750 / 1.0825 = $2,737.84 The present value of the perpetuity at any point in time is $18,750 at a discount rate of 8 percent. The present value of the next 25 payments is $16,012.16 while the present value of the remaining payments is only $2,737.84. This illustrates the value of a perpetuity is derived primarily from the payments received early in the annuity's remaining life while the payments to be received later have little worth today. 74) Short Answer

Amortizing a loan is when the borrower pays back the loan, both in principal and interest, over time. The process of providing for a loan to be paid off by making regular principal reductions is called amortizing the loan.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) A pure discount bond: 1) ______ A) has no face value. B) pays interest annually. C) pays interest semiannually. D) pays no coupon. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 06-02 How to Value Bonds Source : Chapter 06 Test Bank > TB 06-01 A pure discount bond:

2) A level coupon bond: 2) ______ A) pays the same principal every period. B) pays the same taxes every period. C) is a zero-coupon annuity. D) is an annuity over the life of the bond. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 06-02 How to Value Bonds Source : Chapter 06 Test Bank > TB 06-02 A level coupon bond:

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3) The coupon of a bond is: 3) ______ A) its time period to maturity. B) its current price. C) its face value. D) its yield to maturity. E) the amount of the interest payment. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 06-01 Definition and Example of a Bond Source : Chapter 06 Test Bank > TB 06-03 The coupon of a bond is:

4) Consider a bond that pays 7% semi-annually and has 8 years to maturity. The market requires

an interest rate of 8% on bonds of this risk. What is this bond's price? 4) ______ A) $942.50 B) $911.52 C) $941.74 D) $1064.81 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-02 How to Value Bonds Source : Chapter 06 Test Bank > TB 06-04 Consider a bond that pays...

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5) Gugenheim, Inc. offers a 7% coupon bond with annual payments. The yield to maturity is

5.85% and the maturity date is 9 years. What is the market price of a $1,000 face value bond? 5) ______ A) $742.66 B) $868.67 C) $869.67 D) $1,078.73 E) $1,079.59 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 06-02 How to Value Bonds Source : Chapter 06 Test Bank > TB 06-05 Gugenheim, Inc. offers a...

6) A consol: 6) ______ A) always sells at a premium. B) always sells at a discount. C) is an agent that makes interest payments. D) has no maturity. E) pays no interest. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 06-02 How to Value Bonds Source : Chapter 06 Test Bank > TB 06-06 A consol:

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7) A bond is listed in the Financial Post as 8.800 of September 22/25. This bond pays: 7) ______ A) $88.25 in July and January. B) $44 in July and January. C) $88.25 in July. D) $88 in July. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-02 How to Value Bonds Source : Chapter 06 Test Bank > TB 06-07 A bond is listed in the Financial Post as 8....

8) A bond with a 7% coupon that pays interest semi-annually and is priced at par will have a

market price of _____ and interest payments of _____ each. 8) ______ A) $1,000; $70 B) $1,070; $35 C) $1,070; $70 D) $1,000; $35 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-02 How to Value Bonds Source : Chapter 06 Test Bank > TB 06-08 A bond with a 7%...

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9) Queen and Bees, Inc. offers a 7% coupon bond with semiannual payments and a yield to

maturity of 7.73%. The bonds mature in 9 years. What is the market price of a $1,000 face value bond? 9) ______ A) $953.28 B) $963.88 C) $1,108.16 D) $1,401.26 E) $1,401.86 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-02 How to Value Bonds Source : Chapter 06 Test Bank > TB 06-09 Queen and Bees, Inc. offers a...

10) Part of the Rock, Inc. has a 6% coupon bond that matures in 11 years. The bond pays interest

semiannually. What is the market price of a $1,000 face value bond if the yield to maturity is 12.9%? 10) ______ A) $434.59 B) $580.86 C) $600.34 D) $605.92 E) $947.87 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-02 How to Value Bonds Source : Chapter 06 Test Bank > TB 06-10 Part of the Rock, Inc. has a ...

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11) Your firm offers a 10-year, zero-coupon bond. The yield to maturity is 8.8%. What is the

current market price of a $1,000 face value bond? 11) ______ A) $430.24 B) $473.26 C) $835.56 D) $919.12 E) $1,088.00 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-02 How to Value Bonds Source : Chapter 06 Test Bank > TB 06-11 Your firm offers a 10-year, zero-coupon bond...

12) The zero-coupon bonds of Quipta Inc. have a market price of $394.47, a face value of

$1,000, and a yield to maturity of 6.87%. How many years is it until this bond matures?? 12) ______ A) 7 years B) 10 years C) 14 years D) 18 years E) 21 years Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-02 How to Value Bonds Source : Chapter 06 Test Bank > TB 06-12 The zero-coupon bonds of Quipta Inc. have a ...

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13) If its yield to maturity is less than its coupon rate, a bond will sell at a ____, and increases in

market interest rates will ____. 13) ______ A) discount; decrease this discount. B) discount; increase this discount. C) premium; decrease this premium. D) premium; increase this premium. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 06-03 Pure Discount Bonds Source : Chapter 06 Test Bank > TB 06-13 If its yield to maturity is less than its co...

14) Zero-coupon bonds: 14) ______ A) always sell at a discount before maturity. B) always sell at a premium before maturity. C) have no face value. D) have no maturity. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 06-03 Pure Discount Bonds Source : Chapter 06 Test Bank > TB 06-14 Zero-coupon bonds:

15) The value of a 20-year zero-coupon bond when the market required rate of return of 9%

(compounded semi-annually) is: 15) ______ A) $414.64. B) $318.38. C) $171.93. D) $178.43. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-03 Pure Discount Bonds Source : Chapter 06 Test Bank > TB 06-15 The value of a 20-year zero-coupon bond when...

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16) A consol is selling at $1,200 with an interest rate of 5%. How much would this bond sell for

if the interest rate were 8% instead? 16) ______ A) $200. B) $750. C) $1,650. D) $1,920. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-03 Pure Discount Bonds Source : Chapter 06 Test Bank > TB 06-16 A consol is selling at...

17) All else constant, a bond will sell at _____ when the yield to maturity is _____ the coupon

rate. 17) ______ A) a premium; higher than B) a premium; equal to C) at par; higher than D) a discount; higher than Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 06-03 Pure Discount Bonds Source : Chapter 06 Test Bank > TB 06-17 All else constant, a bond will sell at _____...

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18) Which of the following amounts is closest to the value of a bond that pays $55 semiannually

and has an effective semiannual interest rate of 5%? The face value is $1,000 and the bond matures in 3 years. There are exactly six months before the first interest payment. 18) ______ A) $1,014. B) $1,055. C) $888. D) $1,025. E) $1,000. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-03 Pure Discount Bonds Source : Chapter 06 Test Bank > TB 06-18 Which of the following amounts is closest to...

19) All else constant, a coupon bond that is selling at a premium, must have: 19) ______ A) a coupon rate that is equal to the yield to maturity. B) a market price that is less than par value. C) semi-annual interest payments. D) a yield to maturity that is less than the coupon rate. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 06-03 Pure Discount Bonds Source : Chapter 06 Test Bank > TB 06-19 All else constant, a coupon bond that is sel...

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20) The newly issued bonds of the Cain Corp. offer a 6% coupon with semiannual interest

payments. The bonds are currently priced at par value. The effective annual rate provided by these bonds must be: 20) ______ A) equal to 3%. B) greater than 3% but less than 4%. C) equal to 6%. D) greater than 6% but less than 7%. E) equal to 12%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-03 Pure Discount Bonds Source : Chapter 06 Test Bank > TB 06-20 The newly issued bonds of the Cain Corp. off...

21) A 12-year, 5% coupon bond pays interest annually. The bond has a face value of $1,000.

What is the percentage change in the price of this bond if the market yield rises to 6% from the current yield of 4.5%? 21) ______ A) 11.11% decrease B) 12.38% decrease C) 12.38% increase D) 14.13% decrease E) 14.13% increase Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 06-03 Pure Discount Bonds Source : Chapter 06 Test Bank > TB 06-21 A 12-year, 5% coupon...

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22) Jackson Central has a 6-year, 8% annual coupon bond with a $1,000 par value. Earls

Enterprises has a 12-year, 8% annual coupon bond with a $1,000 par value. Both bonds currently have a yield to maturity of 6%. Which of the following statements are correct if the market yield increases to 7%? 22) ______ A) Both bonds would decrease in value by 4.61%. B) The Earls bond will increase in value by $88.25. C) The Jackson bond will increase in value by 4.61%. D) The Earls bond will decrease in value by 7.56%. E) The Earls bond will decrease in value by $50.68. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 06-03 Pure Discount Bonds Source : Chapter 06 Test Bank > TB 06-22 Jackson Central has a 6-year,...

23) The value of common stock today depends on: 23) ______ A) the expected future holding period and the discount rate. B) the expected future dividends and the capital gains. C) the expected future dividends, capital gains and the discount rate. D) the expected future holding period and capital gains. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 06-04 Level-Coupon Bonds Source : Chapter 06 Test Bank > TB 06-23 The value of common stock today depends on:

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24) Weisbro and Sons' common stock sells for $21 a share and pays an annual dividend that

increases by 5% annually. The market rate of return on this stock is 9%. What is the amount of the last dividend paid by Weisbro and Sons? 24) ______ A) $.77 B) $.80 C) $.84 D) $.87 E) $.88 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-04 Level-Coupon Bonds Source : Chapter 06 Test Bank > TB 06-24 Weisbro and Sons&#39; common...

25) The Double Dip Co. is expecting its ice cream sales to decline due to the increased interest in

healthy eating. Thus, the company has announced that it will be reducing its annual dividend by 5% a year for the next two years. After that, it will maintain a constant dividend of $1 a share. Two weeks ago, the company paid a dividend of $1.40 per share. What is this stock worth if you require a 9% rate of return? 25) ______ A) $10.86 B) $11.11 C) $11.64 D) $12.98 E) $14.23 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 06-04 Level-Coupon Bonds Source : Chapter 06 Test Bank > TB 06-25 The Double Dip Co. is expecting its ice crea...

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26) Which of the following amounts is closest to what should be paid for Overland common

stock? Overland has just paid a dividend of $2.25. These dividends are expected to grow at a rate of 5% in the foreseeable future. The required rate of return is 11%. 26) ______ A) $20.45 B) $21.48 C) $37.50 D) $39.38 E) $47.70 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-04 Level-Coupon Bonds Source : Chapter 06 Test Bank > TB 06-26 Which of the following amounts is closest to...

27) The Felix Corp. projects to pay a dividend of $.75 next year and then have it grow at 12% for

the following 3 years before growing at 8% indefinitely thereafter. The equity has a required return of 10% in the market. The price of the stock should be ___. 27) ______ A) $9.38 B) $17.05 C) $41.67 D) $59.80 E) $62.38 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 06-04 Level-Coupon Bonds Source : Chapter 06 Test Bank > TB 06-27 The Felix Corp. projects to pay a dividend o...

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28) A stock you are interested in paid a dividend of $1 last month. The anticipated growth rate in

dividends and earnings is 25% for the next 2 years before settling down to a constant 5% growth rate. The discount rate is 12%. Calculate the expected price of the stock. 28) ______ A) $15.38 B) $20.50 C) $21.05 D) $22.27 E) $26.14 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 06-04 Level-Coupon Bonds Source : Chapter 06 Test Bank > TB 06-28 A stock you are interested in paid a dividen...

29) The dividend growth rate is equal to the product of what two ratios? 29) ______ A) ROA, current ratio. B) ROE, retention ratio. C) PM, ROA. D) ROA, ROE. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 06-05 Consols Source : Chapter 06 Test Bank > TB 06-29 The dividend growth rate is equal to the pro...

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30) Which of the following values is closest to the amount that should be paid for a stock that

will pay a dividend of $10 one year from now and $11 two years from now? The stock will be sold in 2 years for an estimated price of $120. The appropriate discount rate is 9%. 30) ______ A) $114. B) $119. C) $124. D) $129. E) $138. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-04 Level-Coupon Bonds Source : Chapter 06 Test Bank > TB 06-30 Which of the following values is closest to ...

31) Which of the following amounts is closest to what should be paid for Overland common

stock? Overland has just paid a dividend of $2.25. These dividends are expected to grow at a rate of 5% in the foreseeable future. The risk of this company suggests that future cash flows should be discounted at a rate of 11%. 31) ______ A) $39.38 B) $37.50 C) $21.48 D) $20.45 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-04 Level-Coupon Bonds Source : Chapter 06 Test Bank > TB 06-31 Which of the following amounts is closest to...

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32) 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 $1.36 per year? The next dividend will be paid in exactly 1 year. The required rate of return is 12.5%. 32) ______ A) $17.00 B) $9.52 C) $10.88 D) $12.24 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 06-04 Level-Coupon Bonds Source : Chapter 06 Test Bank > TB 06-32 What would be the maximum an investor should...

33) Mortgage Instruments Inc. is expected to pay dividends of $1.03 next year. The company just

paid dividends of $1. This growth rate is expected to continue. How much should be paid for Mortgage Instruments stock if the appropriate discount rate is 5%? 33) ______ A) $20. B) $21. C) $34. D) $52. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-04 Level-Coupon Bonds Source : Chapter 06 Test Bank > TB 06-33 Mortgage Instruments Inc. is expected to pay...

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34) S&P Inc. common stock sells for $39.86 a share at a market rate of return of 9.5%. The

company just paid its annual dividend of $1.20. What is the rate of growth of its dividend? 34) ______ A) 5.2% B) 5.5% C) 5.9% D) 6.0% E) 6.3% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-04 Level-Coupon Bonds Source : Chapter 06 Test Bank > TB 06-34 S&amp;P Inc. common stock sells for...

35) A company just paid a dividend of $0.40. The dividends are expected to grow at a rate of 7%

for the next six years and then at a rate of 4% thereafter. The expected dividend in year 8 is: 35) ______ A) $4.33. B) $0.65. C) $4.39. D) $0.69. E) $0.67. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-04 Level-Coupon Bonds Source : Chapter 06 Test Bank > TB 06-35 A company just paid a dividend of...

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36) The Bell Weather Co. is a new firm in a rapidly growing industry. The company is planning

on increasing its annual dividend by 20% a year for the next four years and then decreasing the growth rate to 5% per year. The company just paid its annual dividend of $1.00 per share. What is the current value of one share if the required rate of return is 9.25%? 36) ______ A) $35.63 B) $38.19 C) $41.05 D) $43.19 E) $45.81 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 06-04 Level-Coupon Bonds Source : Chapter 06 Test Bank > TB 06-36 The Bell Weather Co. is a new firm in a rapi...

37) Zeta Corporation has issued a $1,000 face value zero-coupon bond. Which of the following

values is closest to the correct price for the bond if the appropriate discount rate is 4% and the bond matures in 8 years? 37) ______ A) $968. B) $731. C) $1,000. D) $1,125. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-02 How to Value Bonds Source : Chapter 06 Test Bank > TB 06-37 Zeta Corporation has issued a...

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38) The No-zip Snap Company had net earnings of $127,000 this past year. Dividends were paid

of $38,100 on the company's equity of $1,587,500. The estimated growth rate for No-Zip is: 38) ______ A) 2.4% B) 5.6% C) 7.2% D) 16.8% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-05 Consols Source : Chapter 06 Test Bank > TB 06-38 The No-zip Snap Company had net earnings of ...

39) The No-zip Snap Company had net earnings of $127,000 this past year. Dividends were paid

of $38,100 on the company's equity of $1,587,500. If No-Zip has 100,000 shares outstanding with a current market price of $11 5/8 per share, what is the required rate of return? 39) ______ A) 9% B) 6% C) 4.2% D) 14% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-05 Consols Source : Chapter 06 Test Bank > TB 06-39 The No-zip Snap Company had net earnings of ...

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40) Martha's Vineyard recently paid a $3.60 annual dividend on its common stock. This dividend

increases at an average rate of 3.5% per year. The stock is currently selling for $62.10 a share. What is the market rate of return? 40) ______ A) 2.5% B) 3.5% C) 5.5% D) 6.0% E) 9.5% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-05 Consols Source : Chapter 06 Test Bank > TB 06-40 Martha&#39;s Vineyard recently paid...

41) The discount rate in equity valuation is composed entirely of: 41) ______ A) the dividends paid and the capital gains yield. B) the dividend yield and the growth rate. C) the dividends paid and the growth rate. D) the capital gains earned and the growth rate. E) the capital gains earned and the dividends paid. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 06-05 Consols Source : Chapter 06 Test Bank > TB 06-41 The discount rate in equity valuation is com...

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42) The common stock of Samson Inc. offers an expected total return of 12%. The dividend is

increasing at a constant 8% per year. The dividend yield must be: 42) ______ A) -4%. B) 4%. C) 8%. D) 12%. E) 20%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-05 Consols Source : Chapter 06 Test Bank > TB 06-42 The common stock of Samson Inc. offers an ex...

43) Assume that you are using the dividend growth model to value stocks. If you expect the

market rate of return to increase across the board on all equity securities, then you should also expect the: 43) ______ A) market values of all stocks to increase, all else constant. 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, all else constant. 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 06-05 Consols Source : Chapter 06 Test Bank > TB 06-43 Assume that you are using the dividend growt...

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44) A corporate bond with a face value of $1,000 matures in 4 years and has an 8% coupon paid

at the end of each year. The current price of the bond is $932. What is the yield to maturity for this bond? 44) ______ A) 5.05%. B) 8.58%. C) 10.15%. D) 11.92%. E) 6.48%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-03 Pure Discount Bonds Source : Chapter 06 Test Bank > TB 06-44 A corporate bond with a face value of...

45) Angelina's made two announcements concerning its common stock today. First, the company

announced that its next annual dividend will be $2.16 per share. Secondly, the company announced that future dividends will increase by 4% annually. What is the maximum amount you should pay to purchase a share of Angelina's stock if your goal is to earn a 10% rate of return? 45) ______ A) $21.60 B) $22.46 C) $27.44 D) $34.62 E) $36.00 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 06-04 Level-Coupon Bonds Source : Chapter 06 Test Bank > TB 06-45 Angelina&#39;s made two announcements...

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46) ABC Imports paid a $1.00 per share annual dividend last week. Dividends are expected to

increase by 5% annually. What is one share of this stock worth to you today if the appropriate discount rate is 14%? 46) ______ A) $7.14 B) $7.50 C) $11.11 D) $11.67 E) $12.25 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 06-04 Level-Coupon Bonds Source : Chapter 06 Test Bank > TB 06-46 ABC Imports paid a...

47) The common stock of Eddie's Engines Corp. sells for $25.71 a share. The stock is expected

to pay $1.80 per share next month when the annual dividend is distributed. Eddie's has established a pattern of increasing its dividends by 4% annually and expects to continue doing so. What is the market rate of return on this stock? 47) ______ A) 7% B) 9% C) 11% D) 13% E) 15% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-04 Level-Coupon Bonds Source : Chapter 06 Test Bank > TB 06-47 The common stock of Eddie&#39;s...

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48) LCP, a newly formed medical group, is currently paying dividends of $.50. These dividends

are expected to grow at a 20% rate for the next 5 years and at a 3% rate thereafter. What is the value of the stock if the appropriate discount rate is 12%? 48) ______ A) $8.08. B) $11.17. C) $14.22. D) $17.32. E) $30.90. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 06-04 Level-Coupon Bonds Source : Chapter 06 Test Bank > TB 06-48 LCP, a newly formed medical group, is curren...

49) The discount rate can be thought of as the sum of what two parts? 49) ______ A) ROE, retention ratio. B) Dividend yield, growth rate in dividends. C) Price, growth rate in dividends. D) Dividend yield, price. E) ROA, ROE. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 06-05 Consols Source : Chapter 06 Test Bank > TB 06-49 The discount rate can be thought of as the s...

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50) A firm's value increases when it invests in projects that have: 50) ______ A) a rate of return less than the discount rate. B) a rate of return equal to the discount rate. C) a rate of return greater than the discount rate. D) a rate of return equal to or less than the discount rate. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-50 A firm&#39;s value increases...

51) A firm is known as a 'Cash Cow': 51) ______ A) because it has several good growth opportunities. B) because it pays out all of its non-growing earnings. C) because dividends are growing at a rapid rate. D) because the discount rate is extremely low. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 06-07 Interest Rates and Bond Prices Source : Chapter 06 Test Bank > TB 06-51 A firm is known as a &#39;Cash Cow&#39;:

52) The P/E ratio is a multiple of earnings that investors pay for a stock. The P/E is __________

related to growth, __________ related to the discount rate, and __________ related to the stock's risk. 52) ______ A) positively; positively; negatively. B) negatively; positively; positively. C) positively; negatively; negatively. D) negatively; negatively; positively. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Hard Topic : 06-07 Interest Rates and Bond Prices Source : Chapter 06 Test Bank > TB 06-52 The P/E ratio is a multiple of earnings that...

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53) Firms with higher expected growth opportunities usually sell for: 53) ______ A) a lower price earnings multiple. B) the same price earnings multiple for all firms. C) a higher price earnings multiple. D) a price that depends on the payout ratio only. E) a price independent of the P/E. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 06-07 Interest Rates and Bond Prices Source : Chapter 06 Test Bank > TB 06-53 Firms with higher expected growth opportunit...

54) The average Japanese P/E ratio was reported as between 40 and 100 in recent years while the

average U.S. P/E ratio was 25. The reason for the higher Japanese P/E ratio has been partially explained by: 54) ______ A) growth opportunities over stated earnings. B) understated earnings and low interest rates. C) overstated earnings and low interest rates. D) understated earnings and overstated growth opportunities. E) low interest rates and greater growth opportunities. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 06-08 Yield to Maturity Source : Chapter 06 Test Bank > TB 06-54 The average Japanese P/E ratio was reported ...

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55) Stand Still Co. has been earning $1 per share on 400,000 shares and paying all earnings out.

The cost of capital for a company of this risk is 10%. The company has an investment opportunity that costs $1,500,000 and will earn $230,000 after taxes per year. The company must reinvest 35% of these earnings to continue the expansion. What is the value of the company without the investment and with the investment? 55) ______ A) $200,000; $1,500,000 B) $4,000,000; $6,600,000 C) $4,000,000; $3,995,000 D) $400,000; $15,000,000 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-55 Stand Still Co. has been earning...

56) The net present value of a growth opportunity, NPVGO, can be defined as: 56) ______ A) the present value of an investment in one new project. B) the steady growth in dividends from continual re-investment with positive NPV. C) continual reinvestment of earnings when r < g. D) a single period investment when r > g. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-56 The net present value of a growth opportunit...

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57) If the quoted dividend yield in the paper was 2.2% and the dividend was listed as $0.72 what

price is used in the calculation of dividend yield? 57) ______ A) the day open of $32.15. B) the day low of $32. C) the day close of $32.73. D) the day high of $33.50. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-05 Consols Source : Chapter 06 Test Bank > TB 06-57 If the quoted dividend yield in the paper wa...

58) The closing price of a stock is quoted at 22.87, with a P/E of 26 and a net change of 1.42.

Based on this information, which one of the following statements is correct? 58) ______ A) The closing price on the previous day was $1.42 higher than today's closing price. B) A dealer will buy the stock at $22.87 and sell it at $26 a share. C) The stock increased in value between yesterday's close and today's close by $.0142. D) The earnings per share are equal to 1/26th of $22.87. E) The earnings per share have increased by $1.42 this year. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-10 Holding-Period Return Source : Chapter 06 Test Bank > TB 06-58 The closing price of a stock is quoted at 22...

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59) Spot rates are the interest rates that prevail in the market from: 59) ______ A) the current period until the sale of the security. B) time zero until the asset's maturity. C) one period forward to maturity. D) some unknown future period. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-59 Spot rates are the interest rates that preva...

60) The term structure can be described as the: 60) ______ A) relationship of spot rates of interest and bond prices. B) relationship of coupon rates and money rates. C) relationship of spot rates of interest and maturity. D) relationship of coupon rates and maturity. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-60 The term structure can be described as the:

61) Which of the following statements is true? 61) ______ A) The spot rate is a weighted average of the yields to maturity. B) The spot rate is always higher than the yield to maturity. C) The yield to maturity is a weighted average of spot rates. D) The yield to maturity is always higher than the spot rate. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-61 Which of the following statements is true?

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62) A forward rate prevailing from period three through to period four can be: 62) ______ A) readily observed in the market place. B) extracted from high coupon bonds. C) extracted from spot rates with 2 and 3-year maturities. D) extracted from spot rates with 3 and 4-year to maturity. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Hard Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-62 A forward rate prevailing from period three ...

63) The expectations hypothesis states that the forward rate over second period is: 63) ______ A) set to the one-period spot rate expected to prevail over the second period. B) equal to the first period spot rate. C) always greater than the spot rate in period one. D) always greater than the period 3 forward rate. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-63 The expectations hypothesis states that the ...

64) Term structure refers to: 64) ______ A) how interest rates vary over different structures of bonds. B) how interest rates vary over different structures of corporate securities. C) how interest rates vary over time for similar bonds with different maturities. D) the maturity dates of a bond issue. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-64 Term structure refers to:

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65) Which of the following amounts is closest to the present value of a bond with coupon

payment of $80 and a face value of $1,000? Interest payments are made at the end of each of 2 years, and the bond matures in 2 years. The spot interest rate for the first year is 10%, and the spot interest rate for the second year is 12%. 65) ______ A) $910 B) $934 C) $949 D) $1,000 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-65 Which of the following amounts is closest to...

66) What can you deduce about forward rates of interest if the liquidity-preference hypothesis of

the term structure is correct? 66) ______ A) The forward rate is less than investor's expectations of next year's one-year interest

rate. B) The forward rate is greater than investor's expectations of next year's one-year interest rate. C) The forward rate is equal to investor's expectations of next year's one-year interest rate. D) The forward rate is equal to the risk-free interest rate. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-66 What can you deduce about forward rates of i...

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67) Given r1 = .050 and r2 = .054, what can you deduce about investor's expectations of future

short-term interest rates if the expectations hypothesis is correct? 67) ______ A) Investors expect future short-term rates to be greater than current short-term rates. B) Investors expect future short-term rates to be less than current short-term rates. C) Investors expect future short-term rates to be equal to current short-term rates. D) Investors expect future short-term rates to be higher than current forward rates. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-67 Given r1 = .050 and r2 = .054, what can you ...

68) The market rate of interest on 2 year bonds is 6.25% while the rate on a one year bond

maturing on one year is 5.50%. The forward rate on a one year bond one year from now is 6.5%. The liquidity premium to induce investors to hold the 2 year bond is: 68) ______ A) 0.250%. B) 0.005%. C) 0.125%. D) 0.500%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-68 The market rate of interest on 2 year bonds ...

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69) Suppose that a bond that will mature in three years is now traded at $99.83. The annual

coupon payment is $5.635. Its yield to maturity is (Round of to one decimal) 69) ______ A) 3.42%. B) 5.10%. C) 5.70%. D) 7.20%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-69 Suppose that a bond that will mature in thre...

70) The liquidity preference hypothesis explains that the 2nd year forward rates are set higher

than the expected spot rate over year two because: 70) ______ A) of a downward sloping yield curve. B) of long term rates being greater than short term rates. C) investors must be induced to buy the riskier two-year bond. D) two year bonds are less risk than one year's bonds when rates are higher. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-70 The liquidity preference hypothesis explains...

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71) Suppose that an investor disagrees with market expectations and feels that the forward rate

prevailing in the market is higher than what it should be, then the investor can make profit by: 71) ______ A) selling a bond now and buying it up later. B) selling a bond now. C) buying a bond now. D) buying a bond now and selling it later. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-71 Suppose that an investor disagrees with mark...

72) Suppose that a bond that will mature in two years has a face value of $1000 and a 20%

coupon rate. The one-year spot market interest rate is 13% and the expected second period's forward rate is 12%. According to the expectation hypothesis, the two-year spot rate is: 72) ______ A) 11.50%. B) 9.12%. C) 12.74%. D) 7.00%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-72 Suppose that a bond that will mature in two ...

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73) In the above example, the price of the bond is 73) ______ A) $1121. B) $1000. C) $1325. D) $1200. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-73 In the above example, the price of the bond ...

74) Suppose that there are three zero coupon bonds with maturity date 1 year, 2 year and 3 year

respectively. The current price of the 1 year, 2 year and 3 year bonds respectively are $826.45, $718.18 and $640.66 respectively. The yield to maturity of the first year bond is: 74) ______ A) 21%. B) 18%. C) 12%. D) 11%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-74 Suppose that there are three zero coupon bon...

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75) A 25-year bond has 2 years left till maturity. It will mature for a value of $1,000 and the

bond has a coupon rate of 14% compounded annually. The bond is currently selling for $937.37. What is the current yield to maturity (rounded to the nearest whole percentage)? 75) ______ A) 21%. B) 18%. C) 12%. D) 11%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-75 A 25-year bond has 2 years left till maturit...

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 76) 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.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 06-04 Level-Coupon Bonds Source : Chapter 06 Test Bank > TB 06-76 A number of publicly traded firms pay no div...

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77) Calculate the YTM on a bond priced at $1,036 which has 2 years to maturity, a 10% coupon

rate, and a return of $1,000 at maturity.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 06-03 Pure Discount Bonds Source : Chapter 06 Test Bank > TB 06-77 Calculate the YTM on a bond priced at...

78) Given the opportunity to invest in one of the three bonds listed below, which would you

purchase? Assume an interest rate of 7%. Bond

Face Value

Annual Coupon Rate

Maturity

Price

$1,000

1 year

$990

$1,000

7.5%

17 years

$990

$1,000

8.5%

25 years

$990

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 06-03 Pure Discount Bonds Source : Chapter 06 Test Bank > TB 06-78 Given the opportunity to invest in one of th...

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79) Show that a firm with earnings of $10,000 a year in perpetuity would be better off paying all

earnings in dividends rather than investing 25% of its earnings (also in perpetuity) in projects earning 14% if its discount rate is 15%.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-79 Show that a firm with earnings of...

80) Given the following set of spot rates: Year

Spot Rate

.050

.054

.059

.066

Calculate the 1-year forward rates over each of the next 3 years.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 06-06 Bond Concepts Source : Chapter 06 Test Bank > TB 06-80 Given the following set of spot rates:[Creat...

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81) Explain why some bond investors are subject to liquidity risk and/or default risk. How does

each of these risks affect the yield of a bond?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 06-03 Pure Discount Bonds Source : Chapter 06 Test Bank > TB 06-81 Explain why some bond investors are subject ...

82) Define what is meant by interest rate risk. Assume you are the manager of a $100 million

portfolio of corporate bonds and you believe interest rates will fall. What adjustments should you make to your portfolio based on your beliefs?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 06-03 Pure Discount Bonds Source : Chapter 06 Test Bank > TB 06-82 Define what is meant by interest rate risk. ...

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Answer Key Test name: Chapter 06 1) 2) 3) 4) 5) 6) 7) 8)

D D E C D D B D $1,000; $35. 9) A 10) C 11) A 12) C 13) C 14) A 15) C 16) B 17) D 18) D 19) D 20) D 21) B 22) D 23) C 24) B 25) C 26) D 27) C 28) C 29) B 30) B 31) A 32) C 33) D 34) E 35) B

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36) C 37) B 38) B 39) A 40) E 41) B 42) B 43) C 44) C 45) E 46) D 47) C 48) B 49) B 50) C 51) B 52) C 53) C 54) D 55) C 56) B 57) C 58) D 59) B 60) C 61) C 62) D 63) A 64) C

how interest rates vary over time for similar bonds with different maturities. 65) B 66) B 67) A 68) D 69) C

5.70%. 70) C 71) D 72) C

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73) A 74) A 75) B 76) Short Answer

Our basic principle of stock valuation is that the value of a share of stock is simply equal to the present value of all of the expected dividends on the stock. According to the dividend growth model, an asset that has no expected cash flows has a value of zero, so if investors are willing to purchase shares of stock in firms that pay no dividends, they evidently expect that the firms will begin paying dividends at some point in the future. 77) Short Answer

$1.036 = 100/(1 + YTM)1 + 1,100/(1 + YTM)2? YTM = 8%. 78) Short Answer

PV of Bond A = $971.96 < Price Do not buy YTM (5.05) PV of Bond B = $1048.82 > Price Buy YTM (7.61) PV of Bond C = $1,174.80 > Price Buy YTM (8.6) 79) Short Answer

All as dividends: Value = $10,000/.15 = $66,667 Investment: Value = $7,500/.15 + (-2,500 + 2,850/1.15)/.15 = $50,000 - 144.93 = $49,855.07 80) Short Answer

1-year forward rate next year: 1.0542/1.050 = 1.058 1-year forward rate in 2 years: 1.0593/1.0542 = 1.069 1-year forward rate in 3 years: 1.0664/1,9583 = 1.087 81) Short Answer

Liquidity problems exist in thinly traded bonds making some bonds difficult to sell at their actual value. Default risk is the likelihood the corporation will default on its bond obligations. If either (or both) of these risks exist, investors will require compensation by demanding a high yield. 82) Short Answer

Interest rate risk is the risk that arises for bond owners from fluctuating interest rates. All else the same, if interest rates are expected to fall you should purchase long-term bonds and/or low coupon bonds, and sell shorter-term, higher-coupon bonds.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) A $25 investment produces $27.50 at the end of the year with no risk. Which of the following is not true? 1) ______ A) NPV is positive if the interest rate is less than 10%. B) NPV is negative if the interest rate is less than 10%. C) NPV is zero if the interest rate is equal to 10%. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 07-01 Why Use Net Present Value? Source : Chapter 07 Test Bank > TB 07-01 A $25 investment produces ...

2) The difference between the present value of an investment's future cash flows and its initial

cost is the: 2) ______ A) net present value. B) internal rate of return. C) pay back period. D) discounted pay back period. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 07-01 Why Use Net Present Value? Source : Chapter 07 Test Bank > TB 07-02 The difference between the present value of ...

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3) Accepting positive NPV projects benefits the stockholders because: 3) ______ A) it most easily understood valuation process. B) the value of the expected cashflows are equal to the cost. C) the value of the expected cashflows are greater than the cost. D) it is the most easily calculated. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 07-01 Why Use Net Present Value? Source : Chapter 07 Test Bank > TB 07-03 Accepting positive NPV projects benefits the...

4) Which statement concerning the net present value (NPV) of an investment or a financing

project is correct? 4) ______ A) a financing project should be accepted if, and only if, the NPV is exactly equal to

zero. B) an investment project should be accepted only if the NPV is equal to the initial cash flow. C) any type of project should be accepted if the NPV is positive and rejected if it is negative. D) any type of project with greater total cash inflows than total cash outflows, should always be accepted. E) an investment project that has positive cash flows for every time period after the initial investment should be accepted. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 07-01 Why Use Net Present Value? Source : Chapter 07 Test Bank > TB 07-04 Which statement concerning the net present v...

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5) Which of the following does not characterize NPV? 5) ______ A) NPV is the simplest of all investment rules. B) NPV incorporates all relevant information. C) NPV uses all of the project's cash flows. D) NPV discounts all future cash flows. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 07-01 Why Use Net Present Value? Source : Chapter 07 Test Bank > TB 07-05 Which of the following does not characterize...

6) If a project is assigned a required rate of return equal to zero, then: 6) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 07-01 Why Use Net Present Value? Source : Chapter 07 Test Bank > TB 07-06 If a project is assigned a required rate of ...

7) Payback is frequently used to analyze independent projects because: 7) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 07-02 The Payback Period Rule Source : Chapter 07 Test Bank > TB 07-07 Payback is frequently used to analyze indepe...

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8) The payback period rule accepts all investment projects in which the payback period for the

cash flows is: 8) ______ A) greater than or equal to the cut-off point. B) greater than the cut-off point. C) less than the cut-off point. D) positive. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 07-02 The Payback Period Rule Source : Chapter 07 Test Bank > TB 07-08 The payback period rule accepts all investme...

9) Consider an investment with an initial cost of $20,000 and is expected to last for 5 years. The

expected cash flow in years 1 and 2 are $5000, in years 3 and 4 are $5,500 and in year 5 is $1,000. The total cash inflow is expected to be $22,000 or an average of $4,400 per year. Compute the payback period in years. 9) ______ A) 3.18 B) 3.82 C) 4.55 D) 4.00 Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 07-02 The Payback Period Rule Source : Chapter 07 Test Bank > TB 07-09 Consider an investment with an initial cost ...

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10) An investment project is most likely to be accepted by the payback period rule and not

accepted by the NPV rule if the project has: 10) ______ A) a large initial investment with moderate positive cash flows over a very long period of

time. B) a very large negative cash flow at the termination of the project. C) most of the cash flow at the beginning of the project. D) All projects approved by the payback period rule will be accepted by the NPV rule. E) The payback period rule and the NPV rule cannot be used to evaluate the same type of projects. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 07-02 The Payback Period Rule Source : Chapter 07 Test Bank > TB 07-10 An investment project is most likely to be a...

11) The discounted payback rule states that you should accept projects: 11) ______ A) which have a discounted payback period that is greater than some pre-specified

period of time. B) if the discounted payback is positive and rejected if it is negative. C) only if the discounted payback period equals some pre-specified period of time. D) if the discounted payback period is less than some pre-specified period of time. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 07-03 Defining the Rule Source : Chapter 07 Test Bank > TB 07-11 The discounted payback rule states that you ...

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12) An investment with an initial cost of $16,000 produces cash flows of $5000 annually. If the

cash flow is evenly spread out over the year and the firm can borrow at 10%, the discounted payback period is _____ years. 12) ______ A) 4.55 B) 4.05 C) 3.20 D) 3.52 Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 07-03 Defining the Rule Source : Chapter 07 Test Bank > TB 07-12 An investment with an initial cost of ...

13) An investment project has the cashflow stream of -250, 75, 125, 100, and 50. The cost of

capital is 12%. What is the discount payback period? 13) ______ A) 2.5 years. B) 2.7 years. C) 3.38 years. D) 1.40 years. E) 1.25 years. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 07-03 Defining the Rule Source : Chapter 07 Test Bank > TB 07-13 An investment project has the cashflow strea...

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14) The discounted payback period rule: 14) ______ A) considers the time value of money. B) discounts the cutoff point. C) ignores uncertain cash flows. D) is preferred to the NPV rule. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 07-03 Defining the Rule Source : Chapter 07 Test Bank > TB 07-14 The discounted payback period rule:

15) The payback period rule: 15) ______ 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 so that depreciation is just equal to positive cash flows in the payback year. C) requires an arbitrary choice of a cut-off point. D) varies the cut-off point with the interest rate. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 07-02 The Payback Period Rule Source : Chapter 07 Test Bank > TB 07-15 The payback period rule:

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16) Which one of the following statements is correct concerning the payback period? 16) ______ A) An investment is acceptable if its calculated payback period is less than some pre-

specified period of time. B) An investment should be accepted if the payback is positive and rejected if it is negative. C) An investment should be rejected if the payback is positive and accepted if it is negative. D) An investment is acceptable if its calculated payback period is greater than some prespecified period of time. E) An investment should be accepted any time the payback period is less than the discounted payback period, given a positive discount rate. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 07-02 The Payback Period Rule Source : Chapter 07 Test Bank > TB 07-16 Which one of the following statements is cor...

17) It will cost $3,000 to acquire a small ice cream cart. Cart sales are expected to be $1,400 a

year for three years. After the three years, the cart is expected to be worthless as that is the expected remaining life of the cooling system. What is the payback period of the ice cream cart? 17) ______ A) 0.83 years. B) 1.14 years. C) 1.83 years. D) 2.14 years. E) 2.83 years. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 07-02 The Payback Period Rule Source : Chapter 07 Test Bank > TB 07-17 It will cost $3,000 to acquire a...

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18) A project has an initial cost of $8,600 and produces cash inflows of $3,200, $4,900, and

$1,500 over the next three years, respectively. What is the discounted payback period if the required rate of return is 8%? 18) ______ A) 2.05 years B) 2.13 years C) 2.33 years D) 3.00 years E) never Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 07-03 Defining the Rule Source : Chapter 07 Test Bank > TB 07-18 A project has an initial cost of ...

19) Ginny is considering an investment that will cost her $120,000. The investment produces no

cash flows for the first year. In the second year, the cash inflow is $35,000. This inflow will increase to $55,000 and then $75,000 for the following two years before ceasing permanently. Ginny requires a 10% rate of return and has a required discounted payback period of three years. Ginny should _______ this project because the discounted payback period is ______. 19) ______ A) accept; 2.03 years B) accept; 2.97 years C) accept; 3.97 years D) reject; 3.03 years E) reject; 3.97 years Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 07-03 Defining the Rule Source : Chapter 07 Test Bank > TB 07-19 Ginny is considering an investment that will...

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20) The average accounting rate of return is determined by: 20) ______ A) dividing the yearly cashflows by the investment. B) dividing the average cashflows by the investment. C) dividing the average net income by the average investment. D) dividing the average net income by the initial investment. E) dividing the net income by the cashflow. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 07-04 Problems with the Payback Method Source : Chapter 07 Test Bank > TB 07-20 The average accounting rate of return is det...

21) The investment decision rule that relates average net income to average investment is the: 21) ______ A) discounted cash flow rule. B) average accounting rate of return method. C) average payback rule. D) average profitability index. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 07-04 Problems with the Payback Method Source : Chapter 07 Test Bank > TB 07-21 The investment decision rule that relates av...

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22) An investment that requires an initial cash outlay of $100,000 has a useful life of 3 years. In

each of these years, the before-tax cash flow is $40,000. If the tax rate is 34% and straightline depreciation is used, the average accounting return is: 22) ______ A) 40.00%. B) 26.40%. C) 13.34%. D) 4.4% Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 07-04 Problems with the Payback Method Source : Chapter 07 Test Bank > TB 07-22 An investment that requires an initial cash ...

23) The internal rate of return for a project will increase if: 23) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 07-05 Managerial Perspective Source : Chapter 07 Test Bank > TB 07-23 The internal rate of return for a project wi...

24) The internal rate of return tends to be: 24) ______ 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 analysts. D) used primarily to differentiate between mutually exclusive projects. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 07-05 Managerial Perspective Source : Chapter 07 Test Bank > TB 07-24 The internal rate of return tends to be:

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25) The two fatal flaws of the internal rate of return rule are: 25) ______ A) arbitrary determination of a discount rate and failure to consider initial expenditures. B) arbitrary determination of a discount rate and failure to correctly analyze mutually

exclusive investment projects. C) arbitrary determination of a discount rate and the multiple rate of return problem. D) failure to consider initial expenditures and failure to correctly analyze mutually exclusive investment projects. E) failure to correctly analyze mutually exclusive investment projects and the multiple rate of return problem. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 07-06 Summary of Payback Source : Chapter 07 Test Bank > TB 07-25 The two fatal flaws of the internal rate of ...

26) A mutually exclusive project is a project whose: 26) ______ A) acceptance or rejection has no effect on other projects. B) NPV is always negative. C) IRR is always negative. D) acceptance or rejection affects other projects. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 07-05 Managerial Perspective Source : Chapter 07 Test Bank > TB 07-26 A mutually exclusive project is a project wh...

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27) A project will have more than one IRR if: 27) ______ A) the IRR is positive. B) the IRR is negative. C) the NPV is zero. D) the cash flow pattern exhibits more than one sign change. E) the cash flow pattern exhibits exactly one sign change. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 07-05 Managerial Perspective Source : Chapter 07 Test Bank > TB 07-27 A project will have more than one IRR if:

28) Using the internal rate of return rule, a conventional project should be accepted if the internal

rate of return is: 28) ______ A) only equal to the current weighted average cost of capital. B) greater than the current weighted average cost of capital. C) less than the current weighted average cost of capital. D) negative. E) positive. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 07-05 Managerial Perspective Source : Chapter 07 Test Bank > TB 07-28 Using the internal rate of return rule, a co...

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29) The internal rate of return may be defined as: 29) ______ A) the discount rate that makes the NPV equal to zero. B) the difference between the market rate of interest and the NPV. C) the market rate of interest less the risk-free rate. D) the project acceptance rate set by management. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 07-05 Managerial Perspective Source : Chapter 07 Test Bank > TB 07-29 The internal rate of return may be defined a...

30) The Balistan Rug Company is considering investing in a new loom that will cost $12,000.

The new loom will create a positive end-of-year cash flow of $5,000 for the next 3 years. The internal rate of return for this project is: 30) ______ A) between 10% and 15%. B) between 15% and 20%. C) between 20% and 25%. D) between 25% and 30%. E) less than 10%. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 07-05 Managerial Perspective Source : Chapter 07 Test Bank > TB 07-30 The Balistan Rug Company is considering inve...

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31) The Carnation Chemical Company is investing in an incinerator to dispose of PCB waste.

The incinerator costs $1.5 million and will generate end-of-year cash of $1 million for the next 3 years. At the end of 3 years, the incinerator will be worthless and must be disposed of at the cost of $500,000. The internal rate of return for this project is: 31) ______ A) between 10% and 20%. B) between 20% and 30%. C) between 30% and 40%. D) more than 40%. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 07-05 Managerial Perspective Source : Chapter 07 Test Bank > TB 07-31 The Carnation Chemical Company is investing ...

32) The IRR decision rule can be reversed because: 32) ______ A) the NPV rule is not the same as the IRR. B) the IRR is based on a mutually exclusive investment. C) instead of an investment project it is a financing project. D) the IRR is greater than 100%. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 07-06 Summary of Payback Source : Chapter 07 Test Bank > TB 07-32 The IRR decision rule can be reversed becaus...

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33) Which of the following correctly orders the investment rules of average accounting return

(AAR), internal rate of return (IRR), and net present value (NPV) from the most desirable to the least desirable? 33) ______ A) AAR, IRR, NPV. B) AAR, NPV, IRR. C) IRR, AAR, NPV. D) NPV, AAR, IRR. E) NPV, IRR, AAR. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 07-04 Problems with the Payback Method Topic : 07-05 Managerial Perspective Source : Chapter 07 Test Bank > TB 07-33 Which of the following correctly orders the ...

34) A project will have only one internal rate of return if: 34) ______ A) all cash flows after the initial expense are positive. B) average accounting return is positive. C) net present value is negative. D) net present value is positive. E) net present value is zero. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 07-06 Summary of Payback Source : Chapter 07 Test Bank > TB 07-34 A project will have only one internal rate o...

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35) You have a choice between two projects, Project 1 pays $12,000 back at the end of 1 period

on an investment of $10,000. Project 2 pays back $6,500 at the end of 1 period on an investment of $5,000. Which project should be chosen and what is the problem that you must be concerned with this choice? 35) ______ A) Project 1; discount rate. B) Project 2; discount rate. C) Project 1; project scales. D) Project 2; project scales. E) Project 1, cash flow timings. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 07-06 Summary of Payback Source : Chapter 07 Test Bank > TB 07-35 You have a choice between two projects, Proj...

36) The problem of multiple IRRs can occur when: 36) ______ A) there is only one sign change in the cash flows. B) the first cash flow is always positive. C) the cash flows decline over the life of the project. D) there is more than one sign change in the cash flows. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 07-06 Summary of Payback Source : Chapter 07 Test Bank > TB 07-36 The problem of multiple IRRs can occur when:

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37) The elements that cause problems with the use of the IRR in projects that are mutually

exclusive are: 37) ______ A) the discount rate and scale problems. B) timing and scale problems. C) the discount rate and timing problems. D) scale and reversing flow problems. E) timing and reversing flow problems. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 07-06 Summary of Payback Source : Chapter 07 Test Bank > TB 07-37 The elements that cause problems with the us...

38) A situation in which accepting one investment prevents the acceptance of another investment

is called the: 38) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 07-06 Summary of Payback Source : Chapter 07 Test Bank > TB 07-38 A situation in which accepting one investmen...

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39) 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: 39) ______ A) the internal rate of return for the cash flows of each project. B) the net present value of each project using the internal rate of return as the discount rate. C) the discount rate that equates the discounted payback periods for each project. D) the discount rate that makes the net present value of each project equal to 1. E) the internal rate of return for the differences in the cash flows of the two projects. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 07-06 Summary of Payback Source : Chapter 07 Test Bank > TB 07-39 You are trying to determine whether to accep...

40) If there is a conflict between mutually exclusive projects due to the IRR, one should: 40) ______ A) drop the two projects immediately. B) spend more money on gathering information. C) depend on the NPV as it will always provide the most value. D) depend on the AAR because it does not suffer from these same problems. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 07-06 Summary of Payback Source : Chapter 07 Test Bank > TB 07-40 If there is a conflict between mutually excl...

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41) The profitability index is the ratio of: 41) ______ A) average net income to average investment. B) internal rate of return to current market interest rate. C) net present value of cash flows to internal rate of return. D) net present value of cash flows to average accounting return. E) present value of cash flows to initial investment cost. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 07-07 The Discounted Payback Period Rule Source : Chapter 07 Test Bank > TB 07-41 The profitability index is the ratio of:

42) Under capital rationing the profitability index is used to select investments because of limited

capital by their: 42) ______ A) excess profit to achieve the highest payoff. B) reward per dollar cost to achieve the highest incremental NPV. C) incremental IRR to maximize the total rate of return. D) capital usage rate to stay within budget. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 07-07 The Discounted Payback Period Rule Source : Chapter 07 Test Bank > TB 07-42 Under capital rationing the profitability in...

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43) You are considering a project with the following data:

Internal rate of return 8.7% Profitability ratio 0.98 Net present value -$393 Payback period 2.44 years Required return 9.5% Which one of the following is correct given this information? 43) ______ A) The discount rate used in computing the net present value must have been less than

8.7%. B) The discounted payback period will have to be less than 2.44 years. C) The discount rate used to compute the profitability ratio was equal to the internal rate of return. D) This project should be accepted based on the profitability ratio. E) This project should be rejected based on the internal rate of return. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 07-08 The Average Accounting Return Source : Chapter 07 Test Bank > TB 07-43 You are considering a project with the follo...

44) Suppose that a project has a cash flow pattern -$2,000, $25,000 and -$25,000. Its IRR is

given by: 44) ______ A) 12.20% B) 9.61% or 1040.39% C) 25.25% or 250.52% D) 4100.11% Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 07-06 Summary of Payback Source : Chapter 07 Test Bank > TB 07-44 Suppose that a project has a cash flow patte...

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45) Suppose that a project has a cash flow pattern -$2,000, $25,000 and - $25,000. For its

modified IRR at a discount rate of 10%, the relevant numbers are: 45) ______ A) (-$2,000, $25,000) B) (-$2,000, $2,129) C) (-$5,000, $5,000) D) (-$2,000, $2,273) Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 07-06 Summary of Payback Source : Chapter 07 Test Bank > TB 07-45 Suppose that a project has a cash flow patte...

46) Suppose that a project has a cash flow pattern -$2,000, $25,000 and -$25,000 and a discount

rate of 10%. Its modified IRR is given by: 46) ______ A) 12.65% B) 25.22% or 400% C) 25.22% or 250% D) 10.16% Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 07-06 Summary of Payback Source : Chapter 07 Test Bank > TB 07-46 Suppose that a project has a cash flow patte...

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SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 47) Explain the differences and similarities between net present value (NPV) and the profitability index (PI).

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 07-07 The Discounted Payback Period Rule Source : Chapter 07 Test Bank > TB 07-47 Explain the differences and similarities bet...

48) The Ziggy Trim and Cut Company can purchase equipment on sale for $4,300. The asset has

a three-year life, will produce a cash flow of $1,200 in the first and second year, and $3,000 in the third year. The interest rate is 12%. Calculate the project's payback assuming end-ofyear cash flows. Also, calculate the project's IRR. Should the project be taken? Check your answer by computing the project's NPV.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 07-05 Managerial Perspective Source : Chapter 07 Test Bank > TB 07-48 The Ziggy Trim and Cut Company can purchase ...

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49) The Ziggy Trim and Cut Company can purchase equipment on sale for $4,300. The asset has

a three-year life, will produce a cash flow of $1,200 in the first and second year, and $3,000 in the third year. The interest rate is 12%. Calculate the project's discounted payback and Profitability Index assuming end-of-year cash flows. Should the project be taken? If the accounting rate of return was positive, how would this affect your decision?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 07-03 Defining the Rule Topic : 07-07 The Discounted Payback Period Rule Source : Chapter 07 Test Bank > TB 07-49 The Ziggy Trim and Cut Company can purchase ...

50) The Walker Landscaping Company can purchase a piece of equipment for $3,600. The asset

has a two-year life, will produce a cash flow of $600 in the first year and $4200 in the second year. The interest rate is 15%. Calculate the project's payback assuming steady cashflows. Also, calculate the project's IRR. Should the project be taken? Check your answer by computing the project's NPV.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 07-02 The Payback Period Rule Topic : 07-05 Managerial Perspective Source : Chapter 07 Test Bank > TB 07-50 The Walker Landscaping Company can purchase ...

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51) The Walker Landscaping Company can purchase a piece of equipment for $3,600. The asset

has a two-year life, will produce a cash flow of $600 in the first year and $4200 in the second year. The interest rate is 15%. Calculate the project's discounted payback and Profitability Index assuming steady cashflows. Should the project be taken? If the accounting rate of return was positive, how would this affect your decision?

52) Cutler Compacts will generate cash flows of $30,000 in year one, and $65,000 in year two.

However, if they make an immediate investment of $20,000, they can expect to have cash streams of $55,000 in year 1 and $63,000 in year 2 instead. The interest rate is 9%. Calculate the NPV of the proposed project. Why would the IRR be a poor choice in this situation?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 07-06 Summary of Payback Source : Chapter 07 Test Bank > TB 07-52 Cutler Compacts will generate cash flows of ...

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53) Given the cash flow stream of the following mutually exclusive projects, prove through the

incremental investment that Project B, with the higher NPV, will be preferred to project A.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 07-06 Summary of Payback Source : Chapter 07 Test Bank > TB 07-53 Given the cash flow stream of the following ...

54) The IRR rule is said to be a special case of the NPV rule. Explain why this is so and why it

has some limitations NPV does not?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 07-06 Summary of Payback Source : Chapter 07 Test Bank > TB 07-54 The IRR rule is said to be a special case of...

55) The NPV rule and PI give the same results when there is no conflict. In the case of a

mutually exclusive set of investments, explain the potential conflict and the way it should be solved with supporting examples.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 07-07 The Discounted Payback Period Rule Source : Chapter 07 Test Bank > TB 07-55 The NPV rule and PI give the same results wh...

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56) The NPV rule and PI give the same results when there is no conflict. In the case of capital

rationing, explain the potential conflict and the way it should be solved with supporting examples.

57) List and briefly discuss the advantages and disadvantages of the internal rate of return (IRR)

rule.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 07-06 Summary of Payback Source : Chapter 07 Test Bank > TB 07-57 List and briefly discuss the advantages and ...

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58) Given the goal of maximization of firm value and shareholder wealth, we have stressed the

importance of net present value (NPV). And yet, many financial decision-makers at some of the most prominent firms in the world continue to use less desirable measures such as the payback period and the average accounting return (AAR). Why do you think this is the case?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 07-08 The Average Accounting Return Source : Chapter 07 Test Bank > TB 07-58 Given the goal of maximization of firm value...

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Answer Key Test name: Chapter 07 1) B 2) A 3) C 4) C 5) A 6) A 7) C 8) C 9) B 10) B 11) D 12) B 13) C 14) A 15) C 16) A 17) D 18) E 19) E

3 + 49752/51226 = 3.97Years. 20) C 21) B 22) D

($40000-$33333) x (1-0.34)/ $100000 = 4.40%. 23) A 24) A 25) E 26) D

acceptance or rejection affects other projects. 27) D 28) B 29) A

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the discount rate that makes the NPV equal to zero. 30) A

between 10% and 15%. Using excel we have IRR of 12%. 31) D

Using Excel we get an irr of 53%. 32) C 33) E 34) A 35) C

Project 1; project scales. 36) D 37) B 38) C 39) E 40) C 41) E 42) B 43) E 44) B

9.61% or 1040.39%. 45) D

(-$2,000, $2,273). 46) D

By using excel we get Modified IRR of 10.16%. 47) Short Answer

The NPV and PI are basically the same calculation, and both rules lead to the same accept/reject decision. The main difference between the two is that the PI may be useful in determining which projects to accept if funds are limited; however, the PI may lead to incorrect decisions in considering mutually exclusive investments. 48) Short Answer

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Payback-2.633 Years. Trial and error produces IRR = 10.41%. Do not take project as IRR < 12% Reject the project NPV = ($136.60) 49) Short Answer ∑PVCF

PVCF

-4,300

1.2

+1200

2028.06

-2,271.94

+3000

2135.34

-1365.599

DPP cannot be calculated as NPV < 0. PI = ∑CFATt/Initial Investment = 4163.40/4300 = .968 = .97 - Both measures indicate rejection. A positive accounting rate of return should not change the decision. DPP and PI indicate that your cost of capital is not being covered. 50) Short Answer

Payback = 1.714 years Calculated IRR = 16.67. Accept the project. NPV = $97.54. 51) Short Answer ∑PVCF

PVCF

-3,600

+600

521.74

-3,078.26

+4200

3175.80

97.54

DPP = 1 + 3078.26/3175.80 = 1.969 = 1.97 years PI = ∑CFATt/Initial Investment = 3697.54/3600 = 1.027 = 1.03 Both measures indicate acceptance. A positive accounting rate of return would be consistent with this decision. Reliance on AAR should not be the key, as DPP and PI indicate earning a rate greater than cost of capital. 52) Short Answer

Use incremental cash flow approach: NPV = 1,252, accept project. With more than one sign change, there will be more than one IRR. 53) Short Answer

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0 1 2 3 NPV IRR Project A: -500 150 245 320 46.39 17.76 Project B: -800 360 360 360 50.01 16.65 Incremental investment in B: -300 210 115 40 NPV = 3.63 54) Short Answer

At some K NPV = 0; by definition, when NPV = 0 cost of capital = IRR. Problems occur conflicts with mutually exclusive projects timing and size problems NPV always the best choice 55) Short Answer

Please refer to section 7.7 (The Profitability Index) of the text for the answer. 56) Short Answer

Please refer to section 7.7 (The Profitability Index) of the text for the answer. 57) Short Answer

The advantages of the rule are its close relationship with NPV and the ease with which it is understood and communicated. The two disadvantages are that there may be multiple solutions and the rule may lead to a ranking conflict in evaluating mutually exclusive investments. The student should add a brief explanation demonstrating their understanding of each. 58) Short Answer

This is an open-ended question which allows the creative student to speculate on the value of non-discounted cash flow evaluation measures. We use it as a springboard to stress that even rational financial managers sometimes find it expedient to use a group of measures. For example, firms may rely on the IRR because it is easier to explain to board members than NPV. Also, for large projects, AAR provides shareholders with some insights as to the project's impact on net income and earnings per share.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) One of the key differences between corporate finance and financial accounting courses is: 1) ______ A) the focus on cash flows instead of earnings. B) the focus on marginal tax rates versus average tax rates. C) the role of total income flow versus incremental flows. D) the focus on corporate avarice versus stewardship. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 08-01 Incremental Cash Flows Source : Chapter 08 Test Bank > TB 08-01 One of the key differences between corporate...

2) A cost that has already been paid, or the liability to pay has already been incurred, is a(n): 2) ______ A) salvage value expense. B) net working capital expense. C) sunk cost. D) opportunity cost. E) erosion cost. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 08-01 Incremental Cash Flows Source : Chapter 08 Test Bank > TB 08-02 A cost that has already been paid, or the li...

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3) A decrease in a firm's current cash flows resulting from the implementation of a new project

is referred to as: 3) ______ A) salvage value expense. B) net working capital expense. C) sunk cost. D) opportunity cost. E) erosion cost. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 08-01 Incremental Cash Flows Source : Chapter 08 Test Bank > TB 08-03 A decrease in a firm&#39;s current cash...

4) A firm purchases a new truck for $30,000. It will be depreciated over 5 years at $6,000 per

year. If the tax rate is 30% what is the time 0 cash flow? 4) ______ A) -$6,000 B) -$21,000 C) -$30,000 D) -$28,200 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 08-01 Incremental Cash Flows Source : Chapter 08 Test Bank > TB 08-04 A firm purchases a new truck for $30,000. It...

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5) Money that the firm has already spent or is committed to spend regardless of whether a

project is taken is called a(n): 5) ______ A) sunk cost. B) opportunity cost. C) erosion. D) fixed cost. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 08-01 Incremental Cash Flows Source : Chapter 08 Test Bank > TB 08-05 Money that the firm has already spent or is ...

6) The value of a previously purchased building used by a proposed project is an example of

a(n): 6) ______ A) sunk cost. B) opportunity cost. C) erosion. D) fixed cost. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 08-01 Incremental Cash Flows Source : Chapter 08 Test Bank > TB 08-06 The value of a previously purchased building...

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7) A reduction in the sales of an existing product caused by the introduction of a new product is

an example of a(n): 7) ______ A) sunk cost. B) opportunity cost. C) erosion. D) fixed cost. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 08-01 Incremental Cash Flows Source : Chapter 08 Test Bank > TB 08-07 A reduction in the sales of an existing prod...

8) The QT Company is generating a cash flow of $333,000 per year. If they invest in a new

press, they expect to increase their cash flow to $400,000 per year. The cash outflow for the new press is $250,000; to accept or reject the investment, they have to consider: 8) ______ A) the press cost of $250,000 and total cash flow of $400,000. B) the change in cash flow of $67,000 versus the price cost of $250,000. C) the current cash flow of $333,000 and the price cost of $250,000. D) the opportunity cost of the facility of $333,000. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 08-01 Incremental Cash Flows Source : Chapter 08 Test Bank > TB 08-08 The QT Company is generating a cash flow of ...

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9) What is the nominal rate of interest given a real rate of interest of 5% and an inflation rate of

7%? 9) ______ A) 12.00% B) 2.00% C) 12.35% D) 1.90% Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 08-03 Sunk Costs Source : Chapter 08 Test Bank > TB 08-09 What is the nominal rate of interest given a...

10) The cash flow in dollars received in year 3 is expected to be $12,372. The firm uses a real

discount rate of 4% and the inflation rate is expected to be 2.5%. What is the real cash flow for year 3? 10) ______ A) $13,916.82 B) $11,488.63 C) $10,998.66 D) $10,242.15 E) $14,944.75 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 08-03 Sunk Costs Source : Chapter 08 Test Bank > TB 08-10 The cash flow in dollars received in year 3 ...

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11) Sales for year 2 of the new project are expected to increase by 10%. Current assets are

expected to increase by 17% for every dollar increase in sales while accounts payable are expected to increase by 6%. For year 2 the change in cash flows due to working capital will be: 11) ______ A) +10% of sales. B) -10% of sales. C) +1.1% of sales. D) -1.1% of sales. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 08-02 Cash Flows-Not Accounting Income Source : Chapter 08 Test Bank > TB 08-11 Sales for year 2 of the new project are expe...

12) Interest expense is typically excluded in the project cash flow because: 12) ______ A) all projects are always financed only by equity. B) taxes cannot be adjusted for the correct debt rate. C) the discount rate or WACC reflects the cost of debt. D) the analysis is too crude to handle debt impacts. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 08-02 Cash Flows-Not Accounting Income Source : Chapter 08 Test Bank > TB 08-12 Interest expense is typically excluded in th...

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13) What is the inflation rate given a nominal interest rate is 13% when the real rate is 6%? 13) ______ A) 19.00% B) 6.60% C) 7.00% D) 19.78% Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 08-03 Sunk Costs Source : Chapter 08 Test Bank > TB 08-13 What is the inflation rate given a nominal i...

14) You spent $500 last week fixing the transmission in your car. Now, the brakes are acting up

and you are trying to decide whether to fix them or trade the car in for a newer model. In analyzing the brake situation, the $500 you spent fixing the transmission is a(n) _____ cost. 14) ______ A) opportunity B) fixed C) incremental D) sunk Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 08-01 Incremental Cash Flows Source : Chapter 08 Test Bank > TB 08-14 You spent $500 last week fixing the transmis...

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15) Changes in the net working capital: 15) ______ 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) affect the initial and the final cash flows of a project but not the cash flows of the middle years. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 08-01 Incremental Cash Flows Source : Chapter 08 Test Bank > TB 08-15 Changes in the net working capital:

16) A project will produce an operating cash flow of $7,300 a year for three years. The initial

cash investment in the project will be $11,600. The net after-tax salvage value is estimated at $3,500 and will be received during the last year of the project's life. What is the net present value of the project if the required rate of return is 11%? 16) ______ A) $8,798.29 B) $9,896.87 C) $10,072.72 D) $13,353.41 E) $20,398.29 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 08-02 Cash Flows-Not Accounting Income Source : Chapter 08 Test Bank > TB 08-16 A project will produce an operating cash flo...

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17) The cash flow in dollars received in year 3 is expected to be $12,372. The firm uses a real

discount rate of 4% and the inflation rate is expected to be 2.5%. What is the present value of the year 3 cash flow? 17) ______ A) $10,213.35 B) $12,372.00 C) $9,777.77 D) $9,105.23 E) $13,285.83 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 08-03 Sunk Costs Source : Chapter 08 Test Bank > TB 08-17 The cash flow in dollars received in year 3 ...

18) Peter's Boats has sales of $760,000 and a profit margin of 5%. The annual depreciation

expense is $80,000. What is the amount of the operating cash flow if the company has no long-term debt? 18) ______ A) $34,000 B) $86,400 C) $118,000 D) $120,400 E) $123,900 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 08-04 Opportunity Costs Source : Chapter 08 Test Bank > TB 08-18 Peter&#39;s Boats has sales of $760,000 and a...

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19) Le Place has sales of $439,000, depreciation of $32,000, and net working capital of $56,000.

The firm has a tax rate of 34% and a profit margin of 6%. The firm has no interest expense. What is the amount of the operating cash flow? 19) ______ A) $49,384 B) $52,616 C) $54,980 D) $58,340 E) $114,340 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 08-04 Opportunity Costs Source : Chapter 08 Test Bank > TB 08-19 Le Place has sales of $439,000, depreciation...

20) Bluedo's has sales of $435,000, depreciation of $35,000, and net working capital of $56,000.

The firm has a tax rate of 34% and a profit margin of 8%. The firm has no interest expense. What is the amount of the operating cash flow? 20) ______ A) $46,068 B) $57,968 C) $69,800 D) $322,100 E) $114,340 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 08-04 Opportunity Costs Source : Chapter 08 Test Bank > TB 08-20 Bluedo&#39;s has sales of $435,000, depreciation...

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21) Ben's Border Café is considering a project which will produce sales of $16,000 and increase

cash expenses by $10,000. If the project is implemented, taxes will increase from $23,000 to $24,500 and depreciation will increase from $4,000 to $5,500. What is the amount of the operating cash flow using the top-down approach? 21) ______ A) $4,000 B) $4,500 C) $6,000 D) $7,500 E) $8,500 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 08-04 Opportunity Costs Source : Chapter 08 Test Bank > TB 08-21 Ben&#39;s Border Caf&#233; is considering a project...

22) A project's operating cash flow will increase when: 22) ______ A) the depreciation expense increases. B) the sales projections are lowered. C) the interest expense is lowered. D) the net working capital requirement increases. E) the earnings before interest and taxes decreases. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 08-04 Opportunity Costs Source : Chapter 08 Test Bank > TB 08-22 A project&#39;s operating cash flow...

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23) The cash flow tax savings generated as a result of a firm's tax-deductible depreciation

expense is called the: 23) ______ A) after-tax depreciation savings. B) depreciable basis. C) depreciation tax shield. D) operating cash flow. E) after-tax salvage value. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 08-04 Opportunity Costs Source : Chapter 08 Test Bank > TB 08-23 The cash flow tax savings generated as a res...

24) Ronnie's Coffee House is considering a project which will produce sales of $6,000 and

increase cash expenses by $2,500. If the project is implemented, taxes will increase by $1,300. The additional depreciation expense will be $1,000. An initial cash outlay of $2,000 is required for net working capital. What is the amount of the operating cash flow using the top-down approach? 24) ______ A) $2,000 B) $1,500 C) $2,200 D) $3,500 E) $4,200 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 08-04 Opportunity Costs Source : Chapter 08 Test Bank > TB 08-24 Ronnie&#39;s Coffee House is considering a...

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25) The incremental cash flow from projects for a company is computed as the: 25) ______ A) net operating cash flow generated by the project, less any sunk costs and erosion

costs. B) sum of the incremental operating cash flow and after-tax salvage value of the project. C) net income generated by the project, plus the annual depreciation expense. D) sum of the incremental operating cash flow, capital spending, and change in net working capital of the project. E) sum of the sunk costs, opportunity costs, and erosion costs of the project. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 08-04 Opportunity Costs Source : Chapter 08 Test Bank > TB 08-25 The incremental cash flow from projects for ...

26) The bottom-up approach to computing the operating cash flow applies only when: 26) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 08-04 Opportunity Costs Source : Chapter 08 Test Bank > TB 08-26 The bottom-up approach to computing the oper...

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27) The top-down approach to computing the operating cash flow: 27) ______ A) ignores all non-cash 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 08-04 Opportunity Costs Source : Chapter 08 Test Bank > TB 08-27 The top-down approach to computing the opera...

28) You have been asked to evaluate two machines. The benefits from ownership are identical.

Machine A costs $300 to buy and install, lasts for 5 years, and costs $160 per year to operate. Machine B costs $500, lasts for 5 years, and costs $120 per year to operate. Both machines have zero salvage value. Assuming that this is a one-time acquisition, which machine do you recommend if the cost of capital is 15%? 28) ______ A) Machine A, the PV is $66 more than Machine B. B) Machine A, the PV of its costs is $66 less than Machine B. C) Machine A, because the project length is two years less than Machine B. D) Machine B, the PV is $66 more than Machine A. E) Machine B, the PV of its costs is $66 less than Machine A. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 08-06 Allocated Costs Source : Chapter 08 Test Bank > TB 08-28 You have been asked to evaluate two machines...

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29) You have been asked to evaluate 2 pollution control devices. The wet scrub costs $100 to set

up and $50 per year to operate. It must be completely replaced every 3 years, and it has no salvage value. The dry scrub device costs $200 to set up and $30 per year to operate. It lasts for 5 years and has no salvage value. Assuming that pollution control equipment is replaced as it wears out, which device do you recommend if the cost of capital is 10%? 29) ______ A) Dry scrub, the EAC is $11.00. B) Wet scrub, the EAC is $90.21. C) Dry scrub, the EAC is $82.76. D) Wet scrub, the EAC is $9.79. E) Dry scrub, the EAC is $124.34. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 08-06 Allocated Costs Source : Chapter 08 Test Bank > TB 08-29 You have been asked to evaluate 2 pollution ...

30) Milton Toy Co. recorded sales of $2,500 and costs of $1,875. Net accounts receivable rose

by $350 and net accounts payable declined by $240. What were cash sales minus cash costs? 30) ______ A) $625 B) $35 C) ($110) D) $90 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 08-02 Cash Flows-Not Accounting Income Source : Chapter 08 Test Bank > TB 08-30 Milton Toy Co. recorded sales of $2,500 and ...

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31) You have been asked to evaluate an infinitely-lived project. Sales in the first year are

projected to be $100. Costs are projected at $50. There is no depreciation, and the tax rate is 30%. The real required return is 10%. The inflation rate is projected to be 8%. Sales and costs will increase at the rate of inflation. The project costs $300. What is the NPV? 31) ______ A) $142.03 B) $36.36 C) $71.72 D) $50.00 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 08-03 Sunk Costs Source : Chapter 08 Test Bank > TB 08-31 You have been asked to evaluate an infinitel...

32) Marshall's & Co. purchased a corner lot in Montreal five years ago for a cost of $640,000.

The lot was recently appraised at $810,000. At the time of the purchase, the company spent $50,000 to grade the lot and another $4,000 to build a small building on the lot, to house a parking lot attendant who has overseen the use of the lot for daily commuter parking. The company now wants to build a new retail store on the site. The building cost is estimated at $1.2 million. What amount should be used as the initial cash flow for this building project? 32) ______ A) $1,200,000 B) $1,840,000 C) $1,890,000 D) $2,010,000 E) $2,060,000 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 08-03 Sunk Costs Source : Chapter 08 Test Bank > TB 08-32 Marshall&#39;s &amp; Co. purchased a corner lot...

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33) Cash revenues in a particular year are equal to sales less: 33) ______ A) the change in capital investment. B) the change in accounts payable. C) the change in NWC. D) the change in accounts receivable. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 08-02 Cash Flows-Not Accounting Income Source : Chapter 08 Test Bank > TB 08-33 Cash revenues in a particular year are equal...

34) Which of the following is not a relevant item to consider in cash flow estimation? 34) ______ A) A change in current assets invested in the project. B) A change in current liabilities to finance new inventories. C) Regular meeting fees for the board of directors incurred when the go-no go decision

is made. D) Any net changes in working capital over the life of the investment. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 08-01 Incremental Cash Flows Source : Chapter 08 Test Bank > TB 08-34 Which of the following is not a relevant ite...

35) Tax shield refers to a reduction in taxes created by: 35) ______ A) a reduction in sales. B) an decrease in interest expense. C) non-cash expenses. D) a project's incremental expenses. E) opportunity costs. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 08-05 Side Effects Source : Chapter 08 Test Bank > TB 08-35 Tax shield refers to a reduction in taxes cr...

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36) The equivalent annual cost method is useful in determining: 36) ______ A) the annual operating cost of a machine if the annual maintenance is performed versus

when the maintenance is not performed as recommended. B) the tax shield benefits of depreciation given the purchase of new assets for a project. C) which one of two machines to acquire given equal machine lives but unequal machine costs. D) which one of two machines to purchase when the machines are mutually exclusive, have different machine lives, and will be replaced once they are worn out. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 08-06 Allocated Costs Source : Chapter 08 Test Bank > TB 08-36 The equivalent annual cost method is useful ...

37) If the inflation rate was positive the expected NPV of an investment would be: 37) ______ A) understated if real cash flows were discounted by the nominal discount rate. B) understated if nominal cash flows were discounted by the nominal discount rate. C) overstated if the real cash flows were discounted by the nominal discount rate. D) understated if the nominal cash flows were discounted by the real discount rate. E) overstated if the real cash flows are discounted by the real discount rate. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 08-03 Sunk Costs Source : Chapter 08 Test Bank > TB 08-37 If the inflation rate was positive the expec...

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SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 38) You are considering whether to replace an existing flow meter. The existing meter can be sold now for $50 or it can be sold in 1 year for $10. It costs $30 per year to operate and maintain. A new meter costs $400 and has a 10-year life. It could be sold for $40 at the end of its life. The new meter costs $14 per year to operate and maintain. What do you recommend if the cost of capital is 12%?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 08-06 Allocated Costs Source : Chapter 08 Test Bank > TB 08-38 You are considering whether to replace an ex...

39) A proposed investment has a cost of $250. It will have a life of 4 years. The cost will be

depreciated straight-line to a zero salvage value and will be worth $50 at that time. Cash sales will be $230 per year and cash costs will run $120 per year. The firm will also need to invest $70 in net working capital at year 0. The appropriate discount rate is 8% (use for all flows), and the corporate tax rate is 40%. What are the cash flows in years 1, 2, 3, and 4?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 08-04 Opportunity Costs Source : Chapter 08 Test Bank > TB 08-39 A proposed investment has a cost of $250. It...

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40) A machine lasts 3 years and has a purchase price of $100. It costs $40 per year to operate and

can be sold as junk for $15 at the end of its life. What is the EAC of the costs of operating a series of such machines into perpetuity if the discount rate is 15%?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 08-06 Allocated Costs Source : Chapter 08 Test Bank > TB 08-40 A machine lasts 3 years and has a purchase p...

41) RoadRollers Paving Company is considering buying a new asphalt laying machine. The

machine costs $1,300,000 and can be depreciated to zero on a straight-line basis over its life of 10 years. The machine is expected to have no salvage value. Revenues are expected to be $600,000 per year, and costs are estimated at $220,000 per year. Operating cash flows are expected to rise with inflation, forecasted at 4% per year. The risk-free rate of interest is 2% and the real interest rate is 4.0%, and given the expected inflation rate, the nominal rate is 8.16%. The firm is in the 34% tax bracket. Should the investment be undertaken?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 08-05 Side Effects Source : Chapter 08 Test Bank > TB 08-41 RoadRollers Paving Company is considering bu...

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42) Recently, you calculated the cashflows for the Highfeed Dryer project to determine the

feasibility of a new feed mix process. Since that time you have now discovered that the calculation of the standard cash flow for Year 1 of $55,000 did not consider the following anticipated changes: account receivables are expected to increase $7,000; cash will rise by $2,000; inventory will increase by $4,000 and account payable are expected to increase $5,000. Determine the new estimated cash flow for Year 1.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 08-02 Cash Flows-Not Accounting Income Source : Chapter 08 Test Bank > TB 08-42 Recently, you calculated the cashflows for t...

43) The Expresso Roast Corporation is considering the purchase of a new bean roaster and

grinder. The revenues are expected to be the same for Expresso Roast no matter which machine is acquired. The Quick-Roast machine has a cost of $75,000 and is expected to last 4 years with operating costs of $12,000 per year. The Mellow-Roast Co. machine has a cost of $50,000 and operating costs of $4,500 per year but will last for only 2 years. The discount rate is 8%. What is the present value of the costs? What is the EAC and which machine should be chosen?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 08-06 Allocated Costs Source : Chapter 08 Test Bank > TB 08-43 The Expresso Roast Corporation is considerin...

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44) The Equivalent Annual Cost method allows the comparison of the costs of equipment with

unequal lives. If Quick-roll machine has an eleven-year life, and an NPV of $2,100, while the Zip-roller machine has a seven-year life and an NPV of $2,000. Which machine would you choose if the business is expected to continue and the discount rate for both is 14%?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 08-06 Allocated Costs Source : Chapter 08 Test Bank > TB 08-44 The Equivalent Annual Cost method allows the...

45) Jackson & Sons uses packing machines to prepare its products for shipping. One machine

costs $136,000 and lasts about 4 years before it needs replacing. The operating cost per machine is $6,000 a year. What is the equivalent annual cost of one packing machine if the required rate of return is 12%? (Round your answer to whole dollars.)

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 08-06 Allocated Costs Source : Chapter 08 Test Bank > TB 08-45 Jackson &amp; Sons uses packing machines to ...

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46) Bruno's, Inc. is analyzing two machines to determine which one it should purchase. The

company requires a 14% rate of return and uses straight-line depreciation to a zero book value. Machine A has a cost of $290,000, annual operating costs of $8,000, and a 3-year life. Machine B costs $180,000, has annual operating costs of $12,000, and has a 2-year life. Whichever machine is purchased will be replaced at the end of its useful life. Which machine should Bruno's purchase and why? (Round your answer to whole dollars.)

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 08-06 Allocated Costs Source : Chapter 08 Test Bank > TB 08-46 Bruno&#39;s, Inc. is analyzing two machines to...

47) You are considering replacing your current dado cutter with a new machine. The current

machine is expected to last three more years but faces increasing repair costs of $2,500; $3,500; and $4,000 over the three years. You could salvage the machine now for $5,000; and then $3,000; $1,500; and 0 thereafter. The new dado cutter would cost $12,000 and require upkeep of $1,500 a year. The machine would last six years and be salvaged for $1,000. Should you replace the old machine now or wait one year? (Assume the tax rate is 0% and the cost of capital is 11%).

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 08-06 Allocated Costs Source : Chapter 08 Test Bank > TB 08-47 You are considering replacing your current d...

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48) Your boss just turned back your capital budgeting report because she is unsure of your

results. The yearly revenues are going up at a constant rate equal to the consumer price index of 4% and the discount used was 6%. The boss also mentions that the long-term Treasury bond rate is only 71/2%. Explain the boss' dilemma and how it should be corrected.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 08-03 Sunk Costs Source : Chapter 08 Test Bank > TB 08-48 Your boss just turned back your capital budg...

49) This chapter introduced three new methods for calculating project operating cash flow

(OCF). Under what circumstances is each method appropriate?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 08-04 Opportunity Costs Source : Chapter 08 Test Bank > TB 08-49 This chapter introduced three new methods fo...

50) When is it appropriate to use the equivalent annual cost (EAC) methodology, and how do

you make a decision using it?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 08-06 Allocated Costs Source : Chapter 08 Test Bank > TB 08-50 When is it appropriate to use the equivalent...

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Answer Key Test name: Chapter 08 1) A 2) C 3) E 4) C 5) A 6) B 7) C 8) B 9) C 10) B 11) D 12) C 13) B 14) D 15) A 16) A 17) A 18) C 19) D 20) C 21) B 22) A 23) C 24) C 25) D 26) B 27) A 28) B 29) C 30) B 31) D 32) D 33) D 34) C 35) C 36) D 37) A

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38) Short Answer

-The cost of keeping the old machine 1 more year in year 1 is: $50 + $30/(1.12) - $10(1.12) = $67.86; $67.86(1.12) = $77.00 - The equivalent annual cost of the new machine is: $400 + $14 * A.12,10 - $40/(1.12)10 = $471.87; $4 71.87/5.65 = $83.51 Because the cost of keeping the old machine is less than the cost of the new machine, the old machine should not be replaced. 39) Short Answer

Year 1: (Rev - Exp) (1 - t) + t(CCA)? ($230 - $120) (1 -.4) +.4($62.5) = $91 Year 2 & 3: Same as year 1. Year 4: $91 + ($50) (1 -.4) = $121 40) Short Answer

The present value of the cost of the machine is: $100 + $40 * A.15,3 -15/(1.15)3 = $181.47 The machine's equivalent annual cost is: $181.47/2.283 = $79.48 41) Short Answer

Initial cost = $1,300,000 PV of cash flows = ($380,000) (1 -.34)/(1.04) * A.04,10 = $1,955,974.73 Depreciation tax shield = (8.1109) ($130,000) (.34) = $358,501.78 NPV = $2,314,476.51 - 1,300,000 = $1,014,476.51); Accept. 42) Short Answer

Change in Working Capital = ($7,000 + 2,000 + 4,000) - $5,000 = 8,000. Therefore, Yr. 1 cash flow = $55,000 - 8,000 = $47,000. 43) Short Answer

PV Quick-Roast = 75,000 + 12,000 * Ann. Factor(.08,4) = 114,745.52 PV Mellow-Roast = 50,000 + 4,500 * Ann. Factor(.08,2) = 58,024.69 EAC (QR) = $114,745.52/Ann. Factor(.08,4)3.312 = $34,645.39 EAC (MR) = $58,024.69/Ann. Factor(.08,2)1.783 = $32,543.29

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44) Short Answer

EAC11 = 2,100/6.4951 = 323.32 EAC7 = 2,000/4.8684 = 410.11 Choose the Zip-roller machine assuming replacement. 45) Short Answer

Equivalent Annual Cost = $50,776 NPV = -136,000 - 6000/(1 + 0.12)1 - 6000/(1 + 0.12)2 - 6000/(1 + 0.12)3 - 6000/(1 + 0.12)4 = 154,224.10 154,224.10 = EAC * {1-(1/(1 + 0.12)4)}/0.12 EAC = 50,775.88 46) Short Answer

Machine B; because it will save the company about $11,600 a year NPVA = -290,000 - 8000/(1 + 0.14)1 - 8000/(1 + 0.14)2 - 8000/(1 + 0.14)3 = -308,573.06 308,573.06 = EACA * {1-(1/(1 + 0.14)3)}/0.14 EACA = 132,912 (rounded) NPVB = -180,000 - 12000/(1 + 0.14)1 -12000/(1 + 0.14)2 = -199,759.93 199,759.93 = EACB * {1-(1/(1 + 0.14)2)}/0.14 EACB = 121,312 (rounded) Machine B lowers the annual cost of the equipment by about $11,600, = ($132,912 - $121,312). 47) Short Answer

EACNEW = [12000 + 1500A.11,6 + 1000PV.11,6]/A.11,6 = 18,880.45/4.2305 = $4462.94 PV Yearly Cost of OLD = 5000 + (2500/1.11) + (3000/1.11) = 9954.95 Year 1 COSTSOLD = 9954.95(1.11) = 11,049.99 > EACNEW; Replace 48) Short Answer

The rates do not match. Nominal cashflows are being used as they increase at CPI inflation. Discount rate < LT T-Bond rate implies error or use of real rate. Real rate approximation of 6% from Nominal-Inflation; Nominal would approximate 6 + 4 = 10%. The boss is correct to be concerned about this. Correct by using real cashflows with real rates or nominal cashflows with nominal rates.

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49) Short Answer

Three additional formulations of OCF provided in this chapter are the bottom-up, top-down, and tax-shield approaches. The first is useful when the analyst has prepared pro forma income statements for a project (since OCF is equal to net income plus depreciation). The top-down approach defines OCF as sales minus costs minus taxes, and is useful if one has reliable estimates of the relevant dollar costs (perhaps in a situation where fixed and variable costs are the focus of the analysis). Finally, the tax-shield approach separately illustrates the project benefits associated with after-tax gross profit (revenue gains and/or cost reductions) and with the depreciation tax shield. 50) Short Answer

The EAC should be used to evaluate two or more mutually exclusive projects with different lives that will be replicated essentially forever. The manager should choose the project whose EAC is the lowest, that is, the least negative EAC value.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) In order to make a decision with a decision tree: 1) ______ A) one starts furthest out in time to make the first decision. B) One must begin at time 0. C) Any path can be taken to get to the end. D) Any path can be taken to get back to the beginning. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 09-01 Decision Trees Source : Chapter 09 Test Bank > TB 09-01 In order to make a decision with a decision ...

2) At stage 2 of the decision tree, it 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 $44,000. The cost of capital is 15%. What is the NPV of the project at stage 1? 2) ______ A) -$13,275 B) -$20,232 C) $2,087 D) $7,536 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 09-01 Decision Trees Source : Chapter 09 Test Bank > TB 09-02 At stage 2 of the decision tree, it shows th...

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3) In a decision tree, the NPV to make the yes/no decision is dependent on: 3) ______ A) only the cash flows from successful path. B) on the path where the probabilities add up to one. C) all cash flows and probabilities. D) only the cash flows and probabilities of the successful path. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 09-01 Decision Trees Source : Chapter 09 Test Bank > TB 09-03 In a decision tree, the NPV to make the yes/...

4) Sensitivity analysis helps you determine the: 4) ______ A) range of possible outcomes given possible 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 situations. D) degree to which a project is reliant upon the fixed costs. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-04 Sensitivity analysis helps you determine the...

5) As the degree of sensitivity of a project to a single variable rises, the: 5) ______ 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 the future value of that variable. D) lower the maximum potential value of the project. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-05 As the degree of sensitivity of a project to...

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6) Sensitivity analysis is conducted by: 6) ______ 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 change in the project's

NPV. D) assigning either the best or the worst possible value to every variable and comparing the results to those achieved by the base case. E) reviewing a project after implementation to determine how the actual results are comparing to the predicted results. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-06 Sensitivity analysis is conducted by:

7) The sales level that results in a project's net income exactly equaling zero is called the _____

break-even. 7) ______ A) operational B) leveraged C) accounting D) cash E) present value Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-07 The sales level that results...

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8) The sales level that results in a project's net present value exactly equaling zero is called the

_____ break-even. 8) ______ A) operational B) leveraged C) accounting D) cash E) present value Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-08 The sales level that results...

9) Fixed production costs are: 9) ______ A) directly related to labor costs. B) measured as cost per unit of time. C) measured as cost per unit of output. D) dependent on the amount of goods or services produced. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-09 Fixed production costs are:

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10) An investigation of the degree to which NPV depends on assumptions made about critical

variables is called a(n) 10) ______ A) operating analysis. B) sensitivity analysis. C) marginal benefit analysis. D) decision tree analysis. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-10 An investigation of the degree to which NPV ...

11) Scenario analysis is different than sensitivity analysis because: 11) ______ A) no economic forecasts are changed. B) several variables are changed together. C) scenario analysis deals with actual data versus sensitivity analysis which deals with a

forecast. D) it is short and simple. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-11 Scenario analysis is different than sensitiv...

12) The accounting profit break-even point occurs when: 12) ______ A) the total revenue curve cuts the total cost curve. B) the total revenue curve cuts the fixed cost curve. C) the variable cost curve cuts the total cost curve. D) the total revenue curve cuts the variable cost curve. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-12 The accounting profit break-even point occur...

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13) In the present-value break-even the EAC is used to: 13) ______ A) determine the opportunity cost of 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. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Hard Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-13 In the present-value break-even the EAC is u...

14) The present value break-even point is superior to the accounting break-even point because: 14) ______ A) present value break-even is more complicated to calculate. B) present value break-even covers the economic opportunity costs of the investment. C) present value break-even is the same as sensitivity analysis. D) present value break-even covers the fixed costs of production, which the accounting

break-even does not. E) present value break-even covers the variable costs of production, which the accounting break-even does not. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Hard Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-14 The present value break-even point is superi...

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15) The Mini-Max Company has the following cost information on their new prospective project.

Fixed costs are $200/year. (Initial investment is $700). Variable costs: $3/unit. Depreciation: $140/year. Price: $8/unit. Discount rate: 12%. Project life: 5 years. Tax rate: 34%. Calculate the accounting break-even point. 15) ______ A) 68.00 units/year. B) 103.03 units/year. C) 113.33 units/year. D) 25.00 units/year. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-15 The Mini-Max Company has the following cost ...

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16) The Mini-Max Company has the following cost information on their new prospective project.

Fixed costs are $200/year. (Initial investment is $700). Variable costs: $3/unit. Depreciation: $140/year. Price: $8/unit. Discount rate: 12%. Project life: 3 years. Tax rate: 34%. Calculate the present value break-even point. 16) ______ A) 68.00 units/year. B) 113.89 units/year. C) 84.42 units/year. D) 75 units/year. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-16 The Mini-Max Company has the following cost ...

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17) The Adept Co. is analyzing a proposed project. The company expects to sell 2,500 units, give

or take 10%. The expected variable cost per unit is $8 and the expected fixed costs are $12,500. Cost estimates are considered accurate within a plus or minus 5% range. The depreciation expense is $4,000. The sale price is estimated at $16 a unit, give or take 2%. The company bases its sensitivity analysis on the expected case scenario What is the sales revenue under the optimistic case scenario? 17) ______ A) $40,000 B) $43,120 C) $44,000 D) $44,880 E) $48,400 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-17 The Adept Co. is analyzing a proposed projec...

18) The Adept Co. is analyzing a proposed project. The company expects to sell 2,500 units, give

or take 10%. The expected variable cost per unit is $8 and the expected fixed costs are $12,500. Cost estimates are considered accurate within a plus or minus 5% range. The depreciation expense is $4,000. The sale price is estimated at $16 a unit, give or take 2%. The company bases its sensitivity analysis on the expected case scenario What is the contribution margin under the expected case scenario? 18) ______ A) $2.67 B) $3.00 C) $7.92 D) $8.00 E) $8.72 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-18 The Adept Co. is analyzing a proposed projec...

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19) The Adept Co. is analyzing a proposed project. The company expects to sell 2,500 units, give

or take 10%. The expected variable cost per unit is $8 and the expected fixed costs are $12,500 (including depreciation). Cost estimates are considered accurate within a plus or minus 5% range. The depreciation expense is $4,000. The sale price is estimated at $16 a unit, give or take 2%. The company bases its sensitivity analysis on the expected case scenario What is the amount of the fixed cost per unit under the pessimistic case scenario? 19) ______ A) $4.55 B) $5.00 C) $5.83 D) $6.02 E) $6.55 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-19 The Adept Co. is analyzing a proposed projec...

20) The Adept Co. is analyzing a proposed project. The company expects to sell 2,500 units, give

or take 10%. The expected variable cost per unit is $8 and the expected fixed costs are $12,500. Cost estimates are considered accurate within a plus or minus 5% range. The depreciation expense is $4,000. The sale price is estimated at $16 a unit, give or take 2%. The company bases its sensitivity analysis on the expected case scenario. The company is conducting a sensitivity analysis on the sales price using a sales price estimate of $17. Using this value, the earnings before interest and taxes will be: 20) ______ A) $4,000. B) $6,000. C) $8,500. D) $10,000. E) $18,500. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-20 The Adept Co. is analyzing a proposed projec...

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21) The Adept Co. is analyzing a proposed project. The company expects to sell 2,500 units, give

or take 10%. The expected variable cost per unit is $8 and the expected fixed costs are $12,500. Cost estimates are considered accurate within a plus or minus 5% range. The depreciation expense is $4,000. The sale price is estimated at $16 a unit, give or take 2%. The company bases its sensitivity analysis on the expected case scenario. The company conducts a sensitivity analysis using a variable cost of $9. The total variable cost estimate will be: 21) ______ A) $21,375. B) $22,500. C) $23,625. D) $24,125. E) $24,750. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-21 The Adept Co. is analyzing a proposed projec...

22) From the information below, calculate the accounting break-even point.

Fixed costs are $2,000/year. (Initial investment is $2,000.) Variable costs: $6/unit. Depreciation: $250/year. Price: $20/unit. Discount rate: 10%. Project life: 4 years. Tax rate: 34%. 22) ______ A) 88 units/year. B) 161 units/year. C) 143 units/year. D) 100 units/year. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-22 From the information below, calculate the ac...

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23) Given the following information, calculate the present value break-even point.

Fixed costs: $2000/year. (Initial investment $2000). Variable costs: $6/unit. Depreciation: $250/year. Price: $20/unit. Discount rate: 10%. Project life: 4 years. Tax rate: 34%. 23) ______ A) 100 units/year. B) 143 units/year. C) 202 units/year. D) 286 units/year. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-23 Given the following information, calculate t...

24) Including the option to expand in your project analysis will tend to: 24) ______ A) extend the duration of a project but not affect the project's net present value. B) increase the net present value of a project. C) decrease the net present value of a project. D) have no effect on either a project's cash flows or its net present value. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 09-04 Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-24 Including the option to expand in your proje...

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25) The option to wait: 25) ______ A) increases in value as the project's sensitivity to new technology increases. B) is independent of the project's discount rate. C) is valueless when a project is profitable given immediate implementation. D) decreases the net present value of a project. E) may have value even if a project currently does not. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 09-04 Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-25 The option to wait:

26) Last month you introduced a new product to the market. Consumer demand has been

overwhelming and it appears that strong demand will exist over the long term. Given this situation, management should consider the option to: 26) ______ A) suspend. B) expand. C) abandon. D) contract. E) withdraw. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 09-04 Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-26 Last month you introduced a new product to t...

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27) All else equal, the contribution margin must increase as: 27) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-27 All else equal, the contribution margin must...

28) All else constant, as the variable cost per unit increases, the: 28) ______ A) contribution margin decreases. B) sensitivity to fixed costs decreases. C) degree of operating leverage decreases. D) operating cash flow increases. E) net profit increases. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-28 All else constant, as the variable cost per ...

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SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 29) The Marx Brewing Company recently installed a new bottling machine. The machine's initial cost is $2,000 and can be depreciated on a straight-line basis to a zero salvage in 5 years. The machine's per year fixed cost is $1,800, and its variable cost is $0.50 per unit. The selling price per unit is $1.50. Marx's tax rate is 34%, and it uses a 16% discount rate. Calculate the accounting break-even point on the new machine, as well as the present value break-even point on the new machine.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-29 The Marx Brewing Company recently installed ...

30) The Marx Brewing Company recently installed a new bottling machine. The machine's initial

cost is $2,000 and can be depreciated on a straight-line basis to a zero salvage in 5 years. The machine's per year fixed cost is $1,800, and its variable cost is $0.50 per unit. The selling price per unit is $1.50. Marx's tax rate is 34%, and it uses a 16% discount rate. If Marx sells 2500 units what is the accounting profit and contribution margin for Marx Brewing?

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31) From the information below, calculate the impact of discount rate changes on the present-

value break-even point. Fixed costs are $2,500/year. (Initial investment is $2,000.) Variable costs: $8/unit. Depreciation: $500/year. Price: $25/unit. Initial Discount rate: 10%. Project life: 4 years. Tax rate: 34%. If the discount rate were 15% and 5%, what would be the present-value break-even points. How sensitive is the break-even to the discount rate change (show your results)?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 09-02 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-31 From the information below, calculate the im...

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32) Your company has a new project to be considered. You are given the following information

on the best guess of related outcomes for the project. The cost of developing and market testing the product over the next year is $225 million. If the test is successful, which has a 65% chance, the company will spend another $800 million to put the production capabilities in place. The expected cash flows after tax for a successful project are $225 million each year for the next six years with a probability of.8; there is a 20% chance of a zero NPV. If the test fails the cash flows associated with continuing through the sixth year are $125 million per year after tax. The company uses a 12% discount rate for these types of projects. Draw and label the decision tree. Explain what decisions management would make at each node upon their realization.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 09-04 Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-32 Your company has a new project to be conside...

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33) Your company has a new project to be considered. You are given the following information

on the best guess of related outcomes for the project. The cost of developing and market testing the product over the next year is $225 million. If the test is successful, which is expected to be 65%, the company will spend another $800 million to put the production capabilities in place. The expected cash flows after tax for a successful project are $225 million each year for the next six years with a probability of.8; there is a 20% chance of a zero NPV. If the tests fail the cashflows associated with continuing through the sixth year is $125 million per year after tax. The company uses a 12% discount rate for these types of projects. Determine the net present value if the tests are a success. Determine the net present value and the decision to undertake testing or not.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 09-04 Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-33 Your company has a new project to be conside...

34) Sensitivity analysis is a method that allows for evaluation of the NPV given a series of

changes to the underlying assumptions. Discuss why and how scenario analysis is used in addition to sensitivity analysis.

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35) The market value of an investment project should be viewed as the sum of the standard NPV

and the value of managerial options. Explain two different options that management may have, what they are, and how they would influence market value.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 09-04 Break-Even Analysis Source : Chapter 09 Test Bank > TB 09-35 The market value of an investment project sh...

36) Consider the following statement by a project analyst: "I analyzed my project using scenarios

for the base case, best case, and worst case. I computed break-evens and degrees of operating leverage. I did sensitivity analysis and simulation analysis. I computed NPV, IRR, payback, AAR, and PI. 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 reaction." Critique this statement.

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Answer Key Test name: Chapter 09 1) A 2) B 3) C 4) B 5) C 6) C 7) C 8) E 9) B 10) B 11) B 12) A 13) C 14) B 15) A 16) B 17) D 18) D 19) C 20) B 21) B 22) B 23) C 24) B 25) E 26) B 27) C 28) A 29) Short Answer

Accounting break-even is: ($1,800 + $400)/($1.50 - $0.5)(1 - .34) = 2,200 units. Present value break-even is: $610.81 + $1,800(1 - .34) - $400(.34)/($1)(1 - .34) = 2,519 units.

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30) Short Answer

NI = (Rev - Fixed Cost - Variable Cost - Depreciation - Tax) = (3750 - 1800 - 1250 - 400 - 102) = 198 Explanation: Rev = 2500*1.5 = 3750 Fixed cost = 1800 Variable cost = 2500*0.5 Depreciation = 2000/5 = 4000 Tax = (Rev - Fixed Cost - Variable Cost - Depreciation)*Tax rate = (3750 - 1800 - 1250 - 400)*(34%) = 102 31) Short Answer

PV Break-even (10%) = 630.94 + (2500(.66) - 500(.34))/(25 - 8)(.66) = 188.14 (EAC @ 10% = 630.94). PV Break-even (15%) = 700.53 + (2500(.66) - 500(.34))/(25 - 8)(.66) = 194.34. PV Break-even (5%) = 564.02 + (2500(.66) - 500(.34))/(25 - 8)(.66) = 182.17. Not very sensitive; a 50% increase or decrease in the discount rate causes only a 3.3% increase in break-even units or a 3.2% decrease in break-even units necessary respectively. 32) Short Answer

See Figure 9.6 for example diagram 33) Short Answer

NPV1 = Pr[Cost + CFAT * A.12,6] = .65{[-800 + (225)4.1114].8 + .2(0)} = .65(100.52) = 65.34 NPV0 = -225 + 65.34/1.12 = -166.66; Do not invest. 34) Short Answer

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Sensitivity analysis: measures input of changing one input at a time. variables may change simultaneously in reality. estimates may be overly optimistic or pessimistic. Scenario analysis: a variant of sensitivity analysis. allows for multiple factor influences. examines a number of different scenarios. minimizes the false sense of security that may come from sensitivity analysis. 35) Short Answer

To expand project - favorable market reaction Contract business - under conditions of poor demand, etc. Abandonment, equipment replacement, opening and closing facilities. 36) Short Answer

The goal of evaluating an NPV estimate or other decision criteria is to determine the reasonableness of it. If done properly, the added analysis will heighten either the degree of comfort or the degree of discomfort about a project. Ultimately, this type of analysis reveals both the weaknesses and the strengths of a project. Furthermore, it helps isolate potential trouble areas and sharpens the focus on which variables are most crucial for forecasting. The very nature of the process still leaves a great deal of uncertainty even after all of the analysis is complete. However, in the end, the analyst should be better informed and more comfortable in making a decision, not less so.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) The capital gains yield plus the dividend yield on a security is called the: 1) ______ A) geometric return. B) average period return. C) current yield. D) total return. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-01 The capital gains yield plus the dividend yi...

2) The expected return on a security in the market context is: 2) ______ A) a negative function of execs security risk. B) a positive function of the beta. C) a negative function of the beta. D) a positive function of the excess security risk. E) independent of beta. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-02 The expected return on a security in the mar...

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3) A capital gain occurs when: 3) ______ A) the selling price is less than the purchase price. B) the purchase price is less than the selling price. C) there is no dividend paid. D) there is no income component of return. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-03 A capital gain occurs when:

4) Which one of the following is a correct statement concerning risk premium? 4) ______ A) The greater the volatility of returns, the greater the risk premium. B) The lower the volatility of returns, the greater the risk premium. C) The lower the average rate of return, the greater the risk premium. D) The risk premium is not correlated to the average rate of return. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 10-04 Holding-Period Returns Source : Chapter 10 Test Bank > TB 10-04 Which one of the following is a correct stat...

5) Which one of the following statements concerning the standard deviation is correct? 5) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 10-05 Return Statistics Source : Chapter 10 Test Bank > TB 10-05 Which one of the following statements concer...

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6) You bought 100 shares of stock at $20 each. At the end of the year, you received a total of

$400 in dividends, and your stocks were worth $2,500 in total. What was your total dollar return? 6) ______ A) $900. B) $500. C) $400. D) $2,500. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-06 You bought 100 shares of stock at...

7) You bought 100 shares of stock at $20 each. At the end of the year, you received a total of

$400 in dividends, and your stocks were worth $2,500 in total. What was your percentage rate of return? 7) ______ A) 20% B) 25% C) 45% D) 125% E) 145% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-07 You bought 100 shares of stock at...

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8) You bought 100 shares of stock at $20 each. At the end of the year, you received a total of

$400 in dividends, and your stocks were worth $2,500 in total. What were the total dollar capital gain and the total dollar return? 8) ______ A) $400; $500. B) $400; $900. C) $500; $900. D) $900; $2,500. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-08 You bought 100 shares of stock at...

9) Zolo Co. just declared that it is increasing its annual dividend from $1.00 per share to $1.25

per share. If the stock price remains constant, then: 9) ______ A) the capital gains yield will decrease. B) the capital gains yield will increase. C) the dividend yield will increase. D) the dividend yield will also remain constant. E) neither the capital gains yield nor the dividend yield will change. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-09 Zolo Co. just declared that it is increasing...

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10) Six months ago, you purchased 100 shares of stock in ABC Co. at $43.89 a share. ABC stock

pays a quarterly dividend of $.10 a share. Today, you sold all of your shares for $45.13 per share. What is the total amount of your capital gains on this investment? 10) ______ A) $1.24 B) $1.64 C) $40.00 D) $124.00 E) $134.00 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-10 Six months ago, you purchased 100 shares of ...

11) A year ago, you purchased 300 shares of IXC Technologies, Inc. stock at $9.03 per share.

The stock pays an annual dividend of $.10 per share. Today, you sold all of your shares for $28.14 per share. What is your total dollar return on this investment? 11) ______ A) $5,703 B) $5,733 C) $5,753 D) $5,763 E) $5,853 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-11 A year ago, you purchased 300 shares of IXC ...

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12) A year ago, you purchased 500 shares of New Tech stock at $49.03 per share. The stock pays

an annual dividend of $.10 per share. Today, you sold all of your shares for $58.14 per share. What is your total dollar return on this investment? 12) ______ A) $4,755 B) $4,733 C) $4,753 D) $4,605 E) $4,853 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-12 A year ago, you purchased 500 shares of New ...

13) You just sold 200 shares of XYZ Inc. stock at $38.75 a share. Last year you paid $41.50 a

share to buy this stock. Over the year, you received dividends totaling $1.64 per share. What is your capital gain on this investment? 13) ______ A) -$550 B) -$222 C) -$3 D) $550 E) $878 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-13 You just sold 200 shares of XYZ Inc. stock a...

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14) Excelsior shares are currently selling for $25.00 each. You bought 200 shares one year ago at

$24 and received dividend payments of $1.50 per share. What was your percentage capital gain this year? 14) ______ A) 10.42% B) 4.17% C) 6.25% D) 110.42% E) 104.67% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-14 Excelsior shares are currently selling for...

15) Excelsior shares are currently selling for $25.00 each. You bought 200 shares one year ago at

$24.00 and received dividend payments of $1.50 per share. What was your percentage rate of return? 15) ______ A) 10.42% B) 4.17% C) 6.25% D) 110.42% E) 104.67% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-15 Excelsior shares are currently selling for...

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16) The prices for IMB over the last 3 years are given below. Assuming no dividends were paid,

what was the 3-year holding period return? Year

Price

$70

80 16) ______

A) 17.65%. B) 5.11%. C) 14.29%. D) -8.57%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-02 Dollar Earnings Source : Chapter 10 Test Bank > TB 10-16 The prices for IMB over the last 3 years are...

17) Capital market history shows us that a correct ordering of the average arithmetic mean return

for asset classes, from lowest to highest, is: 17) ______ A) Corporate bonds, Treasury bills, small-company stocks, and large-company stocks. B) U.S. Treasury bills, small-company stocks, large-company stocks, and government

bonds. C) Government bonds, Treasury bills, large-company stocks, and small-company stocks. D) Treasury bills, government bonds, corporate bonds, and large-company stocks. E) Treasury bills, long-term government bonds, intermediate-term government bonds, small-company stock. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-02 Dollar Earnings Source : Chapter 10 Test Bank > TB 10-17 Capital market history shows us that a corre...

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18) On January 1, 2013, Westman Fuji sold for $40.00 and on January 1, 2014, Westman Fuji

sold for $39.50. During 2013 Westman Fuji paid four quarterly dividends of $1.50. Fuji's dividend yield is: 18) ______ A) 2.53%. B) 3.75%. C) 15.00%. D) 15.19%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-18 On January 1, 2013, Westman Fuji sold for...

19) Capital gains are defined as: 19) ______ A) the change in the firm's dividend payout over year. B) assets sold at prices greater than their purchasing price. C) assets sold at prices less than their purchasing price. D) taxes collected by Federal but not by State governments. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-19 Capital gains are defined as:

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20) Kids Toy Co. has had total returns over the past five years of 0%, 7%, -2%, 10%, and 12%.

What was the mean return on this stock and its variability in percent return? 20) ______ A) 6.75%; 6.15%. B) 5.40%; 6.15%. C) 6.75%; 6.33%. D) 5.40%; 5.50%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-20 Kids Toy Co. has had total returns over the ...

21) Kids Toy Co. has had total returns over the past five years of 0%, 7%, -2%, 10%, and 12%.

What is the percentage change in wealth over the five years? 21) ______ A) 29% B) 27% C) 5.8% D) 5.4% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 10-02 Dollar Earnings Source : Chapter 10 Test Bank > TB 10-21 Kids Toy Co. has had total returns over the ...

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22) The return on your portfolio over the last 5 years were -5%, 20%, 0%, 10% and 5%. What

was the standard deviation of your return? What is your best guess as to next year's return? 22) ______ A) 2.74%; 6.00%. B) 5.31%; 5.65%. C) 9.62%; 6.00%. D) 9.62%; 15.00%. E) 12.70%; 20.00%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-05 Return Statistics Source : Chapter 10 Test Bank > TB 10-22 The return on your portfolio over the last 5...

23) If the expected return on the market is 16%, then using the historical risk premium of 8.5%,

the current risk-free rate is: 23) ______ A) 4.5%. B) 7.5%. C) 10.0%. D) 10.5%. E) 12.5%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-23 If the expected return on the market is...

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24) The total annual returns on common stocks averaged 13.30% from 1957 to 2003. Small

company stocks averaged 10.64%, long-term bonds averaged 8.96%, while Treasury Bills averaged 6.80%. What was the average risk premium earned by long-term Bonds, and small company stocks respectively? 24) ______ A) 9.5%; 1.8% B) 4.4%; 11.9% C) 2.16%; 3.84% D) 1.8%; 13.3% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-24 The total annual returns on common stocks av...

25) The Alpha stock you bought for $26.75 a year ago is now selling for $32.50. Alpha also paid

you $2.25 in dividends. What would your dollar return be from this stock? 25) ______ A) $7.75 B) $8.00 C) $8.25 D) $5.75 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-25 The Alpha stock you bought for...

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26) Suppose you own a risky asset with an expected return of 12% and a standard deviation of

20%. If the returns are normally distributed, the approximate probability of receiving a return greater than 32% is: 26) ______ A) 0.67. B) 0.33. C) 0.05. D) 0.02. E) 0.16. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-05 Return Statistics Source : Chapter 10 Test Bank > TB 10-26 Suppose you own a risky asset with an expect...

27) Suppose you own a risky asset with an expected return of 12% and a standard deviation of

20%. If the returns are normally distributed, the approximate probability of receiving a return greater than 72%, or less than -48% is: 27) ______ A) greater than 99% B) greater than 95% C) less than 5% D) less than 1% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-05 Return Statistics Source : Chapter 10 Test Bank > TB 10-27 Suppose you own a risky asset with an expect...

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28) Last year you bought some Alpha stock for $26.75 a share. It is currently selling for $32.50.

You received a dividend of $2.25 during the year. What is your total rate of return? 28) ______ A) 30% B) 21% C) 8.5% D) 12% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-05 Return Statistics Source : Chapter 10 Test Bank > TB 10-28 Last year you bought some Alpha stock for...

29) The return pattern on your favorite stock has been 5%, 8%, -12%, 15%, 21% over the last

five years. What are your average return and total change in wealth per year over the period? 29) ______ A) 4.5%, 6.5% B) 15%, 21% C) 7.4%, 6.8% D) 9.2%, 8.6% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-29 The return pattern on your favorite stock ha...

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30) If the average return on common stocks was 13.3%, the average Treasury bill rate was 3.8%,

and the average inflation rate was 3.2% what would be the expected nominal and approximate real market return for common stocks if the Treasury bill rate is expected to be 5.5% and the inflation rate is 4.1%? 30) ______ A) 9.5%, 13.6%. B) 13.6%, 9.5%. C) 15.90%, 10.9%. D) 14.6%, 9.1%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 10-04 Holding-Period Returns Source : Chapter 10 Test Bank > TB 10-30 If the average return on common stocks was 1...

31) The long-term inflation rate average was 3.2% and you invested in long-term corporate

bonds over the same period which earned 6.1%. What were the average risk premium you earned and your precise rate of return? 31) ______ A) 2.9%; -2.9% B) 9.3%; 10.3% C) 2.9%; 2.81% D) cannot be determined Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 10-04 Holding-Period Returns Source : Chapter 10 Test Bank > TB 10-31 The long-term inflation rate average was 3.2...

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32) Capital market history shows us that the average return relationship between securities

where: 32) ______ A) lowest return is inflation, then corporate bonds, Treasuries, small company stocks, to

highest return all common stocks. B) lowest return is Treasury bills, inflation, small company stocks, highest return all common stocks. C) lowest return is Treasury bills, corporate bonds, government bonds, all common stocks, highest small company stocks. D) lowest return is Treasury bills, government bonds, corporate bonds, all common stocks, highest small company stocks. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 10-04 Holding-Period Returns Source : Chapter 10 Test Bank > TB 10-32 Capital market history shows us that the ave...

33) The normal distribution is a theoretical distribution for a population. The distribution can be

used to estimate how risky a cash flow or return is. If the mean is 12% and the standard deviation is 22.5%, what is the range of possible returns for a 2 standard deviation change and what percentage of all observations would fall within 2 standard deviations? 33) ______ A) 24%, 68%. B) 24%, 96%. C) 90%, 68%. D) 90%, 96%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-05 Return Statistics Source : Chapter 10 Test Bank > TB 10-33 The normal distribution is a theoretical dis...

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34) The market portfolio of common stocks earned 20.4% last year. Treasury bills earned 5.3%

on average last year. The average inflation rate was 2.5%. What was the equity risk premium? 34) ______ A) 12.6% B) 22.9% C) 25.7% D) 15.1% E) 23.2% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-34 The market portfolio of common stocks earned...

35) The market portfolio of common stocks earned 20.4% last year. Treasury bills earned 5.3%

on average last year. The average inflation rate was 2.5%. What was the real return on TBills? 35) ______ A) 2.8%. B) 5.3% C) 7.8% D) 3.9% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 10-04 Holding-Period Returns Source : Chapter 10 Test Bank > TB 10-35 The market portfolio of common stocks earned...

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36) The market portfolio of common stocks earned 14.7% last year. Treasury bills earned 5.7%

on average last year. The average inflation rate was 4.0%. What was the risk premium on the market portfolio of equities? 36) ______ A) 5.0%. B) 9.0%. C) 6.5%. D) 12.2%. E) 18.7%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 10-04 Holding-Period Returns Source : Chapter 10 Test Bank > TB 10-36 The market portfolio of common stocks earned...

37) The market portfolio of common stocks earned 14.7% last year. Treasury bills earned 5.7%

on average last year. The average inflation rate was 4.0%. What was the real return on equities? 37) ______ A) 5.0%. B) 9.0%. C) 9.7%. D) 10.7%. E) 12.6%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 10-04 Holding-Period Returns Source : Chapter 10 Test Bank > TB 10-37 The market portfolio of common stocks earned...

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38) A security has an expected return of 10% and a standard deviation of 3%. If the security is

normally distributed, then about 68% of the time, the security return will be 38) ______ A) between 10% and 13%. B) between 7% and 10%. C) between 7% and 13%. D) between 4% and 10%. E) between 13% and 16%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 10-05 Return Statistics Source : Chapter 10 Test Bank > TB 10-38 A security has an expected return of ...

39) You have a sample of returns observations for the Malta Stock Fund. The 4 returns are

7.25%, 5.60%, 12.50%, 1.00%. What is the average return and variance of these returns? 39) ______ A) 6.50%, 0.0017. B) 6.59%, 0.0023. C) 26.35%, 0.0067. D) 8.80%, 0.0017. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 10-04 Holding-Period Returns Source : Chapter 10 Test Bank > TB 10-39 You have a sample of returns observations fo...

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40) If you were to estimate the expected return on the market portfolio, you would need to know

or estimate: 40) ______ A) the beta of the portfolio, the risk-free rate, and the level of the market over the next

year. B) the risk-free rate and beta of the portfolio. C) the historical risk premium and the risk free rate. D) the level of the market over the next year, the risk-free rate, and the historical risk premium. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 10-04 Holding-Period Returns Source : Chapter 10 Test Bank > TB 10-40 If you were to estimate the expected return ...

41) A stock had the following prices and dividends. What is the geometric average return on this

stock? Year

Price

Dividend

$23.19

—

$24.90

$.23

$23.18

$.24

$24.86

$.25 41) ______

A) 3.0% B) 3.3% C) 3.6% D) 3.8% E) 4.0% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-05 Return Statistics Source : Chapter 10 Test Bank > TB 10-41 A stock had the following prices and dividen...

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42) A stock had returns of 8%, 14%, and 2% for the past three years. Based on these returns,

what is the probability that this stock will earn at least 20% in any one given year? 42) ______ A) 0.5% B) 1.0% C) 2.3% D) 5.0% E) 16.0% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 10-05 Return Statistics Source : Chapter 10 Test Bank > TB 10-42 A stock had returns of...

43) The returns on your portfolio over the last 5 years were -5%, 20%, 0%, 10% and 5%. What is

the arithmetic average return? 43) ______ A) 5.0% B) 6.0% C) 7.5% D) 8.0% E) 10.0% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 10-06 Average Stock Returns and Risk-Free Returns Source : Chapter 10 Test Bank > TB 10-43 The returns on your portfolio over the last ...

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44) The average compound return earned per year over a multi-year period is called the _____

average return. 44) ______ A) arithmetic B) standard C) variant D) geometric E) real Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 10-06 Average Stock Returns and Risk-Free Returns Source : Chapter 10 Test Bank > TB 10-44 The average compound return earned per year ...

45) Estimates using the arithmetic average will probably tend to _____ values over the long-term

while estimates using the geometric average will probably tend to _____ values over the short-term. 45) ______ A) overestimate; overestimate B) overestimate; underestimate C) underestimate; overestimate D) underestimate; underestimate E) accurately; accurately Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 10-06 Average Stock Returns and Risk-Free Returns Source : Chapter 10 Test Bank > TB 10-45 Estimates using the arithmetic average will ...

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SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 46) Little John Industries sold for $1.90 on January 1 and ended the year at $2.50. In addition, the stock paid dividends of $0.20 per share. Calculate Little John's dividend yield, capital gain yield, and total rate of return for the year.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-46 Little John Industries sold for...

47) You earned a total return of -5% on NoDotCom this year, earned -40% last year, and earned

30% two years ago. Calculate both the three-year holding period return and the average three-year return.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-47 You earned a total return of ...

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48) Explain why a financial manager of a large company should use the standard deviation as the

measure of risk to determine the discount rate?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 10-01 Returns Source : Chapter 10 Test Bank > TB 10-48 Explain why a financial manager of a large c...

49) Suppose you are the risk manager of a bank with a trading portfolio of $1 billion. You have

just received the latest information about the portfolio allocations made by the trading branch of your bank, which tells you that the portfolio will earn a premium return of 23% over the risk-free rate in one year. You have carried out an independent analysis and found that the return on your portfolio over the next ten days is normally distributed with a mean of 0.77% and a standard deviation of 5%. Find the ten-day 1% value at risk for this portfolio.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 10-05 Return Statistics Source : Chapter 10 Test Bank > TB 10-49 Suppose you are the risk manager of a bank w...

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50) A stock has returns of 3%, 18%, -24%, and 16% for the past four years. Based on this

information, what is the 95% probability range for any given year?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 10-05 Return Statistics Source : Chapter 10 Test Bank > TB 10-50 A stock has returns of...

51) List 2 shortcomings of using value at risk (VaR) as a risk management tool.

Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Hard Topic : 10-05 Return Statistics Source : Chapter 10 Test Bank > TB 10-51 List 2 shortcomings of using value at risk (...

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Answer Key Test name: Chapter 10 1) 2) 3) 4) 5) 6)

D B B A B A Return = 2500 + 400 - (100*20) = 900$. 7) C

Return(%) = 900/(100*20) = 0.45 = 45%. 8) C

Capital Gain = 2500 - (100*20)= 500$ Total Dollar return calculation is as per Q No. 10-6. 9) C

the dividend yield will also remain constant. 10) D

Capital Gain = 100*(45.13-43.89) = 124$. 11) D

Total Dollar return = (300*0.10) + 300*(28.14 - 9.03) = 5763$. 12) D

Total Dollar return= (500*0.10) + 500*(58.14 - 49.03) = 4605$. 13) A

Capital gain= 200*(38.75-41.50) = -550$. 14) B

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Capital Gain (%) = 200(25-24)/200*24 = 0.417 = 4.17%. 15) A 16) C 17) D 18) C

Fuji's dividend yield = 1.50*4/40= 0.15 = 15%. 19) B 20) B 21) A

If assume $100 is the share price at beginning then end price is $129 (by adding return) Change in wealth over the five years = (129.19-100)/100 = 0.291 = 29%. 22) C 23) B 24) C

The average risk premium earned by long-term Bonds = 8.96-6.80 = 2.16% Small company stocks = 10.64-6.80= 3.84%. 25) B 26) E 27) D 28) A 29) C

average return = 5 + 8 - 12 + 15 + 21/5 =7.4% Total change in wealth=6.8%. 30) C 31) A

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The average risk premium = 6.1%-3.2% = 2.9% Precise rate of return = 3.2 - 6.1 = -2.9%. 32) D 33) D 34) D 35) A 36) B 37) D 38) C 39) B

Average return = 7.25 + 5.60 + 12.5 + 1/4 = 6.59% Variance = 0.006759/4 - 1 = 0.0023. 40) C 41) B 42) C 43) B 44) D 45) B 46) Short Answer

Dividend yield = $0.20/$1.90 = 10.53% Capital Gain = $0.60/$1.90 = 31.58% Total return = 10.53% + 31.58% = 42.11% or.8/1.9 = .4211. 47) Short Answer

3-year holding period return = (0.95) (0.60) (1.30) = 0.741 -1 or -25.9% Average three-year return = (-.05 + -.40 + .30)/3 = -.15/3 = -5%. 48) Short Answer

Project is incremental to firm adds risk based on covariance with market risk diversify set of investments by firm 49) Short Answer

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Let R denote the return on the portfolio, and x denote the return corresponding to the 1% VaR.

Thus, the 1% 10 day VaR is $108.62 million. 50) Short Answer

-35.4 to 41.9% Average return = (.03 + .18 -.24 + .16) ÷ 4 = .0325; Total squared deviation = (.03 -.0325)2 + (.18 -.0325)2 + (-.24 -.0325)2 + (.16 -.0325)2 = .00000625 + .02175625 + .07425625 +.01625625 = .112275; Standard deviation = √(.112275 ÷ (4 - 1) = √.037425 = .19346 = 19.346%; 95% probability range = 3.25% ± (2 × 19.346%) = -35.44% to 41.94% 51) Short Answer

VaR represents the maximum possible loss in dollars for a given confidence level. Although Value-at-Risk is a widely used tool in risk management, there are various shortcomings with the measure. 1. VaR often provides a false sense of security as it is not calculated at a 100 percent confidence interval. 2. VaR is based on historical data and since markets are generally efficient, this historical data may not be the best predictor of the future exposure to risk. 3. VaR assumes a normal return distribution, which may not always be true in the financial markets

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) When a security is added to a portfolio the appropriate return and risk contributions are: 1) ______ A) the expected return of the asset and its standard deviation. B) the most probable return and the beta. C) the expected return and the beta. D) the most probable return and its standard deviation. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 11-03 Expected Return and Variance Source : Chapter 11 Test Bank > TB 11-01 When a security is added to a portfolio the ...

2) When stocks with the same expected return are combined into a portfolio: 2) ______ A) the expected return of the portfolio is less than the average expected return of the

stocks. B) the expected return of the portfolio is greater than the average expected return of the stocks. C) the expected return of the portfolio is equal to the average expected return of the stocks. D) there is no relationship between the expected return of the portfolio and the expected return of the stocks. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 11-03 Expected Return and Variance Source : Chapter 11 Test Bank > TB 11-02 When stocks with the same expected return ar...

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3) Covariance measures the interrelationship between two securities in terms of: 3) ______ A) both expected return and direction of return movement. B) both size and direction of return movement. C) the standard deviation of returns. D) both expected return and size of return movements. E) the correlations of returns. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 11-02 Expected Return, Variance, and Covariance Source : Chapter 11 Test Bank > TB 11-03 Covariance measures the interrelationship be...

4) GenLabs has been a hot stock the last few years, but it is risky. The expected returns for

GenLabs are highly dependent on the state of the economy as follows: State of Economy

Probability

GenLabs Returns

Depression

.05

-50%

Recession

.10

-15%

Mild Slowdown

.20

Normal

.30

15%

Broad Expansion

.20

25%

Strong Expansion

.15

40%

The expected return on GenLabs is: 4) ______ A) 20.5% B) 12.5% C) 8.5% D) 3.3% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 11-02 Expected Return, Variance, and Covariance Source : Chapter 11 Test Bank > TB 11-04 GenLabs has been a hot stock the last few ye...

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5) GenLabs has been a hot stock the last few years, but it is risky. The expected returns for

GenLabs are highly dependent on the state of the economy as follows: State of Economy

Probability

GenLabs Returns

Depression

.05

-50%

Recession

.10

-15%

Mild Slowdown

.20

Normal

.30

15%

Broad Expansion

.20

25%

Strong Expansion

.15

40%

The variance and standard deviation of GenLabs returns are: 5) ______ A) 0.042875; 0.2070628. B) 0.0714612; 8.450.845142. C) 0.093958; 0.3065169. D) 0.112750; 0.335809. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 11-02 Expected Return, Variance, and Covariance Source : Chapter 11 Test Bank > TB 11-05 GenLabs has been a hot stock the last few ye...

6) Systematic risk is measured by: 6) ______ A) the mean. B) beta. C) the geometric average. D) the standard deviation. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 11-06 The Example of Supertech and Slowpoke Source : Chapter 11 Test Bank > TB 11-06 Systematic risk is measured by:

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7) If the correlation between two stocks is -1, the returns: 7) ______ A) generally move in the same direction. B) move perfectly opposite one another. C) are unrelated to one another as it is <0. D) have standard deviations of equal size but opposite signs. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 11-02 Expected Return, Variance, and Covariance Source : Chapter 11 Test Bank > TB 11-07 If the correlation between two stocks is -1,...

8) Stock A has an expected return of 20%, and stock B has an expected return of 4%. 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? 8) ______ A) 20.0%. B) 4.0%. C) 12.0%. D) Greater than 20%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 11-03 Expected Return and Variance Source : Chapter 11 Test Bank > TB 11-08 Stock A has an expected return of 20%, and s...

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9) Idaho Slopes (IS) and Dakota Steppes (DS) are both seasonal businesses. IS is a downhill

skiing facility, while DS is a tour company that specializes in walking tours and camping. The equally likely returns on each company over the next year is expected to be: Economy

Idaho Slopes

Dakota Steppes

Strong Downturn

-10%

Mild Downturn

-4%

Slow Growth

Moderate Growth

12%

Strong Growth

20%

The means of IS and DS are: 9) ______ A) 4.4%; 4.6%. B) 5.5%; 5.75%. C) 10%; 6%. D) 4%; 6%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 11-02 Expected Return, Variance, and Covariance Source : Chapter 11 Test Bank > TB 11-09 Idaho Slopes (IS) and Dakota Steppes (DS) ar...

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10) Idaho Slopes (IS) and Dakota Steppes (DS) are both seasonal businesses. IS is a downhill

skiing facility, while DS is a tour company that specializes in walking tours and camping. The equally likely returns on each company over the next year is expected to be: Economy

Idaho Slopes

Dakota Steppes

Strong Downturn

-10%

Mild Downturn

-4%

Slow Growth

Moderate Growth

12%

Strong Growth

20%

The variances of IS and DS are: 10) ______ A) .0145; .00038. B) .011584; .000304. C) .006454; .000154. D) .0008068; .000193. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 11-02 Expected Return, Variance, and Covariance Source : Chapter 11 Test Bank > TB 11-10 Idaho Slopes (IS) and Dakota Steppes (DS) ar...

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11) Idaho Slopes (IS) and Dakota Steppes (DS) are both seasonal businesses. IS is a downhill

skiing facility, while DS is a tour company that specializes in walking tours and camping. The equally likely returns on each company over the next year is expected to be: Economy

Idaho Slopes

Dakota Steppes

Strong Downturn

-10%

Mild Downturn

-4%

Slow Growth

Moderate Growth

12%

Strong Growth

20%

The covariance between the IS and DS returns is: 11) ______ A) .00187. B) .00240. C) .00028. D) .000056. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 11-02 Expected Return, Variance, and Covariance Source : Chapter 11 Test Bank > TB 11-11 Idaho Slopes (IS) and Dakota Steppes (DS) ar...

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12) Idaho Slopes (IS) and Dakota Steppes (DS) are both seasonal businesses. IS is a downhill

skiing facility, while DS is a tour company that specializes in walking tours and camping. The equally likely returns on each company over the next year is expected to be: Economy

Idaho Slopes

Dakota Steppes

Strong Downturn

-10%

Mild Downturn

-4%

Slow Growth

Moderate Growth

12%

Strong Growth

20%

The correlation between the returns of IS and DS is: 12) ______ A) +1.00 B) -1.10 C) +0.30 D) -0.03 E) 0.03 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 11-02 Expected Return, Variance, and Covariance Source : Chapter 11 Test Bank > TB 11-12 Idaho Slopes (IS) and Dakota Steppes (DS) ar...

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13) Idaho Slopes (IS) and Dakota Steppes (DS) are both seasonal businesses. IS is a downhill

skiing facility, while DS is a tour company that specializes in walking tours and camping. The equally likely returns on each company over the next year is expected to be: Economy

Idaho Slopes

Dakota Steppes

Strong Downturn

-10%

Mild Downturn

-4%

Slow Growth

Moderate Growth

12%

Strong Growth

20%

If IS and DS are combined in a portfolio with 50% invested in each, the expected return and risk would be: 13) ______ A) 5.625%; 37.2%. B) 4.5%; 5.48%. C) 8.0%; 8.2%. D) 5.0%; 0%. E) 4.5%; 0%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 11-03 Expected Return and Variance Source : Chapter 11 Test Bank > TB 11-13 Idaho Slopes (IS) and Dakota Steppes (DS) ar...

14) A portfolio invests into Buzz's Bauxite Boring Equity, which expected return is 16%, and

Zum's Inc. bonds, which return expected is 8%. Sixty percent of the funds are invested in Buzz's and the rest in Zum's. What is the expected return on the portfolio? 14) ______ A) 9.6%. B) 12.8%. C) 24.1%. D) 6.4%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 11-03 Expected Return and Variance Source : Chapter 11 Test Bank > TB 11-14 A portfolio invests into...

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15) You have plotted the data for two securities over time on the same graph, ie., the monthly

return of each security for the last 5 years. If the pattern of the movements of the two securities rose and fell as the other did, these two securities would have: 15) ______ A) no correlation at all. B) a weak negative correlation. C) a strong negative correlation. D) a strong positive correlation. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 11-02 Expected Return, Variance, and Covariance Source : Chapter 11 Test Bank > TB 11-15 You have plotted the data for two securities...

16) If the covariance of stock 1 with stock 2 is -.0065, then what is the covariance of stock 2 with

stock 1? 16) ______ A) -.0065. B) less than -.0065. C) greater than +.0065. D) +.0065. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 11-02 Expected Return, Variance, and Covariance Source : Chapter 11 Test Bank > TB 11-16 If the covariance of stock 1 with stock 2 is...

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17) Standard deviation measures _______ risk. 17) ______ A) total B) nondiversifiable C) unsystematic risk D) systematic risk Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 11-02 Expected Return, Variance, and Covariance Source : Chapter 11 Test Bank > TB 11-17 Standard deviation measures _______ risk.

18) The rate of return on the common stock of Flowers by Flo is expected to be 14% in a

booming economy, 8% in a normal economy, and only 2% in a recessionary economy. The probabilities of these economic states are 20% for a boom, 70% for a normal economy, and 10% for a recession. What is the variance of the returns on the common stock of Flowers by Flo? 18) ______ A) 0.001044 B) 0.001280 C) 0.001863 D) 0.002001 E) 0.002471 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 11-02 Expected Return, Variance, and Covariance Source : Chapter 11 Test Bank > TB 11-18 The rate of return on the common stock of Fl...

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19) You are comparing stock A to stock B. Given the following information, which one of these

two stocks should you prefer and why? Rate of Return if State Occurs State of Economy

Probability of State of Economy

Stock A

Stock B

Boom

60%

15%

Recession

40%

-6% 19) ______

A) Stock A; because it has an expected return of 7% and appears to be more risky. 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. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Hard Topic : 11-02 Expected Return, Variance, and Covariance Source : Chapter 11 Test Bank > TB 11-19 You are comparing stock A to stock B. Given ...

20) If you have a portfolio of two risky stocks which turns out to have no diversification. The

reason you have no diversification is: 20) ______ A) the returns are too small. B) the returns move perfectly opposite of one another. C) the returns are too large to offset. D) the returns move perfectly with one another. E) the returns are completely unrelated to one another. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 11-03 Expected Return and Variance Source : Chapter 11 Test Bank > TB 11-20 If you have a portfolio of two risky stocks ...

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21) A portfolio will usually contain: 21) ______ A) only one riskless asset. B) only one risky asset. C) two or more assets. D) no assets. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 11-03 Expected Return and Variance Source : Chapter 11 Test Bank > TB 11-21 A portfolio will usually contain:

22) If the correlation between two stocks is +1, then a portfolio combining these two stocks will

have a variance that is: 22) ______ A) less than the weighted average of the two individual variances. B) greater than the weighted average of the two individual variances. C) equal to the weighted average of the two individual variances. D) less than or equal to average variance of the two weighted variances, depending on

other information. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 11-03 Expected Return and Variance Source : Chapter 11 Test Bank > TB 11-22 If the correlation between two stocks is +1,...

23) The standard deviation of a portfolio will tend to increase when: 23) ______ A) a risky asset in the portfolio is replaced with Treasury bills. B) short-term bonds are replaced with Treasury Bills. C) the portfolio concentration in a single cyclical industry increases. D) the weights of the various diverse securities become more evenly distributed. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 11-03 Expected Return and Variance Source : Chapter 11 Test Bank > TB 11-23 The standard deviation of a portfolio will t...

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24) The opportunity set of portfolios is: 24) ______ A) all possible return combinations of those securities. B) all possible risk combinations of those securities. C) all possible risk-return combinations of those securities. D) the best or highest risk-return combination. E) the lowest risk-return combination. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 11-05 The Risk and Return for Portfolios Source : Chapter 11 Test Bank > TB 11-24 The opportunity set of portfolios is:

25) A portfolio has 35% of its funds invested in Security One and 65% of its funds invested in

Security Two. Security One has a standard deviation of 6%. Security Two has a standard deviation of 12%. The securities have a coefficient of correlation of 0.5. Which of the following values is closest to the standard deviation of the portfolio? 25) ______ A) 8.16%. B) 9.03%. C) 0.816% D) 8.08% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 11-03 Expected Return and Variance Source : Chapter 11 Test Bank > TB 11-25 A portfolio has 35% of its funds invested in...

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26) A portfolio has 25% of its funds invested in Security C and 75% of its funds invested in

Security D. Security C has an expected return of 8% and a standard deviation of 6%. Security B has an expected return of 10% and a standard deviation of 10%. The securities have a coefficient of correlation of.6. Which of the following values is closest to portfolio return and variance? 26) ______ A) .095; .001675. B) .095; .0072. C) .100; .00849. D) .090; .0081. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 11-03 Expected Return and Variance Source : Chapter 11 Test Bank > TB 11-26 A portfolio has 25% of its funds invested in...

27) When many assets are included in a portfolio or index, the risk of the portfolio or index will

be: 27) ______ A) less than the risk of the securities because the correlations are greater than 1. B) equal to the risk of the securities because the correlations are equal to 1. C) less than the risk of the securities because the correlations are usually less than 1. D) unaffected by the risk of securities because their correlations are less than 1. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 11-03 Expected Return and Variance Source : Chapter 11 Test Bank > TB 11-27 When many assets are included in a portfolio...

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28) The diversification effect on a portfolio of two stocks: 28) ______ A) increases as the correlation between the stocks declines. B) increases as the correlation between the stocks rises. C) decreases as the correlation between the stocks rises. D) Both increases as the correlation between the stocks declines; and decreases as the

correlation between the stocks rises. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 11-04 Covariance and Correlation Source : Chapter 11 Test Bank > TB 11-28 The diversification effect on a portfolio of...

29) Which one of the following would indicate a portfolio is being effectively diversified? 29) ______ A) An increase in the portfolio beta. B) A decrease in the portfolio beta. C) An increase in the portfolio rate of return. D) A decrease in the portfolio standard deviation. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 11-06 The Example of Supertech and Slowpoke Source : Chapter 11 Test Bank > TB 11-29 Which one of the following would indicate a ...

30) Diversification can effectively reduce risk. Once a portfolio is diversified the type of risk

remaining is: 30) ______ A) individual security risk. B) riskless security risk. C) risk related to the market portfolio. D) total standard deviations. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 11-06 The Example of Supertech and Slowpoke Source : Chapter 11 Test Bank > TB 11-30 Diversification can effectively reduce risk....

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31) For a highly diversified equally weighted portfolio, the portfolio variance is: 31) ______ A) the average covariance. B) the average expected value. C) the average variance. D) the weighted average expected value. E) the weighted average variance. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 11-06 The Example of Supertech and Slowpoke Source : Chapter 11 Test Bank > TB 11-31 For a highly diversified equally weighted po...

32) A well-diversified portfolio has negligible: 32) ______ A) expected return. B) systematic risk. C) unsystematic risk. D) variance. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 11-06 The Example of Supertech and Slowpoke Source : Chapter 11 Test Bank > TB 11-32 A well-diversified portfolio has negligible:

33) As we add more securities to a portfolio, the ____ will decrease: 33) ______ A) total risk B) systematic risk C) unsystematic risk D) standard error Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 11-06 The Example of Supertech and Slowpoke Source : Chapter 11 Test Bank > TB 11-33 As we add more securities to a portfolio, th...

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34) The CML is the pricing relationship between: 34) ______ A) efficient portfolios and beta. B) the risk-free asset and standard deviation of the portfolio return. C) the optimal portfolio return and the standard deviation of portfolio return. D) beta and the standard deviation of portfolio return. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 11-08 Variance and Standard Deviation of a Portfolio Source : Chapter 11 Test Bank > TB 11-34 The CML is the pricing relationship between:

35) You've owned a share of stock for 6 years. It returned 5% in 3 of those years and -5% in the

other 3. What was the variance? 35) ______ A) 0.15%. B) 0.16%. C) 0.25%. D) 0%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 11-02 Expected Return, Variance, and Covariance Source : Chapter 11 Test Bank > TB 11-35 You&#39;ve owned a share of stock...

36) The total number of variance and covariance terms in the portfolio is N2. How many of these

would be (including non-unique) covariances? 36) ______ A) N. B) N2. C) N2- N. D) N2- N/2. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Hard Topic : 11-05 The Risk and Return for Portfolios Source : Chapter 11 Test Bank > TB 11-36 The total number of variance and covariance ...

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37) Total risk can be divided into: 37) ______ A) standard deviation and variance. B) standard deviation and covariance. C) portfolio risk and beta. D) portfolio risk and unsystematic risk. E) portfolio risk and covariance. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 11-05 The Risk and Return for Portfolios Source : Chapter 11 Test Bank > TB 11-37 Total risk can be divided into:

38) Beta measures: 38) ______ A) the ability to diversify risk. B) how an asset covaries with the market. C) the actual return on an asset. D) the standard of the assets' returns. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 11-08 Variance and Standard Deviation of a Portfolio Source : Chapter 11 Test Bank > TB 11-38 Beta measures:

39) The dominant portfolio with the lowest possible risk measures is: 39) ______ A) the efficient frontier. B) the minimum variance portfolio. C) the upper tail of the efficient set. D) the tangency portfolio. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 11-05 The Risk and Return for Portfolios Source : Chapter 11 Test Bank > TB 11-39 The dominant portfolio with the lowest possi...

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40) The measure of beta associates most closely with: 40) ______ A) idiosyncratic risk. B) risk-free return. C) systematic risk. D) unexpected risk. E) unsystematic risk. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 11-08 Variance and Standard Deviation of a Portfolio Source : Chapter 11 Test Bank > TB 11-40 The measure of beta associates most closely ...

41) An efficient set of portfolios is: 41) ______ A) the complete opportunity set. B) the portion of the opportunity set 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. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 11-05 The Risk and Return for Portfolios Source : Chapter 11 Test Bank > TB 11-41 An efficient set of portfolios is:

42) A stock with a beta of zero would be expected to: 42) ______ A) have a rate of return equal to the risk-free rate. B) have a rate of return equal to the market rate. C) have a rate of return equal to zero. D) have a rate of return equal to the one. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 11-08 Variance and Standard Deviation of a Portfolio Source : Chapter 11 Test Bank > TB 11-42 A stock with a beta of zero would be expecte...

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43) The combination of the efficient set of portfolios with a riskless lending and borrowing rate

results in: 43) ______ A) the capital market line which shows that all investors will only invest in the riskless

asset. B) the capital market line which shows that all investors will invest in a combination of the riskless asset and the tangency portfolio. C) the security market line which shows that all investors will invest in the riskless asset only. D) the security market line which shows that all investors will invest in a combination of the riskless asset and the tangency portfolio. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 11-08 Variance and Standard Deviation of a Portfolio Source : Chapter 11 Test Bank > TB 11-43 The combination of the efficient set of port...

44) The elements along the diagonal of the Variance Covariance matrix are: 44) ______ A) covariances. B) security weights. C) security selections. D) variances. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 11-05 The Risk and Return for Portfolios Source : Chapter 11 Test Bank > TB 11-44 The elements along the diagonal of the Varia...

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45) The elements in the off-diagonal positions of the Variance Covariance matrix are: 45) ______ A) covariances. B) security selections. C) variances. D) security weights. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 11-05 The Risk and Return for Portfolios Source : Chapter 11 Test Bank > TB 11-45 The elements in the off-diagonal positions o...

46) The separation principle states that an investor will: 46) ______ A) choose any efficient portfolio and invest some amount in the riskless asset to generate

the expected return. B) choose an efficient portfolio based on individual risk tolerance or utility. C) never choose to invest in the riskless asset because the expected return on the riskless asset is lower over time. D) invest only in the riskless asset and tangency portfolio choosing the weights based on individual risk tolerance. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 11-08 Variance and Standard Deviation of a Portfolio Source : Chapter 11 Test Bank > TB 11-46 The separation principle states that an inve...

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47) The beta of a security is calculated by: 47) ______ A) dividing the covariance of the security with the market by the variance of the market. B) dividing the correlation of the security with the market by the variance of the market. C) dividing the variance of the market by the covariance of the security with the market. D) dividing the variance of the market by the correlation of the security with the market. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 11-08 Variance and Standard Deviation of a Portfolio Source : Chapter 11 Test Bank > TB 11-47 The beta of a security is calculated by:

48) You want your portfolio beta to be 1.20. 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 0.6. You have another $400 to invest and want to divide it between an asset with a beta of 1.6 and a risk-free asset. How much should you invest in the risk-free asset? 48) ______ A) $0 B) $140 C) $200 D) $320 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 11-08 Variance and Standard Deviation of a Portfolio Source : Chapter 11 Test Bank > TB 11-48 You want your portfolio beta to be 1.20. Cur...

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49) You have a $1,000 portfolio that is invested in stocks A and B plus a risk-free asset. $400 is

invested in stock A. Stock A has a beta of 1.3 and stock B has a beta of.7. How much needs to be invested in stock B if you want a portfolio beta of.90? 49) ______ A) $0 B) $268 C) $482 D) $543 E) $600 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 11-08 Variance and Standard Deviation of a Portfolio Source : Chapter 11 Test Bank > TB 11-49 You have a $1,000...

50) Suppose the JumpStart Corporation's common stock has a beta of 0.8. If the risk-free rate is

4% and the expected market return is 9%, the expected return for JumpStart's common is: 50) ______ A) 3.2%. B) 4.0%. C) 7.2%. D) 8.0%. E) 9.0%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 11-08 Variance and Standard Deviation of a Portfolio Source : Chapter 11 Test Bank > TB 11-50 Suppose the JumpStart...

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51) Suppose the MiniCD Corporation's common stock has a return of 12%. Assume the risk-free

rate is 4%, the expected market return is 9%, and no unsystematic influence affected Mini's return. The beta for MiniCD is: 51) ______ A) 0.89. B) 1.60. C) 2.40. D) 3.00. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 11-08 Variance and Standard Deviation of a Portfolio Source : Chapter 11 Test Bank > TB 11-51 Suppose the MiniCD...

52) A portfolio contains four assets. Asset 1 has a beta of 0.8 and comprises 30% of the portfolio.

Asset 2 has a beta of 1.1 and comprises 30% of the portfolio. Asset 3 has a beta of 1.5 and comprises 20% of the portfolio. Asset 4 has a beta of 1.6 and comprises the remaining 20% of the portfolio. If the riskless rate is expected to be 3% and the market risk premium is 6%, what is the beta of the portfolio, the expected return on the portfolio and the market? 52) ______ A) 1.19; 6.57%; 6.00% B) 1.19; 7.14%; 6.00% C) 1.19; 10.14%; 9.00% D) 1.25; 10.50%; 6.00% E) 1.25; 10.50%; 9.00% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 11-09 The Efficient Set for Two Assets Source : Chapter 11 Test Bank > TB 11-52 A portfolio contains four assets. Asset 1 ha...

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53) The characteristic line is graphically depicted as: 53) ______ A) the plot of the relationship between beta and expected return. B) the plot of the returns of the security against the beta. C) the plot of the security against the market index returns. D) the plot of the beta against the market index returns. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 11-08 Variance and Standard Deviation of a Portfolio Topic : 11-09 The Efficient Set for Two Assets Source : Chapter 11 Test Bank > TB 11-53 The characteristic line is graphically depic...

54) A security that is fairly priced will have a return _____ the Security Market Line. 54) ______ A) below B) on or below C) on D) on or above E) above Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 11-09 The Efficient Set for Two Assets Source : Chapter 11 Test Bank > TB 11-54 A security that is fairly priced will have a...

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SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 55) A portfolio exists containing stocks D, E, and F held in proportions 30%, 40%, and 30% respectively. The expected returns on the three stocks are given by 12%, 20%, and 28% respectively. Calculate the portfolio's expected return.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 11-09 The Efficient Set for Two Assets Source : Chapter 11 Test Bank > TB 11-55 A portfolio exists containing stocks D, E, a...

56) According to the CAPM, the expected return on a risky asset depends on three components.

Describe each component, and explain its role in determining the expected return.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 11-09 The Efficient Set for Two Assets Source : Chapter 11 Test Bank > TB 11-56 According to the CAPM, the expected return o...

57) Explain in words what beta is and why it is an important tool of security valuation.

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58) A portfolio is made up of 75% of stock 1, and 25% of stock 2. Stock 1 has a variance of 0.08,

and stock 2 has a variance of 0.035. The covariance between the stocks is -0.001. Calculate both the variance and the standard deviation of the portfolio.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 11-03 Expected Return and Variance Source : Chapter 11 Test Bank > TB 11-58 A portfolio is made up of 75% of stock 1, an...

59) Given the following information on three stocks: Stock

Expected Return

Standard Deviation

.060

.000

.100

.250

267

.375

σ_BC = -.05333 Suppose you desire to invest in any one of the stocks listed above. Can any be recommended?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 11-02 Expected Return, Variance, and Covariance Source : Chapter 11 Test Bank > TB 11-59 Given the following information on three sto...

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60) Given the following information on three stocks: Stock

Expected Return

Standard Deviation

.060

.000

.100

.250

267

.375

σ_BC = -.05333 Now suppose you diversify into two securities. Given all choices, can any portfolio be eliminated? Assume equal weights. Portfolio Variance

Portfolio Expected Return

A&B

.015625

.0800

A&C

.035156

.1635

B&C

.024115

.1835

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61) Given the following information on 3 stocks: Stock A

Stock B

Stock C

T- Bills

Market Port

Exp. Return

.19

.15

.09

.07

.18

Variance

.0200

.1196

.0205

.0000

.0064

Covariance with Mkt Portfolio

.007

.0045

.0013

.0000

.0064

Using the CAPM, calculate the expected return for Stocks A, B, and C. Which stocks would you recommend purchasing?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 11-08 Variance and Standard Deviation of a Portfolio Source : Chapter 11 Test Bank > TB 11-61 Given the following information on 3 stocks:...

62) Returns for the IC Company and the S&P 500 Index over the previous 4-year period are

given below: Year

IC Co.

S&P 500

30%

17%

20%

-8%

What are the average returns of IC and the S&P 500 index? If you had invested $1.00 in IC, how much would you have had after 4 years? What is the correlation between the returns on IC and the S&P?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 11-02 Expected Return, Variance, and Covariance Source : Chapter 11 Test Bank > TB 11-62 Returns for the IC Company and the S&amp;P 5...

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63) Draw and explain the relationship between the opportunity set for a two-asset portfolio when

the correlation is: [Choose from -1, -.5, 0, +.5, and +1]

Question Details Bloom's : Apply Difficulty : Hard Topic : 11-04 Covariance and Correlation Source : Chapter 11 Test Bank > TB 11-63 Draw and explain the relationship between th...

64) The diagram below represents an opportunity set for a two-asset combination. Indicate the

correct efficient set with labels; explain why it is so.

Question Details Bloom's : Understand Difficulty : Hard Topic : 11-04 Covariance and Correlation Source : Chapter 11 Test Bank > TB 11-64 The diagram below represents an opportunity ...

65) 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.

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66) Why are some risks diversifiable and some non-diversifiable? Give an example of each.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 11-05 The Risk and Return for Portfolios Source : Chapter 11 Test Bank > TB 11-66 Why are some risks diversifiable and some no...

67) 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?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 11-06 The Example of Supertech and Slowpoke Source : Chapter 11 Test Bank > TB 11-67 We routinely assume that investors are risk-...

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

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38) B 39) B 40) C 41) D 42) A 43) B 44) D 45) A 46) D 47) A 48) A 49) D 50) D 51) B 52) C 53) C 54) C 55) Short Answer

Portfolio return = .3(.12) +.4(.20) +.3(.28) = .20 56) Short Answer

The CAPM suggests that the expected return is a function of (1) the risk-free rate of return, which is the pure time value of money, (2) the market risk premium, which is the reward for bearing systematic risk, and (3) beta, which is the amount of systematic risk present in a particular asset. Better answers will point out that both the pure time value of money and the reward for bearing systematic risk are exogenously determined and can change on a daily basis, while the amount of systematic risk for a particular asset is determined by the firm's decisionmakers. 57) Short Answer

Beta is a measure of systematic risk, which is the only risk an investor can expect to earn compensation for bearing. Beta specifically measures the amount of systematic risk an asset has relative to an average asset. The amount of systematic risk inherent in a particular security determines the amount of risk premium that is applicable to that security. 58) Short Answer

σ² = (.75)²(.08) + (.25)²(.035) + 2(.25)(.75)(-.001) = 0.0468 σ = 2.163 59) Short Answer

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Can't tell, as no security dominates the other. 60) Short Answer

Portfolio A&C is dominated by portfolio B&C. 61) Short Answer

BA = .0070/.0064 = 1.094; ra = .07 + (.18 -.07)1.094 = .1903 BB = .0045/.0064 = 0.703; rb = .07 + (.18 -.07)0.703 = .1473 BC = .0013/.0064 = 0.203; rc = .07 + (.18-.07)0.203 = .0923 Indifferent on A as.1903 _.19. Would buy B as.15 >.1473. Would not buy C as.09 <.0923. 62) Short Answer

Average return is 22/4 = 5.5% for IC and 49/4 = 12.25% for the S&P. After 4 years $1.00 in IC grows to $1.00(1.30)(.92) = 1.196 = $1.20. For n = 4 σIC = 14.52, σSP = 6.38, σIC, SP = 46.125, determining (rIC, SP = 0.498 For n-1 = 3 σIC = 16.76 σSP = 7.37 σIC, SP = 61.50 determining (rIC, SP = .498 63) Short Answer

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Opportunity set is made up of a portfolio of two asset combinations with weights from (0,100) to (100, 0). Upper point--maximum return portfolio, 100% in highest return sec. Inflection point--minimum variance portfolio See diagram.

64) Short Answer

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Efficient set is portion of opportunity set that dominates. Provides maximum return for given risk or converse.

65) Short Answer

The student should correctly draw a SML with points C and D correctly identified. In this case, asset C is underpriced and asset D is overpriced. This condition cannot persist in equilibrium because investors will buy C with its high expected return and sell D with its low expected return. This buying and selling activity will force the prices back to a level that eventually causes both C and D to plot on the SML. 66) Short Answer

A reasonable answer would, at a minimum, explain that some risks (diversifiable) affect only a specific security, and when put into a portfolio, losses as a result of these firm-specific events will tend to be offset by price gains amongst other securities. Non-diversifiable risk, however, is unavoidable because such risks affect all or almost all securities in the market and can't be eliminated by forming portfolios. In the second part of the question, the students get a chance to use a minor amount of imagination. A strong answer would note the dependence of diversification effects on the degree of correlation between the assets used to form portfolios. 67) Short Answer

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This question, of course, gets to the point of the chapter: that rational investors will diversify away as much risk as possible. From the discussion in the text, most students will also have picked up that it is quite easy to eliminate diversifiable risk in practice, either by holding portfolios with 25 to 30 assets, or by holding shares in a diversified mutual fund. And, as noted in the text, there will be no return for bearing diversifiable risk, thus, total risk is not particularly important to a diversified investor.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Both the APT and the CAPM imply a positive relationship between expected return and risk. The APT views risk: 1) ______ A) very similarly to the CAPM via the beta of the security. B) in terms of individual inter-security correlation versus the beta of the CAPM. C) via the industry wide or market-wide factors creating correlation between securities versus the CAPM beta. D) the standardized deviation of the covariance. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 12-06 Betas and Expected Returns Source : Chapter 12 Test Bank > TB 12-01 Both the APT and the CAPM imply a positive r...

2) In the equation R = INSERT IMAGE + U, the three symbols stand for: 2) ______ 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) risk, expected return, and unsystematic risk. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 12-01 Factor Models: Announcements, Surprises, and Expected Returns Source : Chapter 12 Test Bank > TB 12-02 In the equation R = INSERT IMAGE + U, the th...

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3) Which of the following is true about the impact on the market price of a security when a

company makes an announcement and the market has discounted the news? 3) ______ A) The price will change a great deal; even though the impact is primarily in the future,

the future value is discounted to the present. B) The price will change little, since the impact is primarily in the future. C) The price will change little, since the market considers this information unimportant. D) The price will change little, since the market considers this information untrue. E) The price will change little, since the market has already included this information in the security's price. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 12-01 Factor Models: Announcements, Surprises, and Expected Returns Source : Chapter 12 Test Bank > TB 12-03 Which of the following is true about the imp...

4) Shareholders discount many corporate announcements because of their prior expectations. If

an announcement causes the price to change it will mostly be driven by: 4) ______ A) the expected part of the announcement. B) market inefficiency. C) the innovation or unexpected part of the announcement. D) the systematic risk. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 12-02 Risk: Systematic and Unsystematic Source : Chapter 12 Test Bank > TB 12-04 Shareholders discount many corporate announc...

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5) The unexpected return on a security, U, is made up of: 5) ______ A) market risk and systematic risk. B) systematic risk and idiosyncratic risk. C) idiosyncratic risk and unsystematic risk. D) expected return and market risk. E) expected return and idiosyncratic risk. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 12-02 Risk: Systematic and Unsystematic Source : Chapter 12 Test Bank > TB 12-05 The unexpected return on a security, U, is m...

6) Systematic risk is defined as: 6) ______ A) a risk that specifically affects an asset or small group of assets. B) any risk that affects a large number of assets. C) any risk that has a huge impact on the return of a security. D) the random component of return. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 12-02 Risk: Systematic and Unsystematic Source : Chapter 12 Test Bank > TB 12-06 Systematic risk is defined as:

7) In normal market conditions or when the market is rising if a security has a negative beta: 7) ______ A) the security always has a positive return. B) the security has an expected return above the risk-free return. C) the security has an expected return less than the risk-free rate. D) the security has an expected return equal to the market portfolio. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 12-03 Systematic Risk and Betas Source : Chapter 12 Test Bank > TB 12-07 In normal market conditions or when the mark...

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8) If company A makes a new product discovery and their stock rises 5% this will have: 8) ______ A) no effect on Company B's stock price because it is a systematic risk element. B) no effect on Company B's stock price because it is an unsystematic risk element. C) a large effect on Company B's stock price because it is a systematic risk element. D) a large effect on Company B's stock price because it is an unsystematic risk element. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 12-02 Risk: Systematic and Unsystematic Source : Chapter 12 Test Bank > TB 12-08 If company A makes a new product discovery a...

9) The term Corr(εR, εT) = 0 tells us that: 9) ______ A) the error terms of company R and T are 0. B) the unsystematic risk of companies R and T is unrelated or uncorrelated. C) the correlation between the returns of companies R and T is greater than zero. D) the systematic risk companies R and T is unrelated. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 12-02 Risk: Systematic and Unsystematic Source : Chapter 12 Test Bank > TB 12-09 The term Corr(&#949;R, &#949;T) = 0 te...

10) The systematic response coefficient for productivity, βP, would produce an unexpected

change in any security return of ________ if the expected rate of productivity was 1.5% and the actual rate was 2.25%. 10) ______ A) 0.75(βP)% B) -0.75(βP)% C) 2.25(βP)% D) -2.25% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 12-03 Systematic Risk and Betas Source : Chapter 12 Test Bank > TB 12-10 The systematic response coefficient for prod...

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11) If the expected rate of inflation was 3% and the actual rate was 6.2%; the systematic response

coefficient from inflation, βI, would result in a change in any security return of: 11) ______ A) 9.2%. B) 3.2 βI%. C) -3.2 βI%. D) 3.0%. E) 6.2 βI%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 12-03 Systematic Risk and Betas Source : Chapter 12 Test Bank > TB 12-11 If the expected rate of inflation was 3% and...

12) A factor is a variable that: 12) ______ A) affects the returns of risky assets in a systematic fashion. B) affects the returns of risky assets in an unsystematic fashion. C) correlates with risky asset returns in a unsystematic fashion. D) does not correlate with the returns of risky assets in an systematic fashion. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 12-03 Systematic Risk and Betas Source : Chapter 12 Test Bank > TB 12-12 A factor is a variable that:

13) In a portfolio of risky assets the response to a factor, Fi, can easily be determined by: 13) ______ A) summing the weighted βis and multiplying by the innovation in Fi. B) summing the Fis. C) adding the average weighted expected returns. D) Summing the weighted random errors. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 12-04 Portfolios and Factor Models Source : Chapter 12 Test Bank > TB 12-13 In a portfolio of risky assets the response ...

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14) Based on a multi-factor APT model, the concept of portfolio diversification is to minimize

which one of the following? 14) ______ A) weighted average of betas B) weighted average of betas × F C) F D) weighted average of unsystematic risks E) weighted average of expected returns Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 12-04 Portfolios and Factor Models Source : Chapter 12 Test Bank > TB 12-14 Based on a multi-factor APT model, the conce...

15) In the One Factor (APT) Model, the characteristic line to estimate βi passes through the

origin, unlike the estimate used in the CAPM because: 15) ______ A) the relationship is between the actual return on a security and the market index. B) the relationship measures the change in the security return over time versus the

change in the market return. C) the relationship measures the change in excess return on a security versus GNP. D) the relationship measures the change in excess return on a security versus the change in the factor about its mean of zero. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 12-03 Systematic Risk and Betas Source : Chapter 12 Test Bank > TB 12-15 In the One Factor (APT) Model, the character...

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16) The betas along with the factors in the APT adjust the expected return for: 16) ______ A) calculation errors. B) unsystematic risks. C) spurious correlations of factors. D) differences between actual and expected levels of factors. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Hard Topic : 12-03 Systematic Risk and Betas Source : Chapter 12 Test Bank > TB 12-16 The betas along with the factors in the APT ...

17) The single factor APT model that resembles the market model uses _____________ as the

single factor. 17) ______ A) arbitrage fees B) GNP C) the inflation rate D) the market return E) the risk-free return Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 12-03 Systematic Risk and Betas Source : Chapter 12 Test Bank > TB 12-17 The single factor APT model that resembles t...

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18) Assume that the single factor APT model applies and a portfolio exists such that 2/3 of the

funds are invested in Security Q and the rest in the risk-free asset. Security Q has a beta of 1.5. The portfolio has a beta of: 18) ______ A) 0.00. B) 0.50. C) 0.75. D) 1.00. E) 1.50. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 12-03 Systematic Risk and Betas Source : Chapter 12 Test Bank > TB 12-18 Assume that the single factor APT model appl...

19) For a diversified portfolio including a large number of stocks: 19) ______ A) the weighted average expected return goes to zero. B) the weighted average of the betas goes to zero. C) the weighted average of the unsystematic risk goes to zero. D) the return of the portfolio goes to zero. E) the return on the portfolio equals the risk-free rate. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 12-04 Portfolios and Factor Models Source : Chapter 12 Test Bank > TB 12-19 For a diversified portfolio including a larg...

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20) Which of the following statements is true? 20) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 12-04 Portfolios and Factor Models Source : Chapter 12 Test Bank > TB 12-20 Which of the following statements is true?

21) The acronym APT stands for: 21) ______ A) Above Par Terms. B) Absolute Profit Technique. C) Arbitrage Pricing Theory. D) Asset Puting Theory. E) Assured Price Techniques. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 12-06 Betas and Expected Returns Source : Chapter 12 Test Bank > TB 12-21 The acronym APT stands for:

22) The acronym CAPM stands for: 22) ______ A) Capital Asset Pricing Model. B) Certain Arbitrage Pressure Model. C) Current Arbitrage Prices Model. D) Cumulative Asset Price Model. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 12-06 Betas and Expected Returns Source : Chapter 12 Test Bank > TB 12-22 The acronym CAPM stands for:

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23) Assuming that the single factor APT model applies, the beta for the market portfolio is: 23) ______ A) zero. B) one. C) the average of the risk free beta and the beta for the highest risk security. D) impossible to calculate without collecting sample data. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 12-04 Portfolios and Factor Models Source : Chapter 12 Test Bank > TB 12-23 Assuming that the single factor APT model ap...

24) Suppose the JumpStart Corporation's common stock has a beta of 0.8. If the risk-free rate is

4% and the expected market return is 9%, the expected return for JumpStart's common stock is: 24) ______ A) 3.2%. B) 4.0%. C) 7.2%. D) 8.0%. E) 9.0%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 12-04 Portfolios and Factor Models Source : Chapter 12 Test Bank > TB 12-24 Suppose the JumpStart Corporation&#39;s...

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25) Suppose the MiniCD Corporation's common stock has a return of 12%. Assume the risk-free

rate is 4%, the expected market return is 9%, and no unsystematic influence affected Mini's return. The beta for MiniCD is: 25) ______ A) 0.89. B) 1.60. C) 2.40. D) 3.00. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 12-03 Systematic Risk and Betas Source : Chapter 12 Test Bank > TB 12-25 Suppose the MiniCD Corporation&#39;s...

26) A security that has a beta of zero will have an expected return of: 26) ______ A) zero. B) the market risk premium. C) the risk free rate. D) less than the risk free rate but not negative. E) less than the risk free rate which can be negative. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 12-05 Portfolios and Diversification Source : Chapter 12 Test Bank > TB 12-26 A security that has a beta of zero will have...

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27) A criticism of the CAPM is that it: 27) ______ A) ignores the return on the market portfolio. B) ignores the risk-free return. C) requires a single measure of systematic risk. D) utilizes too many factors. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 12-05 Portfolios and Diversification Source : Chapter 12 Test Bank > TB 12-27 A criticism of the CAPM is that it:

28) To estimate the cost of equity capital for a firm using APT or CAPM, it is necessary to have: 28) ______ A) company financial leverage, beta, and the market risk premium. B) company financial leverage, beta, and the risk-free rate. C) beta, company financial leverage, and the industry beta. D) beta, company financial leverage, and the market risk premium. E) beta, the risk-free rate, and the market risk premium. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 12-06 Betas and Expected Returns Source : Chapter 12 Test Bank > TB 12-28 To estimate the cost of equity capital for a...

29) Three factors likely to occur in the APT model are: 29) ______ A) unemployment, inflation, and current rates. B) inflation, GNP, and interest rates. C) current rates, inflation and change in housing prices. D) unemployment, college tuition, and GNP. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 12-04 Portfolios and Factor Models Source : Chapter 12 Test Bank > TB 12-29 Three factors likely to occur in the APT mod...

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30) To estimate the required return for a security using APT or CAPM, it is necessary to have: 30) ______ A) last period's return, beta, and the standard deviation. B) last period's return, beta, and the risk-free rate. C) beta, the market risk premium, and the risk-free rate. D) beta, last period's return, and the standard deviation. E) beta, last period's return, and the market risk premium. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 12-06 Betas and Expected Returns Source : Chapter 12 Test Bank > TB 12-30 To estimate the required return for a securi...

31) An advantage of the APT over CAPM is: 31) ______ A) APT can handle multiple factors. B) if the factors can be properly identified, the APT may have more

explanation/predictive power for returns. C) the APT forces unsystematic risk to be negative to offset systematic risk; thus making the total portfolio risk free, allowing for an arbitrage opportunity for the astute investor. D) APT can handle multiple factors; and if the factors can be properly identified, the APT may have more explanation/predictive power for returns. E) All of these. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 12-06 Betas and Expected Returns Source : Chapter 12 Test Bank > TB 12-31 An advantage of the APT over CAPM is:

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32) Suppose that we have identified three important systematic risk factors given by exports,

inflation, and industrial production. At the beginning of the year, growth in these three factors is estimated at -1%, 2.5%, and 3.5% respectively. However, actual growth in these factors turns out to be 1%, -2%, and 2%. The factor betas are given by βEX = 1.8, βI = 0.7, and βIP = 1.0. If the expected return on the stock is 6%, and no unexpected news concerning the stock surfaces, calculate the stock's total return. 32) ______ A) 2.95% B) 4.95% C) 6.55% D) 7.40% E) 8.85% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 12-06 Betas and Expected Returns Source : Chapter 12 Test Bank > TB 12-32 Suppose that we have identified three import...

33) Suppose that we have identified three important systematic risk factors given by exports,

inflation, and industrial production. At the beginning of the year, growth in these three factors is estimated at -1%, 2.5%, and 3.5% respectively. However, actual growth in these factors turns out to be 1%, -2%, and 2%. The factor betas are given by βEX = 1.8, βI = 0.7, and βIP = 1.0. Calculate the stock's total return if the company announces that they had an industrial accident and the operating facilities will close down for some time thus resulting in a loss by the company of 7% in return. Assume that the expected return on the stock is 6%. 33) ______ A) -4.05% B) -2.05% C) 4.55% D) 0.40% E) 1.85% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 12-06 Betas and Expected Returns Source : Chapter 12 Test Bank > TB 12-33 Suppose that we have identified three import...

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34) Suppose that we have identified three important systematic risk factors given by exports,

inflation, and industrial production. At the beginning of the year, growth in these three factors is estimated at -1%, 2.5%, and 3.5% respectively. However, actual growth in these factors turns out to be 1%, -2%, and 2%. The factor betas are given by βEX = 1.8, βI = 0.7, and βIP = 1.0. What would the stock's total return be if the actual growth in each of the factors equals to the expected growth? Assume no unexpected news on the patent. Assume that the expected return on the stock is 6%. 34) ______ A) 4% B) 5% C) 6% D) 7% E) 8% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 12-06 Betas and Expected Returns Source : Chapter 12 Test Bank > TB 12-34 Suppose that we have identified three import...

35) Which of the following statements is/are true? 35) ______ A) Both APT and CAPM argue that expected excess return must be proportional to the

beta(s). B) APT and CAPM are the only approaches to measure expected returns in risky assets. C) Both CAPM and APT are risk-based models. D) Both APT and CAPM argue that expected excess return must be proportional to the beta(s); and APT and CAPM are the only approaches to measure expected returns in risky assets. E) Both APT and CAPM argue that expected excess return must be proportional to the beta(s); and Both CAPM and APT are risk-based models. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 12-06 Betas and Expected Returns Source : Chapter 12 Test Bank > TB 12-35 Which of the following statements is/are tru...

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36) Financial models used to describe returns are based either on a theoretical construct or

parametric methods. Parametric models rely on: 36) ______ A) security betas explaining systematic factor relationships. B) finding regularities and relations in past market data. C) there being no true explanations of pricing relationships. D) always being able to find the exception to the rule. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 12-07 The Linear Relationship Source : Chapter 12 Test Bank > TB 12-36 Financial models used to describe returns ar...

37) A growth stock portfolio and a value portfolio might be characterized by: 37) ______ A) each by their P/E relative to the index P/E; high P/E for growth and lower for value. B) as earning a high rate of return for a growth security and a low rate of return for value

security irrespective of risk. C) low unsystematic risk and high systematic risk respectively. D) moderate systematic risk and zero systematic risk respectively. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 12-07 The Linear Relationship Source : Chapter 12 Test Bank > TB 12-37 A growth stock portfolio and a value portfol...

38) Style portfolios are characterized by: 38) ______ A) their stock attributes; P/Es less than the market P/E are value funds. B) their systematic factors, higher systematic factors are benchmark portfolios. C) their stock attributes; higher stock attribute factors are benchmark portfolios. D) their systematic factors, P/Es greater than the market are value portfolios. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 12-07 The Linear Relationship Source : Chapter 12 Test Bank > TB 12-38 Style portfolios are characterized by:

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SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 39) An investor is considering the three stocks given below: Stock Return

Expected

Beta

6.0%

-0.10

13.3%

2.10

9.2%

0.75%

Market Portfolio

10.0%

1.00

T-Bills

7.0%

0.00

Calculate the expected return and beta of a portfolio equally weighted between stocks B and C. Demonstrate that holding stock A reduces risk by comparing the risk of an equallyweighted portfolio between stock B and T-Bills with a portfolio equally weighted between stock B and A.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 12-05 Portfolios and Diversification Source : Chapter 12 Test Bank > TB 12-39 An investor is considering the three stocks ...

40) Explain the conceptual differences in the theoretical development of the CAPM and APT.

Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Hard Topic : 12-06 Betas and Expected Returns Source : Chapter 12 Test Bank > TB 12-40 Explain the conceptual differences in the th...

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41) You have a 3-factor model to explain returns. Explain what a factor represents in the context

of the APT? Each factor is multiplied by a β what do these represent and how do they relate to the actual return?

Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Hard Topic : 12-06 Betas and Expected Returns Source : Chapter 12 Test Bank > TB 12-41 You have a 3-factor model to explain returns...

42) Identify at least two accounting measures that are used in empirical asset pricing models and

explain how these measures can be used to identify assets that are expected to have higher returns in the future.

Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Hard Topic : 12-07 The Linear Relationship Source : Chapter 12 Test Bank > TB 12-42 Identify at least two accounting measures th...

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

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Rf = 6%-((-1%)*1.8 + 2.5%*0.7 + 3.5%*1) = 2.55% Then: R = 2.55% + 1.8*1% + 0.7*(-2%) + 1*2% = 4.95%. 33) B 34) C 35) E 36) B 37) A 38) A 39) Short Answer

Stock B and C: Rp =.5(13.3%) +.5(9.2%) = 11.25% Stock B and C: β p =.5(2.1) +.5(0.75) = 1.425 Stock B and T-bills: βB&TBILL =.5(2.1) +.5(0) = 1.05 Stock's B and A: βB&A =.5(2.1) +.5(-0.1) = 1.00 40) Short Answer

CAPM depends on efficient sets notions incorporate Rf to get separation principle the APT adds factors until there is no correlation between unsystematic risks of securities both show unsystematic risk approaches zero and systematic risks remain 41) Short Answer

Factor variable that explains some of the return measures the unexpected change in some underlying "economic" data β systematic risk of a security to a Factor measure security response to a Factor change explain how actual return varies from the expected return by the magnitude of β times the value of the factor. 42) Short Answer

Two common measures used in empirical models are PE and M/B, or the price-earnings ratio and the market-to-book ratio. A low value in either of these measures as compared to the average security would tend to identify securities that can be expected to produce higher returns in the future.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) The NPV formula for risky projects evaluates ________ using the ________. 1) ______ A) riskless discount rate; expected incremental cashflows. B) certain cashflows; risk-free discount rate. C) expected incremental cashflows; risk-free discount rate. D) certain cashflows; risky discount rate. E) expected incremental cashflows; risky discount rate. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 13-01 The Cost of Equity Capital Source : Chapter 13 Test Bank > TB 13-01 The NPV formula for risky projects evaluates...

2) In terms of the decision of what to do with extra cash, the firm's managers should undertake

projects only if: 2) ______ A) the firm never pays a dividend. B) the expected return on the project is greater than that of an asset of similar risk. C) the expected return on the project is less than that of an asset of similar risk. D) the expected return on the project is equal to that of an asset of similar risk. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 13-01 The Cost of Equity Capital Source : Chapter 13 Test Bank > TB 13-02 In terms of the decision of what to do with ...

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3) The WACC is used to _______ the expected cash flows when the firm has ________. 3) ______ A) discount; debt and equity in the capital structure. B) capitalize; short term financing on the balance sheet. C) increase; debt and equity in the capital structure. D) decrease; short term financing on the balance sheet. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 13-01 The Cost of Equity Capital Source : Chapter 13 Test Bank > TB 13-03 The WACC is used to _______ the expected cas...

4) If the CAPM is used to estimate the cost of equity capital, the expected excess market return

is equal to: 4) ______ A) the return on the stock minus the risk-free rate. B) the difference between the return on the market and the risk-free rate. C) the beta times the market risk premium. D) the beta times the risk-free rate. E) the market rate of return. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 13-01 The Cost of Equity Capital Source : Chapter 13 Test Bank > TB 13-04 If the CAPM is used to estimate the cost of ...

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5) The Consolidated Transfer Co. is an all-equity financed firm. The beta is 0.75, the market

risk premium is 8% and the risk-free rate is 4%. What is the expected return of Consolidated? 5) ______ A) 10%. B) 7%. C) 13%. D) 9%. E) 8%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 13-01 The Cost of Equity Capital Source : Chapter 13 Test Bank > TB 13-05 The Consolidated Transfer Co. is an all-equi...

6) Assuming the CAPM or one-factor model holds, what is the cost of equity for a firm if the

firm's equity has a beta of 1.2, the risk-free rate of return is 2%, the expected return on the market is 9%, and the return to the company's debt is 7%? 6) ______ A) 10.8%. B) 12.8%. C) 10.4%. D) 14.4%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 13-01 The Cost of Equity Capital Source : Chapter 13 Test Bank > TB 13-06 Assuming the CAPM or one-factor model holds,...

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7) The cost of equity for Gruwom Corp. is 8.4%. If the return to the market is 10% and the risk-

free rate is 5%, then the equity beta is: 7) ______ A) 0.48. B) 1.25. C) 0.68. D) 1.68. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 13-01 The Cost of Equity Capital Source : Chapter 13 Test Bank > TB 13-07 The cost of equity for Gruwom Corp. is 8.4%....

8) Two stock market-based costs of liquidity, that affect the cost of capital are the: 8) ______ A) bid-ask spread and the specialist spread. B) market impact cost and the brokerage costs. C) investor opportunity cost and the brokerage costs. D) bid-ask spread and the market impact costs. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 13-07 Sdeterminants of Beta Source : Chapter 13 Test Bank > TB 13-08 Two stock market-based costs of liquidity, t...

9) The use of WACC to select investments is theoretically acceptable when: 9) ______ A) the correlation of all new projects are equal. B) the NPV is positive when discounted by the WACC. C) the systematic risk of the projects are equal to the systematic risk of the firm. D) the firm is well diversified and the unsystematic risk is negligible. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 13-01 The Cost of Equity Capital Source : Chapter 13 Test Bank > TB 13-09 The use of WACC to select investments is the...

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10) If the risk of an investment project is different than the firm's risk then: 10) ______ A) you must calculate the discount rate for the project based on the firm's risk. B) you must calculate the discount rate for the project based on the project risk. C) you must exercise risk aversion and use the market rate. D) an average rate across prior projects is acceptable because estimates contain errors. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 13-04 Beta Estimation in Practice Source : Chapter 13 Test Bank > TB 13-10 If the risk of an investment project is diff...

11) The constant growth dividend valuation model can also be used to estimate the cost of equity

capital as: 11) ______ A) D1/[rs - g]. B) D1/Po - g. C) D1/Po + g. D) Po(rs - g). E) (D1/Po)(1 + rs). Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 13-01 The Cost of Equity Capital Source : Chapter 13 Test Bank > TB 13-11 The constant growth dividend valuation model...

12) If the project beta, IRR co-ordinates plot above the SML the project should be: 12) ______ A) accepted because it is overvalued. B) accepted because it is undervalued. C) rejected because it is overvalued. D) rejected because it is undervalued. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 13-01 The Cost of Equity Capital Source : Chapter 13 Test Bank > TB 13-12 If the project beta, IRR co-ordinates plot a...

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13) The beta of a security provides: 13) ______ A) an estimate of the market risk premium. B) an estimate of the slope of the CML. C) an estimate of the slope of the SML. D) an estimate of the systematic risk of the security. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 13-01 The Cost of Equity Capital Source : Chapter 13 Test Bank > TB 13-13 The beta of a security provides:

14) Regression analysis can be used to: 14) ______ A) estimate beta. B) estimatethe risk-free rate. C) estimate standard deviations. D) estimate variances. E) estimate expected returns. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 13-02 Estimation of Beta Source : Chapter 13 Test Bank > TB 13-14 Regression analysis can be used to:

15) Beta measures depend highly on the: 15) ______ A) direction of the market variance. B) the overall cycle of the market. C) the variance of the market and asset, but not their co-movement. D) the standard deviation of the security and the market and how they are correlated. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 13-02 Estimation of Beta Source : Chapter 13 Test Bank > TB 13-15 Beta measures depend highly on the:

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16) The formula for calculating beta is given by the dividing the _________ of the stock with the

market portfolio by the _________ of the market portfolio. 16) ______ A) variance; covariance B) covariance; variance C) standard deviation; variance D) expected return; variance E) expected return; covariance Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 13-02 Estimation of Beta Source : Chapter 13 Test Bank > TB 13-16 The formula for calculating beta is given by...

17) The best fit line of pairwise plot of the returns of the security against the market index returns

is called: 17) ______ A) the SML. B) the CML. C) the characteristic line. D) the risk line. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 13-02 Estimation of Beta Source : Chapter 13 Test Bank > TB 13-17 The best fit line of pairwise plot of the re...

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18) The slope of the characteristic line is the estimated: 18) ______ A) intercept. B) beta. C) unsystematic risk. D) market variance. E) market risk premium. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 13-02 Estimation of Beta Source : Chapter 13 Test Bank > TB 13-18 The slope of the characteristic line is the ...

19) When using the cost of debt, the relevant number is the: 19) ______ A) pre-tax cost of debt since most corporations pay taxes at the same tax rate. B) pre-tax cost of debt since it is the actual rate the firm is paying bondholders. C) post-tax cost of debt since dividends are tax deductible. D) post-tax cost of debt since interest is tax deductible. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 13-04 Beta Estimation in Practice Source : Chapter 13 Test Bank > TB 13-19 When using the cost of debt, the relevant nu...

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20) Betas may vary substantially across an industry. The decision to use the industry or company

beta to estimate the cost of capital depends on: 20) ______ A) how small the estimation errors are of all betas. B) how similar the firm's operations are to the operations of all other firms in the

industry. C) whether your company is a leader or follower. D) the size of your company's public float. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 13-02 Estimation of Beta Source : Chapter 13 Test Bank > TB 13-20 Betas may vary substantially across an indus...

21) If a stock's monthly return is consistently positive when the market's monthly return is

negative, and vice-versa, then the beta of the company's stock will likely be: 21) ______ A) zero. B) negative. C) positive. D) very high. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 13-02 Estimation of Beta Source : Chapter 13 Test Bank > TB 13-21 If a stock&#39;s monthly return is consistently...

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22) Beta is useful in the calculation of: 22) ______ A) the company's variance. B) the companies discount rate. C) the company's standard deviation. D) unsystematic risk. E) the risk free-rate or the market rate. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 13-02 Estimation of Beta Source : Chapter 13 Test Bank > TB 13-22 Beta is useful in the calculation of:

23) Companies that have highly cyclical sales will have a: 23) ______ A) low beta if sales are highly dependent on the market cycle. B) high beta if sales are highly dependent on the market cycle. C) high beta if sales are independent of the market cycle. D) low beta if sales are independent of the market cycle. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 13-02 Estimation of Beta Source : Chapter 13 Test Bank > TB 13-23 Companies that have highly cyclical sales wi...

24) An industry is likely to have a low beta if the: 24) ______ A) stream of revenues is unstable than the market. B) economy is in an expansion. C) market for its goods is affected by the market cycle. D) stream of revenues is more volatile than the market. E) stream of revenues is stable and less volatile than the market. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 13-02 Estimation of Beta Source : Chapter 13 Test Bank > TB 13-24 An industry is likely to have a low beta if ...

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25) Suppose that the Simmons Corporation's common stock has a beta of 1.6. If the risk-free rate

is 5% and the market risk premium is 4%, the expected return for Simmons' common is: 25) ______ A) 4.0%. B) 5.0%. C) 5.6%. D) 10.6%. E) 11.4%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 13-01 The Cost of Equity Capital Source : Chapter 13 Test Bank > TB 13-25 Suppose that the Simmons Corporation&#39;s...

26) Suppose the Barges Corporation's common stock has an expected return of 12%. Assume

that the risk-free rate is 5%, and the market risk premium is 6%. If no unsystematic influence affected Barges' return, the beta for Barges is: 26) ______ A) 1.00. B) 1.17. C) 1.20. D) 2.50. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 13-01 The Cost of Equity Capital Source : Chapter 13 Test Bank > TB 13-26 Suppose the Barges Corporation&#39;s...

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27) For a multi-product firm, if a project's beta is different from that of the overall firm, then: 27) ______ A) the CAPM can no longer be used. B) the project should be discounted using the overall firm's beta. C) the project should be discounted at a rate commensurate with its own beta. D) the project should be discounted at the market rate in all cases. E) the project should be discounted at the T-bill rate in all cases. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 13-03 Measuring Company Betas Source : Chapter 13 Test Bank > TB 13-27 For a multi-product firm, if a project&#39;s...

28) The β of all equity firm versus the β of the same firm with leverage is different: 28) ______ A) by the impact of business risk. B) by the β of the assets. C) because the β of the assets are not exposed to financial leverage. D) because the β of the assets are exposed to financial leverage. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 13-03 Measuring Company Betas Source : Chapter 13 Test Bank > TB 13-28 The &#946; of all equity firm versus the...

29) Comparing two otherwise equal firms, the beta of the common stock of a levered firm is

_________ than the beta of the common stock of an unlevered firm. 29) ______ A) equal to B) significantly less C) slightly less D) greater Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 13-03 Measuring Company Betas Source : Chapter 13 Test Bank > TB 13-29 Comparing two otherwise equal firms, the bet...

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30) Slippery Slope Roof Contracting has an equity beta of 1.2, a capital structure with 2/3 of risk-

free debt, and a tax rate of zero. What is their asset beta? 30) ______ A) 1.8. B) 0.40. C) 0.72. D) 1.2. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 13-03 Measuring Company Betas Source : Chapter 13 Test Bank > TB 13-30 Slippery Slope Roof Contracting has an equit...

31) The beta of a firm is more likely to be high under what two conditions? 31) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 13-03 Measuring Company Betas Source : Chapter 13 Test Bank > TB 13-31 The beta of a firm is more likely to be high...

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32) RKKL is considering buying a company that has no leverage but an asset beta of 0.7. The

market risk premium is 6% and the risk-free rate is 2%. If they plan to use 75% debt, what will the required rate of return be? 32) ______ A) 18.8% B) 6.2% C) 8.0% D) 14.6% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 13-03 Measuring Company Betas Source : Chapter 13 Test Bank > TB 13-32 RKKL is considering buying a company that ha...

33) A firm with cyclical earnings is characterized by: 33) ______ A) revenue patterns that vary with the business cycle. B) high levels of debt in their capital structures. C) high fixed costs. D) high price per unit. E) low contribution margins. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 13-03 Measuring Company Betas Source : Chapter 13 Test Bank > TB 13-33 A firm with cyclical earnings is characteriz...

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34) A firm with high operating leverage has: 34) ______ A) low amounts of fixed cost in their production process. B) high amounts of variable cost in their production process. C) high amounts of fixed cost in their production process. D) high price per unit. E) low price per unit. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 13-03 Measuring Company Betas Source : Chapter 13 Test Bank > TB 13-34 A firm with high operating leverage has:

35) If a firm has low fixed costs relative to all other firms in the same industry, a large change in

volume (either up or down) would have: 35) ______ A) a smaller change in EBIT for the firm versus the other firms. B) no effect in any way on the firms as volume does not affect fixed costs. C) a decreasing effect on the cyclical nature of the business. D) a large change in EBIT for the firm versus the other firms. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 13-03 Measuring Company Betas Source : Chapter 13 Test Bank > TB 13-35 If a firm has low fixed costs relative to al...

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36) A firm with high operating leverage is characterized by _______ while one with high

financial leverage is characterized by ________. 36) ______ A) low fixed cost of production; low fixed financial costs B) high variable cost of production; high variable financial costs C) high fixed costs of production; high fixed financial costs D) low costs of production; high fixed financial costs E) high fixed costs of production; low variable financial costs Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 13-03 Measuring Company Betas Source : Chapter 13 Test Bank > TB 13-36 A firm with high operating leverage is chara...

37) Two firms have the same operating structure and the same operating systematic risk, ß =.8.

Firm 1 has 20% debt in their capital structure while Firm 2 has four units of debt for every 7 units of equity. If the tax rate faced by both firms is 0.4 which has the riskier equity? 37) ______ A) Firm 1 because it has a higher ratio of debt to equity. B) Neither because they both have the same ß =.8. C) Firm 2 because it has a higher ratio of debt to equity. D) Neither firm because systematic risk is unaffected by the financing. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 13-03 Measuring Company Betas Source : Chapter 13 Test Bank > TB 13-37 Two firms have the same operating structure ...

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38) Two firms have the same operating structure and the same operating systematic risk, ß =.8.

firm 1 has 20% debt in their capital structure while Firm 2 has four units of debt for every 7 units of equity. The tax rate faced by both firms is 0.4. The debt beta is assumed to be zero. What is the difference in systematic risk between the riskier firm and the less risky firm? 38) ______ A) 0.26 Firm 2 beta greater than Firm 1 beta. B) 0.15 Firm 2 beta greater than Firm 1 beta. C) 0.30 Firm 2 beta greater than Firm 1 beta. D) 0.10 firm 2 beta greater than Firm 1 beta. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 13-03 Measuring Company Betas Source : Chapter 13 Test Bank > TB 13-38 Two firms have the same operating structure ...

39) The beta of a portfolio of the firm's debt and equity: 39) ______ A) is equal to the sum of all the betas. B) is equal to the sum of all the betas weighted by their market value weight. C) is greater than the beta of each component. D) is always less than zero. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 13-03 Measuring Company Betas Source : Chapter 13 Test Bank > TB 13-39 The beta of a portfolio of the firm&#39;s...

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40) Firms whose revenues are strongly cyclical and whose operating leverage is high are likely to

have: 40) ______ A) low betas. B) high betas. C) zero betas. D) negative betas. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 13-03 Measuring Company Betas Source : Chapter 13 Test Bank > TB 13-40 Firms whose revenues are strongly cyclical a...

41) The Tenplen Corporation has an equity beta of 1.2 and a debt beta of 0.8. The firm's market

value debt to equity ratio is 0.6. Tenplen has a tax rate of zero. What is the asset beta? 41) ______ A) 0.70. B) 1.04. C) 1.09 D) 0.96. E) 0.72. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 13-03 Measuring Company Betas Source : Chapter 13 Test Bank > TB 13-41 The Tenplen Corporation has an equity beta o...

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42) The Tenplen Corporation has an asset beta of 1.05 and a debt beta of 0.8. The debt portion of

the capital structure in market terms is 0.375. Tenplen has a tax rate of zero. What is the equity beta? 42) ______ A) 0.80. B) 0.90. C) 1.05. D) 1.20. E) 0.40. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 13-03 Measuring Company Betas Source : Chapter 13 Test Bank > TB 13-42 The Tenplen Corporation has an asset beta of...

43) The use of debt is called: 43) ______ A) operating leverage. B) production leverage. C) financial leverage. D) total asset turnover risk. E) business risk. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 13-04 Beta Estimation in Practice Source : Chapter 13 Test Bank > TB 13-43 The use of debt is called:

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44) Jake's Sound Systems has 210,000 shares of common stock outstanding at a market price of

$36 a share. Last month, Jake's paid an annual dividend of $1.593 per share. The dividend growth rate is 4%. Jake's also has 6,000 bonds outstanding with a face value of $1,000 per bond. The bonds carry a 7% coupon, pay interest annually, and mature in 4.89 years. The bonds are selling at 99% of face value. The company's tax rate is 34%. What is Jake's weighted average cost of capital? 44) ______ A) 5.3% B) 5.8% C) 6.3% D) 7.01% E) 7.2% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 13-04 Beta Estimation in Practice Source : Chapter 13 Test Bank > TB 13-44 Jake&#39;s Sound Systems has 210,000 ...

45) Jack's Construction Co. has 80,000 bonds outstanding that are selling at par value. Bonds

with similar characteristics are yielding 8.5%. The company also has 4 million shares of common stock outstanding. The stock has a beta of 1.1 and sells for $40 a share. The Treasury bill is yielding 4% and the market risk premium is 8%. Jack's tax rate is 35%. What is Jack's weighted average cost of capital? 45) ______ A) 7.10% B) 7.39% C) 10.38% D) 10.65% E) 11.37% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 13-04 Beta Estimation in Practice Source : Chapter 13 Test Bank > TB 13-45 Jack&#39;s Construction Co. has 80,000 ...

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46) Phil's Carvings, Inc. wants to have a weighted average cost of capital of 9%. The firm has an

after-tax cost of debt of 5% and a cost of equity of 11%. What debt-equity ratio is needed for the firm to achieve its targeted weighted average cost of capital? 46) ______ A) 0.33 B) 0.40 C) 0.50 D) 0.60 E) 0.67 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 13-04 Beta Estimation in Practice Source : Chapter 13 Test Bank > TB 13-46 Phil&#39;s Carvings, Inc. wants to have...

47) Peter's Audio Shop has a cost of debt of 7%, a cost of equity of 11%, and a cost of preferred

stock of 8%. The firm has 104,000 shares of common stock outstanding at a market price of $20 a share. There are 40,000 shares of preferred stock outstanding at a market price of $34 a share. The bond issue has a total face value of $500,000 and sells at 102% of face value. The tax rate is 34%. What is the weighted average cost of capital for Peter's Audio Shop? 47) ______ A) 6.14% B) 6.54% C) 8.60% D) 9.14% E) 9.45% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 13-04 Beta Estimation in Practice Source : Chapter 13 Test Bank > TB 13-47 Peter&#39;s Audio Shop has a cost of debt...

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48) The current market rate of return is 12% and the risk-free rate is 4%. You have been given

the job of determining your firm's cost of capital components. The company has 1 million shares outstanding with a current value of $22.50 per share. The debt represents 30% of the capital structure and the yield to maturity is 12%. The beta of the equity is 1.4 and the tax rate is 30%. What is the market value of the firm and the debt respectively? 48) ______ A) 22,500,000; 6,750,000 B) 32,142,857; 9,642,857 C) 32,142,857; 22,500,000 D) 15,750,000; 9,642,857 E) 9,642,857; 22,500,000 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 13-04 Beta Estimation in Practice Source : Chapter 13 Test Bank > TB 13-48 The current market rate of return is 12% and...

49) The current market rate of return is 12% and the risk-free rate is 4%. You have been given

the job of determining your firm's cost of capital components. The company has 1 million shares outstanding with a current value of $22.50 per share. The debt represents 30% of the capital structure and the yield to maturity is 12%. The beta of the equity is 1.4 and the tax rate is 30%. What is the firm's market value of debt and equity respectively? 49) ______ A) 22,500,000; 6,750,000 B) 2,020,000; 22,500,000 C) 4,750,000; 15,750,000 D) 9,642,857; 15,750,000 E) 9,642,857; 22,500,000 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 13-04 Beta Estimation in Practice Source : Chapter 13 Test Bank > TB 13-49 The current market rate of return is 12% and...

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50) The current market rate of return is 12% and the risk-free rate is 4%. You have been given

the job of determining your firm's cost of capital components. The company has 1 million shares outstanding with a current value of $22.50 per share. The debt represents 30% of the capital structure and the yield to maturity is 12%. The beta of the equity is 1.4 and the tax rate is 30%. What is the required rate of return on equity? 50) ______ A) 9.6% B) 14.4% C) 15.2% D) 18.56% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 13-04 Beta Estimation in Practice Source : Chapter 13 Test Bank > TB 13-50 The current market rate of return is 12% and...

51) The current market rate of return is 12% and the risk-free rate is 4%. You have been given

the job of determining your firm's cost of capital components. The company has 1 million shares outstanding with a current value of $22.50 per share. The debt represents 30% of the capital structure and the yield to maturity is 12%. The beta of the equity is 1.4 and the tax rate is 30%. What is the market value of debt and its' net cost to the firm? 51) ______ A) 9,642,857; 8.4%. B) 9,642,857; 12%. C) 6,750,000; 8.4%. D) 6,750,000; 12%. E) 4,725,000; 12%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 13-04 Beta Estimation in Practice Source : Chapter 13 Test Bank > TB 13-51 The current market rate of return is 12% and...

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52) The current market rate of return is 12% and the risk-free rate is 4%. You have been given

the job of determining your firm's cost of capital components. The company has 1 million shares outstanding with a current value of $22.50 per share. The debt represents 30% of the capital structure and the yield to maturity is 12%. The beta of the equity is 1.4 and the tax rate is 30%. What is the firm's WACC? 52) ______ A) 10.44% B) 13.16% C) 14.24% D) 19.04% E) 14.28% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 13-04 Beta Estimation in Practice Source : Chapter 13 Test Bank > TB 13-52 The current market rate of return is 12% and...

53) The NuPress Valet Co. has an improved version of its' hotel stand. The investment cost is

expected to be 72 million dollars and will return 13.50 million dollars for 5 years in net cash flows. The ratio of debt to equity is 1 to 1. The cost of equity is 13%, the cost of debt is 9%, and the tax rate is 34%. What is the NPV of the project? 53) ______ A) - 4,500,000 B) -24,517,378 C) -19,489,708 D) -20,123,870 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 13-04 Beta Estimation in Practice Source : Chapter 13 Test Bank > TB 13-53 The NuPress Valet Co. has an improved versio...

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54) The Upper Tier 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 floatation cost of debt is 6.6 percent. What should the firm use as their weighted average floatation cost? 54) ______ A) 8.01% B) 8.52% C) 8.33% D) 7.76% E) 8.60% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 13-06 Using an Industry Beta Source : Chapter 13 Test Bank > TB 13-54 The Upper Tier has a current debt-equity rat...

55) XYZ INC has several divisions and the one managed by Dr. Donaldson has an asset base of

$4 million and earnings after taxes are $2 million. A new project would earn $2 million per year on an investment of $5 million. As a result, the ROA of the division changed from: 55) ______ A) 50% to 44%. B) 55% to 40%. C) 44% to 50%. D) 50% to 70%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 13-13 The Cost of Debt Source : Chapter 13 Test Bank > TB 13-55 XYZ INC has several divisions and the one ma...

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56) XYZ INC has several divisions and the one managed by Dr. Donaldson has an asset base of

$4 million and earnings after taxes are $2 million. A new project would earn $2 million per year on an investment of $3 million. If the new project is on, Mr. Donaldson's bonus should not be based on: 56) ______ A) EVA. B) ROA. C) Sales. D) Accounting profits. E) Cash flows. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 13-13 The Cost of Debt Source : Chapter 13 Test Bank > TB 13-56 XYZ INC has several divisions and the one ma...

57) One Caveat of using EVA as a measure of performance measurement is, managers: 57) ______ A) may not have incentive to work hard. B) may overstate earnings. C) may cut back production. D) none of these. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 13-13 The Cost of Debt Source : Chapter 13 Test Bank > TB 13-57 One Caveat of using EVA as a measure of perf...

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SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 58) Explain the factors that determine beta and how an asset beta can differ from equity betas.

Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 13-03 Measuring Company Betas Source : Chapter 13 Test Bank > TB 13-58 Explain the factors that determine beta and ...

59) The Neptune Company offers network communications systems to computer users. The

company is planning a major investment expansion but is unsure of the correct measure of equity capital as it has no traded equity. Your job is to determine the basis of the equity cost. List and explain the steps you will need to take.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 13-04 Beta Estimation in Practice Source : Chapter 13 Test Bank > TB 13-59 The Neptune Company offers network communica...

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60) On-line Text Co. 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.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 13-04 Beta Estimation in Practice Source : Chapter 13 Test Bank > TB 13-60 On-line Text Co. has four new text publishin...

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61) Given the sample of returns of the Top Black Asphalt Company and the S&P 500 index,

calculate Top Black's covariance and beta. Year

Rs (Top Black )

Rm (Market )

+15%

+8%

+6%

+2%

-10%

-7%

Year

Rs (Top Black )

Rm –(Market )

+15%

+8%

12%

6.4%

.00768

+6%

+2%

0.4%

.00012

-10%

-7%

-13%

-8.6%

.00118

-3%

1.4%

-.00042

0.4%

-.00004

Rs -S Rm -m (Rs-S )(Rm-m )

.00860

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 13-02 Estimation of Beta Source : Chapter 13 Test Bank > TB 13-61 Given the sample of returns of the Top Black...

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62) Eyes of the 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 = 1.0, βE = 2.0, and the beta for the overall firm is 1.3. The firm is considering the following capital expenditures:

Publishing

Entertainment

Proposed Project

Initial Investment

IRR

$1M

.130

$3M

.121

$2M

.090

$4M

.160

$6M

.170

$5M

.140

Which projects would the firm accept if it uses the opportunity cost of capital for the entire company? Which projects would it accept if it estimates the cost of capital separately for each division? Use 6% as the risk-free rate, and 12% as the expected return on the market.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 13-04 Beta Estimation in Practice Source : Chapter 13 Test Bank > TB 13-62 Eyes of the World Corporation has traditiona...

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63) On-line Text Co. has four new text publishing products that they must decide on publishing

to expand their services. The firm's WACC has been 17%. The projects are of equal risk, ßs of 1.6. The risk-free rate is 7% and the market rate is expected to be 12%. The projects are expected to earn as follows: • Project W: 14% • Project X: 18% • Project Y: 17% • Project Z: 15% What projects should be selected and why?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 13-04 Beta Estimation in Practice Source : Chapter 13 Test Bank > TB 13-63 On-line Text Co. has four new text publishin...

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Answer Key Test name: Chapter 13 1) 2) 3) 4) 5)

E B A B A Using CAPM ER = 0.04 + 0.75 (0.08) = 10%. 6) C 7) C 8) D 9) C 10) B 11) C 12) B

accepted because it is undervalued. 13) D 14) A 15) D 16) B 17) C 18) B 19) D 20) B 21) B 22) B 23) B 24) E 25) E 26) B 27) C 28) C 29) D 30) B

Beta of Asset = 1.2 x 1/3 + 0 x 2/3 = 0.40.

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31) B 32) A

Beta (L) = Beta (UL) x ( 1 + (1-t)(D/E) = 0.7 ( 1 + (1-0)0.75/0.25) = 2.8 Using CAPM = 0.02 + 2.8 (0.06) = 18.8%. 33) A 34) C 35) A 36) C 37) C 38) B

B( L) of Firm 1 = 0.8 ( 1 + (1-0.4) (0.20/0.80)) = 0.92 B(L) of Firm 2 = 0.8 ( 1 + (1-0.4) (4/7)) = 1.07 Firm 2 - Firm 1 1.07- 0.92 = 0.15. 39) B 40) B 41) C

1.2 x (1/(1 + 0.4)) + 0.8 x (0.40/(1 + 0.4)) = 1.09. 42) D

1.05 = E (0.625) + 0.375 (0.8) E = 1.20. 43) C 44) D

$36 = $1.593 (1 + 0.04)/(K-0.04) K = 0.08602 WACC = 0.60024 (0.08602) + 0.39976 (0.07 (1-0.34)) = 7.01%. 45) C 46) C 47) D 48) B

($22.5) X 1,000,000 = 22,500,000 Total Value of firm = $22,500,000/ 0.70 = 32142857 Value of Debt = 32142857 x 0.30 = 9642857. 49) E

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Market Value of Equity = 1000000 x $22.5 = $22500000 Market Value of Debt = $22500000 x 0.3/0.7 = 9642857. 50) C

Using CAPM ER = 0.04 + 1.4 (0.12-0.04) = 15.20%. 51) A

22500000* 0.3/0.7 = 9642857 Net cost of debt = 0.12 (1-0.30) = 8.4%. 52) B

WACC = 0.70 (15.2%) + 0.30 (0.12 (1-0.3)) = 13.16%. 53) D 54) E 55) A

Existing ROA = 2/4 = 0.5 or 50% After considering new project We have 4/9 = 0.4444 Or 44.44%. 56) B

ROA. 57) B 58) Short Answer

Operating leverage Cyclicality of revenues Financial leverage Asset beta = equity beta with no financial leverage Equity beta > asset beta with financial leverage 59) Short Answer

Collect estimates of beta for firms in the same business. Collect market value D/E ratio and tax rate for each company. Delever and estimate an average asset beta. Relever to D/E ratio desired. RF rate and market risk premium, calculate (estimate) equity cost of capital. 60) Short Answer

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Rs =.042 + 1.6(.123 -.042) =.1716, or 17.16% Accept projects X and Z because their IRR's exceed the required return of 17.16 percent, which is computed using the appropriate beta of 1.6. 61) Short Answer

Step 1: Calculate the average return for each stock: Rs = 3%, Rm = 1.6% Step 2: Calculate the deviation of each monthly return from the average. Step 3: Calculate the cross product of the deviations and sum,.00860. Covariance =.0086/4 =.00215. Step 4: Calculate the squared deviations of Rm (NOTE: Not Given Above) Step 5: Sum the product of the deviations and the squared deviations of Rm (which is equal to.01172, VAR =.00293 and STD =.05413; for Top Black VAR =.0083 and STD =.091104) Step 6: Divide the sum of the cross-products of the deviations by the sum of the squared market deviations:.0086/.01172 =.73378 =.74; Cov/Var(m) =.00215/.00293=.73378 =.74 62) Short Answer

- Overall firm cost of capital: 6% + (12% - 6%)1.3 = 13.8% - Accept projects E1, E2, and E3. - Publishing cost of capital: 6% + (12% - 6%)1.0 = 12% - Accept projects P1 and P2. - Entertainment cost of capital: 6% + (12% - 6%)2.0 = 18% - Accept no projects in this division. Results in contrast to - Overall cost of capital when own risk is considered. 63) Short Answer

Required Rate of Return: = 7 + 1.6(12 - 7) = 7 + 1.6(5) = 7 + 8 = 15% Projects X, Y > 15% Accept, NPV > 0 Project Z = 15% Indifferent, NPV = 0 Project W < 15% Reject WACC rate of 17% is irrelevant. The risk of the projects must be different than risk of company.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) In an efficient market, the price of a security will: 1) ______ 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 new information with no further price adjustments related to that information. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 14-01 Can Financing Decisions Create Value? Source : Chapter 14 Test Bank > TB 14-01 In an efficient market, the price of a secur...

2) In analyzing the financial decision of the firm, it turns out that the typical firm: 2) ______ A) has more capital expenditure opportunities with positive NPVs than financing

opportunities. B) has more financing opportunities with positive NPVs than capital expenditure opportunities. C) has about the same number of capital expenditure opportunities and financing opportunities. D) has no opportunities for positive NPVs in either capital expenditures or in financing. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 14-01 Can Financing Decisions Create Value? Source : Chapter 14 Test Bank > TB 14-02 In analyzing the financial decision of the f...

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3) If the financial markets are efficient, then investors should expect their investments in those

markets to: 3) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 14-01 Can Financing Decisions Create Value? Source : Chapter 14 Test Bank > TB 14-03 If the financial markets are efficient, then...

4) In an efficient market when a firm announces a new product or product enhancement with

superior technology providing positive NPV the price of the stock will: 4) ______ A) rise gradually over the next few days. B) decline gradually over the next few days. C) rise on the same day to the new price. D) stay at the same price, with no net effect. E) drop on the same day to the new price. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 14-02 A Description of Efficient Capital Markets Source : Chapter 14 Test Bank > TB 14-04 In an efficient market when a firm announces...

5) If you excel in analyzing the future outlook of firms, you would prefer that the financial

markets be ____ form efficient so that you can have an advantage in the marketplace. 5) ______ A) weak B) semistrong C) strong Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Source : Chapter 14 Test Bank > TB 14-05 If you excel in analyzing the future outlook...

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6) Your best friend works in the finance office of the Delta Corporation. You are aware that this

friend trades Delta stock based on information he overhears in the office. You know that this information is not known to the general public. Your friend continually brags to you about the profits he earns trading Delta stock. Based on this information, you would tend to argue that the financial markets are at best _____ form efficient. 6) ______ A) weak B) strong C) semistrong Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 14-03 Foundations of Market Efficiency Source : Chapter 14 Test Bank > TB 14-06 Your best friend works in the finance office...

7) If the efficient market hypothesis holds, investors should expect: 7) ______ A) to earn only a supernormal return. B) to receive a high price for their securities. C) to always be able to pick stocks that will outperform the market averages. D) to earn only a normal return; and to receive a fair price for their securities. E) to receive a fair price for their securities; and to always be able to pick stocks that will

outperform the market averages. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 14-02 A Description of Efficient Capital Markets Source : Chapter 14 Test Bank > TB 14-07 If the efficient market hypothesis holds, in...

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8) The model, Pt = Pt-1 + Expected Return + Random errors, supports the weak form of the

efficient market hypothesis if: 8) ______ A) the random error can be predicted by past prices. B) there is correlation between random errors period to period. C) the random errors are unrelated from one period to the next period. D) the expected return is not based on the security's risk. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 14-03 Foundations of Market Efficiency Source : Chapter 14 Test Bank > TB 14-08 The model, Pt = Pt-1 + Expected Return + Ran...

9) The hypothesis that market prices reflect all publicly available information is called _____

form efficiency. 9) ______ A) weak B) strong C) semistrong Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 14-03 Foundations of Market Efficiency Source : Chapter 14 Test Bank > TB 14-09 The hypothesis that market prices reflect al...

10) 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: 10) ______ A) moderate form of the efficient market hypothesis. B) semi-strong form of the efficient market hypothesis. C) strong form of the efficient market hypothesis. D) weak form of the efficient market hypothesis. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 14-03 Foundations of Market Efficiency Source : Chapter 14 Test Bank > TB 14-10 An investor discovers that for a certain gro...

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11) Which one of the following statements is correct concerning market efficiency? 11) ______ A) Real asset markets are more efficient than financial markets. 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 shares of stock. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 14-01 Can Financing Decisions Create Value? Source : Chapter 14 Test Bank > TB 14-11 Which one of the following statements is cor...

12) When the 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 to the actual return due to: 12) ______ A) a predictable amount based on the past prices. B) a component based on new information unrelated to past prices. C) the security's risk. D) the risk free rate. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 14-03 Foundations of Market Efficiency Source : Chapter 14 Test Bank > TB 14-12 When the stock price follows a random walk t...

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13) Which form of the efficient market hypothesis implies that security prices reflect all

information contained in past prices? 13) ______ A) The weak form. B) The semi-strong form. C) The strong form. D) The hard form. E) The past form. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 14-03 Foundations of Market Efficiency Source : Chapter 14 Test Bank > TB 14-13 Which form of the efficient market hypothesi...

14) According to the efficient market hypothesis, financial markets fluctuate daily because they: 14) ______ A) are inefficient. B) slowly react to new information. C) are continually reacting to new information. D) offer tremendous arbitrage opportunities. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 14-03 Foundations of Market Efficiency Source : Chapter 14 Test Bank > TB 14-14 According to the efficient market hypothesis...

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15) Under the concept of an efficient market, a random walk in stock prices means that: 15) ______ A) there is no driving force behind price changes. B) technical analysts can predict future price movements to earn excess returns. C) the unexplained portion of price change in one period is unrelated to the unexplained

portion of price change in any other period. D) the unexplained portion of price change in one period that cannot be explained by expected return, can only be explained by the unexplained portion of price change in a prior period. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Hard Topic : 14-03 Foundations of Market Efficiency Source : Chapter 14 Test Bank > TB 14-15 Under the concept of an efficient market, a ...

16) Insider trading does not offer any advantages if the financial markets are: 16) ______ A) weak form efficient. B) semistrong form efficient. C) strong form efficient. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 14-03 Foundations of Market Efficiency Source : Chapter 14 Test Bank > TB 14-16 Insider trading does not offer any advantage...

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17) An investor discovers that predictions about weather patterns published years in advance and

found 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: 17) ______ A) moderate form of the efficient market hypothesis. B) semi-strong form of the efficient market hypothesis. C) strong form of the efficient market hypothesis. D) weak form of the efficient market hypothesis. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 14-03 Foundations of Market Efficiency Source : Chapter 14 Test Bank > TB 14-17 An investor discovers that predictions about...

18) Serial correlation studies generally show that: 18) ______ A) semi-strong efficiency is supported. B) the relationships are significant and can be used to predict price in the next period. C) the correlations are small relative to both the estimation errors and transactions costs. D) patterns exist in the data that can be exploited. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 14-04 The Different Types of Efficiency Source : Chapter 14 Test Bank > TB 14-18 Serial correlation studies generally show th...

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19) The abnormal return on a security, for a particular day, can be estimated by the equation: 19) ______ A) AR = R - Rm. B) AR = Rm- R. C) AR = Rm- Rf. D) AR = R - Rf. E) AR = Rf - Rm. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 14-04 The Different Types of Efficiency Source : Chapter 14 Test Bank > TB 14-19 The abnormal return on a security, for a par...

20) 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? 20) ______ A) 8 percent B) 79 percent C) -.3 percent D) -.4 percent E) -.39 percent Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 14-04 The Different Types of Efficiency Source : Chapter 14 Test Bank > TB 14-20 Assume today is an earnings announcement day...

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21) A lawyer works for a firm that advises corporate firms planning to sue other corporations for

antitrust damages. He finds that he can "beat the market" by short-selling the stock of the firm that will be sued. This finding is a violation of the: 21) ______ A) moderate form of the efficient market hypothesis. B) semi-strong form of the efficient market hypothesis. C) strong form of the efficient market hypothesis. D) weak form of the efficient market hypothesis. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 14-03 Foundations of Market Efficiency Source : Chapter 14 Test Bank > TB 14-21 A lawyer works for a firm that advises corpo...

22) The market price of a stock moves or fluctuates daily. This fluctuation is: 22) ______ A) inconsistent with the semi-strong efficient market hypothesis because prices should

be stable. B) inconsistent with the weak form efficient market hypothesis because all past information should be priced in. C) consistent with the semi-strong form of the efficient market hypothesis because as new information arrives daily prices will adjust to it. D) consistent with the strong form because prices are controlled by insiders. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 14-03 Foundations of Market Efficiency Source : Chapter 14 Test Bank > TB 14-22 The market price of a stock moves or fluctua...

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23) Suppose that firms with unexpectedly high earnings earn abnormally high returns for several

months after the announcement. This would be evidence of: 23) ______ A) efficient markets in the weak form. B) inefficient markets in the weak form. C) efficient markets in the semi-strong form. D) inefficient markets in the semi-strong form. E) inefficient markets in the strong form. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 14-04 The Different Types of Efficiency Source : Chapter 14 Test Bank > TB 14-23 Suppose that firms with unexpectedly high ea...

24) Which of the following is not true about serial correlation? 24) ______ A) It measures the correlation between the current return on a security and the current

return on another security. B) It involves only one security. C) Positive serial correlation indicates a tendency for continuation. D) Negative serial correlation indicates a tendency toward reversal. E) Significant positive or negative serial correlation coefficients are indicative of market inefficiency in the weak form. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 14-04 The Different Types of Efficiency Source : Chapter 14 Test Bank > TB 14-24 Which of the following is not true about ser...

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25) On May 12, 2001, the WWF announced the demise of the XFL. The WWF stock price

jumped up significantly on the day. 25) ______ A) These results are consistent with strong from efficiency because insiders knew the

league would fold. B) These results are consistent with semi-strong form efficiency as the demise would reverse the negative cashflow. C) These results are inconsistent with weak form efficiency because past price behavior predicted the collapse. D) These results are inconsistent with all forms of market efficiency because a failure is a negative event. E) These results are consistent with all forms of market efficiency as all information is known and priced in. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 14-04 The Different Types of Efficiency Source : Chapter 14 Test Bank > TB 14-25 On May 12, 2001, the WWF announced the demis...

26) Individuals that continually monitor the financial markets seeking mispriced securities: 26) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 14-04 The Different Types of Efficiency Source : Chapter 14 Test Bank > TB 14-26 Individuals that continually monitor the fin...

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27) Evidence on stock prices finds that the sudden death of a chief executive officer causes stock

prices to fall and the sudden death of an active founding chief executive officer causes the stock price to rise. This contrary evidence happens because: 27) ______ A) markets are inefficient and unsure of the real value of the events. B) death is inevitable and market prices are random. C) things simply happen. D) the value of the founding executive was a negative to the firm. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 14-05 The Weak Form Source : Chapter 14 Test Bank > TB 14-27 Evidence on stock prices finds that the sudd...

28) If the market is weak-form efficient: 28) ______ A) semistrong form efficiency must not hold. B) strong form efficiency must hold. C) semistrong form efficiency may hold. D) semistrong form efficiency must hold. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 14-03 Foundations of Market Efficiency Source : Chapter 14 Test Bank > TB 14-28 If the market is weak-form efficient:

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29) Studies of the performance of professionally managed mutual funds find that these funds: 29) ______ A) do not outperform a market index. Assuming mutual fund managers rely primarily on

public information, this finding refutes the semi-strong form of the efficient market hypothesis. B) do not outperform a market index. Assuming mutual fund managers rely primarily on public information, this finding supports the semi-strong form of the efficient market hypothesis. C) outperform a market index. Assuming mutual fund managers rely primarily on public information, this finding does not refute the semi-strong form of the efficient market hypothesis. D) outperform a market index. Assuming mutual fund managers rely primarily on public information, this finding supports the semi-strong form of the efficient market hypothesis. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 14-05 The Weak Form Source : Chapter 14 Test Bank > TB 14-29 Studies of the performance of professionally...

30) In examining the issue of whether the choice of accounting methods affects stock prices,

studies have found that: 30) ______ 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 increases stock prices. D) accounting changes can affect stock prices if the company were either to withhold

information or provide incorrect information. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 14-08 The Evidence Source : Chapter 14 Test Bank > TB 14-30 In examining the issue of whether the choice...

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31) Studies on the timing of corporate issues of new equities suggest that corporations tend to

offer: 31) ______ A) new issues after stock price increases. This behavior is consistent with the weak form

of the efficient market hypothesis. B) new issues after stock price increases. This behavior is inconsistent with the weak form of the efficient market hypothesis. C) new issues randomly with regard to stock price changes. This behavior is consistent with the weak form of the efficient market hypothesis. D) new issues randomly with regard to stock price changes. This behavior is inconsistent with the weak form of the efficient market hypothesis. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 14-08 The Evidence Source : Chapter 14 Test Bank > TB 14-31 Studies on the timing of corporate issues of...

32) Ritter's study of Initial Public Offerings (IPOs) showed that the post offering stock

performance was: 32) ______ A) less than the control group by about 3.3% in the five years following the IPO. B) incorrectly priced at issuance because over the next five years the abnormal returns

were greater than zero on average. C) immaterial to the pricing of the IPO because future market performance is unknown at issuance. D) equal across IPOs, irrespective of risk or which year they were issued. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 14-08 The Evidence Source : Chapter 14 Test Bank > TB 14-32 Ritter&#39;s study of Initial Public Offerings...

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33) When the stock return data has been divided into market capitalization groups, the return

performance of: 33) ______ A) all such groups has been the same over time. B) small capitalization stocks have outperformed large capitalization stocks even after

risk adjustment. C) small capitalization stocks have under performed large capitalization stocks once adjusted for risk. D) small and large capitalization stocks have performed equally on a risk-adjusted basis. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 14-06 The Semistrong and Stong Forms Source : Chapter 14 Test Bank > TB 14-33 When the stock return data has been divided ...

34) The stock market crash of October 1987 and the Great Crash of 1929, although not fully

explained, may be (partially) explained by: 34) ______ A) new information coming to the market; being efficient the market was priced down. B) technical difficulties in order processing. C) the bubble theory that prices move wildly above equilibrium values and eventually

fall back to equilibrium causing large losses. D) the conspiracy theory that large institutions and rich investors control the market and caused the general population to suffer large wealth losses. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 14-06 The Semistrong and Stong Forms Source : Chapter 14 Test Bank > TB 14-34 The stock market crash of October 1987 and t...

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35) The abnormal returns for initial public offerings over longer periods seem to call market

efficiency into question because: 35) ______ A) the average returns at announcement are large and positive while the long-term results

are much lower than the returns for seasoned equity offerings. B) the average returns at announcement are small and negative while the long-term results are much lower than the returns for seasoned equity offerings. C) the average returns at announcement are zero while the long-term results are much higher than the returns for seasoned equity offerings. D) the average returns at announcement are large and positive while the long-term results are much higher than the returns for seasoned equity offerings. E) the average returns at announcement are zero while the long-term results are much lower than the returns for seasoned equity offerings. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 14-08 The Evidence Source : Chapter 14 Test Bank > TB 14-35 The abnormal returns for initial public offe...

36) A carmaker announced a recall for faulty brakes. The company stock returned 0.004 the day

before the announcement; -0.001 the day of the announcement and 0.0045 the day after the announcement. The market average was 0.006, 0.0072 and 0.004 for the three days respectively. The daily beta for the carmaker is 0.9. What are the three abnormal returns for the car maker's stock? 36) ______ A) -.002, -.0082,.0005 B) -.002, -.00748,.0005 C) C..01,.0062,.0085 D) -.0014, -.00748,.0009 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 14-04 The Different Types of Efficiency Source : Chapter 14 Test Bank > TB 14-36 A carmaker announced a recall for faulty bra...

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37) Technical analysts believe that the: 37) ______ A) future stock prices are unpredictable and therefore plot past prices. B) stock prices are in equilibrium and advise not to follow price patterns. C) future stock prices are a reflection of the past and plot prices to find reoccurring price

patterns. D) stock prices are only predictable based on the outlook for corporations earnings. E) SML is the most reliable predictor. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 14-03 Foundations of Market Efficiency Source : Chapter 14 Test Bank > TB 14-37 Technical analysts believe that the:

38) 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. 38) ______ A) This is true because there are no differences in risk and return. B) This is true because in an efficient stock market prices do not fluctuate. C) This is false because professional portfolio managers prefer to generate commissions. D) This is false because investors may not hold a desirable risk-return combination in

their portfolio. E) This is false because the markets are controlled by the institutional investors. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 14-03 Foundations of Market Efficiency Source : Chapter 14 Test Bank > TB 14-38 If the securities market is efficient an inv...

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SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 39) Define the three forms of market efficiency.

Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 14-03 Foundations of Market Efficiency Source : Chapter 14 Test Bank > TB 14-39 Define the three forms of market efficiency.

40) Explain why it is that in an efficient market, investments have an expected NPV of zero.

Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 14-01 Can Financing Decisions Create Value? Source : Chapter 14 Test Bank > TB 14-40 Explain why it is that in an efficient marke...

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41) The Nu-Tux Seat Company has an expansion opportunity and is considering selling their

100,000 share investment in Slip-Cover currently worth $2 million or raising other external funding. The share price has been holding in a narrow range day-to-day. If Nu-Tux decides to unload their holding is there any concern about getting the full $2 million, aside from investment banker/brokerage fees. Explain these concerns about market behavior and cite the evidence.

Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Hard Topic : 14-05 The Weak Form Source : Chapter 14 Test Bank > TB 14-41 The Nu-Tux Seat Company has an expansion opp...

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42) You have observed an apparent, yet odd, increase in stock prices when companies have spun-

off divisions. You have just collected the data on 50 such events. The average beta (market value-weighted) is 1.15 for this group. Day Relative to Event

Average Sample Return

Average Market Return

-4

-.025

-.03

-3

.04

.02

-2

.07

.11

-1

.35

.09

1.20

.06

.05

.08

-.05

-.12

-.01

.00

.03

.04

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 14-04 The Different Types of Efficiency Source : Chapter 14 Test Bank > TB 14-42 You have observed an apparent, yet odd, incr...

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43) The Pan Fries Company just announced a new model of their cooker which will reduce

cooking time and fat absorption. The price reaction of their stock is listed below. Calculate the abnormal return behavior, graph it and explain the behavior. Day

Rpf

E (Rpf )

-3

.005

.006

-2

.002

-1

-.003

-.004

.015

.005

.001

-.001

-.003

-.004

.000

.002

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 14-05 The Weak Form Source : Chapter 14 Test Bank > TB 14-43 The Pan Fries Company just announced a new m...

44) 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 about 15%. Is your cousin's performance a violation of market efficiency?

Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 14-04 The Different Types of Efficiency Source : Chapter 14 Test Bank > TB 14-44 Suppose your cousin invests in the stock mar...

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45) Explain the risk that often accompanies the behavioral concept of familiarity.

Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 14-02 A Description of Efficient Capital Markets Source : Chapter 14 Test Bank > TB 14-45 Explain the risk that often accompanies the ...

46) Why should a financial decision-maker such as a corporate treasurer or CFO be concerned

with market efficiency?

Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Hard Topic : 14-02 A Description of Efficient Capital Markets Source : Chapter 14 Test Bank > TB 14-46 Why should a financial decision-maker such a...

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

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38) D 39) Short Answer

The student should present a straightforward discussion of weak (all past prices are in the current price), semistrong form (all public information is in the current price), and strong form (all information is in the current price) market efficiency. 40) Short Answer

In an efficient market, prices are "fair" so that the cost of an investment is neither too high nor too low. Thus, on average, investments in that market will yield a zero NPV. Investors get exactly what they pay for when they buy a security in an efficient market and firms get exactly what their stocks and bonds are worth when they sell them. 41) Short Answer

Large block sales impact or price pressure effect Scholes evidence of only temporary price impact vs. Keim and Madhavan showing a large drop and about a 50% recovery, netting a loss of 1.8% or $36,000 here. Concern of a negative signal on disposal Nu-Tux needs to provide the market with information to minimize the price pressure effect. 42) Short Answer Day E (Rt )

-4

-3

-2

-1

-.0345

.023

.1265

.1035

.069

AAR

.0095

.107

-.0565

.2465

1.131

CAARt

.0095

.0265

-.030

.2165

1.3475

Day

E (Rt )

.092

-.138

0.0

.046

AARt

-.042

.088

-.01

-.016

CAARt

1.3055

1.3935

1.3835

1.3675

Little happens on Day -4 through -2 and Days + 1 through + 4. CAARt fluctuates around 0 then moves up on Day -1 and 0 to total 1.35%. CAARt fluctuates randomly around 1.35% thereafter. Response in short interval; market impounds information quickly; diagram (data) supports semi-strong efficiency. 43) Short Answer

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Day

CAR

-3

-.001

-2

.000

-.001

-1

.001

.000

.010

.002

.012

.001

.013

-.002

.011

44) Short Answer

No, market efficiency does not preclude investors from "beating the market." It is entirely possible to earn higher returns than the market at times. However, if your cousin is able to do so consistently, then there would certainly be some doubt cast upon market efficiency. 45) Short Answer

Investors who display the behavioral characteristic of familiarity tend to hold investments that are under diversified. This causes their portfolio to carry unsystematic risk, which is uncompensated. Thus, they are accepting greater risk than necessary for the expected rate of return. 46) Short Answer

Good answers to this question might indicate that market efficiency is a necessary condition for the "maximize shareholder wealth" rule. Unless we are confident that the market price is an economically meaningful number, seeking to maximize it is silly. Similarly, students should recognize that there is a very strong link between managerial decisions and the value of the firm, as reflected in security prices. Finally, as a preview of the cost of capital discussion in later chapters, instructors might point out that market efficiency ensures that the required returns on new securities will be directly related to the risk-return profile of the firm and, therefore, to managerial actions.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) A stock certificate often has a stated value on it. This amount is the: 1) ______ A) book value. B) stated book value. C) subordinated liquidation value. D) par value. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-01 A stock certificate often has a stated value...

2) The total shareholders' equity of a corporation is determined by: 2) ______ A) the sum of the capital in excess of par and the retained earnings. B) the par value of preferred stock. C) the sum of the treasury stock and the preferred stock. D) sum of the number of shares issued multiplied by the par value of each share and

retained earnings. E) the market price of company's debt. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-02 The total shareholders&#39; equity of...

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3) Authorized common stock usually refers to: 3) ______ A) the stock's par value. B) last year's retained earnings. C) book value per share. D) maximum number of shares that a corporation is authorized to issue and is stated in

the article of incorporation. E) treasury stock. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-03 Authorized common stock usually refers to:

4) If cumulative voting is permitted: 4) ______ A) the total number of votes a shareholder has is equal to the number of shares owned. B) the total number of votes a shareholder has is equal to the number of shares owned

times the average number of years the shareholder has owned the shares. C) the total number of votes a shareholder has can be calculated as the number of shares owned times the number of directors to be elected. D) the total number of votes a shareholder has is equal to the number of shares times the number of board meetings the shareholder has attended. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-04 If cumulative voting is permitted:

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5) Retained earnings are: 5) ______ A) the amount of cash that the firm has saved up. B) the difference between the net income earned and the dividends paid in a year. C) the difference between the market price of the stock and the book value. D) the amount of stock repurchased. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-05 Retained earnings are:

6) The book value of the shareholders' ownership is represented by: 6) ______ A) the sum of the par value of common stock, the capital surplus and the accumulated

retained earnings. B) the total assets minus the net worth. C) the sum of the preferred stock, debt and the capital surplus. D) the sum of the total assets minus the current liabilities. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-06 The book value of the...

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7) Moose Momentos had equity accounts in 2014 as follows:

Common Stock ($1 Par Value) $120,000; Retained Earnings $32,000; Total Shareholders' Equity is equal to: 7) ______ A) $90,000. B) $92,000. C) $122,000. D) $152,000. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-07 Moose Momentos had equity accounts in 2014 a...

8) The market value of the ownership of the firm equals: 8) ______ A) the market price of the stock times the number of shares outstanding. B) the sum of the market price of the bonds and the stock. C) the par value of the stock times the number of shares outstanding. D) the market price of the stock minus the retained earnings. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-08 The market value of the ownership of the fir...

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9) The market-to-book value ratio and the Tobin's Q ratio are both indicators of a successful

firm when: 9) ______ A) their values are both greater than 0. B) their values are both no less than 10. C) their values are both less than 0. D) their values are both less than 1. E) their values are both greater than 1. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-09 The market-to-book value ratio and the Tobin...

10) There are 3 directors seats up for election. If you own 1,000 shares of stock and you can cast

3,000 votes for a particular director, this is illustrative of: 10) ______ A) cumulative voting. B) absolute priority voting. C) sequential voting. D) straight voting. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-10 There are 3 directors seats up for election....

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11) A grant of authority allowing someone else to vote shares of stock that you own is called a: 11) ______ A) power-of-share authorization. B) proxy. C) share authority grant (SAG). D) restricted conveyance. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-11 A grant of authority allowing someone else t...

12) A corporation has 2,000 shares outstanding, and 6 directors are up for election. The stock

features cumulative voting. About how many shares do you have to own to guarantee electing at least yourself to one position on the board of directors (ignoring possible ties)? 12) ______ A) 1,000. B) 333. C) 287. D) 1,715. E) 343. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-12 A corporation has 2,000 shares outstanding, ...

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13) If you own 1,000 shares of stock and you can cast only 1,000 votes for a particular director,

then the stock features: 13) ______ A) cumulative voting. B) absolute priority voting. C) sequential voting. D) straight voting. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-13 If you own 1,000 shares of stock and you can...

14) If a group other than management solicits the authority to vote shares to replace

management, a _____ is said to occur. 14) ______ A) proxy fight B) stockholder derivative action C) tender offer D) vote of confidence Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-14 If a group other than management solicits th...

15) The market-to-book value ratio implies growth and success when it is: 15) ______ A) less than 1. B) less than 0. C) less than 10. D) greater than 1. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-15 The market-to-book value ratio implies growt...

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16) Different classes of stock usually are issued to: 16) ______ A) maintain ownership control by holding the class of stock with greater voting rights. B) pay less in dividends between the classes of stock. C) fool investors into thinking that equity is equity and there is no difference in control

or value features. D) to extract perquisites without the other class of stockholders knowing. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-16 Different classes of stock usually are issue...

17) Mike's Mopeds used internal financing as a source of long-term financing for 70% of its total

needs in 2014. The company borrowed an additional 20% of its total needs in the long-term debt markets in 2014. What were Mike's net new stock issues, in percentage terms, for 2014? 17) ______ A) -10% B) -5% C) 5% D) 10% E) 15% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-17 Mike&#39;s Mopeds used internal financing...

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18) The Lory Bookstore used internal financing as a source of long-term financing for 85% of its

total needs in 2014. The company borrowed an additional 25% of its total needs in the longterm debt markets in 2014. What were Lory's net new stock issues in that year? 18) ______ A) -20% B) -10% C) 10% D) 20% E) 30% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-18 The Lory Bookstore used internal financing a...

19) Which of the following does not represent a major difference between debt and equity? 19) ______ A) Creditors do not have voting power as stockholders do. B) Payment on interest on debt in considered an expense, while payment of dividends is

not. C) Unpaid debt is a liability of the firm, and if not paid, can result in liquidation of the firm. Unpaid dividends cannot. D) One of the costs of issuing equity is the possibility of financial distress, while no financial distress is associated with debt. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 15-01 Common Stock Topic : 15-02 Authorized versus Issued Common Stock Source : Chapter 15 Test Bank > TB 15-19 Which of the following does not represent a ...

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20) Corporations try to create hybrid securities that look like equity but are called debt because: 20) ______ A) bankruptcy costs are eliminated or reduced. B) these securities have lower risk than debt. C) both debt interest expense is tax deductible; and these securities have lower risk than

debt. D) both debt interest expense is tax deductible; and bankruptcy costs are eliminated. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 15-02 Authorized versus Issued Common Stock Source : Chapter 15 Test Bank > TB 15-20 Corporations try to create hybrid securities...

21) Technically speaking, a long-term corporate debt offering that features a specific attachment

to a property is generally called a: 21) ______ A) debenture. B) bond. C) long-term liability. D) preferred liability. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 15-02 Authorized versus Issued Common Stock Source : Chapter 15 Test Bank > TB 15-21 Technically speaking, a long-term corporate ...

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22) A standard arrangement for the orderly retirement of long-term debt calls for the corporation

to make regular payments into a(n): 22) ______ A) custodial account. B) sinking fund. C) retirement fund. D) irrevocable trustee fund. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 15-02 Authorized versus Issued Common Stock Source : Chapter 15 Test Bank > TB 15-22 A standard arrangement for the orderly retir...

23) Debt that may be extinguished before maturity is referred to as: 23) ______ A) sinking-fund debt. B) debentures. C) callable debt. D) indenture debt. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 15-02 Authorized versus Issued Common Stock Source : Chapter 15 Test Bank > TB 15-23 Debt that may be extinguished before maturit...

24) If a firm retires a debt issue before maturity the specific amount they pay is: 24) ______ A) the amortization amount. B) the call price. C) the sinking fund amount. D) the spread premium. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 15-02 Authorized versus Issued Common Stock Source : Chapter 15 Test Bank > TB 15-24 If a firm retires a debt issue before maturi...

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25) If a debenture is subordinated, it: 25) ______ A) has a higher priority status than specified creditors. B) is secondary to equity. C) must give preference to the specified creditor in the event of default. D) has been issued because the company is in default. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 15-02 Authorized versus Issued Common Stock Source : Chapter 15 Test Bank > TB 15-25 If a debenture is subordinated, it:

26) Long-term debt is sometimes called: 26) ______ A) secured debt. B) subordinated debt. C) funded debt. D) capital debt. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 15-02 Authorized versus Issued Common Stock Source : Chapter 15 Test Bank > TB 15-26 Long-term debt is sometimes called:

27) The amount of loan a person or firm borrows from a lender is the: 27) ______ A) creditor. B) indenture. C) debenture. D) principal. E) amortization. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 15-02 Authorized versus Issued Common Stock Source : Chapter 15 Test Bank > TB 15-27 The amount of loan a person or firm borrows ...

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28) The written agreement between a corporation and its bondholders is called the: 28) ______ A) collateral agreement. B) deed. C) indenture. D) deed of conveyance. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 15-02 Authorized versus Issued Common Stock Source : Chapter 15 Test Bank > TB 15-28 The written agreement between a corporation ...

29) Preferred stock has both a tax advantage and a tax disadvantage. Those two are: 29) ______ A) in default there are no taxes and dividends are taxed in corporate hands at 70%. B) corporate dividend receipts are taxed on 30% of the total dividends and a liability is

created for arrears. C) dividends are not a tax-deductible expense but are 70% exempt from corporate taxation. D) dividends are fully tax deductible but are not equity capital. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 15-03 Retained Earnings Source : Chapter 15 Test Bank > TB 15-29 Preferred stock has both a tax advantage and...

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30) 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): 30) ______ A) maintenance of security provision. B) collateral restriction. C) affirmative indenture. D) restrictive covenant. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 15-02 Authorized versus Issued Common Stock Source : Chapter 15 Test Bank > TB 15-30 The written agreement between a corporation ...

31) Income trusts are structured such that income is taxed in the hands of the: 31) ______ A) income trust. B) operating entity. C) unit holders. D) there is no tax on income trusts. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 15-04 Market Value, Book Value, and Replacement Value Source : Chapter 15 Test Bank > TB 15-31 Income trusts are structured such that incom...

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32) Which of the following statements about preferred stock is true? 32) ______ A) Unlike dividends paid on common stock, dividends paid on preferred stock are a tax-

deductible expense. B) Unpaid dividends on preferred stock are a debt of the corporation. 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 difference in the voting rights of preferred and common stockholders. E) None of these. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 15-03 Retained Earnings Source : Chapter 15 Test Bank > TB 15-32 Which of the following statements about pref...

33) Not paying the dividends on a cumulative preferred issue may result in: 33) ______ A) preferred dividend arrears that can be eliminated by the common shareholders only

after common dividends are paid. B) additional voting rights are granted to common stockholders if dividends are in arrears. C) full payment of dividends to common shareholders. D) both preferred dividend arrears that can be eliminated by the common shareholders only after common dividends are paid; and additional voting rights are granted to common stockholders if dividends are in arrears. E) both voting rights are granted to preferred stockholders if preferred dividends are in arrears; and no payment of dividends to common shareholders. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 15-03 Retained Earnings Source : Chapter 15 Test Bank > TB 15-33 Not paying the dividends on a cumulative pre...

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34) Which of the following statements is true? 34) ______ A) In recent years external equity has been a large percentage of total sources of

financing even though this is, by far, the most expensive source of financing. B) In recent years external equity has been a large percentage of total sources of financing. Some argue that this relationship exists because financial managers think stock prices are too high. C) In recent years external equity has been a small percentage of total sources of financing even though this is, by far, the cheapest source of financing. D) In recent years external equity has been a small percentage of total sources of financing. Some argue that this relationship exists because financial managers think stock prices are too low, even though this is inconsistent with efficient markets. E) In recent years external equity has been a small percentage of total sources of financing in part because of the legal reserves that the firms must hold against equity. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 15-05 Shareholders' Rights Source : Chapter 15 Test Bank > TB 15-34 Which of the following statements is true?

35) Tree Top Toys needs to finance their new production facility for spyglasses. The cost is $12

million. They expect to payout $6 million or 40% of their net cash flow. Any external financing will be raised 80% borrowings and the remaining equity. Unfortunately, the company has no internal excess short-term funds to use. How much total debt cash flow will be used? 35) ______ A) $0.6 million. B) $2.4 million. C) $9.0 million. D) $9.6 million. E) $3.0 million. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 15-05 Shareholders' Rights Source : Chapter 15 Test Bank > TB 15-35 Tree Top Toys needs to finance their new pro...

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36) Based on historical experience, which of the following best describes the "pecking order" of

long-term financing strategy in Canada? 36) ______ A) Long-term debt first, new common equity, internal financing last. B) Long-term debt first, internal financing, new common equity last. C) Internal financing first, new common equity, long-term borrowing last. D) Internal financing first, long-term borrowing, new common equity last. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 15-05 Shareholders' Rights Source : Chapter 15 Test Bank > TB 15-36 Based on historical experience, which of the...

37) Financial deficits are created when: 37) ______ A) profits and retained earnings are greater than the capital-spending requirement. B) profits and retained earnings are less than the capital-spending requirement. C) profits and retained earnings are equal to the capital-spending requirement. D) profits and retained earnings are greater than or equal to the capital-spending

requirement. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 15-05 Shareholders' Rights Source : Chapter 15 Test Bank > TB 15-37 Financial deficits are created when:

38) Firms follow the "pecking order" in their long-term financing because: 38) ______ A) internally generated funds are the cheapest source of financing. B) outsiders will know less about the company and reduce the threat of any takeover. C) other financial strategies create more agency problems. D) firms prefer to issue safe securities with less valuation risk first. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Hard Topic : 15-05 Shareholders' Rights Source : Chapter 15 Test Bank > TB 15-38 Firms follow the "pecking order" in their lo...

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39) Financial economists prefer to use market values when measuring debt ratios because: 39) ______ A) market values are more stable than book values. B) market values are a better reflection of current value than historical value. C) market values are readily available and do not have to be calculated like book values. D) market values are more difficult to calculate which makes financial economists more

valuable. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-39 Financial economists prefer to use market va...

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 40) Information on shareholder's equity as currently shown on the books of the Enstat Corporation is given as: Common shares ($2.00 par value)

$350,000

Capital in Excess of Par

Retained Earnings

7,800,000

Treasury Stock

400,000

The current market price of Enstat is $80.00, the same as the price paid for the Treasury stock. From this information, calculate Enstat's book value per share.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-40 Information on shareholder&#39;s equity...

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41) Information on shareholder's equity as currently shown on the books of the Enstat

Corporation is given as: Common shares ($2.00 par value)

$350,000

Capital in Excess of Par

Retained Earnings

7,800,000

Treasury Stock

400,000

The current market price of Enstat is $80.00, the same as the price paid for the Treasury stock. Rework the shareholder's equity as it appears on the books if the company issues 40,000 new share of common at $70 per share.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-41 Information on shareholder&#39;s equity...

42) If Enstat was to put their firm in place today the cost of the assets are estimated to be $9.5

million. The stock price is currently $120 per share and there is no debt outstanding. Calculate the market-to-book value and Tobin's Q ratio. How well is Enstat being managed?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-42 If Enstat was to put their firm in place tod...

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43) The Knot Knit Corporation needs to elect 9 directors. There are 120,000 shares outstanding.

Under cumulative voting, how many shares would you need to own to guarantee that your favorite candidate is elected?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-43 The Knot Knit Corporation needs to elect 9 d...

44) Identify the general rights that are commonly granted to common stock shareholders.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 15-01 Common Stock Source : Chapter 15 Test Bank > TB 15-44 Identify the general rights that are commonl...

45) Preferred Stock, as a hybrid security, presents somewhat of a puzzle as to why they are

issued. What elements give rise to the puzzle and how is it explained?

Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Hard Topic : 15-03 Retained Earnings Source : Chapter 15 Test Bank > TB 15-45 Preferred Stock, as a hybrid security, prese...

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46) What is indenture?

Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 15-02 Authorized versus Issued Common Stock Source : Chapter 15 Test Bank > TB 15-46 What is indenture?

47) Explain the main differences between debt and equity.

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

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38) D 39) B 40) Short Answer

Book Value per Share = $7,750,000/170,000 = $45.59 41) Short Answer Common shares ($2.00 par value)

$390,000

Capital in Excess of Par

2,720,000

Retained Earnings

7,800,000

Treasury Stock

400,000 $10,510,000

42) Short Answer

Book Value per Share = $7,750,000/170,000 = $45.59 Market-to-Book = M/B = 80/45.59 = 1.755 Tobin's Q = MV Assets/Replacement Value = 80(170,000)/9,500,000 = 13,600,000/9,500,000 = 1.432 Both ratios are above 1.0; Company is returning value to investors. The lower Tobin's Q ratio over the M/B ration may reflect low book value of assets and high-accumulated depreciation. 43) Short Answer

Total Votes 120,000 * 9 = 1,080,000 and 108,000 votes for any 1 candidate would guarantee that candidate's election. In order to place 108,000 votes, you would need to hold 108,000/9 = 12,000 shares. OR: 120,000/(9 + 1) = 12,000 44) Short Answer

Common stock shareholders generally have the right to: 1. share proportionally in dividends. 2. share proportionally in assets remaining after liabilities have been paid in a liquidation. 3. vote on stockholder matters of great importance, such as a merger or acquisition. 4. vote to elect directors to the board. 5. share proportionately in any new stock offering. 45) Short Answer

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There are two offsetting tax effects to consider in evaluating a preferred stock. First, dividends are not deducted from corporate income in computing the tax liability of the issuing corporation. Second, when a corporation purchases preferred stock, 70% of the dividends received are exempt from corporate taxation. The three reasons why preferred stock is issued are: regulated public utilities can pass the tax disadvantage of issuing preferred stock on to their customers, companies reporting losses to the IRS may issue preferred stock, and firms issuing preferred stock can avoid the threat of bankruptcy that exists with debt financing. 46) Short Answer

The written agreement between the corporate debt issuer and the lender, setting forth maturity date, interest rate, and all other terms, is called an indenture. 1. The indenture completely describes the nature of the indebtedness. 2. The indenture lists all restrictions placed on the firm by the lenders. These restrictions are placed in restrictive covenants. Examples are i) Restrictions on further indebtedness. ii) A maximum on the dividends that can be paid. iii) A minimum level of working capital. 47) Short Answer

1. Debt generally does not provide any voting rights or company ownership. Equity does. 2. Interest is tax-deductible, dividends are not. 3. Unpaid debt is a liability of the firm and can force the firm to liquidate or reorganize. Unpaid dividends are not a liability of the firm. 4. Interest is taxed as part of the personal income of individual recipients. Dividends are taxed as personal income but possibly at a lower rate. Dividends paid to corporate shareholders are at least partially tax-exempt, interest is not.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) The firm's capital structure refers to: 1) ______ A) the way a firm invests its assets. B) the amount of equity or capital in the firm. C) the amount of dividends a firm pays. D) the way in which a firm's assets are financed. E) how much cash the firm holds. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 16-01 The Capital Structure Question and The Pie Model Source : Chapter 16 Test Bank > TB 16-01 The firm&#39;s capital...

2) A general rule for managers to follow is to set the firm's capital structure such that: 2) ______ A) the firm's value is minimized. B) the firm's value is maximized. C) the firm's bondholders are made well off. D) the firms suppliers of raw materials are satisfied. E) the firms dividend payout is maximized. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 16-01 The Capital Structure Question and The Pie Model Source : Chapter 16 Test Bank > TB 16-02 A general rule for managers to follow is to ...

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3) A levered firm is a company that: 3) ______ A) is financed by common stock. B) has some debt in the capital structure. C) has all equity in the capital structure. D) has no debt in the capital structure. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 16-01 The Capital Structure Question and The Pie Model Source : Chapter 16 Test Bank > TB 16-03 A levered firm is a company that:

4) A manager should attempt to maximize the value of the firm by: 4) ______ A) changing the capital structure if and only if the value of the firm decreases. B) changing the capital structure if and only if the value of the firm increases to the

benefit of the stockholders. C) changing the capital structure if and only if the value of the firm increases only to the benefits the debt holders. D) changing the capital structure if and only if the value of the firm increases although it decreases the stockholders' value. E) changing the capital structure if and only if the value of the firm increases and stockholder wealth is constant. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 16-02 Maximizing Firm Value versus Maximizing Shareholder Interests Source : Chapter 16 Test Bank > TB 16-04 A manager should attempt to maximize the val...

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5) The unlevered cost of capital is: 5) ______ 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 a firm with equal parts debt and common stock in its

capital structure. E) equal to the profit margin for a firm with some debt in its capital structure. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 16-02 Maximizing Firm Value versus Maximizing Shareholder Interests Source : Chapter 16 Test Bank > TB 16-05 The unlevered cost of capital is:

6) The effect of financial leverage depends on the operating earnings of the company. Which of

the following is not true? 6) ______ A) Below the indifference or break-even point in EBIT the non-levered structure is

superior. B) Financial leverage increases the slope of the EPS line. C) Above the indifference or break-even point the increase in EPS for all equity plans is less than debt-equity plans. D) Above the indifference or break-even point the increase in EPS for all equity plans is greater than debt-equity plans. E) The rate of return on operating assets is unaffected by leverage. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 16-03 Financial Leverage and Firm Value: An Example Source : Chapter 16 Test Bank > TB 16-06 The effect of financial leverage depends on ...

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7) In the absence of taxes, the capital structure chosen by a firm doesn't matter because of: 7) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 16-03 Financial Leverage and Firm Value: An Example Source : Chapter 16 Test Bank > TB 16-07 In the absence of taxes, the capital structu...

8) The Modigliani-Miller Proposition I without taxes states: 8) ______ A) A firm cannot change the total value of its outstanding securities by changing its

capital structure proportions. B) When new projects are added to the firm the firm value is the sum of the old value plus the new. C) Managers can make correct corporate decisions that will satisfy all shareholders if they select projects that maximize value. D) The determination of value must consider the timing and risk of the cash flows. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 16-03 Financial Leverage and Firm Value: An Example Source : Chapter 16 Test Bank > TB 16-08 The Modigliani-Miller Proposition I without ...

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9) A key assumption of MMs Proposition I (no taxes) is: 9) ______ A) that financial leverage increases risk. B) that individuals can borrow on their own account at rates less than the firm. C) that individuals must be able to borrow on their own account at rates equal to the

firm. D) managers are acting to maximize the value of the firm. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 16-03 Financial Leverage and Firm Value: An Example Source : Chapter 16 Test Bank > TB 16-09 A key assumption of MMs Proposition I (no ta...

10) The use of personal borrowing to change the overall amount of financial leverage to which

an individual is exposed is called: 10) ______ A) homemade leverage. B) dividend recapture. C) the weighted average cost of capital. D) private debt placement. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 16-03 Financial Leverage and Firm Value: An Example Source : Chapter 16 Test Bank > TB 16-10 The use of personal borrowing to change the ...

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11) In an EPS- EBIT graphical relationship, the slope of the debt ray is steeper than the equity

ray. The debt ray has a lower intercept because: 11) ______ A) more shares are outstanding for the same level of EBIT. 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 higher the interest rate the greater the slope. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Hard Topic : 16-03 Financial Leverage and Firm Value: An Example Source : Chapter 16 Test Bank > TB 16-11 In an EPS- EBIT graphical relationship, the ...

12) In an EPS-EBIT graphical relationship, the debt ray and equity cross. At this point, the equity

and debt are: 12) ______ A) equivalent with respect to EPS but above and below this point equity is always

superior. B) at breakeven in EPS but above this point debt increases EPS via leverage and decreases EPS below this point. C) equal but away from breakeven equity is better as fewer shares are outstanding. D) at breakeven and MM Proposition II states that debt is the better choice. E) at breakeven and debt is the better choice below breakeven because small payments can be made. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Hard Topic : 16-03 Financial Leverage and Firm Value: An Example Source : Chapter 16 Test Bank > TB 16-12 In an EPS-EBIT graphical relationship, the d...

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13) When comparing levered vs. unlevered capital structures, leverage works to increase EPS for

high levels of EBIT because: 13) ______ A) interest payments on the debt vary with EBIT levels. B) interest payments on the debt stay fixed, leaving less income to be distributed over

less shares. C) interest payments on the debt stay fixed, leaving more income to be distributed over less shares. D) interest payments on the debt stay fixed, leaving less income to be distributed over more shares. E) interest payments on the debt stay fixed, leaving more income to be distributed over more shares. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 16-03 Financial Leverage and Firm Value: An Example Source : Chapter 16 Test Bank > TB 16-13 When comparing levered vs. unlevered capital...

14) Financial leverage impacts the performance of the firm by: 14) ______ A) increasing the volatility of the firm's EBIT. B) decreasing the volatility of the firm's EBIT. C) decreasing the volatility of the firm's net income. D) increasing the volatility of the firm's net income. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 16-03 Financial Leverage and Firm Value: An Example Source : Chapter 16 Test Bank > TB 16-14 Financial leverage impacts the performance o...

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15) The increase in risk to equity holders when financial leverage is introduced is evidenced by: 15) ______ A) higher EPS as EBIT increases. B) a higher variability of EPS with debt than all equity. C) increased use of homemade leverage. D) equivalence value between levered and unlevered firms in the presence of taxes. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 16-03 Financial Leverage and Firm Value: An Example Source : Chapter 16 Test Bank > TB 16-15 The increase in risk to equity holders when ...

16) Thompson & Thomson is an-all equity firm that has 500,000 shares of stock outstanding. The

company is in the process of borrowing $8 million at 9% interest to repurchase 200,000 shares of the outstanding stock. What is the value of this firm if you ignore taxes? 16) ______ A) $20.0 million. B) $20.8 million. C) $21.0 million. D) $21.2 million. E) $21.3 million Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 16-03 Financial Leverage and Firm Value: An Example Source : Chapter 16 Test Bank > TB 16-16 Thompson &amp; Thomson is an-all equity firm...

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17) The capital structure chosen by a firm doesn't matter because of: 17) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 16-03 Financial Leverage and Firm Value: An Example Source : Chapter 16 Test Bank > TB 16-17 The capital structure chosen by a firm doesn...

18) MM Proposition I with no tax supports the argument that: 18) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 16-03 Financial Leverage and Firm Value: An Example Source : Chapter 16 Test Bank > TB 16-18 MM Proposition I with no tax supports the ar...

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19) You own 25% of Unique Vacations, Inc. You have decided to retire and want to sell your

shares in this closely held, all-equity firm. The other shareholders have agreed to have the firm borrow $1.5 million to purchase your 1,000 shares of stock. What is the total value of this firm today if you ignore taxes? 19) ______ A) $4.8 million. B) $5.1 million. C) $5.4 million. D) $5.7 million. E) $6.0 million. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 16-03 Financial Leverage and Firm Value: An Example Source : Chapter 16 Test Bank > TB 16-19 You own 25% of Unique Vacations, Inc. You ha...

20) A firm has debt market value of $5,000, equity market value of $16,000, a leveraged market

value of $21,000, a cost of debt of 8%, a cost of equity of 12%, and a tax rate of 34%. What is the firm's weighted average cost of capital? 20) ______ A) 7.29%. B) 7.94%. C) 8.87%. D) 10.40%. E) 11.05%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-20 A firm has debt market value of...

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21) The difference between a market value balance sheet and a book value balance sheet is that a

market value balance sheet: 21) ______ A) places assets on the right hand side. B) places liabilities on the left-hand side. C) does not equate the right hand with the left-hand side. D) lists items in terms of market values, not historical costs. E) uses the market rate of return. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Easy Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-21 The difference between a market value balanc...

22) MM Proposition I with taxes supports the theory that: 22) ______ A) there is a positive linear relationship between the amount of debt in a levered firm and

its 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. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-22 MM Proposition I with taxes supports the the...

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23) MM Proposition I with taxes is based on the concept that: 23) ______ A) the optimal capital structure is the one that is totally financed with equity. B) the capital structure of the firm does not matter because investors can use homemade

leverage. C) the firm is better off with debt based on the weighted average cost of capital. D) the value of the firm increases as total debt increases because of the interest tax shield. E) the cost of equity increases as the debt-equity ratio of a firm increases. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-23 MM Proposition I with taxes is based on the ...

24) The interest tax shield is a key reason why: 24) ______ A) the required rate of return on assets rises when debt is added to the capital structure. B) the value of an unlevered firm is equal to the value of a levered firm. C) the net cost of debt to a firm is generally less than the 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. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-24 The interest tax shield is a key reason why:

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25) The Montana Hills Co. has expected earnings before interest and taxes of $17,100, 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 34 percent, what is the value of the firm? 25) ______ A) $91,016.13 B) $137,903.23 C) $99,516.13 D) $106,666.67 E) $146,403.23 Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-25 The Montana Hills Co. has expected earnings ...

26) The Winter Wear Company has expected earnings before interest and taxes of $2,100, an

unlevered cost of capital of 14% and a tax rate of 34%. The company also has $2,800 of debt that carries a 7% coupon. The debt is selling at par value. What is the value of this firm? 26) ______ A) $9,900. B) $10,852. C) $11,748. D) $12,054. E) $12,700. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-26 The Winter Wear Company has expected earning...

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27) A firm has zero debt in its capital structure. Its overall cost of capital is 10%. The firm is

considering a new capital structure with 60% debt. The interest rate on the debt would be 8%. Assuming there are no taxes or other imperfections, its cost of equity with the new capital structure would be: 27) ______ A) 9%. B) 14%. C) 13%. D) 10%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 16-04 Leverage and Returns to Shareholders Source : Chapter 16 Test Bank > TB 16-27 A firm has zero debt in its capital structur...

28) In a world of no corporate taxes if the use of leverage does not change the value of the

levered firm relative to the unlevered firm this is known as: 28) ______ A) conservation of energy principle. B) MM Proposition I that leverage is invariant to market value. C) MM Proposition II that the cost of equity is always constant. D) MM Proposition I that the market value of the firm is invariant to the capital

structure. E) MM Proposition III that there is no risk associated with leverage in a no tax world. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 16-03 Financial Leverage and Firm Value: An Example Source : Chapter 16 Test Bank > TB 16-28 In a world of no corporate taxes if the use ...

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29) What is its cost of equity if there are no taxes or other imperfections? The firm has a debt-to-

equity ratio of 0.60. Its cost of debt is 8%. Its overall cost of capital is 12%. 29) ______ A) 18%. B) 14.4%. C) 10%. D) 13.5%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 16-04 Leverage and Returns to Shareholders Source : Chapter 16 Test Bank > TB 16-29 What is its cost of equity if there are no t...

30) A firm has a debt-to-equity ratio of 1. Its cost of equity is 16%, and its cost of debt is 8%. If

there are no taxes or other imperfections, what would be its cost of equity if the debt-toequity ratio were 0? 30) ______ A) 8%. B) 10%. C) 12%. D) 14%. E) 16%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 16-04 Leverage and Returns to Shareholders Source : Chapter 16 Test Bank > TB 16-30 A firm has a debt-to-equity ratio of 1. Its ...

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31) A full-equity firm has a cost of equity of 15%. If the company issues debt such that the debt-

to-equity ratio is 1.2, what is its cost of equity if its cost of debt is 10% and there are no taxes or other imperfections? 31) ______ A) 21%. B) 18%. C) 15%. D) 10%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 16-04 Leverage and Returns to Shareholders Source : Chapter 16 Test Bank > TB 16-31 A full-equity firm has a cost of equity of 1...

32) If a firm is unlevered and has a cost of equity capital of 12%, what would the cost of equity

be if the firm becomes levered at 2:1? The expected cost of debt would be 8%. 32) ______ A) 14.67%. B) 16.0%. C) 20.0%. D) 14.0%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 16-04 Leverage and Returns to Shareholders Source : Chapter 16 Test Bank > TB 16-32 If a firm is unlevered and has a cost of equ...

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33) The reason that MM Proposition I does not hold in the presence of corporate taxation is

because: 33) ______ A) levered firms pay less taxes compared with identical unlevered firms. B) bondholders require higher rates of return compared with stockholders. C) earnings per share are no longer relevant with taxes. D) dividends are no longer relevant with taxes. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-33 The reason that MM Proposition I does not ho...

34) The Boston Firm is unlevered with assets of $30 million and EBIT of $6 million. If the firm's

tax rate is 34%, calculate both its after-tax cash flow and its value, given a risk-adjusted discount rate of 12%. 34) ______ A) $2,400,000; $30,000,000. B) $2,400,000; $2,400,000. C) $3,960,000; $33,000,000. D) $3,960,000; $30,000,000. E) $2,400,000; $33,000,000. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-34 The Boston Firm is unlevered with assets of ...

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35) Bryan invested in Bryco, Inc. stock when the firm was financed solely with equity. The firm

is now utilizing debt in its capital structure. To unlever his position, Bryan needs to: 35) ______ A) borrow some money and purchase additional shares of Bryco stock. B) maintain his current position as the debt of the firm did not affect his personal leverage position. C) sell some shares of Bryco stock and hold the proceeds in cash. D) sell some shares of Bryco stock and loan it out such that he creates a personal debtequity ratio equal to that of the firm. E) create a personal debt-equity ratio that is equal to exactly 50% of the debt-equity ratio of the firm. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 16-03 Financial Leverage and Firm Value: An Example Source : Chapter 16 Test Bank > TB 16-35 Bryan invested in Bryco, Inc. stock when the...

36) The change in firm value due to infusion of debt in the presence of corporate taxes is: 36) ______ A) positive as equity holders face a lower effective tax rate. B) positive as equity holders gain the tax shield on the debt interest. C) negative because of the increased risk of default and fewer shares outstanding. D) negative because of a reduction of equity outstanding. Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Medium Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-36 The change in firm value due to infusion of ...

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37) A firm has zero debt in its capital structure. Its overall cost of capital is 9%. The firm is

considering a new capital structure with 40% debt. The interest rate on the debt would be 4%. Assuming that the corporate tax rate is 34%, what is the cost of equity with the new capital structure? 37) ______ A) 10.32%. B) 11.20% C) 11.00%. D) 13.95%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-37 A firm has zero debt in its capital structur...

38) A firm has a debt-to-equity ratio of 1. Its cost of equity is 16%, and its cost of debt is 8%. If

the corporate tax rate is 0.25, what would its cost of equity be if the debt-to-equity ratio were 0? 38) ______ A) 11.11%. B) 12.57%. C) 13.33%. D) 16.00%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-38 A firm has a debt-to-equity ratio of 1. Its ...

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39) A firm has a debt-to-equity ratio of 0.5. Its cost of equity is 22%, and its cost of debt is 16%.

If the corporate tax rate is 0.40, what would its cost of equity be if the debt-to-equity ratio were 0? 39) ______ A) 22.00%. B) 21.07%. C) 14.00%. D) 20.62%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-39 A firm has a debt-to-equity ratio of 0.5. It...

40) What is its cost of equity for a firm if the corporate tax rate is 40%? The firm has a debt-to-

equity ratio of 1.5. If it had no debt, its cost of equity would be 16%. Its current cost of debt is 12%. 40) ______ A) 22.0%. B) 18.4%. C) 17.44. D) 19.6%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-40 What is its cost of equity for a firm if the...

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41) A firm has a debt-to-equity ratio of 1.75. If it had no debt, its cost of equity would be 9%. Its

cost of debt is 7%. What is its cost of equity if the corporate tax rate is 50%? 41) ______ A) 10.0%. B) 10.75%. C) 12.50%. D) 7.73%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-41 A firm has a debt-to-equity ratio of 1.75. I...

42) Assume the corporate tax rate is 50%. A firm has perpetual expected EBIT of $100. The firm

has no debt in its capital structure. Its cost of equity is 10%. What would be the value of the firm if it issued $400 in perpetual debt? 42) ______ A) $700. B) $800. C) $900. D) $1,000. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-42 Assume the corporate tax rate is...

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43) A full equity firm has 5,000 shares outstanding worth $7 each. They are planning on issuing

$10,000 of new perpetual debt at the 8% market rate of interest and using the proceeds to buy up stock. The effective tax rate is 25%. What is the change in the share price if they make the debt for equity exchange? 43) ______ A) $.50 per share B) $.20 per share C) $.80 per share D) $.16 per share Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-43 A full equity firm has 5,000 shares outstand...

44) The Hifalutin Co. has a perpetual EBIT of $3,000. It has no debt in its capital structure, and

its cost of equity is 15%. The corporate tax rate is 40%. There are 300 shares outstanding. Hifalutin has announced that it will borrow $3,750 in perpetual debt at 8% and use the proceeds to buy up stock. What will the stock price be after the recapitalization? 44) ______ A) $40. B) $35. C) $45. D) $50. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-44 The Hifalutin Co. has a perpetual EBIT of...

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45) The Hifalutin Co. has a perpetual EBIT of $3,000. It has no debt in its capital structure, and

its cost of equity is 15%. The corporate tax rate is 40%. There are 300 shares outstanding. Hifalutin has announced that it will borrow $3,750 in perpetual debt at 8% and use the proceeds to buy up stock. How many shares will be purchased? 45) ______ A) 93.75 shares. B) 66.67 shares. C) 50.00 shares. D) 83.33 shares. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-45 The Hifalutin Co. has a perpetual EBIT of...

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 46) Based on MM with taxes and without taxes, how much time should a financial manager spend analyzing the capital structure of his firm? What if the analysis is based on the static theory?

Question Details Accessibility : Keyboard Navigation Bloom's : Apply Difficulty : Hard Topic : 16-02 Maximizing Firm Value versus Maximizing Shareholder Interests Source : Chapter 16 Test Bank > TB 16-46 Based on MM with taxes and without taxes, ho...

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47) Eigner Engineering is currently unlevered with 2,000 shares outstanding and assets valued at

$50,000. The company expects operating income in the current period to be $6,000. Suppose that the company can exchange 400 shares of stock for $10,000 in debt paying 10% interest. From the standpoint of EPS, would the exchange be wise? Assume no taxes.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 16-02 Maximizing Firm Value versus Maximizing Shareholder Interests Source : Chapter 16 Test Bank > TB 16-47 Eigner Engineering is currently unlevered wi...

48) Consider two firms, U and L, both with $50,000 in assets. Firm U is unlevered, and firm L

has $20,000 of debt that pays 8% interest. Firm U has 1,000 shares outstanding, while firm L has 600 shares outstanding. Mike owns 20% of firm L and believes that leverage works in his favor. Steve tells Mike that this is an illusion and that with the possibility of borrowing on his account at 8% interest, he can replicate Mike's payout from firm L. Given a level of operating income of $2,500, show the specific strategy that Mike has in mind.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 16-03 Financial Leverage and Firm Value: An Example Source : Chapter 16 Test Bank > TB 16-48 Consider two firms, U and L, both with...

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49) Consider two firms, U and L, both with $50,000 in assets. Firm U is unlevered, and firm L

has $20,000 of debt that pays 8% interest. Firm U has 1,000 shares outstanding, while firm L has 600 shares outstanding. Mike owns 20% of firm L and believes that leverage works in his favor. Steve tells Mike that this is an illusion and that with the possibility of borrowing on his account at 8% interest, he can replicate Mike's payout from firm L. Mike tells Steve that while his analysis looks good on paper, Steve will never be able to borrow at 8%, but would have to pay a more realistic rate of 12%. If Mike is right, what will Steve's payout be?

50) Consider two firms, U and L, both with $50,000 in assets. Firm U is unlevered, and firm L

has $20,000 of debt that pays 8% interest. Firm U has 1,000 shares outstanding, while firm L has 600 shares outstanding. Mike owns 20% of firm L and believes that leverage works in his favor. Steve tells Mike that this is an illusion and that with the possibility of borrowing on his account at 8% interest, he can replicate Mike's payout from firm L. Suppose the tax authorities allow firms to deduct their interest expense from operating income. Both firm U and firm L are in the 34% tax bracket. Show what happens to the market value of both firms if the debt held by firm L is permanent.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-50 Consider two firms, U and L, both with...

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51) The JumpStart Corporation is unlevered and valued at $500,000. JumpStart has 200,000

shares outstanding. The company announces that in the near future it will issue $200,000 of debt and buy back $200,000 of stock. If the firm is in the 34% tax bracket, how many shares of stock will be repurchased?

52) The Nantucket Nugget is unlevered and is valued at $640,000. Nantucket is currently

deciding whether including debt in its capital structure would increase its value. Under consideration is issuing $300,000 in new debt with an 8% interest rate. Nantucket would repurchase $300,000 of stock with the proceeds of the debt issue. There are currently 32,000 shares outstanding and their effective marginal tax bracket is zero. What is the change in value and how many shares of stock will be repurchased?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 16-04 Leverage and Returns to Shareholders Source : Chapter 16 Test Bank > TB 16-52 The Nantucket Nugget is unlevered and is val...

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53) The Nantucket Nugget is unlevered and is valued at $640,000. Nantucket is currently

deciding whether including debt in its capital structure would increase its value. The current cost of equity is 12%. Under consideration is issuing $300,000 in new debt with an 8% interest rate. Nantucket would repurchase $300,000 of stock with the proceeds of the debt issue. There are currently 32,000 shares outstanding and their effective marginal tax bracket is zero. What will Nantucket's new WACC be?

54) The Nantucket Nugget is unlevered and is valued at $640,000. Nantucket is currently

deciding whether including debt in its capital structure would increase its value. The current of cost of equity is 12%. Under consideration is issuing $300,000 in new debt with an 8% interest rate. Nantucket would repurchase $300,000 of stock with the proceeds of the debt issue. There are currently 32,000 shares outstanding and their effective marginal tax bracket is 34%. What will Nantucket's new WACC be?

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55) The weighted average cost of capital is invariant to leverage under MM conditions with no

taxes. Graph the relationship between the weighted average cost of capital and leverage, the cost of equity and leverage and the cost of debt and leverage. Explain why this relationship holds.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 16-04 Leverage and Returns to Shareholders Source : Chapter 16 Test Bank > TB 16-55 The weighted average cost of capital is inva...

56) The Blue Mountain Company is an all-equity firm worth $32 million and 5 million shares

outstanding. A new capital structure is planned to replace $12 million of equity with debt. They believe it can be raised at 6% interest. If the tax rate is 30%, create the market value balance sheets: i) before any exchange is announced ii) at the time of the announcement, and iii) at the culmination of the exchange

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-56 The Blue Mountain Company is an all-equity f...

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57) Anderson's Furniture Outlet has an unlevered cost of capital of 10%, a tax rate of 34%, and

expected earnings before interest and taxes of $1,600. The company has $3,000 in bonds outstanding that have an 8% coupon and pay interest annually. The bonds are selling at par value. What is the cost of equity?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-57 Anderson&#39;s Furniture Outlet...

58) 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 minimize shareholder costs?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 16-05 The Choice between Debt and Equity Source : Chapter 16 Test Bank > TB 16-58 In each of the theories of capital structure...

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Answer Key Test name: Chapter 16 1) 2) 3) 4) 5) 6)

D B B B B D Above the indifference or break-even point the increase in EPS for all equity plans is greater than debt-equity plans. 7) E

homemade leverage. 8) A

A firm cannot change the total value of its outstanding securities by changing its capital structure proportions. 9) C 10) A 11) C 12) B

at breakeven in EPS but above this point debt increases EPS via leverage and decreases EPS below this point. 13) C 14) D 15) B 16) A 17) E

homemade leverage. 18) C 19) E

$1.5 Million/25% = 6.00 Million. 20) D

WACC = 0.12 X (16000/ 21000) + 0.08 X (1-0.034) 5000/ 21000 = 10.40%.

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21) D 22) A 23) D 24) C 25) C 26) B 27) C

K = 0.10 + 0.60 / 0.40 (0.10-0.08) (1-0) = 0.13 OR 13%. 28) D 29) B

0.12 = E * 1/1.6 + 0.08 * 0.60/ 1.60 On solving the equation we get E = 14.4%. 30) C 31) A

0.15 = E*1/2.2 + 0.10*1.2/ 2.2 On solving the equation we get E = 21%. 32) C

0.12 = E * 1/3 + 0.08 * 2/3 On solving E = 20.00%. 33) A 34) C

$6 Million (1-0.34) = $3,960,000 Value of Firm = $3,960,000 / 12% = $33,000,000. 35) D 36) B 37) B

R = 0.09 + 0.40/0.60 (1-0.34) (0.09-0.04) E = 11.20%. 38) B

r S = r 0 + B/ S ( 1 − T c ) ( r 0 − r B ) 0.16 = r 0 + 1 (1-0.25) (r0-0.08) = 12.57%. 39) D

r S = r 0 + B/ S ( 1 − T c ) ( r 0 − r B ) 0.22 = r0 + 0.5 x (1-0.4) (r0 - 0.16) On solving the above equation we get r 0 = 20.62%.

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40) D 41) B 42) A 43) A

$7 X 5000 + 0.25 X 10000 = $37500 Value per share = $37500 / 5000 = $7.5 Change in share price = $7.5- $7.0 = $0.50. 44) C

Value of firm before recapitalization = 3000 x (1-0.40)/0.15 = 12,000 Value per share = 12,000 / 300 = 40 Value of Firm after Recapitalization = $12000 + 0.40 X $3750 = $13500 Value per share = $13500/ 300 = 45. 45) D 46) Short Answer

Under either MM scenario, the financial manager should invest no time in analyzing the firm's capital structure. With no taxes, capital structure is irrelevant. With taxes, MM says a firm will maximize its value by using 100% debt. In both cases, the manager has nothing to decide. With the static theory, however, the manager must determine the optimal amount of debt and equity by analyzing the trade off between the benefits of the interest tax shield versus the financial distress costs. Ultimately, finding the optimal capital structure is challenging in this case. 47) Short Answer Unlevered

Levered

Operating Income

$6,000

Interest on Debt

-0-

1.000

Earnings

$6000

$5,000

EPS

$3.00

$3.125

# of shares

2000

1600

48) Short Answer

Mike is entitled to.2 ($2,500 - $1,600) = $180 Steve borrows $4,000 at 8% interest (20% of Firm L's Debt) and pays $320 in interest. Steve purchases 20% of firm U's equity and gets.2($2,500) = $500 Steve's total payout is $500 - $320 = $180, or Mikes payout. 49) Short Answer

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Steve borrows $4,000 at 12% interest = $480 Steve purchases 20% of Firm U's equity and gets.2($2,500) = $500 Steve's total payout is $500 - $480 = $20 50) Short Answer

Firm U: No Change - Still Worth $50,000 Firm L: New Value - $50,000 + (.34) ($20,000) => $56,800 51) Short Answer

New Firm Value: $500,000 + (.34) ($200,000) => $568,000 New Price Per Share = $568,000/200,000 => $2.84 Number of shares repurchased = $200,000/$2.84 => 70,422.5 52) Short Answer

New Firm Value: $640,000 + (.0) ($300,000) => $640,000 Number of shares Repurchased = 300,000/20 = 15,000 Capital Structure = D + E = 300,000 + 340,000 Number of Shares Outstanding = 32,000 - 15,000 - 17,000 Value of Equity = 17,000 * 20 = 340,000 The value of the firm stays at $640,000 (MM I) and the number of shares is reduced to 17,000. 53) Short Answer

New Firm Value: $640,000 + (.0) ($300,000) => $640,000 Capital Structure = D + E = 300,000 + 340,000 rs =.12 + (300/340) * (.12 -.08) =.12 +.0353 =.1553 WACC = (300/640) * (.08) + (340/640) * (.1553) =.0375 +.0825 =.12 The value of the firm stays at $640,000 (MM I), the cost of levered equity rises to 15.53% and the WACC remains at 12%. 54) Short Answer

New Firm Value: $640,000 + (.34) ($300,000) => $742,000 Capital Structure = D + E = 300,000 + 442,000 rs =.12 + (300/442) * (.12 -.08) * (1 -.34) =.12 +.0179 =.1379 WACC = (300/742) * (.08) * (1-.34) + (442/742) * (.1379) =.0213 +.0821 =.1034 The value of the firm increases to $742,000 (From Value of the Tax Shield), increasing the relative weight of equity and the cost of levered equity rises to 13.79% and the WACC falls to at 10.34% consistent with the increase in firm value. 55) Short Answer

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MM Proposition I and II greater leverage causes increase in risk see summary 56) Short Answer

Blue Mountain i)

Assets

32,000,000

Equity

32,000,000

(5 million shares @ 6.4/share)

ii)

Assets

32,000,000

Equity

35,500,000

(5 million shares @ 7.12/share)

.3 (12,000,000)

3,600,000

Tax Shield 35,600,000 iii)

Assets

32,000,000

Debt

12,000,000

Tax

3,600,000

Equity

23,600,000

35,600,000

TOTAL

35,600,000

(3,314,606.74 shares = 5,000,000 – 12,000,000/7.12)

Shield

57) Short Answer

VU = [EBIT × (1 - Tc)] ÷ RU = [$1,600 × (1 -.34)] ÷.10 = $10,560 VL = VU + (Tc × D) = $10,560 + (.34 × $3,000) = $11,580 VL - VD = VE = $11,580 - $3,000 = $8,580 RE = RU + (RU - RD) × D/E × (1 - TC) =.10 + [(.10 -.08) × ($3,000 ÷ $8,580) × (1 -.34)] =.10 +.00462 =.10462 = 10.46% 58) Short Answer

This question requires students to differentiate between the cost of equity and the weighted average cost of capital. In fact, it gets to the essence of capital structure theory: the firm trades off higher equity costs for lower debt costs. The shareholders benefit because their investment in the firm is levered, enhancing the return on their investment. Thus, even though the cost of equity rises, the overall cost of capital declines and firm value rises.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Indirect costs of financial distress: 1) ______ A) effectively limit the amount of equity a firm issues. B) serve as an incentive to increase the financial leverage of a firm. C) include direct costs such as legal and accounting fees. D) include the costs incurred by a firm as it tries to avoid seeking bankruptcy protection. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 17-02 Bankruptcy Risk or Bankruptcy Costs? Source : Chapter 17 Test Bank > TB 17-01 Indirect costs of financial distress:

2) Although the use of debt provides tax benefits to the firm, debt also puts pressure on the

firms to: 2) ______ A) meet interest and principal payments which if not met can put the company into

financial distress. B) make dividend payments which if not met can put the company into financial distress. C) meet both interest and dividend payments which when met increase the firm cash flow. D) meet increased tax payments thereby increasing firm value. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 17-01 Costs of Financial Distress Source : Chapter 17 Test Bank > TB 17-02 Although the use of debt provides tax benefi...

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3) The Trunk Line Company will earn $60 if it does well. The debt holders are promised

payments of $35 if the firm does well. If the firm does poorly the repayment will be $20 because of the deadweight cost of bankruptcy, expected earnings will be $30. The probability of the firm performing poorly or well is 50%. If bondholders are fully aware of these costs what will they pay for the debt? The interest rate on the bonds is 10%. 3) ______ A) $32.50. B) $27.50. C) $25.00. D) $29.55. E) $35.00. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 17-01 Costs of Financial Distress Source : Chapter 17 Test Bank > TB 17-03 The Trunk Line Company will earn...

4) TL Company has expected earnings of $75 in one year if it does well and $25 if it does

poorly. The firm has outstanding debt of $50 that is due in one year. However, given the financial distress costs, the debt holders will only receive $40 in one year if the firm does well and $15 if it does poorly. There is a 60 percent chance the firm will do well and a 40 percent chance that it will do poorly. What is the current value of the debt if the interest rate on bonds is 8 percent? 4) ______ A) $27.78 B) $27.50 C) $30.00 D) $26.67 E) $28.40 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 17-01 Costs of Financial Distress Source : Chapter 17 Test Bank > TB 17-04 TL Company has expected earnings of...

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5) The Trunk Line Company debt holders are promised payments of $35 if the firm does well

but will receive only $20 if the firm does poorly. If the bonds are selling for $25, the promised return to the bondholders is, approximately: 5) ______ A) 2.90%. B) 40.00%. C) 27.30%. D) 16.86%. E) 100.00%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 17-01 Costs of Financial Distress Source : Chapter 17 Test Bank > TB 17-05 The Trunk Line Company debt holders are prom...

6) The possibility of bankruptcy has a negative effect on the value of the firm because: 6) ______ A) increased bankruptcy risk lowers value. B) reorganization is costless but risk is not. C) a bankruptcy has real costs associated with it. D) value enhancing strategies are no longer available. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 17-01 Costs of Financial Distress Source : Chapter 17 Test Bank > TB 17-06 The possibility of bankruptcy has a negative...

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7) Given realistic estimates of the probability and cost of bankruptcy, the future costs of a

possible bankruptcy are borne by: 7) ______ A) by all investors in the firm. B) debt holders only because if default occurs interest and principal payments are not

made. C) equity holders because debt holders will pay less providing less cash for the equity holders. D) management because if the firm defaults they will lose their jobs. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 17-01 Costs of Financial Distress Source : Chapter 17 Test Bank > TB 17-07 Given realistic estimates of the probability...

8) While difficult to determine exactly, White, Altman, and Weiss estimated the distress costs to

be about _______ of the firm's market value. 8) ______ A) 1%. B) 3%. C) 5-6%. D) 8-10%. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 17-02 Bankruptcy Risk or Bankruptcy Costs? Source : Chapter 17 Test Bank > TB 17-08 While difficult to determine exactly, White,...

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9) The value of a firm in financial distress diminishes if the firm: 9) ______ A) has no bankruptcy risk. B) is declared solvent and does not undergo financial reorganization. C) is a partnership. D) is declared bankrupt and proceeds to be liquidated, or is a partnership. E) is declared bankrupt and proceeds to be liquidated, or is declared insolvent and

undergoes financial reorganization. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 17-01 Costs of Financial Distress Source : Chapter 17 Test Bank > TB 17-09 The value of a firm in financial distress di...

10) Conflicts of interest between stockholders and bondholders are known as: 10) ______ A) trustee costs. B) financial distress costs. C) dealer costs. D) agency costs. E) underwriting costs. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 17-02 Bankruptcy Risk or Bankruptcy Costs? Source : Chapter 17 Test Bank > TB 17-10 Conflicts of interest between stockholders a...

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11) One of the indirect costs of bankruptcy is the incentive for managers to take large risks.

When following this strategy, the firm will: 11) ______ A) rank all projects and take the project which results in the highest expected value of

the firm. B) rank all projects and take the project which results in the highest expected value of the firm's bonds. C) rank all projects and take the project which results in the highest expected value of the firm's stock. D) always take the low risk project. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 17-02 Bankruptcy Risk or Bankruptcy Costs? Source : Chapter 17 Test Bank > TB 17-11 One of the indirect costs of bankruptcy is t...

12) The optimal capital structure has been achieved when the: 12) ______ 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 pre-tax cost of debt. D) debt-equity ratio selected results in the lowest possible weighed average cost of

capital. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Hard Topic : 17-10 Integration of Tax Effects and Financial Distress Costs Source : Chapter 17 Test Bank > TB 17-12 The optimal capital structure has been achie...

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13) When shareholders pursue selfish strategies such as taking large risks or paying excessive

dividends, these will result in: 13) ______ A) no action by debt holders since these are equity holder concerns. B) positive agency costs, as bondholders impose various restrictions and covenants,

which will diminish the firm value. C) investments of the same risk class that the firm is in. D) undertaking scale enhancing projects. E) lower agency costs, as shareholders have more control over the firm's assets. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 17-02 Bankruptcy Risk or Bankruptcy Costs? Source : Chapter 17 Test Bank > TB 17-13 When shareholders pursue selfish strategies ...

14) Indirect costs of bankruptcy are born principally by: 14) ______ A) bondholders. B) stockholders. C) managers. D) the Federal government. E) the firm's suppliers. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 17-02 Bankruptcy Risk or Bankruptcy Costs? Source : Chapter 17 Test Bank > TB 17-14 Indirect costs of bankruptcy are born princi...

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15) One of the indirect bankruptcy costs is the incentive toward underinvestment. Following this

strategy may result in: 15) ______ A) the firm always choosing projects with the positive NPVs. B) the firm accepting negative NPV projects that it would clearly reject in an all equity

firm. C) bondholders contributing the full amount of the investment, but both stockholders and bondholders sharing in the benefits of the project. D) both the firm always choosing projects with the positive NPVs; and stockholders contributing the full amount of the investment, but both stockholders and bondholders sharing in the benefits of the project. E) both the firm turning down positive NPV projects that it would accept in an all-equity firm; and stockholders contributing the full amount of the investment, but both stockholders and bondholders sharing in the benefits of the project. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 17-02 Bankruptcy Risk or Bankruptcy Costs? Source : Chapter 17 Test Bank > TB 17-15 One of the indirect bankruptcy costs is the ...

16) "Junk bond" is a term used to describe bonds: 16) ______ A) of highest quality. B) issued by junk yards. C) with short periods to maturity. D) with low yields to maturity. E) with relatively higher probabilities of default. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 17-01 Costs of Financial Distress Source : Chapter 17 Test Bank > TB 17-16 "Junk bond" is a term used to describe bonds...

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17) The main difference between positive and negative covenants is (are): 17) ______ A) a positive covenant is one you must not do, while a negative covenant must be carried

out. B) actions that you must do regularly versus periodically. C) a positive covenant is one you must do, while a negative covenant limits actions the firm can take. D) no difference as they are both restrictive. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 17-03 Description of Costs Source : Chapter 17 Test Bank > TB 17-17 The main difference between positive and neg...

18) Covenants restricting the use of leasing and additional borrowings, primarily protect: 18) ______ A) the equity holders from added risk of default. B) the debt holders from the added risk of dilution of their claims. C) the debt holders from the transfer of assets. D) the management from having to pay agency costs. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 17-03 Description of Costs Source : Chapter 17 Test Bank > TB 17-18 Covenants restricting the use of leasing and...

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19) If the firm issues debt but writes protective and restrictive covenants into the loan contract,

then the debt may be issued at a(an) _____ interest rate compared with otherwise similar debt. 19) ______ A) significantly higher B) slightly higher C) equal D) lower Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 17-03 Description of Costs Source : Chapter 17 Test Bank > TB 17-19 If the firm issues debt but writes protectiv...

20) When graphing firm value against debt levels, the debt level that maximizes the value of the

firm is the level where: 20) ______ A) the increase in the present value of distress costs from an additional dollar of debt is

greater than the increase in the present value of the debt tax shield. B) the increase in the present value of distress costs from an additional dollar of debt is equal to the increase in the present value of the debt tax shield. C) the increase in the present value of distress costs from an additional dollar of debt is less than the increase of the present value of the debt tax shield. D) distress costs as well as debt tax shields are zero. E) distress costs as well as debt tax shields are maximized. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 17-04 Direct Costs of Financial Distress: Legal and Administrative Costs of Liquidation or Re Source : Chapter 17 Test Bank > TB 17-20 When graphing firm value against debt levels...

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21) The basic lesson of MM theory is that the value of a firm is dependent upon the: 21) ______ A) capital structure of the firm. B) total cash flows of the firm. C) percentage of a firm to which the bondholders have a claim. D) tax claim placed on the firm by the government. E) size of the stockholders claims on the firm. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 17-04 Direct Costs of Financial Distress: Legal and Administrative Costs of Liquidation or Re Source : Chapter 17 Test Bank > TB 17-21 The basic lesson of MM theory is that the va...

22) The value of the firm is the sum of all claims against it. These marketed and non-marketed

claims: 22) ______ A) increase in value together and are both bought and sold in the financial markets. B) trade-off against one another in value with marketed claims bought and sold in the

financial markets but not non-marketable claims. C) decrease in value together and are both bought and sold in the financial markets. D) trade-off against one another in value with both marketed and non-marketed claims bought and sold in the financial markets. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 17-05 Indirect Costs of Financial Distress Source : Chapter 17 Test Bank > TB 17-22 The value of the firm is the sum of all clai...

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23) When small companies issue large stock offerings, we can expect owner-managers to: 23) ______ A) increase both leisure time and work-related amenities. B) decrease both leisure time and work-related amenities. C) increase leisure time but decrease work related amenities. D) decrease leisure time and increase work related amenities. E) decrease leisure time but keep work related amenities the same. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 17-06 Agency Costs Source : Chapter 17 Test Bank > TB 17-23 When small companies issue large stock offer...

24) When firms issue more debt, the tax shield on debt _____, the agency costs on debt (i.e.,

costs of financial distress) _____, and the agency costs on equity _____. 24) ______ A) increases; increases; increases B) decreases; decreases; decreases C) increases; increases; decreases D) decreases; decreases; increases E) increases; decreases; decreases Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 17-06 Agency Costs Source : Chapter 17 Test Bank > TB 17-24 When firms issue more debt, the tax shield o...

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25) The free cash flow hypothesis states: 25) ______ A) that firms with greater free cash flow will pay more in dividends reducing the risk of

financial distress. B) that firms with greater free cash flow should issue new equity to force managers to minimize wasting resources and to work harder. C) that issuing debt requires interest and principal payments reducing the potential of management to waste resources. D) that issuing equity reduces the potential of management to waste resources. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 17-06 Agency Costs Source : Chapter 17 Test Bank > TB 17-25 The free cash flow hypothesis states:

26) Issuing debt instead of new equity in a closely held firm more likely: 26) ______ A) causes the owners-managers to work less hard and shirk their duties as they have less

capital at risk. B) causes the owner-managers to consume more perquisites because the cost is passed to the debt holders. C) causes both more shirking and perquisite consumption since the government provides a tax shield on debt. D) cause agency costs to fall as owner-managers do not need to worry about other shareholders. E) cause the owner-manager to reduce shirking and perquisite consumption as the excess cash flow must be used to meet debt payments. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 17-06 Agency Costs Source : Chapter 17 Test Bank > TB 17-26 Issuing debt instead of new equity in a clos...

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27) The pecking order states how financing should be raised. In order to avoid asymmetric

information problems and misinterpretation of whether management is sending a signal on security overvaluation the firm's first rule is to: 27) ______ A) finance with internally generated funds as there is no market interaction. B) always issue debt then the market won't know when management thinks the security is overvalued. C) reduce asymmetry before any financing activity. D) increase the financial slack to reduce the reliance on internally generated funds. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 17-07 Can Debt Costs be Reduced? Source : Chapter 17 Test Bank > TB 17-27 The pecking order states how financing shoul...

28) Which of the following is true when a firm has level coupon debt outstanding and growth

opportunities? 28) ______ A) The firm should be 100% debt financed because the greater the debt the greater tax

shield. B) 100% debt financing is suboptimal because increased firm value does not increase the current interest needed to shield income today. C) Firm value will only increase if the debt level is increased to 100%. D) The high growth firm will have high debt ratios as they need greater financing. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 17-08 Protective Covenants Source : Chapter 17 Test Bank > TB 17-28 Which of the following is true when a firm h...

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29) The introduction of personal taxes may reveal a disadvantage to the use of debt if the: 29) ______ A) personal tax rate on the distribution of income to stockholders is less than the

personal tax rate on interest income. B) personal tax rate on the distribution of income to stockholders is greater than the personal tax rate on interest income. C) personal tax rate on the distribution of income to stockholders is equal to the personal tax rate on interest income. D) the personal tax rate on interest income is zero. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 17-09 Consolidation of Debt Source : Chapter 17 Test Bank > TB 17-29 The introduction of personal taxes may revea...

30) In the Miller Model, when the quantity (1-Tc)(1-Ts) = (1-Tb), then: 30) ______ A) the firm should hold no debt. B) the value of the levered firm is greater than the value of the unlevered firm. C) the tax shield on debt is exactly offset by higher personal taxes paid on interest

income. D) the tax shield on debt is exactly offset by higher levels of dividends. E) the tax shield on debt is exactly offset by higher capital gains. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 17-09 Consolidation of Debt Source : Chapter 17 Test Bank > TB 17-30 In the Miller Model, when the quantity (1-Tc...

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31) What three factors are important to consider in determining a target debt to equity ratio? 31) ______ A) Taxes, asset types, and pecking order and financial slack. B) Asset types, uncertainty of operating income, and pecking order and financial slack. C) Taxes, financial slack and pecking order, and uncertainty of operating income. D) Taxes, asset types, and uncertainty of operating income. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 17-10 Integration of Tax Effects and Financial Distress Costs Source : Chapter 17 Test Bank > TB 17-31 What three factors are important to consider...

32) The Zercon Company has an EBIT of $50,000 and a market value debt of $100,000

outstanding with a 9% coupon rate. The cost of equity for an all-equity firm would be 14%. Zercon has a 35% corporate tax rate. Investors face a 20% tax rate on debt receipts and a 15% rate on equity. Determine the value of Zercon. 32) ______ A) $263,080. B) $332,143. C) $258,537. D) $162,948. E) $120,000. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 17-09 Consolidation of Debt Source : Chapter 17 Test Bank > TB 17-32 The Zercon Company has an EBIT of ...

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33) Suppose a Miller equilibrium exists with a corporate tax rate of 30% and a personal tax rate

on income from bonds of 35%. What is the personal tax rate on income from stocks? 33) ______ A) 10.05%. B) 7.1%. C) 45.5%. D) 0.0%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 17-09 Consolidation of Debt Source : Chapter 17 Test Bank > TB 17-33 Suppose a Miller equilibrium exists with a c...

34) Given the following information, leverage will add how much value to the unlevered firm per

dollar of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 50% Personal tax rate on income from stocks: 10% 34) ______ A) -$0.188. B) $0.340. C) $0.633. D) -$0.050. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 17-09 Consolidation of Debt Source : Chapter 17 Test Bank > TB 17-34 Given the following information, leverage wi...

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35) Given the following information, leverage will add how much value to the unlevered firm per

dollar of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 10% Personal tax rate on income from stocks: 50% 35) ______ A) -$0.188. B) $0.340. C) $0.633. D) -$0.050. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 17-09 Consolidation of Debt Source : Chapter 17 Test Bank > TB 17-35 Given the following information, leverage wi...

36) Given the following information, leverage will add how much value to the unlevered firm per

dollar of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 30% Personal tax rate on income from stocks: 30% 36) ______ A) $0.246. B) $0.340. C) $0.006. D) -$0.050. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 17-09 Consolidation of Debt Source : Chapter 17 Test Bank > TB 17-36 Given the following information, leverage wi...

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37) Given the following information, leverage will add how much value to the unlevered firm per

dollar of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 20% Personal tax rate on income from stocks: 0% 37) ______ A) $0.825. B) $0.528. C) $0.175. D) $0.472. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 17-09 Consolidation of Debt Source : Chapter 17 Test Bank > TB 17-37 Given the following information, leverage wi...

38) The Lanoi Company has an EBIT of $30,000 and a market value debt of $150,000

outstanding with an 8% coupon rate. The cost of equity for an all-equity firm would be 12%. Lanoi has a 30% corporate tax rate. Investors face a 20% tax rate on debt receipts and a 12% rate on equity. Determine the value of Lanoi. 38) ______ A) $130,500. B) $142,698. C) $248,537. D) $290,500 E) $332,143. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 17-09 Consolidation of Debt Source : Chapter 17 Test Bank > TB 17-38 The Lanoi Company has an EBIT of...

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39) Given the following information, leverage will add how much value to the unlevered firm per

dollar of debt? Corporate tax rate: 30% Personal tax rate on income from bonds: 20% Personal tax rate on income from stocks: 0% 39) ______ A) $0.125. B) $0.472. C) $0.528. D) $0.825. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 17-09 Consolidation of Debt Source : Chapter 17 Test Bank > TB 17-39 Given the following information, leverage wi...

40) The optimal capital structure: 40) ______ A) will be the same for all firms in the same industry. B) will remain constant over time unless the firm makes an acquisition. C) of a firm will vary over time as taxes and market conditions 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 17-10 Integration of Tax Effects and Financial Distress Costs Source : Chapter 17 Test Bank > TB 17-40 The optimal capital structure:

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41) The MM theory with taxes implies that firms should issue maximum debt. In practice, this is

not true because: 41) ______ A) debt is more risky than equity. B) bankruptcy is a disadvantage to debt. C) firms will incur large agency costs of short term debt by issuing long term debt. D) both debt is more risky than equity; and bankruptcy is a disadvantage to debt. E) both bankruptcy is a disadvantage to debt; and firms will incur large agency costs of

short term debt by issuing long term debt. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 17-10 Integration of Tax Effects and Financial Distress Costs Source : Chapter 17 Test Bank > TB 17-41 The MM theory with taxes implies that firms ...

42) Your firm has a debt-equity ratio of.60. Your cost of equity is 11% and your after-tax cost of

debt is 7%. What will your cost of equity be if the target capital structure becomes a 50/50 mix of debt and equity? 42) ______ A) 9.50%. B) 10.50%. C) 11.00%. D) 11.25%. E) 12.00%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 17-10 Integration of Tax Effects and Financial Distress Costs Source : Chapter 17 Test Bank > TB 17-42 Your firm has a debt-equity ratio of.60. You...

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43) The Aggie Company has an EBIT of $70,000 and a market value debt of $100,000

outstanding with a 9% coupon rate. The cost of equity for an all-equity firm would be 14%. Aggie has a 35% corporate tax rate. Investors face a 20% tax rate on debt receipts and a 15% rate on equity. Determine the value of Aggie. 43) ______ A) $120,000. B) $162,948. C) $258,537. D) $263,080. E) $394062.5 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 17-10 Integration of Tax Effects and Financial Distress Costs Source : Chapter 17 Test Bank > TB 17-43 The Aggie Company has an EBIT of...

44) The optimal capital structure will tend to include more debt for firms with: 44) ______ A) the highest depreciation deductions. B) the lowest marginal tax rate. C) substantial tax shields from other sources. D) lower probability of financial distress. E) less taxable income. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Hard Topic : 17-10 Integration of Tax Effects and Financial Distress Costs Source : Chapter 17 Test Bank > TB 17-44 The optimal capital structure will tend to i...

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45) The optimal capital structure of a firm _____ the marketed claims and _____ the

nonmarketed claims against the cash flows of the firm. 45) ______ A) minimizes; minimizes B) minimizes; maximizes C) maximizes; minimizes D) maximizes; maximizes Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 17-10 Integration of Tax Effects and Financial Distress Costs Source : Chapter 17 Test Bank > TB 17-45 The optimal capital structure of a firm ____...

46) Studies have found that firms with high proportions of intangible assets are likely to use

_______ debt compared with firms with low proportions of intangible assets. 46) ______ A) more B) the same amount of C) less D) either more or the same amount of Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 17-10 Integration of Tax Effects and Financial Distress Costs Source : Chapter 17 Test Bank > TB 17-46 Studies have found that firms with high prop...

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SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 47) Rotomax Inc. has recently undertaken a lot of new ventures and borrowed a huge sum of money from the market. Currently, its face value of debt face equals $150 (all figures are in millions). The firm's assets will be worth either $200 (boom) or $135 (recession) next year. Currently, it has a new project that will generate $60 next year with certainty. The investment needed for this project is $52. Assume that the probability of each state is 0.50. How much is this project opportunity worth? How much is the project opportunity worth to current equity holders if they have to finance the project by equity? Will the current shareholders be interested in investing in this project?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 17-02 Bankruptcy Risk or Bankruptcy Costs? Source : Chapter 17 Test Bank > TB 17-47 Rotomax Inc. has recently undertaken a lot o...

48) The Do-All-Right Marketing Research firm has promised payments to their bondholders that

total $100. The company believes that there is an 85% chance that the cash flow will be sufficient to meet these claims. However, there is a 15% chance that cash flows will fall short, in which case total earnings are expected to be $65. If the bonds sell in the market for $84, what is an estimate of the bankruptcy costs for Do-All-Right? Assume a cost of debt of 10%.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 17-01 Costs of Financial Distress Source : Chapter 17 Test Bank > TB 17-48 The Do-All-Right Marketing Research firm has...

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49) Given a situation where the corporate tax rate is 34%, and the personal tax rate on dividends

is 28%, what must the personal tax rate on interest be to achieve the Miller equilibrium?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 17-09 Consolidation of Debt Source : Chapter 17 Test Bank > TB 17-49 Given a situation where the corporate tax ra...

50) The All-Mine Corporation is deciding whether to invest in a new project. The project would

have to be financed by equity, the cost is $2000 and will return $2500 or 25% in one year. The discount rate for both bonds and stock is 15% and the tax rate is zero. The predicted cash flows are $4500 in a good economy, $3000 in an average, economy and $1000 in a poor economy. Each economic outcome is equally likely and the promised debt repayment is $3000. Should the company take the project? What is the value of the firm and its components before and after the project addition?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 17-02 Bankruptcy Risk or Bankruptcy Costs? Source : Chapter 17 Test Bank > TB 17-50 The All-Mine Corporation is deciding whether...

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51) Wigdor Manufacturing is currently all-equity financed, has an EBIT of $2 million and is in

the 34 percent tax bracket. Louis, the company's founder, is the lone shareholder. All earnings are paid out as dividends to Louis. 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 to Louis if he holds all the debt? Compare this to Louis' total cash flow if the firm remains unlevered.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 17-04 Direct Costs of Financial Distress: Legal and Administrative Costs of Liquidation or Re Source : Chapter 17 Test Bank > TB 17-51 Wigdor Manufacturing is currently all-equity...

52) Establishing a capital structure for a firm is not simple. Although financial theory guides the

process, there is no simple formula. List and explain four main items that one should consider in determining the capital structure.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 17-10 Integration of Tax Effects and Financial Distress Costs Source : Chapter 17 Test Bank > TB 17-52 Establishing a capital structure for a firm ...

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53) Is there an easily identifiable debt-equity ratio that will maximize the value of a firm? Why

or why not?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 17-10 Integration of Tax Effects and Financial Distress Costs Source : Chapter 17 Test Bank > TB 17-53 Is there an easily identifiable debt-equity ...

54) 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 the other?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 17-10 Integration of Tax Effects and Financial Distress Costs Source : Chapter 17 Test Bank > TB 17-54 Describe some of the sources of business ris...

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Answer Key Test name: Chapter 17 1) 2) 3) 4) 5)

D A C A B 35-25/25 = 0.40 Or 40% 6) C 7) C 8) B

3% According to Weiss (1990) 9) E

is declared bankrupt and proceeds to be liquidated, or is declared insolvent and undergoes financial reorganization. 10) D 11) C 12) D 13) B

positive agency costs, as bondholders impose various restrictions and covenants, which will diminish the firm value. 14) B 15) E

both the firm turning down positive NPV projects that it would accept in an all-equity firm; and stockholders contributing the full amount of the investment, but both stockholders and bondholders sharing in the benefits of the project. 16) E

with relatively higher probabilities of default. And also a high yielding fixed income security. 17) C

a positive covenant is one you must do, while a negative covenant limits actions the firm can take.

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18) B 19) D 20) B 21) B 22) B 23) A

increase both leisure time and work-related amenities. 24) C 25) C 26) E

cause the owner-manager to reduce shirking and perquisite consumption as the excess cash flow must be used to meet debt payments. 27) A

finance with internally generated funds as there is no market interaction. 28) B 29) A 30) C

the tax shield on debt is exactly offset by higher personal taxes paid on interest income. 31) D 32) A

V L = V U + [ 1 − ( 1 − T c ) × ( 1 − T S ) ( 1 − T B ) ] × B $50000 (1-0.35)/14% + $100000 X [ (1-0.35) (1-0.15)/(1-0.20)] = $263,080.5 33) B

(1-Tc)(1-Ts) = (1-Tb), 1-{(1-0.35)/ (1-0.30) = 7.14% 34) A 35) C 36) B 37) C 38) D

V L = V U + [ 1 − ( 1 − T c ) × ( 1 − T S ) ( 1 − T B ) ] × B $30000 (1-0.30) + $150000 [(-0.30) (1-0.12)/(1-0.20)] = $290500 39) A 40) C 41) B

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42) E 43) E

V L = V U + [ 1 − ( 1 − T c ) × ( 1 − T S ) ( 1 − T B ) ] × B $70000 (1-0.35)/0.14 + $100000 [ (10.35)(1-0.15)/(1-0.20) = $394062.5 44) D 45) C 46) C 47) Short Answer

The project is worth $60 - $54 = $8. If equity holders finance the project on their own, then the pay-off is: [0.50 * (200 ) + 0.50 * (135) ] + 60 - 54 - 150 = $23.5 On the other hand, if they do not undertake the project, the pay-off is: 0.50 * (200 - 150) + 0.50 * 0 = 0.50 * 50 + 0.50 * 0 = $25 Hence, current shareholders will not be interested in the project. 48) Short Answer

The expected amount bondholders receive if cash flows fall short under bankruptcy is: $84 = [($100 * .85) + (X * .15)]/1.1 => X = $49.34 Without bankruptcy costs, the bonds would sell for: [(100 * .85) + ($65 * .15)]/1.1 => $86.14 Therefore, estimated bankruptcy costs must be $65.00 - $49.34 = $15.66. Impact on price is (.15(15.66))/1.1 = $2.14 49) Short Answer

(1 -.34) (1 -.28) = (1 - Tb) =>.4752 = (1 - Tb) => Tb =.5248 50) Short Answer

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Determine cash flows before the project. Good

Average

Poor

Firm CF

4500

3000

1000

Debt Claim

3000

1000

Equity Claim

1500

Good

Average

Poor

Firm CF

7000

5500

3500

Debt Claim

3000

1000

Equity Claim

4000

1500

5000

B = ((3000 + 3000 + 1000)/3)/1.15 = 2333.33/1.15 = $2028.99 S = ((1500 + 0 + 0)/3)/1.15 = 500/1.15 = $434.78 Determine value with project.

B = ((3000 + 3000 + 3000)/3)/1.15 = 3000/1.15 = 2608.70 S = ((4000 + 2500 + 500)/3)/1.15 = 2333.33/1.15 = $2028.99 Do not accept as NPV goes mostly to bondholders not equity. Equity net change in value = (2028.99 - 434.78) - 2000 = -405.79 51) Short Answer Unlevered

Levered

EBIT

$2,000,000

Interest

400,000

EBT

$2,000,000

$1,600,000

Taxes

680,000

544,000

After-tax earnings = Dividends

$1,320,000

$1,056,000

Interest Income to Louis

400,000

Total cash flow to Louis

$1,320,000

$1,456,000

52) Short Answer

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Taxes--tax shield to debt if TC > TB Type of Assets--tangible assets based firms have lower costs of financial distress Uncertainty of operating income--firms in higher risk classes have greater probability of experiencing financial distress Pecking order and Financial slack-External financing is more expensive financial slack allows for shortfall coverage 53) Short Answer

Students should explain that in a world with taxes, transaction costs, and financial distress costs, there are both benefits and costs to higher debt loads, and there is no way to target exactly what the ideal capital structure should be. 54) Short Answer

Students should intuitively recognize that some of the observed variation in capital structures across industries reflect the differences in the nature of the industries themselves i.e., business risk. Similarly, intuition would suggest that firms with large capital requirements and stable cash flows (e.g., electric utilities) are more likely to be willing to raise funds via large amounts of borrowing. Alternatively, firms with lower tangible asset needs and highly uncertain cash flows (e.g., small software companies) are more likely to employ equity.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) The acceptance of a capital budgeting project is usually evaluated on its own merits. That is, capital budgeting decisions are treated separately from capital structure decisions. In reality, these decisions may be highly interwoven. This may result in: 1) ______ A) firms rejecting positive NPV, all equity projects because changing to a capital structure with debt will always create negative NPV. B) never considering capital budgeting projects on their own merits. C) corporate financial managers first checking with their investment bankers to determine the best type of capital to raise before valuing the project. D) firms accepting some negative NPV all equity projects because changing capital structure adds enough positive leverage tax shield value to create a positive NPV. E) firms never changing the capital structure because all capital budgeting decisions will be subsumed by capital structure decisions. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 18-01 Adjusted Present Value Approach Source : Chapter 18 Test Bank > TB 18-01 The acceptance of a capital budgeting projec...

2) The APV method is comprised of the all-equity NPV of a project and the NPV of financing

effects. The four side effects are: 2) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 18-01 Adjusted Present Value Approach Source : Chapter 18 Test Bank > TB 18-02 The APV method is comprised of the all-equit...

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3) Discounting the unlevered after tax cash flows by the ______ minus the ______ yields the

______. 3) ______ A) cost of capital for the unlevered firm; initial investment; Adjusted Present Value B) cost of equity capital; initial investment; project NPV C) weighted cost of capital; fractional equity investment; project NPV D) cost of capital for the unlevered firm; initial investment; All equity Net Present Value Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 18-01 Adjusted Present Value Approach Source : Chapter 18 Test Bank > TB 18-03 Discounting the unlevered after tax cash flo...

4) The APV method to value a project should be used when the: 4) ______ A) project's level of debt is known over the life of the project. B) project's target debt to value ratio is constant over the life of the project. C) project's debt financing is unknown over the life of the project. D) both project's level of debt is known over the life of the project; and project's target

debt to value ratio is constant over the life of the project. E) both project's target debt to value ratio is constant over the life of the project; and project's debt financing is unknown over the life of the project. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 18-01 Adjusted Present Value Approach Source : Chapter 18 Test Bank > TB 18-04 The APV method to value a project should be ...

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5) The flow-to-equity (FTE) approach in capital budgeting is defined to be the: 5) ______ A) discounting all cash flows from a project at the overall cost of capital. B) scale enhancing discount process. C) discounting of the levered cash flows to the equity holders for a project at the

required return on equity. D) the dividends and capital gains that may flow to a shareholders of any firm. E) discounting of the unlevered cash flows of a project from a levered firm at the WACC. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 18-02 Flow to Equity Approach Source : Chapter 18 Test Bank > TB 18-05 The flow-to-equity (FTE) approach in capital...

6) In calculating the NPV using the Flow-To-Equity approach the discount rate: 6) ______ A) is the all equity cost of capital. B) is the cost of equity for the levered firm. C) is the all equity cost of capital minus the weighted average cost of debt. D) is the weighted average cost of capital. E) is the all equity cost of capital plus the weighted average cost of debt. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 18-02 Flow to Equity Approach Source : Chapter 18 Test Bank > TB 18-06 In calculating the NPV using the Flow-To-Equ...

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7) The appropriate cost of debt to the firm is: 7) ______ A) the weighted cost of debt after tax. B) the levered equity rate. C) the market borrowing rate after tax. D) the coupon rate pre-tax. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 18-03 Step 1: Calculating Levered Cash Flow Source : Chapter 18 Test Bank > TB 18-07 The appropriate cost of debt to the firm is:

8) The Webster Corp. is planning the construction of a new shipping depot for its single

manufacturing plant. The initial cost of the investment is $1 million. Efficiencies from the new depot are expected to reduce costs by $100,000 forever. The corporation has a total value of $60 million and has outstanding debt of $40 million. What is the NPV of the project if the firm has an after-tax cost of debt of 6% and cost equity of 9%? 8) ______ A) $428,571 B) $444,459 C) $565,547 D) $1,000,000 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 18-03 Step 1: Calculating Levered Cash Flow Source : Chapter 18 Test Bank > TB 18-08 The Webster Corp. is planning the constructi...

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9) An appropriate guideline to adopt when determining the valuation formula to use is: 9) ______ A) never use the APV approach. B) use APV if the project is far different from scale enhancing. C) use WACC if the project is close to being scale enhancing. D) never use the APV approach and use WACC if the project is close to being scale

enhancing. E) use APV if the project is far different from scale enhancing and use WACC if the project is close to being scale enhancing. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 18-04 Step 2: Calculating rs Source : Chapter 18 Test Bank > TB 18-09 An appropriate guideline to adopt when deter...

10) Although the three capital budgeting methods are equivalent, they all can have difficulties

making computation impossible at times. The most useful methods or tools from a practical standpoint are: 10) ______ A) APV because debt levels are unknown in future years. B) WACC because projects have variable risk and target debt to value ratios. C) Flow-to-equity, because of variable risk and the knowledge that managers think in terms of suboptimal debt to equity ratios. D) both APV because debt levels are unknown in future years and WACC because projects have constant risk and target debt to value ratios. E) both WACC because projects have constant risk and target debt to value ratios and Flow-to-equity, because of constant risk and the knowledge that managers think in terms of optimal debt to equity ratios. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 18-04 Step 2: Calculating rs Source : Chapter 18 Test Bank > TB 18-10 Although the three capital budgeting methods...

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11) Which of the following are guidelines for the three methods of capital budgeting with

leverage? 11) ______ A) Use APV if project's level of debt is known over the life of the project. B) Use APV if project's level of debt is unknown over the life of the project. C) Use FTE or WACC if the firm's target debt-to-value ratio applies to the project over

its life. D) Both use APV if project's level of debt is known over the life of the project; and use FTE or WACC if the firm's target debt-to-value ratio applies to the project over its life. E) Both use APV if project's level of debt is unknown over the life of the project; and use FTE or WACC if the firm's target debt-to-value ratio applies to the project over its life. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 18-04 Step 2: Calculating rs Source : Chapter 18 Test Bank > TB 18-11 Which of the following are guidelines for th...

12) In order to value a project which is not scale enhancing you need to: 12) ______ A) typically calculate the equity cost of capital using the risk adjusted beta of another

firm before calculating the WACC. B) typically increase the beta of another firm in the same line of business and then calculate the discount rate using the SML. C) typically you can simply apply your current cost of capital. D) discount at the market rate of return since the project will diversify the firm to the market. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 18-06 Weighted Average Cost of Capital Method Source : Chapter 18 Test Bank > TB 18-12 In order to value a project which is not sca...

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13) The value of a project to a levered firm is equal to the unlevered firm project value plus the: 13) ______ A) costs of financial distress, minus floatation costs, plus taxes, plus debt financing

subsidies. B) tax subsidies, minus floatation costs, plus debt financing subsidies. C) tax subsidies, minus floatation costs, minus financial distress costs, plus debt financing subsidies. D) taxes paid, minus floatation costs, plus financial distress costs, plus debt financing subsidies. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 18-05 Step 3: Valuation Source : Chapter 18 Test Bank > TB 18-13 The value of a project to a levered firm is ...

14) The flow-to-equity approach to capital budgeting is a three-step process of: 14) ______ A) calculating the levered cash flow, the cost of equity capital for a levered firm, then

adding the interest expense when the cash flows are discounted. B) calculating the unlevered cash flow, the cost of equity capital for a levered firm, and then discounting the unlevered cash flows. C) calculating the levered cash flow after interest expense, the cost of equity capital for a levered firm, and then discounting the levered cash flows by the cost of equity capital. D) calculating the levered cash flow after interest expense, the cost of equity capital for a levered firm, and then discounting the levered cash flows at the risk free rate. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 18-02 Flow to Equity Approach Source : Chapter 18 Test Bank > TB 18-14 The flow-to-equity approach to capital budge...

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15) The term B x rb gives: 15) ______ A) total cost of debt per year. B) total cost of equity per year. C) unit cost of debt. D) unit cost of equity. E) weighted average cost of capital. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 18-03 Step 1: Calculating Levered Cash Flow Source : Chapter 18 Test Bank > TB 18-15 The term B x rb gives:

16) The weighted average cost of capital is determined by: 16) ______ A) multiplying the weighted average after tax cost of debt by the weighted average cost

of equity. B) adding the weighted average before tax cost of debt to the weighted average cost of equity. C) adding the weighted average after tax cost of debt to the weighted average cost of equity. D) dividing the weighted average before tax cost of debt to the weighted average cost of equity. E) dividing the weighted average after tax cost of debt to the weighted average cost of equity. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 18-03 Step 1: Calculating Levered Cash Flow Source : Chapter 18 Test Bank > TB 18-16 The weighted average cost of capital is dete...

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17) A key difference between the APV, WACC, and FTE approaches to valuation is: 17) ______ A) how the unlevered cash flows are calculated. B) how the ratio of debt to equity is determined. C) how the initial investment is treated. D) whether terminal values are added or not. E) whether debt effects should be considered. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 18-04 Step 2: Calculating rs Source : Chapter 18 Test Bank > TB 18-17 A key difference between the APV, WACC, and ...

18) The FTE approach has been used by the firm to value its capital budgeting projects. The total

investment cost at time 0 is $640,000. The company uses the FTE approach because they maintain a target debt-to-value ratio over project lives. The company has a debt-to-equity ratio of.5. The present value of the project including debt financing is $810,994. What is the relevant initial investment cost to use in determining the value of the project? 18) ______ A) $640,000 B) $170,994 C) $267,628 D) $437,252 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 18-02 Flow to Equity Approach Source : Chapter 18 Test Bank > TB 18-18 The FTE approach has been used by the firm t...

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19) A firm has a total value of $500,000 and debt valued at $300,000. What is the weighted

average cost of capital if the after-tax cost of debt is 9% and the cost of equity is 14%? 19) ______ A) 7.98%. B) 12.13%. C) 11.00%. D) 10.88%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 18-03 Step 1: Calculating Levered Cash Flow Source : Chapter 18 Test Bank > TB 18-19 A firm has a total value of...

20) The Felix Filter Corp. maintains a debt-to-equity ratio of.6. The cost of equity for Felix Filter

Corp. is 16%, the cost of debt is 11% and the marginal tax rate is 30%. What is the weighted average cost of capital? (Round your answer to two decimal places.) 20) ______ A) 8.38% B) 12.89% C) 11.02% D) 13.00% E) 14.13% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 18-03 Step 1: Calculating Levered Cash Flow Source : Chapter 18 Test Bank > TB 18-20 The Felix Filter Corp. maintains a debt-to-e...

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21) The Webster Corp. is planning the construction of a new shipping depot for its single

manufacturing plant. The initial cost of the investment is $1 million. Efficiencies from the new depot are expected to reduce costs by $100,000 for each of the next 20 years. The corporation has a total value of $60 million and has outstanding debt of $40 million. What is the NPV of the project if the firm has an after-tax cost of debt of 6% and cost equity of 9%? 21) ______ A) $59,401 B) $59,901 C) $60,401 D) $69,901 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 18-03 Step 1: Calculating Levered Cash Flow Source : Chapter 18 Test Bank > TB 18-21 The Webster Corp. is planning the constructi...

22) The term scale enhancing refers to: 22) ______ A) a project whose risk is equal to the risk of the firm as a whole. B) cost of debt which does not affect the firm's cost of equity. C) new issues of securities much larger than existing issues. D) past performance out performing future performance. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 18-07 A Comparison of the Adjusted Present Value, Flow to Equity, and Weighted Average Cost o Source : Chapter 18 Test Bank > TB 18-22 The term scale enhancing refers to:

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23) The acronym APV stands for: 23) ______ A) applied present value. B) all purpose variable. C) accepted project verified. D) adjusted present value. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 18-01 Adjusted Present Value Approach Source : Chapter 18 Test Bank > TB 18-23 The acronym APV stands for:

24) To calculate the adjusted present value, you: 24) ______ A) multiply the additional effects by the all equity project value. B) add the additional effects of financing to the all equity project value. C) divide the project's cash flow by the risk-free rate. D) divide the project's cash flow by the risk-adjusted rate. E) add the risk-free rate to the market portfolio when B equals 1. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 18-01 Adjusted Present Value Approach Source : Chapter 18 Test Bank > TB 18-24 To calculate the adjusted present value, you...

25) The Tip-Top Paving Co. has an equity cost of capital of 16.97% The debt-to-value ratio is.6

and a cost of debt of 11%. What is the cost of equity if Tip-Top was unlevered? 25) ______ A) 3.06% B) 13.39% C) 0.08% D) 16.97% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 18-05 Step 3: Valuation Source : Chapter 18 Test Bank > TB 18-25 The Tip-Top Paving Co. has an equity cost of...

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26) The Tip-Top Paving Co. wants to be levered at a debt-to-value ratio of.6. The cost of debt is

11% and the cost of equity for an all-equity firm is 13.39%. What will be Tip-Top's cost of equity? 26) ______ A) 3.06% B) 14.00% C) 0.08% D) 16.97% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 18-05 Step 3: Valuation Source : Chapter 18 Test Bank > TB 18-26 The Tip-Top Paving Co. wants to be levered a...

27) The Tip-Top Paving Co. has a beta of 1.11, a cost of debt of 11% and a debt-to-value ratio

of.6. The current risk-free rate is 9% and the market rate of return is 16.18%. What is the company's cost of equity capital? 27) ______ A) 16.97% B) 26.96% C) 17.96% D) 7.97%. E) 8.96% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 18-06 Weighted Average Cost of Capital Method Source : Chapter 18 Test Bank > TB 18-27 The Tip-Top Paving Co. has a beta of 1.11, a...

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28) Floatation costs are incorporated into the APV framework by: 28) ______ A) adding them into the all equity value of the project. B) subtracting them from the all equity value of the project. C) incorporating them into the WACC. D) disregarding them. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 18-05 Step 3: Valuation Source : Chapter 18 Test Bank > TB 18-28 Floatation costs are incorporated into the A...

29) Non-market or subsidized financing _______ the APV _______: 29) ______ A) has no impact on; as the lower interest rate is offset by the lower discount rate. B) decreases; by decreasing the NPV of the loan. C) increases; by increasing the NPV of the loan. D) has no impact on; as the tax deduction is not allowed with any government supported

financing. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 18-05 Step 3: Valuation Source : Chapter 18 Test Bank > TB 18-29 Non-market or subsidized financing _______ t...

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30) The Telescoping Tube company is planning to raise $2,500,000 in perpetual debt at 11% to

finance part of their expansion. They have just received an offer from the Albanic County Board of Commissioners to raise the financing for them at 8% if they build in Albanic County. What is the total added value of debt financing to Telescoping Tube if their tax rate is 34% and Albanic raises it for them? 30) ______ A) $850,000 B) $1,300,000 C) $1,200,000 D) $1,650,000 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 18-05 Step 3: Valuation Source : Chapter 18 Test Bank > TB 18-30 The Telescoping Tube company is planning to ...

31) The BIM Corporation has decided to build a new facility for its R&D department. The cost

of the facility is estimated to be $125 million. BIM wishes to finance this project using its traditional debt-to-equity ratio of 1.5. The issue cost of equity is 6% and the issue cost of debt is 1%. What is the total floatation cost? 31) ______ A) $8.75 million. B) $3.75 million. C) $3.19 million. D) $1.29 million. E) $0.75 million. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 18-05 Step 3: Valuation Source : Chapter 18 Test Bank > TB 18-31 The BIM Corporation has decided to build a n...

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32) In the Adjusted Present Value (APV) method, flotation costs: 32) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 18-05 Step 3: Valuation Source : Chapter 18 Test Bank > TB 18-32 In the Adjusted Present Value (APV) method, ...

33) The cost of equity should be lowest when the debt-to-equity ratio is: 33) ______ A) Zero B) 0.20 C) 0.25 D) 0.50 E) 1.00 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 18-05 Step 3: Valuation Source : Chapter 18 Test Bank > TB 18-33 The cost of equity should be lowest when the...

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34) A very large firm has a debt beta of zero. If the cost of equity is 11%, and the risk-free rate is

5%, the cost of debt is: 34) ______ A) 5%. B) 6%. C) 11%. D) 15%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 18-05 Step 3: Valuation Source : Chapter 18 Test Bank > TB 18-34 A very large firm has a debt beta of zero. I...

35) The Free-Float Company, a company in the 36% tax bracket, has riskless debt in its capital

structure which makes up 40% of the total capital structure, and equity is the other 60%. The beta of the assets for this business is 0.8 and the equity beta is: 35) ______ A) 0.80. B) 0.73. C) 0.53. D) 1.33. E) 1.47. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 18-07 A Comparison of the Adjusted Present Value, Flow to Equity, and Weighted Average Cost o Source : Chapter 18 Test Bank > TB 18-35 The Free-Float Company, a company in the...

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36) The Free-Float Company, a company in the 36% tax bracket, has a total capital structure

breakdown of 40% riskless debt and 60% equity. The beta of the equity is 1.4, and the asset beta is: 36) ______ A) 0.98. B) 1.22. C) 1.40. D) 1.11. E) 1.26. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 18-07 A Comparison of the Adjusted Present Value, Flow to Equity, and Weighted Average Cost o Source : Chapter 18 Test Bank > TB 18-36 The Free-Float Company, a company in the...

37) The non-market rate financing impact on the APV is: 37) ______ A) calculated by TcB because the tax shield depends only on the amount of financing. B) calculated by subtracting the all equity NPV from the FTE NPV. C) irrelevant because it is always less than the market financing rate. D) calculated by the NPV of the loan using both debt rates. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 18-05 Step 3: Valuation Source : Chapter 18 Test Bank > TB 18-37 The non-market rate financing impact on the ...

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38) The Delta Dam Company has a capital structure of 20% risky debt with a β of.9 and 80%

equity with a β of 1.7. Their current tax rate is 34%. What is the β for Delta Dam Company? 38) ______ A) 1.49 B) 1.06 C) 1.54 D) 0.59 E) 0.82 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 18-07 A Comparison of the Adjusted Present Value, Flow to Equity, and Weighted Average Cost o Source : Chapter 18 Test Bank > TB 18-38 The Delta Dam Company has a capital structur...

39) A firm is valued at $8 million and has debt of $2 million outstanding. The firm has an equity

beta of 1.5 and a debt beta of.60. The beta of the overall firm is: 39) ______ A) 0.600. B) 1.155. C) 1.275. D) 1.500. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 18-07 A Comparison of the Adjusted Present Value, Flow to Equity, and Weighted Average Cost o Source : Chapter 18 Test Bank > TB 18-39 A firm is valued at...

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40) Brad's Boat Company, a company in the 40% tax bracket, has riskless debt in its capital

structure, which makes up 30% of the total capital structure, and equity is the other 70%. The beta of the assets for this business is.9. The equity beta is: 40) ______ A) 0.54. B) 0.90. C) 1.13. D) 1.20. E) 1.49. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 18-07 A Comparison of the Adjusted Present Value, Flow to Equity, and Weighted Average Cost o Source : Chapter 18 Test Bank > TB 18-40 Brad&#39;s Boat Company, a company...

41) Alabaster Incorporated has a beta of 1.05, a cost of debt of 8% and a debt to value ratio of.7.

The current risk-free rate is 3% and the market rate of return is 12.5%. What is the company's cost of equity capital? 41) ______ A) 8.13% B) 10.25% C) 12.97% D) 13.13% E) 16.13% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 18-07 A Comparison of the Adjusted Present Value, Flow to Equity, and Weighted Average Cost o Source : Chapter 18 Test Bank > TB 18-41 Alabaster Incorporated has a beta of 1.05, a...

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42) The Delta Dam Company has a capital structure of 80% risky debt with a β of.9 and 20%

equity with a β of 1.6. Their current tax rate is 34%. What is the β if Delta Dam was an unlevered firm? 42) ______ A) 1.09 B) 1.04 C) 0.80 D) 0.56 E) 0.44 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 18-07 A Comparison of the Adjusted Present Value, Flow to Equity, and Weighted Average Cost o Source : Chapter 18 Test Bank > TB 18-42 The Delta Dam Company has a capital structur...

43) A firm is valued at $6 million and has debt outstanding of $2 million. The firm has an equity

beta of 1.8 and a debt beta of.42. The beta of the overall firm is: 43) ______ A) 1.20. B) 1.34. C) 1.00. D) 1.11. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 18-07 A Comparison of the Adjusted Present Value, Flow to Equity, and Weighted Average Cost o Source : Chapter 18 Test Bank > TB 18-43 A firm is valued at $6 million...

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44) The WACC approach to valuation is not as useful as the APV approach in LBO because: 44) ______ A) there is greater risk with a LBO. B) the capital structure is changing over time. C) there is no tax shield with the WACC. D) the value of the levered and unlevered firms are equal. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Hard Topic : 18-08 Caveat: Adjusted Present Value, Flow to Equity, and Weighted Average Cost of Capital Do Source : Chapter 18 Test Bank > TB 18-44 The WACC approach to valuation is not as use...

45) The value of a corporation in a levered buyout is composed of which following four parts: 45) ______ A) unlevered cash flows and interest tax shields during the debt pay down period,

unlevered terminal value, and asset sales. B) unlevered cash flows and interest tax shields during the debt pay down period, unlevered terminal value and interest tax shields after the pay down period. C) levered cash flows and interest tax shields during the debt pay down period, levered terminal value and interest tax shields after the pay down period. D) levered cash flows and interest tax shields during the debt pay down period, unlevered terminal value and interest tax shields after the pay down period. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 18-08 Caveat: Adjusted Present Value, Flow to Equity, and Weighted Average Cost of Capital Do Source : Chapter 18 Test Bank > TB 18-45 The value of a corporation in a levered buyo...

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46) If the WACC is used in valuing a LBO: 46) ______ A) the WACC remains constant because of the final target debt ratio desired. B) the flotation costs must be added to the total UCF. C) the WACC must be recalculated as the debt is repaid and the cost of capital increases. D) the tax shields of debt are not available because the corporation is no longer publicly

traded. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 18-08 Caveat: Adjusted Present Value, Flow to Equity, and Weighted Average Cost of Capital Do Source : Chapter 18 Test Bank > TB 18-46 If the WACC is used in valuing a LBO:

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 47) A loan of $10,000 is issued at 15% interest. Interest on the loan is to be repaid annually for 5 years, and the non-amortized principal is due at the end of the fifth year. Calculate the NPV of the loan if the company's tax rate is 34%.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 18-01 Adjusted Present Value Approach Source : Chapter 18 Test Bank > TB 18-47 A loan of $10,000 is issued...

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48) The Azzon Oil Company is considering a project that will cost $50 million and have a year-

end after-tax cost savings of $7 million in perpetuity. Azzon's before-tax cost of debt is 10% and its cost of equity is 16%. The project has a similar risk to that of the operation of the firm, and the target debt-equity ratio is 1.5. What is the NPV for the project if the tax rate is 34%?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 18-03 Step 1: Calculating Levered Cash Flow Source : Chapter 18 Test Bank > TB 18-48 The Azzon Oil Company is considering a proje...

49) Quick-Link has debt outstanding whose market value is $200 million, and equity outstanding

with a market value of $800 million. Quick-Link is in the 34% tax bracket, and its debt is considered riskless. Merrill Lynch has provided an equity beta of 1.50. Given a risk-free rate of 3% and an expected market return of 12%, calculate the discount for a scale-enhancing project in the hypothetical case that Quick-Link is all-equity financed.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 18-07 A Comparison of the Adjusted Present Value, Flow to Equity, and Weighted Average Cost o Source : Chapter 18 Test Bank > TB 18-49 Quick-Link has debt outstanding whose market...

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50) A project has an NPV, assuming all-equity financing, of $1.5 million. To finance the project,

debt is issued with associated floatation costs of $60,000. The floatation costs can be amortized over the project's 5-year life. The debt of $10 million is issued at 10% interest, with the principal repaid in a lump sum at the end of the fifth year. If the firm's tax rate is 34%, calculate the project's APV.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 18-05 Step 3: Valuation Source : Chapter 18 Test Bank > TB 18-50 A project has an NPV, assuming all-equity fi...

51) The Alto Horns Corp. is planning on introducing a new line of saxophones. They expect

sales to be $200,000 with total fixed and variable costs representing 70% of sales. The discount rate on the unlevered equity is 17%, but the firm plans to raise $77,820 of the initial $150,000 investment as 9% perpetual debt. The corporate tax rate is 34% and the target debt to value ratio is.3. Calculate the all-equity NPV and the levered NPV using the flow-toequity method.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 18-02 Flow to Equity Approach Source : Chapter 18 Test Bank > TB 18-51 The Alto Horns Corp. is planning on introduc...

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52) The all-equity cost of capital for flat Rock Grinding is 15% and the company has set a target

debt to value ratio of 50%. The current cost of debt for a firm of this risk is 11% and the corporate tax rate is 34%. Calculate the WACC for the Flat Rock Grinding Corporation.

53) 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.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 18-04 Step 2: Calculating rs Source : Chapter 18 Test Bank > TB 18-53 Discuss the adjusted present value, the flow...

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54) Kelly Industries is allowed to raise $5 million in debt through a local government-subsidized

program. While Kelly would be required to pay 12% on its debt issues, the Hampton County program sets the rate at 9%. If the debt issues expire in 4 years, calculate the NPV of this financing decision.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 18-05 Step 3: Valuation Source : Chapter 18 Test Bank > TB 18-54 Kelly Industries is allowed to raise...

55) The Telescoping Tube Company is planning to put a manufacturing facility in place to build

observatory quality but recreational scale telescopes. The systematic risk of this project alone is 25% greater than they currently manage. The company has a target debt to value ratio of 35%. The β of the assets currently managed is.8 and they face a 36% tax rate. The initial investment cost is $4,200,000 and the expected cash flows after-tax are $1,200,000 per year for 6 years. The risk-free rate is 5% and you believe the historical market risk premium of 8.5% is a reasonable estimate. A. What is the all-equity value of the investment? B. What is the added value if the company finances this project with $682,044 worth of 16% debt which requires an interest payment until maturity when the full principal is due. C. If the Albanic County Board of Commissioners approaches the Telescoping Tube Company with an offer to raise the needed $682,044 debt capital as 15% perpetual debt, should the company accept the offer?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 18-07 A Comparison of the Adjusted Present Value, Flow to Equity, and Weighted Average Cost o Source : Chapter 18 Test Bank > TB 18-55 The Telescoping Tube Company is planning to ...

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

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38) C 39) C 40) C 41) C 42) A 43) B 44) B 45) B 46) C 47) Short Answer

After tax interest payments are (.15) ($10,000) (1 -.34) = $990 NPV = $10,000 - $990 A5.15 - $10,000/(1.15)5 ≥ $1,710 48) Short Answer

The WACC is (.6) (.10) (1 -.34) + (.4) (.16) =.1036 NPV = -$50 Million + $7 Million/.1036 ≥ $7.915 Million 49) Short Answer

Unlevered beta = 1.5/[1 +.66(2/8)] = 1.2875 = 1.29 Discount rate = 3% + 1.29(12% - 3%) = 3 + 11.61 = 14.61%. 50) Short Answer

NPV of all equity financed project = $1.5 million PV of floatation costs including deductibility of expenses is: - $60,000 + $12,000(.34). A5.10 ≥ -$44,534 NPVLOAN = 10 -.66[(1 - (1.1)-5)/.1] - 10/1.15 = $1.288868 million APV = $1.5 million + $1.288868 - $.044534 million = $2.744 million. 51) Short Answer

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All equity = ((200,000 × (1 -.7)) × (1 -.34))/.17 - 150,000 Cash flow = (60,000(.66)))/.17 - 150,000 = 39,600/.17 - 150,000 Value = $232,941.18 - 150,000 = $82,941.18 Levered Cashflow Value: Sales

$200,000

Cash Costs

-140,000

Interest

-7,003.8

Tax. Income

52,996.2

Corp. Tax (.34)

18,018.71

Levered CF

34,977.49

(.09 x 77,820)

Discount rate =.17 + (.3/.7)(.66)(.17 -.09) =.19262857 Discount Levered CF = 34,977.49/.19262857 = 181,579.98 FTE NPV = $181,579.98 - 77,820 = $103,760 52) Short Answer

Cost of Equity =.15 + 1(.66)(.11) =.15 +.066 =.216 WACC =.216(.5) +.11(.66)(.5) =.108 +.0363 =.1443 or 14.43% 53) Short Answer

The adjusted present value is defined as follows: the value of the project to the unlevered firm plus the net present value of financing side effects. There are four side effects: the tax subsidy of debt, the costs of issuing new securities, the costs of financial distress, and subsidies to debt financing. The flow to equity approach is an alternative to adjusted present value. It is the discounted cash flow from a project to the equity holders of the levered firm at the cost of equity. Finally, the weighted average cost of capital approach considers the firm that is financed with both debt and equity and allocates the costs proportionally for each capital component. Essentially, the manager should use the WACC or FTE if the firm's target debt-to-value ratio applies to the project over its life. Alternatively, one should use APV if the project's level of debt is known over the life of the project. 54) Short Answer

55) Short Answer

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A. βAnew = βAold (1.25) =.8(1.25) = 1.00 rx = 5 + 1(8.5) = 13.5 NPV = - 4,200,000 + 1,200,000 [(1 - (1.135)-6)/.135)] = 4,200,000 + 1,200,000 (.39425) = 4,200,000 + 4,731,000 = $531,000. B. PVTS = NPVLOAN = 682,044 - 682,044(.16)(1 -.36)A.16,6 - 682,044PV.16,6 = 682,044 109,127(.64)(3.6847) - 682,044(.41044) = 682,044 - 279,938 - 257,344 = $144,762 C. PVTS = NPVLOAN = 682,044 - [682,044(.15)(1 -.36)]/.16 = 682,044 - [102,350.60(.64)]/.16 = 682,044 - 409,266.40 = $272,817.60. Yes, accept the offer.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Distributions to shareholders from capital are called: 1) ______ A) earnings dividends. B) a stock split. C) liquidating dividends. D) stock dividends. E) regular cash dividends. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 19-01 Different Types of Dividends Source : Chapter 19 Test Bank > TB 19-01 Distributions to shareholders from capital a...

2) A dividend is usually a cash distribution from: 2) ______ A) current earnings or accumulated retained earnings. B) the capital surplus account. C) common stock account. D) liquidated capital. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 19-01 Different Types of Dividends Source : Chapter 19 Test Bank > TB 19-02 A dividend is usually a cash distribution fr...

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3) You purchased 200 shares of ABC stock on July 15th. On July 20th, you purchased another

100 shares and then on July 22st you purchased your final 200 shares of ABC stock. The company declared a dividend of $1.10 a share on July 5th to holders of record on Friday, July 23rd. The dividend is payable on July 31st. How much dividend income will you receive on July 31st from ABC? 3) ______ A) $0. B) $220. C) $330. D) $440. E) $550. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 19-02 Standard Method of Cash Dividend Payment Source : Chapter 19 Test Bank > TB 19-03 You purchased 200 shares of ABC stock on Jul...

4) Which of the following is true? 4) ______ A) A 10% stock dividend would increase stockholder wealth by $5 if the current price of

stock is $50 (ignoring transaction costs). B) Stock dividends are not true dividends. C) Stock splits involve a small increase (splintering) in total stock outstanding. D) The most common dividend policy involves regular cash payments with year-end bonuses. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 19-01 Different Types of Dividends Source : Chapter 19 Test Bank > TB 19-04 Which of the following is true?

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5) The ability of shareholders to undo the dividend policy of the firm and create an alternative

dividend payment policy via reinvesting dividends or selling shares of stock is called (a): 5) ______ A) MM Proposition I. B) capital structure irrelevancy. C) homemade leverage. D) homemade dividends. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 19-03 The Benchmark Case: An Illustration of the Irrelevance of Dividend Policy Source : Chapter 19 Test Bank > TB 19-05 The ability of shareholders to undo the divi...

6) The KatyDid Co. is paying a $1.25 per share dividend today. There are 120,000 shares

outstanding with a par value of $1.00 per share. As a result of this dividend, the: 6) ______ A) retained earnings will decrease by $150,000. B) retained earnings will decrease by $120,000. C) common stock account will decrease by $150,000. D) common stock account will decrease by $120,000. E) capital in excess of par value account will decrease by $120,000. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 19-01 Different Types of Dividends Source : Chapter 19 Test Bank > TB 19-06 The KatyDid Co. is paying a ...

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7) Which of the following lists events in chronological order from earliest to latest? 7) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 19-02 Standard Method of Cash Dividend Payment Source : Chapter 19 Test Bank > TB 19-07 Which of the following lists events in chron...

8) In an efficient market, ignoring taxes and time value: 8) ______ A) the price of stock should decrease by the amount of the dividend immediately on

declaration date. B) the price of stock should decrease by the amount of the dividend immediately on exdividend date. C) the price of stock should increase by the amount of the dividend immediately on declaration date. D) the price of stock should increase by the amount of the dividend immediately on exdividend date. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 19-02 Standard Method of Cash Dividend Payment Source : Chapter 19 Test Bank > TB 19-08 In an efficient market, ignoring taxes and t...

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9) The important relationship between the ex-dividend date and the record date is: 9) ______ A) it determines the timing of when the payment is made. B) the record date occurs before ex-dividend date allowing you to sell your stock and

still get the dividend payment. C) the ex-dividend date occurs two business days before the date of record, if you purchase the stock before this date you are entitled to the dividend. D) if you hold your stock past the record date and do not sell before the ex-dividend date then you will be taxed at the capital gain rate. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 19-02 Standard Method of Cash Dividend Payment Source : Chapter 19 Test Bank > TB 19-09 The important relationship between the ex-di...

10) Your company has announced a dividend of $2.50 per share. You and the rest of the marginal

investors are in the 35% tax bracket. What should happen to the stock price? 10) ______ A) the price of stock should decrease by $1.625 per share immediately after the date of

record. B) the price of stock should decrease by $1.625 per share immediately after the exdividend date. C) the price of stock should decrease by $3.85 per share immediately after the date of record. D) the price of stock should decrease by $3.85 per share immediately after the exdividend date. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 19-02 Standard Method of Cash Dividend Payment Source : Chapter 19 Test Bank > TB 19-10 Your company has announced a dividend of....

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11) On the date of record, the stock price drop is: 11) ______ A) a full adjustment for the dividend payment. B) a partial adjustment for the dividend payment because of the tax effect. C) zero because it happened on ex-dividend date. D) zero because it happens on payment date. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 19-02 Standard Method of Cash Dividend Payment Source : Chapter 19 Test Bank > TB 19-11 On the date of record, the stock price drop ...

12) The date on which the board of directors passes a resolution authorizing payment of a

dividend to the shareholders is the _____ date. 12) ______ A) ex-rights B) ex-dividend C) record D) payment E) declaration Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 19-02 Standard Method of Cash Dividend Payment Source : Chapter 19 Test Bank > TB 19-12 The date on which the board of directors pas...

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13) The date before which a new purchaser of a stock is entitled to receive a declared dividend,

but on or after which he/she does not receive the dividend, is called the _____ date. 13) ______ A) ex-rights B) ex-dividend C) record D) payment E) declaration Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 19-02 Standard Method of Cash Dividend Payment Source : Chapter 19 Test Bank > TB 19-13 The date before which a new purchaser of a s...

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14) A firm with 1,000 stockholders plans to terminate operations at the end of two years.

Investors are certain that the firm will generate cash flows of $1,000 at the end of the first year and $50,000 at the end of the second year. The risk-free rate is 10%. Which of the following is true, ignoring transaction costs and taxes? 14) ______ A) The present value of these payments is $42,231 if payments of $1,000 and $50,000 are made. This present value will decrease if the firm borrows to increase payment at the end of the first year. B) The present value of these payments is $42,231 if payments of $1,000 and $50,000 are made. This present value will increase if the firm borrows to increase payment at the end of the first year. C) The present value of these payments is $42,231 if payments of $1,000 and $50,000 are made. This present value will remain the same if the firm borrows to increase payment at the end of the first year. D) The present value of these payments is less than $42,231 if payments of $1,000 and $50,000 are made. This present value will change if the firm borrows to increase payment at the end of the first year. The direction of the change will depend on the type of investors that currently hold stock. E) There is no way to calculate present value without being given the proper discount rate for the firm. The present value would change if the firm borrows to increase payments at the end of year one. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 19-03 The Benchmark Case: An Illustration of the Irrelevance of Dividend Policy Source : Chapter 19 Test Bank > TB 19-14 A firm with 1,000 stockholders plans to term...

15) Which one of the following is an argument in favor of a low dividend policy? 15) ______ A) the tax on capital gains is deferred until the gain is realized. B) few, if any, positive net present value projects are available to the firm. C) a preponderance of stockholders have minimal taxable income. D) corporate tax rates exceed personal tax rates. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 19-05 Alternative Policy: Initial Dividend Is Greater Than Cash Flow Source : Chapter 19 Test Bank > TB 19-15 Which one of the following is an argument in...

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16) If you have a choice of receiving a cash payment of $5 today: 16) ______ A) you are indifferent to receiving $5.07 next year if your opportunity cost is 7%. B) you are indifferent to receiving $5.00 next year if your opportunity cost is 7%. C) you are indifferent to receiving $5.35 next year if your opportunity cost is 10%. D) you are indifferent to receiving $5.35 next year if your opportunity cost is 7%. E) you are indifferent to receiving $5.10 next year if your opportunity cost is 10%. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 19-03 The Benchmark Case: An Illustration of the Irrelevance of Dividend Policy Source : Chapter 19 Test Bank > TB 19-16 If you have a choice of receiving a cash pay...

17) Two important elements of the dividend policy irrelevance proposition are: 17) ______ A) all investors have homogeneous dividend needs and time horizons. B) dividends are paid even if a positive NPV opportunity exists and investors can re-

arrange their own dividend streams. C) investors can re-arrange their dividend streams and the investment policy is set and unaltered by the change in dividend policy. D) all investors have homogeneous dividend needs and dividends are paid even if a positive NPV opportunity exists. E) investors can re-arrange their own dividend streams and the source of financing must be debt. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 19-03 The Benchmark Case: An Illustration of the Irrelevance of Dividend Policy Source : Chapter 19 Test Bank > TB 19-17 Two important elements of the dividend polic...

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18) A firm plans to pay dividends of $12.50 at time 0 and $14 at time 1. Ignoring transaction

costs and assuming that the investor can earn 8% on investments, which statement is true? 18) ______ A) An investor can spend up to $25.46 from dividends at time 0, and without decreasing the present value of all dividends received. B) An investor can spend up to $27.50 from dividends at time 0, and without decreasing the present value of all dividends received. C) An investor can spend up to $25.46 from dividends at time 0, but will decrease the present value of all dividends received. D) An investor can spend up to $27.50 from dividends at time 0, but will decrease the present value of all dividends received. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 19-03 The Benchmark Case: An Illustration of the Irrelevance of Dividend Policy Source : Chapter 19 Test Bank > TB 19-18 A firm plans to pay dividends of...

19) Homemade dividends are described by Modigliani and Miller to be: 19) ______ A) the dividend one pays oneself to avoid risky stocks. B) the re-arrangement of the firm's dividend stream as management needs. C) the re-arrangement of the firm's dividend stream by the investor in their holdings by

buying or selling stock. D) the present value of all dividends to be paid. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 19-03 The Benchmark Case: An Illustration of the Irrelevance of Dividend Policy Source : Chapter 19 Test Bank > TB 19-19 Homemade dividends are described by Modiglia...

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20) The dividend-irrelevance proposition of Miller and Modigliani depended on the following

relationship between investment policy and dividend policy. 20) ______ 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 as desired. C) The investment policy is set before the dividend decision and not changed by

dividend policy. D) Since dividend policy is irrelevant there is no relationship between investment policy and dividend policy. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 19-03 The Benchmark Case: An Illustration of the Irrelevance of Dividend Policy Source : Chapter 19 Test Bank > TB 19-20 The dividend-irrelevance proposition of Mille...

21) The Rent It Company declared a dividend of $.60 a share on October 20th to holders of

record on Monday, November 1st. The dividend is payable on December 1st. You purchased 100 shares of Rent It Company stock on Wednesday, October 27th. How much dividend income will you receive on December 1st from the Rent It Company? 21) ______ A) $0. B) $1.50. C) $6.00. D) $15.00. E) $60.00. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 19-03 The Benchmark Case: An Illustration of the Irrelevance of Dividend Policy Source : Chapter 19 Test Bank > TB 19-21 The Rent It Company declared a dividend of ...

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22) Dividends are relevant and dividend policy irrelevant when: 22) ______ A) cash dividends are always constant and dividend policy is changed as management

needs. B) cash dividends are increased for one payment while others are held constant and dividend policy establishes the trade-off between dividends at different dates. C) cash dividends are always constant and dividend policy establishes the trade-off between dividends at different dates. D) cash dividends are increased for one payment while others are held constant and dividend policy is changed as management needs. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 19-03 The Benchmark Case: An Illustration of the Irrelevance of Dividend Policy Source : Chapter 19 Test Bank > TB 19-22 Dividends are relevant and dividend policy i...

23) You own 300 shares of Abco, Inc. stock. The company has stated that it plans on issuing a

dividend of $.60 a share one year from today and then issuing a final liquidating dividend of $2.20 a share two years from today. Your required rate of return is 9%. Ignoring taxes, what is the value of one share of this stock today? 23) ______ A) $2.36. B) $2.40. C) $2.62. D) $2.80. E) $2.85. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 19-03 The Benchmark Case: An Illustration of the Irrelevance of Dividend Policy Source : Chapter 19 Test Bank > TB 19-23 You own 300 shares of Abco, Inc. stock. The ...

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24) If both dividends and capital gains are currently taxed at the same ordinary income tax rate,

the effect of the tax is different because: 24) ______ A) capital gains are actually taxed, while dividends are taxed on paper only. B) dividends are actually taxed, while capital gains are taxed on paper only. C) dividends are taxable when distributed while capital gains are deferred until the stock

is sold. D) capital gains are taxable when distributed while dividends are deferred until the stock is sold. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 19-04 Current Policy: Dividends Set Equal to Cash Flow Source : Chapter 19 Test Bank > TB 19-24 If both dividends and capital gains are curr...

25) A firm announces that it is willing to purchase a number of shares back at various prices and

shareholders have the option to indicate how many shares they are willing to sell at various prices. This process is called a: 25) ______ A) dividend creation model. B) secondary market transaction. C) free market sale. D) Dutch auction. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 19-04 Current Policy: Dividends Set Equal to Cash Flow Source : Chapter 19 Test Bank > TB 19-25 A firm announces that it is willing to purch...

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26) A firm has a market value equal to its book value. Currently, the firm has excess cash of

$600 and other assets of $5,400. Equity is worth $6,000. The firm has 500 shares of stock outstanding and net income of $900. What will the new earnings per share be if the firm uses its excess cash to complete a stock repurchase? 26) ______ A) $1.20. B) $1.50. C) $1.80. D) $2.00. E) $2.40. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 19-04 Current Policy: Dividends Set Equal to Cash Flow Source : Chapter 19 Test Bank > TB 19-26 A firm has a market value equal to its book ...

27) The observed empirical fact that stocks attract particular investors based on the firm's

dividend policy and the resulting tax impact on investors is called the: 27) ______ A) information content effect. B) clientele effect. C) efficient markets hypothesis. D) MM Proposition I. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 19-07 Homemade Dividends Source : Chapter 19 Test Bank > TB 19-27 The observed empirical fact that stocks attr...

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28) All else equal, the market value of a stock will tend to decrease by roughly the amount of the

dividend on the: 28) ______ A) dividend declaration date. B) ex-dividend date. C) date of record. D) date of payment. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 19-02 Standard Method of Cash Dividend Payment Source : Chapter 19 Test Bank > TB 19-28 All else equal, the market value of a stock ...

29) An open market purchase is: 29) ______ A) an arrangement to buy back short term financial instruments sold to an investment

dealer at a fixed price. B) the buying back of shares from a particular group, usually large shareholders disenchanted with management. C) the buying back of shares because management has few profitable investment opportunities. D) an arrangement in which company buys back its shares just like any other trader in the market. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 19-04 Current Policy: Dividends Set Equal to Cash Flow Source : Chapter 19 Test Bank > TB 19-29 An open market purchase is:

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30) Investing in preferred stock in other companies might be an attractive use of the firm's cash

because: 30) ______ A) preferred stock is more risky than common stock. B) holders of preferred stock usually do not receive promised payments. C) preferred stock has a special tax advantage in this case. D) preferred stock has no maturity. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 19-05 Alternative Policy: Initial Dividend Is Greater Than Cash Flow Source : Chapter 19 Test Bank > TB 19-30 Investing in preferred stock in other compani...

31) Consider two corporations, G and H, that have the same risk. They both have a current stock

price of $60. Corporation G pays no dividend and will have a price of $66 one year from now. Corporation H pays dividends and will have a price of $63 one year from now after payment of a dividend. Corporations pay no income taxes. Investors pay no taxes on capital gains, but they pay a 30% income tax on dividends. What is the value of the dividend that investors expect Corporation H to pay? 31) ______ A) $4.29. B) $3.00. C) $3.15. D) $3.30. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 19-05 Alternative Policy: Initial Dividend Is Greater Than Cash Flow Source : Chapter 19 Test Bank > TB 19-31 Consider two corporations, G and H, that hav...

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32) A corporation has cash flow in excess of investment needs and normal dividend payments.

The corporation is considering two alternative uses of the excess funds. In Alternative 1, the corporation increases current dividends. In Alternative 2, the corporation makes a three-year loan and uses the loan proceeds to pay dividends at the end of three years. The following information may be used in choosing between the alternatives. Stockholders can earn 5% after taxes on their investments. The corporate tax rate is 30%. Stockholders currently have a 20% tax rate and will have a 25% tax rate next year. At what pre-tax return on the loan are stockholders indifferent between the alternatives? 32) ______ A) 9.6%. B) 10.0%. C) 10.4%. D) 10.8%. E) 11.2%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 19-05 Alternative Policy: Initial Dividend Is Greater Than Cash Flow Source : Chapter 19 Test Bank > TB 19-32 A corporation has cash flow in excess of inv...

33) If dividends are taxed at higher rates than are capital gains, then high dividend payout stocks

should sell at lower prices, everything else equal, compared to low dividend paying stocks. One implication of this is that investors in _____ tax brackets will tend to prefer high dividend payout stocks. 33) ______ A) slightly higher than average B) average C) slightly lower than average D) zero Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 19-05 Alternative Policy: Initial Dividend Is Greater Than Cash Flow Source : Chapter 19 Test Bank > TB 19-33 If dividends are taxed at higher rates than ...

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34) Which of the following statements is not true? 34) ______ A) Dividend payments but not capital gains are costs to the firm. B) Stockholder's expected return equals the firm's cost of equity. C) Payments to current stockholders are the implicit cost of the infusion of new equity

capital. D) The security market line provides information as to the cost of equity for a firm. E) The return that the investor in a security receives is the cost of that security to the company that issued the security. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 19-06 The Indifference Proposition Source : Chapter 19 Test Bank > TB 19-34 Which of the following statements is not tru...

35) If stockholders care about taxes, then stocks should attract clienteles based on dividend

yields. Surveys support this by showing that the highest dividend yield stocks are held by investors in the: 35) ______ A) highest tax bracket. B) average tax bracket. C) lowest tax bracket. D) slightly higher than average tax bracket. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 19-07 Homemade Dividends Source : Chapter 19 Test Bank > TB 19-35 If stockholders care about taxes, then stock...

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36) Although dividend payments reduce the total firm funds to pay bondholders the payment of

dividends can reduce agency costs by: 36) ______ A) doing so on a regular schedule. B) sharing the dividend payments with the bondholders. C) reducing the free cash flows to reduce the perquisite consumption. D) transferring the wealth from shareholder to bondholder. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 19-06 The Indifference Proposition Source : Chapter 19 Test Bank > TB 19-36 Although dividend payments reduce the total ...

37) The increase in the stock price after a dividend increase is called the information content

effect because: 37) ______ A) the change in dividend was expected by shareholders. B) the dividend increase signaled investors to adjust the expectations of future earning

upward. C) the dividend change signaled investors to adjust the risk of the firm downward. D) the dividend change signaled shareholders that the firm could now payout less as they enter the mature phase of their business. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 19-06 The Indifference Proposition Source : Chapter 19 Test Bank > TB 19-37 The increase in the stock price after a divi...

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38) For a firm to develop a sensible, useful dividend policy, the three things that should be

considered are: 38) ______ A) dividends should not be paid if positive NPV projects are available, stock should

always be issued to pay dividends, repurchases with surplus cash should be considered if positive NPV projects exist. B) dividends should not be paid if positive NPV projects are available, stock should always not be issued to pay dividends, repurchases with surplus cash should be considered if no positive NPV projects exist. C) dividends should be paid if positive NPV projects are available, stock should always be issued to pay dividends, repurchases with surplus cash should be considered if positive NPV projects exist. D) dividends should be paid if positive NPV projects are available, stock should always not be issued to pay dividends, repurchases with surplus cash should be considered if no positive NPV projects exist. E) dividends should not be paid if positive NPV projects are available, stock should always not be issued to pay dividends, repurchases with surplus cash should be considered if positive NPV projects exist. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 19-07 Homemade Dividends Source : Chapter 19 Test Bank > TB 19-38 For a firm to develop a sensible, useful div...

39) An investor is more likely to prefer a high dividend payout if a firm: 39) ______ A) has high flotation costs. B) has few, if any, positive net present value projects. C) has lower tax rates than the investor. D) has a stock price that is increasing rapidly. E) offers high capital gains which are taxed at a favorable rate. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 19-07 Homemade Dividends Source : Chapter 19 Test Bank > TB 19-39 An investor is more likely to prefer a high ...

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40) Murphy's, Inc. has 10,000 shares of stock outstanding with a par value of $1.00 per share.

The market value is $8 per share. The balance sheet shows $32,500 in the capital above par account, $10,000 in the common stock account, and $42,700 in the retained earnings account. The firm just announced a 10% (small) stock dividend. What will the balance in the retained earnings account be after the dividend? 40) ______ A) $34,700. B) $35,700. C) $42,700. D) $49,700. E) $50,700. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 19-10 Repurchase of Stock Source : Chapter 19 Test Bank > TB 19-40 Murphy&#39;s, Inc. has 10,000 shares...

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 41) Schaeffer Shippers announced that on May 1, 2014, that it will pay a dividend of $5.00 per share on June 15 to all holders on record as of May 31st. The firm's stock price is currently at $70 per share. Assume that all investors are in the 33% tax bracket. Given that the exdividend date is May 29, what should happen to Schaeffer's stock price on May 29?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 19-05 Alternative Policy: Initial Dividend Is Greater Than Cash Flow Source : Chapter 19 Test Bank > TB 19-41 Schaeffer Shippers announced that on May 1, ...

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42) John Madden is considering two investments of similar risk. Investment A is a stock that is

expected to pay a dividend of $100 at the end of each year for two years, but no dividend in the third year. You expect to sell Investment A after three years for a capital gain of $400. Investment B is a stock that is not expected to pay any dividends, but you expect to sell the stock at the end of three years for a capital gain of $600. John is wealthy and is in the 50% tax bracket. Dividends are taxed at the personal tax rate, but capital gains are taxed at 40% of the personal tax rate. Given a discount rate of 10% for both investments, which would you recommend.

43) The Smith Brothers Pharmaceutical Company has $250,000 in excess cash and is considering

two alternatives. One is to pay the extra cash in the form of a dividend to their stockholders. The other is to invest the cash in a T-Bill paying 5% interest after-tax, and then distribute the cash as a dividend. The firm's stockholders can also invest in the T-Bill for the same yield. If the corporate tax rate is 30% and the personal tax rate is 30%, which alternative would you recommend? (Show why!) If the personal tax rate was 40% what should you recommend?

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44) The Generous Cup Corporation and the Happy Mug Corporation have the same operating

risk. Investors expect Generous Cup to pay no dividends and to have a price of $70 in one year. Investors expect Happy Mug to pay a dividend of $4.00 in one year and to have a value of $40 in one year. Corporations pay no income tax. Investors pay 20% on dividends but no tax on capital gains. If the current price of Generous Cup is $62.50, what is the current price of Happy Mug?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 19-06 The Indifference Proposition Source : Chapter 19 Test Bank > TB 19-44 The Generous Cup Corporation and the Happy M...

45) Asquith and Mullins studied a sample of firms that either paid their first-ever cash dividend

or initiated a dividend after 10 years of no dividends. Healey, Palepu and Michaely, and Thaler and Womack found stock prices to fall when dividends are. Explain how these positive and negative stock price results fit with the dividend irrelevance argument of MM and the opposing effects of taxes and current income needs on stock price if future earnings are held constant.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 19-07 Homemade Dividends Source : Chapter 19 Test Bank > TB 19-45 Asquith and Mullins studied a sample of firm...

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46) Lintner suggested that the level of dividends paid by a corporation is affected by

management's estimation of permanent and temporary earnings. His work and the work of Fama and Babiak suggest that dividend policy is related to both the level of dividends and the change in dividends. Explain how a corporation would determine the level of dividends and incorporate the necessary changes in dividends if they were an aggressive company.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 19-07 Homemade Dividends Source : Chapter 19 Test Bank > TB 19-46 Lintner suggested that the level of dividend...

47) 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. Next, describe three real-world factors that may cause one dividend policy to be preferable to another.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 19-06 The Indifference Proposition Source : Chapter 19 Test Bank > TB 19-47 It has been shown that in the absence of tax...

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48) Explain why an ex-dividend date is a required step in the dividend payout process.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 19-02 Standard Method of Cash Dividend Payment Source : Chapter 19 Test Bank > TB 19-48 Explain why an ex-dividend date is a require...

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

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38) B 39) B 40) A 41) Short Answer

The stock price should fall by $5.00(1 -.33) = $3.35. New price = 70 - 3.35 = $66. 65 42) Short Answer

PV of A = 100(1 -.5)/(1.1) + 50/(1.1)2 + 400(1 -.2)/(1.1)3? $327.20 PV of B = 600(1 -.2)/(1.1)3 = $360.63, which is preferred. 43) Short Answer

Alternative A: Pay Dividend Now: $250,000(1 -.3) = $175,000. Invest in Tbills: $175,000(1.05) = $183,750.00. Alternative B: Invest in Tbills: $250,000(1.05) = $262,500.00. Pay out as Dividend: $262,500.00(1 -.3) = $183,750.00. Because the values are identical, it does not matter who does the reinvesting, unless there are other factors to consider. With personal tax rate = 40%. Alternative A: Dividend: $250,000(1 -.4) = $150,000. Invest in Tbills: $150,000(1.05) = $157,500. Value of the corporate reinvestment is greater due to lower tax rate therefore corporation should reinvest. 44) Short Answer

At a price of $70, Generous Cup's rate of return is 12%. $70/(1 + r) = $62.50 => r = 12%. If the two firms have the same risk, then the price of Happy Mug is: ($4.00)(1 -.2)/(1.12) + $40/(1.12) = $38.57 45) Short Answer

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Companies do not like to cut dividends and will increase dividends when future earnings and cash flows are large enough to minimize any future possible cut. Dividend decrease occur when cashflows are constrained. Dividend increase is a signal from management of a positive future. Dividend omissions signal a cash shortfall or earnings weakness. MM conditions are not met, in that, future earnings change up or down versus constant. The current after-tax loss in income from cash dividends is more than made up for by future expected increases in earnings for initiation and the reverse for omissions. 46) Short Answer

Companies smooth out the dividend path. Level of dividends set by long-run target payout for a fair share of corporate income. Maintain stable dividends therefore avoid changes that will be reversed later on. Two parameters that describe dividend policy are target payout and speed of adjustment to target. 47) Short Answer

The first part of the question asks the student to explain the "homemade dividends" proposition. The second part requires the student to identify and describe the effects on dividend policy of such things as taxes, transactions costs, the desire for current income, and information effects. 48) Short Answer

Dividends are paid to the holders of record on the issuing corporation's books as of the official record date. For a shareholder to be added or removed as the official owner on the corporate books requires processing time following the trade of shares. The ex-dividend date acts as the official cut-off point. Any stock trade before this date has ample time to be officially recorded on the corporate books. Any trade on or after the ex-dividend date will not be recorded until after the dividend is paid. Thus, buyers of stock before the ex-dividend date receive the dividend while buyers on or after the ex-dividend date do not.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) An equity issue sold directly to the public is called: 1) ______ A) a rights offer. B) a general cash offer. C) a restricted placement. D) a fully funded sales. E) a standard call issue. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 20-02 The Basic Procedure For a New Issue Source : Chapter 20 Test Bank > TB 20-01 An equity issue sold directly to the public ...

2) An equity issue sold to the firm's existing stockholders is called: 2) ______ A) a rights offer. B) a general cash offer. C) a private placement. D) an underpriced issue. E) an investment banker's issue. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 20-02 The Basic Procedure For a New Issue Source : Chapter 20 Test Bank > TB 20-02 An equity issue sold to...

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3) Management's first step in any issue of securities to the public is: 3) ______ A) to file a registration form with the OSC. B) to distribute copies of the preliminary prospectus. C) to distribute copies of the final prospectus. D) to obtain approval from the board of directors. E) to prepare the tombstone advertisement. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 20-02 The Basic Procedure For a New Issue Source : Chapter 20 Test Bank > TB 20-03 Management&#39;s first step in any...

4) During the OSC waiting period, the potential issuing company can issue a preliminary

prospectus which contains: 4) ______ A) exactly the same information as the final prospectus except and indication of SEC

approval. B) exactly the same information as the final prospectus including red writing stating it is a red herring. C) very limited financial information and red writing stating it is preliminary. D) only a description of what the funds are to be used for. E) information very similar to the final prospectus without a price nor with SEC approval. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 20-02 The Basic Procedure For a New Issue Source : Chapter 20 Test Bank > TB 20-04 During the OSC waiting period, the potential...

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5) Potential investors learn of the information concerning the firm and its new issue from the: 5) ______ A) registration statement. B) prospectus. C) letter of commitment. D) tombstone. E) rights offering. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 20-02 The Basic Procedure For a New Issue Source : Chapter 20 Test Bank > TB 20-05 Potential investors learn of the information...

6) Which of the following is not normally an example of the services offered by investment

bankers? 6) ______ A) Aiding in the sale of securities. B) Facilitating mergers. C) Acting as brokers to both individuals and institutional clients. D) Offering checking accounts to corporations. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 20-03 The Prompt Offering Prospectus System Source : Chapter 20 Test Bank > TB 20-06 Which of the following is not normally an ex...

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7) A group of investment bankers who pool their efforts to underwrite a security are known as

a/an: 7) ______ A) amalgamate. B) conglomerate. C) greenshoe group. D) syndicate. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 20-03 The Prompt Offering Prospectus System Source : Chapter 20 Test Bank > TB 20-07 A group of investment bankers who pool their...

8) A new public equity issue from a company with equity previously outstanding is called a/an: 8) ______ A) initial public offering. B) seasoned equity issue. C) unseasoned equity issue. D) private placement. E) syndicate. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 20-03 The Prompt Offering Prospectus System Source : Chapter 20 Test Bank > TB 20-08 A new public equity issue from a company wit...

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9) A firm-commitment underwriting with an investment banker occurs when: 9) ______ A) the syndicate is in place to handle the issue. B) the spread between the buying and selling price is less than one percent. C) the issue is solidly accepted in the market evidenced by a large price increase. D) the investment banker buys the securities for less than the offering price and accepts

the risk of not being able to sell them. E) the investment banker sells as much of the security as the market can bear without a price decrease. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 20-03 The Prompt Offering Prospectus System Source : Chapter 20 Test Bank > TB 20-09 A firm-commitment underwriting with an inves...

10) In a best-efforts offering, the investment banker makes their money primarily by: 10) ______ A) earning the spread between the buying and offering price. B) earning a commission on each share sold. C) earning the discount between the buying and offering price. D) charging a flat fee for all services. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 20-03 The Prompt Offering Prospectus System Source : Chapter 20 Test Bank > TB 20-10 In a best-efforts offering, the investment b...

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11) Regional Power wants to raise $10 million in new equity. The subscription price is $20.

There are currently 3 million shares outstanding, each with 1 right. How many rights are needed to purchase 1 share? 11) ______ A) 1. B) 3. C) 5. D) 6. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-11 Regional Power wants to raise...

12) Under the _____ method, the underwriter buys the securities for less than the offering price

and accepts the risk of not selling the issue, while under the _____ method, the underwriter does not purchase the shares but merely acts as an agent. 12) ______ A) best-efforts; firm-commitment B) firm-commitment; best-efforts C) general cash offer; best-efforts D) competitive offer; negotiated offer E) seasoned; unseasoned Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 20-03 The Prompt Offering Prospectus System Source : Chapter 20 Test Bank > TB 20-12 Under the _____ method, the underwriter buys...

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13) Empirical evidence suggests that new equity issues are generally: 13) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 20-03 The Prompt Offering Prospectus System Source : Chapter 20 Test Bank > TB 20-13 Empirical evidence suggests that new equity ...

14) Empirical evidence suggests that upon announcement of a new equity issue, current stock

prices generally: 14) ______ A) drop, perhaps because the new issue reflects management's view that common stock

is currently overpriced. B) remain about the same since an efficient market anticipates a new equity issue. C) increase, 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 20-04 Alternative Issue Methods Source : Chapter 20 Test Bank > TB 20-14 Empirical evidence suggests that upon announ...

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15) The winner's curse is used to describe: 15) ______ A) the payoff you receive on lottery tickets. B) getting a full allocation of undesirable IPO shares. C) acquiring all underpriced IPO issues. D) a fully underwritten issue. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 20-03 The Prompt Offering Prospectus System Source : Chapter 20 Test Bank > TB 20-15 The winner&#39;s curse is...

16) The six components that make up the total costs of new issues are: 16) ______ A) the spread, other direct expenses such as filing fees, indirect expenses such as

management time, economies of scale, abnormal returns, and the Green-Shoe option. B) the discount, other direct expenses such as filing fees, indirect expenses such as management time, due diligence costs, abnormal returns, and the Green-Shoe option. C) the spread, other direct expenses such as filing fees, indirect expenses such as management time, abnormal returns, underpricing, and the Green-Shoe option. D) the spread, other direct expenses such as filing fees, economies of scale, due diligence costs, abnormal returns, and underpricing. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 20-05 The Cash Offer Source : Chapter 20 Test Bank > TB 20-16 The six components that make up the total co...

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17) In comparison to debt issuance expenses, the total direct costs of equity issues are: 17) ______ A) considerably less because the equity market is more liquid than the debt market. B) about the same once cost are amortized over the life of the instrument. C) meaningless because debt cannot have any indirect costs like equity. D) considerably greater because of the risk of market movement and price change is

greater. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 20-05 The Cash Offer Source : Chapter 20 Test Bank > TB 20-17 In comparison to debt issuance expenses, the...

18) A rights offering is: 18) ______ A) the issuing of options on shares to the general public to acquire stock. B) the issuing of an option directly to the existing shareholders to acquire stock. C) the issuing of proxies which are used by shareholders to exercise their voting rights. D) strictly a public market claim on the company which can be traded on an exchange. E) the awarding of special perquisites to management. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-18 A rights offering is:

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19) To determine the value of the rights the stockholder needs to know what two pieces of

information in addition to the current stock price: 19) ______ A) the subscription price and the number of rights needed to acquire a new share. B) the amount of new equity to be raised and the detachment date. C) the amount of new equity to be raised and standby fee. D) the detachment date and the subscription price. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-19 To determine the value of the rights the sto...

20) Assuming everything else is constant, when a stock goes ex-rights its price should: 20) ______ A) decrease since the investor who purchases the shares 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) increase since the investor who purchases the shares is gaining an option. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-20 Assuming everything else is constant, when a...

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21) The Wordsmith Corporation has 10,000 shares outstanding at $30 each. They expect to raise

$150,000 by a rights offering with a subscription price of $25 how many rights must you turn in to get a new share? 21) ______ A) 2.00. B) 1.20. C) 0.60. D) 1.67. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-21 The Wordsmith Corporation has 10,000 shares ...

22) If a shareholder or investor wants to acquire new stock under a rights plan they must: 22) ______ A) acquire new stock in the market to get a controlling fraction of shares to be eligible

for rights. B) simply pay a registration fee and turn in the subscription price. C) acquire the correct rights per share desired, turn the rights and the total subscription price into the subscription agent. D) acquire the correct rights and wait for the company to send you the stock. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-22 If a shareholder or investor wants to acquir...

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23) Assuming everything else is constant, if a stock's old price is $25 and the ex-rights or new

stock price is $19, then the value of the right is: 23) ______ A) $6.00. B) -$6.00. C) impossible to determine without the subscription price. D) impossible to determine without the number of rights needed to buy one share. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-23 Assuming everything else is constant, if a s...

24) The ZYX Corporation has a new rights offering, you can buy one share of stock with 3 rights

and $20 per share. The stock is now selling ex-rights for $26. The value of the right and the price rights-on are: 24) ______ A) $2.00, $22.00. B) $6.00, $28.00. C) $2.00, $28.00. D) $6.00, $32.00. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-24 The ZYX Corporation has a new rights offerin...

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25) The Schraeder Corporation has 20,000 shares outstanding at $20 each. They expect to raise

$200,000 by a rights offering with a subscription price of $25. How many rights must you turn in to get a new share? 25) ______ A) 1.25. B) 1.50. C) 2.00. D) 2.50. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-25 The Schraeder Corporation has 20,000 shares ...

26) Bradley Power wants to raise $40 million in new equity. The subscription price is $25. There

are currently 5 million shares outstanding, each with 1 right. How many rights are needed to purchase 1 share? 26) ______ A) 1.000. B) 3.000. C) 3.125. D) 4.525. E) 6.525. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-26 Bradley Power wants to raise ...

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27) If the subscription price for a new equity issue is $15, and the ex-rights price of the stock is

$20.5, and the old stock price is $22.5, then the number of rights needed to purchase a new share is: 27) ______ A) 2.0. B) 2.5. C) 2.75. D) 5.5. E) 7.5. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-27 If the subscription price for a new equity i...

28) The ZYX Corporation intends to issue 50,000 new shares to raise funds for the expansion of

current plant facilities. The current share price is $40 and there are 500,000 shares outstanding. The number of rights needed to buy a share of stock should be: 28) ______ A) 0.10 B) 40.00. C) 0.40. D) 10.00. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-28 The ZYX Corporation intends to issue 50,000 ...

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29) Which of the following statements is true? 29) ______ A) The subscription price is generally above the old stock price. B) The subscription price is generally above the ex-rights price. C) The subscription price is generally below the old stock price. D) The ex-rights price is generally above the old stock price. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-29 Which of the following statements is true?

30) A shareholder who has rights is: 30) ______ A) not always better off to exercise the rights. B) not always better off to sell the rights into the market. C) never better off to let them expire. D) never in the same ownership position again with rights. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-30 A shareholder who has rights is:

31) A standby underwriting arrangement provides the: 31) ______ A) company with methods to cancel the offering. B) company with an alternate investment banker if there is conflict between the issuer

and the agent. C) investment banker with an oversubscription privilege to ensure profits are earned. D) company with an alternative avenue of sale to ensure success of the rights offering. E) investment bankers with an added syndication for the rights offering. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-31 A standby underwriting arrangement provides ...

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32) Smith in evaluating issuance costs from underwritten issues, rights issues with standby

underwriting and pure-rights issues found that 90 percent of the issues are underwritten which was the most expensive method. This is done because: 32) ______ A) investment bankers know more than CFOs and they may buy the issue at an agreed price and disburse the funds sooner. B) investment bankers can increase the price received by increasing confidence in the issue, they will buy the issue at an agreed upon price and disburse the cash sooner. C) investment bankers provide other services including price counsel, increase public confidence and provide funds to the issuer sooner. D) investment bankers know how to price the issue, would not need to set as low as a price as the subscription price and provide price counsel. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-32 Smith in evaluating issuance costs from unde...

33) For a particular stock, the old stock price is $20, the ex-rights price is $15, and the number of

rights needed to buy a new share is 2. Assuming everything else constant, the subscription price is: 33) ______ A) $5. B) $13. C) $17. D) $18. E) $20. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-33 For a particular stock, the old stock price ...

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34) The market for venture capital refers to the: 34) ______ A) private financial marketplace for servicing small, young firms. B) bond markets. C) market for selling rights to individuals who already own shares. D) market for selling equity securities for firms with equity already outstanding. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 20-07 The Selling Period Source : Chapter 20 Test Bank > TB 20-34 The market for venture capital refers to the...

35) Venture capitalists are: 35) ______ A) intermediaries that raise funds from outside investors. B) play an active role in overseeing, advising, and monitoring the companies in which

they invest. C) generally do not want to own the investment forever. D) intermediaries that raise funds from outside investors and play an active role in overseeing, advising, and monitoring the companies in which they invest. E) intermediaries that raise funds from outside investors, play an active role in overseeing, advising, and monitoring the companies in which they invest, and generally do not want to own the investment forever. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 20-07 The Selling Period Source : Chapter 20 Test Bank > TB 20-35 Venture capitalists are:

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36) Venture capitalists provide financing for new firms from the seed and start-up stage, all the

way to mezzanine and bridge financing. In exchange for financing entrepreneurs give: 36) ______ A) a high interest rate debt instrument and control. B) an equity position and usually board of director positions. C) up the right to have an initial public offering. D) control to a court appointed trustee. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 20-07 The Selling Period Source : Chapter 20 Test Bank > TB 20-36 Venture capitalists provide financing for ne...

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 37) The Holyoke Corporation has 120,000 shares outstanding with a current market price of $8.10 per share. The company needs to raise an additional $36,000 to finance new expenditures and has decided on a rights issue. The issue will allow current stockholders to purchase one additional share for 20 rights at a subscription price of $6 per share. Calculate the ex-rights price that would make a new stockholder indifferent between buying shares at the old stock price and exercising the rights or buying the shares' ex-rights.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-37 The Holyoke Corporation has 120,000 shares o...

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38) The Holyoke Corporation has 120,000 shares outstanding with a current market price of

$8.10 per share. The company needs to raise an additional $36,000 to finance new expenditures and has decided on a rights issue. The issue will allow current stockholders to purchase one additional share for 20 rights at a subscription price of $6 per share. If the Ex-Rights price were set at $7.90, would you as a potential new stockholder choose to buy shares ex-rights or buy shares at the old price and exercise your rights?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-38 The Holyoke Corporation has 120,000 shares o...

39) Suppose that the company was also considering structuring the rights issue to allow for an

additional share to be purchased for 10 rights at a subscription price of $3. Prove that a stockholder with 100 shares would be indifferent between purchasing a new share for 10 rights at $3 or purchasing a new share for 20 rights at $6.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-39 Suppose that the company was also considerin...

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40) The evidence on IPO sales is varied from issue to issue, but there are three common themes;

underpricing, underperformance, and the reasons for going public. Explain these three themes.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 20-03 The Prompt Offering Prospectus System Source : Chapter 20 Test Bank > TB 20-40 The evidence on IPO sales is varied from iss...

41) The Direct Interactive Publishing Company is planning to raise $200 million 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 security issue. List and explain three advantages/disadvantages of each method.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-41 The Direct Interactive Publishing Company is...

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42) Yoma Inc. is attempting to raise $5,000,000 in new equity with a rights offering. The

subscription price will be $40 per share. The stock currently sells for $50 per share and there are 250,000 shares outstanding. How many rights are needed to buy a new share?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-42 Yoma Inc. is attempting to raise ...

43) Yoma Inc. is attempting to raise $5,000,000 in new equity with a rights offering. The

subscription price for the 125,00 new shares will be $40 per share. The stock currently sells for $50 per share and there are 250,000 shares outstanding. What will the price per share be if all rights are exercised?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 20-06 Types of Underwriting Source : Chapter 20 Test Bank > TB 20-43 Yoma Inc. is attempting to raise ...

44) What are venture capitalists and what is their role in raising capital for firms?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 20-07 The Selling Period Source : Chapter 20 Test Bank > TB 20-44 What are venture capitalists and what is the...

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

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We set up the indifference equation as follows: N(Old Stock Price) + Subscription Price = (N + 1) (Ex-Rights Price) 20($8.10) + $6 = 21(X) => X = $8.00 38) Short Answer

If you purchase 20 shares at the old price and exercise, your cost will be 20($8.10) + $6 $168.00. If you purchase 21 shares ex-rights, your cost is 21($7.90) = $165.90. This is the cheaper alternative. 39) Short Answer Alternative 1: 20 rights at $6 a share; Ex-Rights Price is $8 Originally owned 100 shares at $8.10

= $810.00

Now own 105 shares at $8.00

= $840.00

Net Investment is $30 Alternative 2: 10 rights at $3 a share; Ex-Rights price is $7.64 Originally owned 100 shares at $8.10

= $810.00

Now own 110 shares at $7.64

= $840.00

Net Investment is $30

= $840.00

40) Short Answer

Underpricing--at issuance most IPOs underpriced excess returns are earned over the initial market price. risk of IPO is great and issuance market reaction reflects future expectations. Underperformance--typically 3 years after IPO the price has fallen below the initial price. issuers are optimistic about the future at issuance but uncertainty is revealed over time and the firm may be less promising. Reasons for going public--establish market value. raise cash to pay down debt and fund operations. allow insiders to sell some of their stock. 41) Short Answer

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Rights lowest cost method. maintains ownership percentage. shareholders can fully participate and maintain wealth. negative, shareholders may not have capital and may not be fully subscribed. use of standby and oversubscription. Underwriting advice on issue characteristics and pricing from investment bankers. access to a broader market. acts to "certify" issuer and issue. acts to guarantee price in firm commitment. Negatives most costly--both direct and other expenses. if best efforts--may be withdrawn. current shareholders may not be able to maintain ownership percentage. 42) Short Answer

Number of new shares = 5,000,000/40 = 125,000 Number of rights needed = 250,000/125,000 = 2 rights/share. 43) Short Answer

Total equity Value = (250,000 × 50) + (125,000 × 40) = 12,500,000 + 5,000,000 = 17,500,000 Price/share = 17,500,000/375,000 = $46.67 Or Ro = (Po - S)/(N + 1) = (50 - 40)/3 = 3.33 (see above for # of rights needed) Px = Po - Ro = 50 - 3.33 = 46.67. 44) Short Answer

Venture capitalists are financial intermediaries that raise funds from outside investors. Venture capitalist firms, otherwise known as VC firms, are typically organized as limited partnerships, which partner with institutional investors such as pension plans, endowments, and corporations. This is the key characteristic that separates venture capitalists from angel investors who typically invest their own money. Second, venture capitalists play an active role in overseeing, advising, and monitoring the companies in which they invest. Third, venture capitalists generally do not want to hold the investment for a long period. In contrast, they generally develop their exit strategy before the initial investment so they are more easily able to move forward and exit the investment.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) The length of time debt remains outstanding with some unpaid balance is called: 1) ______ A) the funded period. B) the sinking fund period. C) the deferred call period. D) the maturity. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 21-01 Long-Term Debt: A Review Source : Chapter 21 Test Bank > TB 21-01 The length of time debt remains outstanding ...

2) Long-term debt is sometimes called: 2) ______ A) funded debt. B) secured debt. C) unfunded debt. D) unsecured debt. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 21-01 Long-Term Debt: A Review Source : Chapter 21 Test Bank > TB 21-02 Long-term debt is sometimes called:

3) Short-term debt is sometimes referred to as: 3) ______ A) secured debt. B) funded debt. C) unfunded debt. D) unsecured debt. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 21-01 Long-Term Debt: A Review Source : Chapter 21 Test Bank > TB 21-03 Short-term debt is sometimes referred to as:

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4) Long term debt, that is privately placed debt, is directly placed: 4) ______ A) with an investment banker. B) with another manufacturing corporation. C) with a lending institution. D) with the federal government. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 21-01 Long-Term Debt: A Review Source : Chapter 21 Test Bank > TB 21-04 Long term debt, that is privately placed deb...

5) The written agreement between a corporation and the bondholder's representative is called: 5) ______ A) a call provision. B) a collateral maintenance agreement (CMA). C) an indenture. D) a prospectus. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 21-02 The Public Issue of Bonds Source : Chapter 21 Test Bank > TB 21-05 The written agreement between a corporation ...

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6) A public issue of bonds approved by the board of directors (and shareholders if necessary)

can be sold when: 6) ______ A) the registration statement has been filed with the OSC and the syndicate is set. B) the investment banker's have accepted the offer for sale and have held it for 20 days

from announcement. C) the registration statement has been filed with the OSC, approved and the 20 day waiting period has elapsed. D) the role of the trustee has been determined and an indenture has been written and signed. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 21-02 The Public Issue of Bonds Source : Chapter 21 Test Bank > TB 21-06 A public issue of bonds approved by the boar...

7) The trustee's job as an agent for the bondholders is to: 7) ______ A) represent the bondholders if the company defaults, manage any sinking fund, and see

that the indenture terms are obeyed. B) advise the company on debt disposition, manage any sinking fund, and minimize indenture covenants. C) represent the bondholders if the company defaults, call the bond issue and minimize indenture covenants. D) advise the company on debt disposition, call the bond issue and see that the terms of the indenture are obeyed. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 21-02 The Public Issue of Bonds Source : Chapter 21 Test Bank > TB 21-07 The trustee&#39;s job as an agent...

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8) A description of the property used as security and the details of the protective covenants are: 8) ______ A) key terms in a rights agreement. B) the basic terms of a bond. C) key parts of a typical bond indenture. D) key parts of a typical bond debenture. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 21-02 The Public Issue of Bonds Source : Chapter 21 Test Bank > TB 21-08 A description of the property used as securi...

9) Suppose that a bond is issued at its par value or face value and if market interest rates rise

after the issue, the price of the bond will likely: 9) ______ A) rise significantly above its par value. B) rise slightly above its par value. C) remain equal to its par value. D) fall below its par value. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 21-02 The Public Issue of Bonds Source : Chapter 21 Test Bank > TB 21-09 Suppose that a bond is issued at its par val...

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10) If a bond was issued at par, the quoted price of the bond will not necessarily equal the par

value of the bond after issuance because: 10) ______ A) time to maturity has shortened and the company is older. B) time to maturity has shortened and interest has accrued. C) interest has accrued and the company is older. D) market interest rates have changes and/or interest has accrued. E) market interest rates have changes and the company is older. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 21-02 The Public Issue of Bonds Source : Chapter 21 Test Bank > TB 21-10 If a bond was issued at par, the quoted pric...

11) The price of a $1,000 face value bond is usually quoted: 11) ______ A) in dollars and cents. B) in thousands of dollars. C) in percentage of face. D) in principal amount. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 21-02 The Public Issue of Bonds Source : Chapter 21 Test Bank > TB 21-11 The price of a $1,000 face...

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12) The main difference between an open-end and closed-end mortgage trust indenture is: 12) ______ A) the mutual fund carries a no load fee. B) security can be diminished as an open-end trust indenture allows for unlimited bond

issuance. C) security can be diminished as a closed-end trust indenture allows for unlimited bond issuance. D) the mortgage trust company does not have any security. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 21-02 The Public Issue of Bonds Source : Chapter 21 Test Bank > TB 21-12 The main difference between an open-end and ...

13) Most debentures are issued by _________ companies and are _______ 13) ______ A) utility and railroad; secured by a pledge on specific assets. B) industrial and finance; unsecured general obligations. C) utility and railroad; unsecured general obligations. D) industrial and finance; secured by a pledge on specific assets. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 21-02 The Public Issue of Bonds Source : Chapter 21 Test Bank > TB 21-13 Most debentures are issued by _________ comp...

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14) The written agreement between a corporation and its bondholders contains a limitation on the

dividends that the corporation can pay. This limitation is: 14) ______ A) a nonrecourse covenant. B) a recourse covenant. C) a negative covenant. D) a positive covenant. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 21-02 The Public Issue of Bonds Source : Chapter 21 Test Bank > TB 21-14 The written agreement between a corporation ...

15) A positive covenant to an indenture or loan agreement would: 15) ______ A) set a condition the company must follow such as not pledge any assets to other

lenders. B) set a condition that the trustee can eliminate sinking fund payments. C) allow the trustee to call the bonds in. D) allow the company to pay dividends only semi-annually. E) set a condition that the company must follow such as providing regular (periodic) financial statements to the lender. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 21-02 The Public Issue of Bonds Source : Chapter 21 Test Bank > TB 21-15 A positive covenant to an indenture or loan ...

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16) As a part of a bond issue, a corporation makes annual payments into an account managed by

a trustee for the purpose of repurchasing bonds. This arrangement is called: 16) ______ A) a call provision. B) a sinking fund. C) a funding provision. D) a trust maintenance fund. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 21-02 The Public Issue of Bonds Source : Chapter 21 Test Bank > TB 21-16 As a part of a bond issue, a corporation mak...

17) A sinking fund is useful to bondholders because: 17) ______ A) it stops the company from going under or into default. B) the funds are usable at the option of the bondholders. C) when a firm has difficulty making payments this sends a signal of potential default. D) a balloon payment is necessary to fully pay off the bonds at maturity. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 21-02 The Public Issue of Bonds Source : Chapter 21 Test Bank > TB 21-17 A sinking fund is useful to bondholders beca...

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18) A bond has a call provision. The call provision allows the ______ to _______ the bonds

before maturity. 18) ______ A) investor; sell back B) trustee; buyback C) issuer; call D) investor; call E) trustee; sell back Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 21-02 The Public Issue of Bonds Source : Chapter 21 Test Bank > TB 21-18 A bond has a call provision. The call provis...

19) A sinking fund is useful to a corporation because: 19) ______ A) the corporation does not have to worry about paying the bondholders. B) it provides the corporation with the option to buy the bonds back at the lower of the

face value or market price. C) the payments to the sinking fund are not necessary when the firm is in financial difficulty. D) they are simple and easy to monitor. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 21-02 The Public Issue of Bonds Source : Chapter 21 Test Bank > TB 21-19 A sinking fund is useful to a corporation be...

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20) Corporations typically have the right to repurchase a debt issue before maturity at a fixed

price, but only after some number of years have passed. Such debt is said to feature: 20) ______ A) a sinking fund. B) a balloon payment. C) a redeemable-at-par provision. D) a deferred call. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 21-02 The Public Issue of Bonds Source : Chapter 21 Test Bank > TB 21-20 Corporations typically have the right to rep...

21) Corporations typically have the right to repurchase a debt issue before maturity by paying the

face value of the bond plus: 21) ______ A) a call premium. B) the amortized value. C) the principal discount. D) a balloon payment. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 21-02 The Public Issue of Bonds Source : Chapter 21 Test Bank > TB 21-21 Corporations typically have the right to rep...

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22) From the corporate perspective, callable bonds may have value over non-callable bonds

because: 22) ______ A) the corporation has the option to control market interest rates. B) interest rates may rise prohibiting the holders from earning higher returns. C) call prices vary inversely with the interest rates. D) the corporation has the option to call the bond if interest rates fall. E) the corporation has the option to call the bond if interest rates rise. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 21-03 The Basic Terms Source : Chapter 21 Test Bank > TB 21-22 From the corporate perspective, callable bon...

23) Chevalier Manufacturing issued a callable bond with a 2020 maturity date. The bond was

sold at par and the call premium was set equal to the coupon rate of 20%. A declining call premium was also in place so that the premium declined evenly over the last ten years of premium to zero. What would be the call premium if the bond was called in 2011? 23) ______ A) $200. B) $20. C) $180. D) $18. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 21-03 The Basic Terms Source : Chapter 21 Test Bank > TB 21-23 Chevalier Manufacturing issued a callable bo...

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24) A firm wishes to issue a perpetual callable bond. The current interest rate is 7%. Next year,

the interest rate will be 6.5% or 8.25% with equal probability. The bond is callable at $1,075, and it will be called if the interest rate drops to 6.5%. What is the correct coupon amount if the bond is priced to sell at par? 24) ______ A) $65.00. B) $75.42. C) $82.50. D) $87.86. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 21-03 The Basic Terms Source : Chapter 21 Test Bank > TB 21-24 A firm wishes to issue a perpetual callable ...

25) A firm wishes to issue a perpetual callable bond. The current interest rate is 7%. Next year,

the interest rate will be 6.5% or 8.25% with equal probability. The bond is callable at $1,075, and it will be called if the interest rate drops to 6.5%. If the coupon were set to $70 what would the bond sell for? 25) ______ A) $824.61. B) $898.82. C) $964.25. D) $1000.00. E) $1031.74. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 21-03 The Basic Terms Source : Chapter 21 Test Bank > TB 21-25 A firm wishes to issue a perpetual callable ...

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26) A firm wishes to issue a perpetual callable bond. The current interest rate is 7%. Next year,

the interest rate will be 6.5% or 8.25% with equal probability. The bond is callable at $1,075, and it will be called if the interest rate drops to 6.5%. What is the cost of the call provision to the firm if the bond sells for $1,000 today? 26) ______ A) -$71.43. B) $0.00. C) $77.41. D) $178.57. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 21-03 The Basic Terms Source : Chapter 21 Test Bank > TB 21-26 A firm wishes to issue a perpetual callable ...

27) If a firm retires or extinguishes a debt issue before maturity, the specific amount they pay is: 27) ______ A) the amortization amount. B) the call price. C) the sinking fund amount. D) the spread premium. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 21-03 The Basic Terms Source : Chapter 21 Test Bank > TB 21-27 If a firm retires or extinguishes a debt iss...

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28) The call policy that maximizes shareholder wealth is to call a bond issue when: 28) ______ A) the bond's price is above par. B) the callable bond value is above par, but below the call price. C) the bond's price exceeds the call premium. D) the callable bond value exceeds the call price. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 21-03 The Basic Terms Source : Chapter 21 Test Bank > TB 21-28 The call policy that maximizes shareholder w...

29) Debt ratings issued by companies such as Moody's and Standard and Poor's depend on: 29) ______ A) the probability of firm default and protection given in indenture in case of default. B) how large the company is and the number of restrictive covenants. C) the size of the fee paid by the issuer and their industry. D) the issue size, type of issue and their industry. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 21-04 Security Source : Chapter 21 Test Bank > TB 21-29 Debt ratings issued by companies such as Moo...

30) Bonds below BBB or Baa are called: 30) ______ A) income bonds. B) deep-discount bonds. C) zero coupon bonds. D) investment grade bonds. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 21-04 Security Source : Chapter 21 Test Bank > TB 21-30 Bonds below BBB or Baa are called:

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31) Studies have shown that around the announcement of bond rating changes: 31) ______ A) bond values increase, and equity values decrease. B) bond values decrease, and equity values increase. C) bond values increase, and equity values do not change. D) bond values decrease, and equity values do not change. E) no unusual behavior occurs in bond or equity values. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 21-04 Security Source : Chapter 21 Test Bank > TB 21-31 Studies have shown that around the announcem...

32) The growth of junk bond markets can be traced to: 32) ______ A) the issuance of callable debt. B) the small difference between the return on high yield versus the return on low yield

bonds. C) the large difference between the return on high yield versus the return on low yield bonds. D) the fact that there is virtually no difference between the return on high vs low yield bonds. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 21-04 Security Source : Chapter 21 Test Bank > TB 21-32 The growth of junk bond markets can be trace...

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33) Junk bond market financing became more important in mergers and corporate restructurings

because: 33) ______ A) firms can issue only limited amounts of debt. B) there was a large supply of junk bonds. C) the marketability of junk bonds increased. D) this permitted firms to have much higher debt-to-equity ratios. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 21-04 Security Source : Chapter 21 Test Bank > TB 21-33 Junk bond market financing became more impor...

34) Floating rate bonds are bonds with: 34) ______ A) floating par values tied to the stock par value. B) floating maturities tied to the expected corporate life. C) floating call provisions indexed by relative interest rates. D) floating coupon rates tied to an interest rate index. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 21-05 Seniority Source : Chapter 21 Test Bank > TB 21-34 Floating rate bonds are bonds with:

35) Put provisions in bonds allow: 35) ______ A) the issuer to call the bond at par on the coupon payment date. B) the holder to redeem the bond at par on the coupon payment date. C) the issuer to extend the maturity of the bond. D) the holder to extend the maturity of the bond. E) the issuer to change the coupon rate on the coupon payment date. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 21-05 Seniority Source : Chapter 21 Test Bank > TB 21-35 Put provisions in bonds allow:

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36) Income bonds provide the same tax advantage as regular coupon paying bonds but have the

advantage of: 36) ______ A) not being in default if a coupon payment is omitted due to a lack of corporate income. B) lacking the smell of death from financial distress. C) being easier to sell in the marketplace given the lower risk of default. D) not having any agency costs between bondholders and stockholders. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 21-05 Seniority Source : Chapter 21 Test Bank > TB 21-36 Income bonds provide the same tax advantage ...

37) The popularity of floating-rate bonds is likely tied to protection against: 37) ______ A) default risk. B) marketability risk. C) inflation risk. D) systematic risk. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 21-05 Seniority Source : Chapter 21 Test Bank > TB 21-37 The popularity of floating-rate bonds is lik...

38) Zeros are bonds that: 38) ______ A) have zero maturity. B) have zero call dates. C) have zero sinking funds. D) have zero coupon rates. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 21-05 Seniority Source : Chapter 21 Test Bank > TB 21-38 Zeros are bonds that:

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39) Zero-coupon bonds eliminate interest rate risk in some cases by: 39) ______ A) removing default risk. B) removing marketability risk. C) removing reinvestment rate risk. D) removing call risk. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 21-05 Seniority Source : Chapter 21 Test Bank > TB 21-39 Zero-coupon bonds eliminate interest rate ri...

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 40) Owers Divestiture Corporation, a firm speculating in corporate reorganizations, has bonds outstanding that were originally issued at par but are now selling, on September 19, 2012, for $1,050 per $1,000 face value. The bonds have a stated interest rate of 8% and mature on January 1, 2022. The bonds pay interest semi-annually on July 1 and January 1 each year. Suppose that an investor buys a $1,000 face value bond on September 1, 2012. What dollar amount will the investor pay to the seller on September 1? How much interest will the investor receive on January 1, 2013?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 21-03 The Basic Terms Source : Chapter 21 Test Bank > TB 21-40 Owers Divestiture Corporation, a firm specul...

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41) Milonas Mining has $30 million in land value and $15 in mortgage bonds issued on the

property. Given that the indenture does not limit the amount of additional bonds that can be issued, the company issues an additional $10 million in mortgage bonds against the property. If Milonas is forced to liquidate its property for $20 million, and the company has no other assets, how much will the original bondholders receive?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 21-03 The Basic Terms Source : Chapter 21 Test Bank > TB 21-41 Milonas Mining has $30 million...

42) A firm wishes to issue a perpetual callable bond. The current interest rate is 9%. Next year,

there is a 40% chance that the interest rate will be 5% and a 60% chance that the rate will be 13.3333%. The bond is callable at $1,090, and it will be called if the interest rate drops to 5%. If the bond sells for par today, what is the coupon?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 21-03 The Basic Terms Source : Chapter 21 Test Bank > TB 21-42 A firm wishes to issue a perpetual callable ...

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43) A firm wishes to issue a perpetual callable bond. The current interest rate is 9%. Next year,

there is a 40% chance that the interest rate will be 5% and a 60% chance that the rate will be 13.3333%. The bond is callable at $1,090, and it will be called if the interest rate drops to 5%. What is the bond's value today if the coupon is set at $100?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 21-03 The Basic Terms Source : Chapter 21 Test Bank > TB 21-43 A firm wishes to issue a perpetual callable ...

44) A firm wishes to issue a perpetual callable bond. The current interest rate is 9%. Next year,

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 21-03 The Basic Terms Source : Chapter 21 Test Bank > TB 21-44 A firm wishes to issue a perpetual callable ...

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45) A firm wishes to issue a perpetual callable bond. The current interest rate is 6%. Next year,

there is a 30% chance that the interest rate will be 4.5% and a 70% chance that the rate will be 8.0%. The bond is callable at $1,000 plus an additional coupon payment and it will be called if the interest rate drops to 4.5%. If the bond sells for par today, what is the coupon?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 21-03 The Basic Terms Source : Chapter 21 Test Bank > TB 21-45 A firm wishes to issue a perpetual callable ...

46) A firm wishes to issue a perpetual callable bond. The current interest rate is 6%. Next year,

there is a 30% chance that the interest rate will be 4.5% and a 70% chance that the rate will be 8.0%. The bond is callable at $1,000 plus an additional coupon payment and it will be called if the interest rate drops to 4.5%. What is the bond's value today if the coupon is set at $70?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 21-05 Seniority Source : Chapter 21 Test Bank > TB 21-46 A firm wishes to issue a perpetual callable ...

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47) A firm wishes to issue a perpetual callable bond. The current interest rate is 6%. Next year,

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 21-06 Protective Covenants Source : Chapter 21 Test Bank > TB 21-47 A firm wishes to issue a perpetual callable ...

48) An Income bond is unique in at least one characteristic. Explain what is different about

income bonds and why they exist. Why are they not more popular?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 21-05 Seniority Source : Chapter 21 Test Bank > TB 21-48 An Income bond is unique in at least one cha...

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49) The choice of whether a private placement or a public bond issue is undertaken depends on

many factors. Three elements of primary concern are registration, interest rates and covenants. How do these affect the choice and why might a private placement be chosen?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 21-06 Protective Covenants Source : Chapter 21 Test Bank > TB 21-49 The choice of whether a private placement or...

50) An income bond is unique in at least one characteristic. Explain what is different about

income bonds and why they exist. Why are they not more popular?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 21-06 Protective Covenants Source : Chapter 21 Test Bank > TB 21-50 An income bond is unique in at least one cha...

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

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38) D 39) C 40) Short Answer

Accrued interest on Sept 1 = (.08/12) (2) (1000) = $13.33 Investor will pay $1,050 + $13.33 = $1,063.33 On Jan 1, 2013, investor will receive $40 in semi-annual interest, which compensates for 4 months of interest of $26.67, (40 - 13.33). 41) Short Answer

Company has pledged a total of $25 million on the property. Original bondholders have 15/25, or 60% of the pledge. Therefore, the original bondholders receive.6($20) = $12 M. 42) Short Answer

[$(1,090 + C).4 + ((C/.133) + C).6]/1.09 = $1,000 ≥ C = $118.67 43) Short Answer

[($1,090 + $100).4 + ((100/.133) + 100).6]/1.09 = $905.62 44) Short Answer

[$(1,090 + C).4 + ((C/.133) + C).6]/1.08 = $1,000 ≥ C = $118.67 Bond Value is $118.67/.09 = $1318.56 Cost of the call provision is $1,318,56 - $1,000 ≥ $318.56 45) Short Answer

[$(1,000 + C + C).3 + ((C/.08) + C).7]/1.06 = $1,000 ≥ C = $75.62 46) Short Answer

[($1,070 + $70).3 + ((70/.08) + 70).7]/1.06 = $946.70 47) Short Answer

[$(1,000 + C + C).3 + ((C/.08) + C).7]/1.06 = $1,000 ≥ C = $75.62 Bond Value is $75.62/.06 = $1260.33 Cost of the call provision is $1,260.33 - $1,000 ≥ $260.33 48) Short Answer

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Coupon payments are dependent on company income. Coupon paid only if income is sufficient. Income bonds exist to reduce the likelihood of financial distress. Coupon payments can be missed without default. Not so popular because: Smell of Death—a signal of the increased prospect of financial distress. Dead-Weight--Agency costs associated with the calculation of income. 49) Short Answer

Registration Private placement does not need to be registered with SEC. Costs are reduced; time to completion is lower. Interest rate higher in direct placement; fewer participants, each must bear greater risk Covenants more restrictive Given higher costs and more restrictive covenants, issuers may choose private placement because of ease of renegotiations and lower cost of distributing bonds. Issuers are willing to pay more for more flexible arrangements and maintaining the privacy of information. 50) Short Answer

Coupon payments are dependent on company income. Coupons are paid only if income is sufficient. Income bonds exist to reduce the likelihood of financial distress. Coupon payments can be missed without default. They are not so popular because of "Smell of Death" and deadweight. "Smell of Death" is a signal of the increased prospect of financial distress. Dead-Weight refers to agency costs associated with the calculation of income.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) In a lease arrangement, the owner of the asset is: 1) ______ A) the lesser. B) the lessee. C) the lessor. D) the leaser. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 22-01 Types of Leases Source : Chapter 22 Test Bank > TB 22-01 In a lease arrangement, the owner of the ass...

2) In a lease arrangement, the user of the asset is: 2) ______ A) the lesser. B) the lessee. C) the lessor. D) the leaser. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 22-01 Types of Leases Source : Chapter 22 Test Bank > TB 22-02 In a lease arrangement, the user of the asse...

3) Which of the following would not be a characteristic of a financial lease? 3) ______ A) They are usually fully amortized. B) They usually require the lessor to maintain and insure the leased assets. C) They usually do not include a cancellation option. D) The lessee usually has the right to renew the lease at expiration. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 22-01 Types of Leases Source : Chapter 22 Test Bank > TB 22-03 Which of the following would not be a charac...

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4) An independent leasing company supplies _______ leases versus the manufacturer who

supplies _______ leases. 4) ______ A) leveraged; direct B) sales and leaseback; sales-type C) capital; sales-type D) direct; sales-type Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 22-01 Types of Leases Source : Chapter 22 Test Bank > TB 22-04 An independent leasing company supplies ____...

5) The city of Oakville sold some buildings and used the proceeds to improve its financial

position. The city then leased the buildings back in order to continue to use these facilities. This is an example of: 5) ______ A) an operating lease. B) a short-term lease. C) a sale and leaseback. D) a fully amortized lease. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 22-01 Types of Leases Source : Chapter 22 Test Bank > TB 22-05 The city of Oakville sold some buildings and...

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6) If the lessor borrows much of the purchase price of a leased asset, the lease is called: 6) ______ A) a leveraged lease. B) a sale-and-leaseback. C) a capital lease. D) a nonrecourse lease. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 22-01 Types of Leases Source : Chapter 22 Test Bank > TB 22-06 If the lessor borrows much of the purchase p...

7) An operating lease's primary characteristics are: 7) ______ A) fully amortized, lessee maintain equipment and there is not cancellation clause. B) not fully amortized, lessor maintains equipment and there is a cancellation clause. C) fully amortized, lessor maintain equipment and there is a cancellation clause. D) not fully amortized, lessor maintains equipment and there is not cancellation clause. E) fully amortized, lessee maintain equipment and lessee can acquire assets at end of

lease for fair market value. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 22-01 Types of Leases Source : Chapter 22 Test Bank > TB 22-07 An operating lease&#39;s primary

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8) Operating leases: 8) ______ A) appear as offsetting items on the lessee's balance sheet. B) are fully expensed at the time the lease is established. C) are not included in the lessee's financial reports. D) are treated the same as a purchase. E) must be disclosed in the lessee's annual report. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 22-02 The Basics Source : Chapter 22 Test Bank > TB 22-08 Operating leases:

9) The Canadian University sold medical equipment and used the proceeds to improve its

financial position. The University then leased the equipment back in order to continue to use these facilities. This is an example of: 9) ______ A) an operating lease. B) a short-term lease. C) a sale and leaseback. D) a fully amortized lease. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 22-01 Types of Leases Source : Chapter 22 Test Bank > TB 22-09 The Canadian University sold medical equipme...

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10) A financial lease has which as its primary characteristics: 10) ______ A) is fully amortized, the lessee maintains equipment and there is no renewal clause and

no-cancellation clause. B) is not fully amortized, the lessor maintains equipment and there is a renewal clause but no-cancellation clause. C) is fully amortized, the lessor maintains equipment and there is a renewal clause and a no-cancellation clause. D) is not fully amortized, the lessor maintains equipment and there is a renewal clause. E) is fully amortized, the lessee maintains equipment and there is a renewal clause and a no-cancellation clause. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 22-01 Types of Leases Source : Chapter 22 Test Bank > TB 22-10 A financial lease has which as its primary c...

11) An advantage of leasing is that the lessee does not own the asset and can cancel: 11) ______ A) only financial leases. B) only operating leases. C) only capital leases. D) any kind of leases anytime. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 22-01 Types of Leases Source : Chapter 22 Test Bank > TB 22-11 An advantage of leasing is that the lessee d...

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12) For accounting purposes, which of the following conditions would not automatically cause a

lease to be a financial lease? 12) ______ A) The lessee can purchase the asset for its 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. C) The lease term is more than 75% of the asset's economic life. D) The PV of the lease payments is more than 90% of the asset's market value at lease

inception. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 22-02 The Basics Source : Chapter 22 Test Bank > TB 22-12 For accounting purposes, which of the follow...

13) Capital leases would show up on the balance sheet of the firm in which manner for a six-year

machinery lease, worth $700,000: 13) ______ A) capital leases do not have to be put on the balance sheet only financial leases do. B) Asset-Machinery $700,000; Liabilities-Long term debt $700,000 because of debt

displacement. C) Asset-Assets under capital lease $700,000; Liabilities-Obligations under capital lease $700,000. D) Assets-Assets under capital lease $700,000; Liabilities-Long term debt $700,000 because of debt displacement. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 22-02 The Basics Source : Chapter 22 Test Bank > TB 22-13 Capital leases would show up on the balance ...

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14) Prior to CICA 3065, "Accounting for Leases", lease activity was only reported in financial

footnotes. This off-balance-sheet-financing made firms with: 14) ______ A) operating leases appear healthier than those with no leases. B) financial leases appear to have greater liabilities than firms using operating leases. C) operating leases appear to have greater liabilities than firms using financial lease. D) financial leases appear to be financially stronger than if the leases were on-balance-

sheet-financing. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 22-02 The Basics Source : Chapter 22 Test Bank > TB 22-14 Prior to CICA 3065, "Accounting for Leases",...

15) The reason the CRA is most concerned about lease contracts is: 15) ______ A) firms that lease generally pay no taxes. B) that leasing usually leads to bankruptcy. C) that leases can be set up solely to avoid taxes. D) because leasing leads to off-balance-sheet-financing. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 22-03 Operating Leases Source : Chapter 22 Test Bank > TB 22-15 The reason the CRA is most concerned about l...

16) A lease with high payments early in its life which then decline to termination would: 16) ______ A) provide greater cash flow to the lessee in the beginning years. B) be evidence of tax avoidance and not acceptable to the CRA. C) be qualified as a capital lease under CICA 3065. D) provide a lower residual value and thus ensure a bargain-purchase price option. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 22-03 Operating Leases Source : Chapter 22 Test Bank > TB 22-16 A lease with high payments early in its life...

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17) The appropriate discount rate for valuing a financial lease is: 17) ______ A) the firm's after-tax weighted average cost of capital. B) the after-tax required return on assets of risks similar to the leased asset. C) the after-tax cost of secured borrowing. D) the pre-tax cost of secured borrowing Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 22-06 Taxes and Leases Source : Chapter 22 Test Bank > TB 22-17 The appropriate discount rate for valuing a ...

18) Your firm is considering leasing a new robotic milling control system. The lease lasts for 5

years. The lease calls for 6 payments of $300,000 per year with the first payment occurring at lease inception. The system would cost $1,050,000 to buy and would be straight-line depreciated to a zero salvage value. The actual salvage value is zero. The firm can borrow at 8%, and the corporate tax rate is 34%. What is the appropriate discount rate for valuing the lease? 18) ______ A) 2.72% B) 5.28% C) 8.00% D) 12.12% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 22-06 Taxes and Leases Source : Chapter 22 Test Bank > TB 22-18 Your firm is considering leasing a new robot...

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19) Your firm is considering leasing a new robotic milling control system. The lease lasts for 5

years. The lease calls for 6 payments of $300,000 per year with the first payment occurring at lease inception. The system would cost $1,050,000 to buy and would be straight-line depreciated to a zero salvage value. The actual salvage value is zero. The firm can borrow at 8%, and the corporate tax rate is 34%. What is the after-tax cash flow from leasing in year 0? 19) ______ A) -$300,000 B) -$495,000 C) -$852,000 D) -$948,000 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 22-06 Taxes and Leases Source : Chapter 22 Test Bank > TB 22-19 Your firm is considering leasing a new robot...

20) Your firm is considering leasing a new robotic milling control system. The lease lasts for 5

years. The lease calls for 6 payments of $300,000 per year with the first payment occurring at lease inception. The system would cost $1,050,000 to buy and would be straight-line depreciated to a zero salvage value. The actual salvage value is zero. The firm can borrow at 8%, and the corporate tax rate is 34%. What is the after-tax cash flow in years 1 through 5? 20) ______ A) $126,600 B) $198,000 C) $269,400 D) $287,250 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 22-04 Financial Leases Source : Chapter 22 Test Bank > TB 22-20 Your firm is considering leasing a new robot...

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21) Your firm is considering leasing a new robotic milling control system. The lease lasts for 5

years. The lease calls for 6 payments of $300,000 per year with the first payment occurring at lease inception. The system would cost $1,050,000 to buy and would be straight-line depreciated to a zero salvage value. The actual salvage value is zero. The firm can borrow at 8%, and the corporate tax rate is 34%. What is the NPV of the lease? 21) ______ A) $111,690 B) $295,040 C) $305,388 D) $309,690 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 22-06 Taxes and Leases Source : Chapter 22 Test Bank > TB 22-21 Your firm is considering leasing a new robot...

22) Your firm is considering leasing a new robotic milling control system. The lease lasts for 5

years. The lease calls for 6 payments of $300,000 per year with the first payment occurring at lease inception. The system would cost $1,050,000 to buy and would be straight-line depreciated to a zero salvage value. The actual salvage value is zero. The firm can borrow at 8%, and the corporate tax rate is 34%. What is the maximum lease payment that you would be willing to make? 22) ______ A) $170,655 B) $175,000 C) $187,842 D) $210,307 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 22-08 The Incremental Cash Flows Source : Chapter 22 Test Bank > TB 22-22 Your firm is considering leasing a new robot...

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23) Your firm is considering leasing a radiographic x-ray machine. The lease lasts for 3 years.

The lease calls for 4 payments of $25,000 per year with the first payment occurring immediately. The computer would cost $140,000 to buy and would be straight-line depreciated to a zero salvage value over 3 years. The actual salvage value is negligible. The firm can borrow at a rate of 12%. The corporate tax rate is 40%. This lease would be classified as a(n): 23) ______ A) operating lease because the asset will be obsolete. B) operating lease because there is no amortization. C) leveraged lease because it is being financed. D) capital lease because the lease life is greater than 75% of the economic life. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 22-01 Types of Leases Source : Chapter 22 Test Bank > TB 22-23 Your firm is considering leasing a radiograp...

24) Your firm is considering leasing a radiographic x-ray machine. The lease lasts for 3 years.

The lease calls for 4 payments of $25,000 per year with the first payment occurring immediately. The computer would cost $140,000 to buy and would be straight-line depreciated to a zero salvage value over 3 years. The actual salvage value is negligible. The firm can borrow at a rate of 12%. The corporate tax rate is 40%. What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in years 1-3? 24) ______ A) $15,000 B) $33,667 C) $2,750 D) $1,500 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 22-04 Financial Leases Source : Chapter 22 Test Bank > TB 22-24 Your firm is considering leasing a radiograp...

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25) Your firm is considering leasing a radiographic x-ray machine. The lease lasts for 3 years.

The lease calls for 4 payments of $25,000 per year with the first payment occurring immediately. The computer would cost $140,000 to buy and would be straight-line depreciated to a zero salvage value over 3 years. The actual salvage value is negligible. The firm can borrow at a rate of 12%. The corporate tax rate is 40%. What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in year 0? 25) ______ A) -$100,000 B) $15,000 C) -$15,000 D) -$125,000 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 22-04 Financial Leases Source : Chapter 22 Test Bank > TB 22-25 Your firm is considering leasing a radiograp...

26) Your firm is considering leasing a radiographic x-ray machine. The lease lasts for 3 years.

The lease calls for 4 payments of $25,000 per year with the first payment occurring immediately. The computer would cost $140,000 to buy and would be straight-line depreciated to a zero salvage value over 3 years. The actual salvage value is negligible. The firm can borrow at a rate of 12%. The corporate tax rate is 40%. What is the NPV of the lease relative to the purchase? 26) ______ A) -$125,000 B) -$36,970 C) $75,000 D) $125,000 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 22-06 Taxes and Leases Source : Chapter 22 Test Bank > TB 22-26 Your firm is considering leasing a radiograp...

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27) The WACC is not used in the lease versus purchase decision because: 27) ______ A) the WACC was used in the decision to acquire the asset, this is only a financing

decision. B) the WACC is used only when a lease alone is considered and not a lease versus purchase. C) the WACC does not include the lease cost of capital and therefore should not be used. D) tax rates of the lessor may be different than the lessee and therefore the WACC is incorrect. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 22-06 Taxes and Leases Source : Chapter 22 Test Bank > TB 22-27 The WACC is not used in the lease versus pur...

28) The risk of cash flow associated with the lease payment and the depreciation shield are: 28) ______ A) different for taxable firms and the depreciation shield should be discounted at a

higher riskier rate. B) different for taxable firms and the depreciation shield should be discounted at a lower riskless rate. C) the same and should be discounted at the same rate. D) dependent on the amount of debt displaced, therefore the discount rate may vary for both. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 22-06 Taxes and Leases Source : Chapter 22 Test Bank > TB 22-28 The risk of cash flow associated with the le...

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29) Debt displacement is associated with leases because: 29) ______ A) all assets not purchased with equity use debt financing. B) debt is always a cheaper source of financing and is lost as leasing is used. C) ICA3065 and the CRA mandate debt displacement. D) lease financing is all debt and causes an imbalance in the optimal debt to equity ratio

which reduces future debt financing. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 22-07 The Cash Flows of Financial Leasing Source : Chapter 22 Test Bank > TB 22-29 Debt displacement is associated with leases ...

30) A financial lease is likely to be most beneficial to both parties when: 30) ______ A) the lessor's tax rate is lower than the lessee's. B) the lessor's tax rate is higher than the lessee's. C) the lessor's tax rate is equal to the lessee's. D) a financial lease cannot be beneficial to both parties. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 22-09 A Detour on Discounting and Debt Capacity With Corporate Taxes Source : Chapter 22 Test Bank > TB 22-30 A financial lease is likely to be most benef...

31) The price or lease payment, that the lessee sets as their bound, is known as: 31) ______ A) the present value of the tax shields. B) the reservation payment, LMIN. C) the present value of operating savings. D) the reservation payment, LMAX. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 22-09 A Detour on Discounting and Debt Capacity With Corporate Taxes Source : Chapter 22 Test Bank > TB 22-31 The price or lease payment, that the lessee ...

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32) Your firm is considering leasing a new computer. The lease lasts for 9 years. The lease calls

for 10 payments of $1,000 per year with the first payment occurring immediately. The computer would cost $7,650 to buy and would be straight-line depreciated to a zero salvage over 9 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 8%. The corporate tax rate is 30%. What is the after-tax cash flow from leasing in years 1-9? 32) ______ A) $255 B) $955 C) $1,295 D) $1,850 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 22-04 Financial Leases Source : Chapter 22 Test Bank > TB 22-32 Your firm is considering leasing a new compu...

33) Your firm is considering leasing a new computer. The lease lasts for 9 years. The lease calls

for 10 payments of $1,000 per year with the first payment occurring immediately. The computer would cost $7,650 to buy and would be straight-line depreciated to a zero salvage over 9 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 8%. The corporate tax rate is 30%. What is the after-tax cash flow from leasing in year 0? 33) ______ A) -$6,950 B) -$700 C) -$7,650 D) -$4,865 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 22-04 Financial Leases Source : Chapter 22 Test Bank > TB 22-33 Your firm is considering leasing a new compu...

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34) Your firm is considering leasing a new computer. The lease lasts for 9 years. The lease calls

35) Your firm is considering leasing a new computer. The lease lasts for 9 years. The lease calls

for 10 payments of $1,000 per year with the first payment occurring immediately. The computer would cost $7,650 to buy and would be straight-line depreciated to a zero salvage over 9 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 8%. The corporate tax rate is 30%. What would the after-tax cash flow in year 9 be if the asset had a residual value of $500 (ignoring any possible risk differences)? 35) ______ A) $955 B) $1,455 C) $605 D) $1,305 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 22-04 Financial Leases Source : Chapter 22 Test Bank > TB 22-35 Your firm is considering leasing a new compu...

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36) Your firm is considering leasing a new computer. The lease lasts for 9 years. The lease calls

for 10 payments of $1,000 per year with the first payment occurring immediately. The computer would cost $7,650 to buy and would be straight-line depreciated to a zero salvage over 9 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 8%. The corporate tax rate is 30%. This lease would be classified as a(n): 36) ______ A) operating lease because the asset will be obsolete. B) operating lease because there is not amortization. C) leveraged lease because it is being financed. D) financial lease because the lease life is greater than 75% of the economic life. E) sale and leaseback because the company gets full use of the asset. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 22-01 Types of Leases Source : Chapter 22 Test Bank > TB 22-36 Your firm is considering leasing a new compu...

37) Your firm is considering leasing a new computer. The lease lasts for 9 years. The lease calls

for 10 payments of $1,000 per year with the first payment occurring immediately. The computer would cost $7,650 to buy and would be straight-line depreciated to a zero salvage over 9 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 8%. The corporate tax rate is 30%. What is the appropriate discount rate for valuing the lease? 37) ______ A) 12.12% B) 8.0% C) 5.60% D) 2.72% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 22-06 Taxes and Leases Source : Chapter 22 Test Bank > TB 22-37 Your firm is considering leasing a new compu...

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38) Your firm is considering leasing a new robotic milling control system. The lease lasts for 5

years. The lease calls for 6 payments of $300 thousand per year with the first payment occurring at lease inception. The black box would cost $1050 thousand to buy and would be straight-line depreciated to a zero salvage. The actual salvage value is zero. The firm can borrow at 8%, and the corporate tax rate is 34%. All answers are in thousands. What is the after-tax cash flow from leasing in year 0? 38) ______ A) -$300 B) -$852 C) -$948 D) -$495 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 22-04 Financial Leases Source : Chapter 22 Test Bank > TB 22-38 Your firm is considering leasing a new robot...

39) Your firm is considering leasing a new robotic milling control system. The lease lasts for 5

years. The lease calls for 6 payments of $300 thousand per year with the first payment occurring at lease inception. The black box would cost $1050 thousand to buy and would be straight-line depreciated to a zero salvage. The actual salvage value is zero. The firm can borrow at 8%, and the corporate tax rate is 34%. All answers are in thousands. What is the after-tax cash flow in years 1 through 5? 39) ______ A) $126.60 B) -$198.00 C) -$287.25 D) $269.40 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 22-04 Financial Leases Source : Chapter 22 Test Bank > TB 22-39 Your firm is considering leasing a new robot...

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SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 40) Sardinas Sardines has assets valued at $10 million and equity of $10 million. The firm recently leased new equipment worth $1 million. Present the balance sheet under two conditions; the lease is judged to be an operating lease, and the lease is judged to be a capital lease.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 22-01 Types of Leases Source : Chapter 22 Test Bank > TB 22-40 Sardinas Sardines has assets valued at...

41) The Blank Button Company is considering the purchase of a new machine for $30,000. The

machine is expected to save the firm $13,750 per year in operating costs over a 5-year period and can be depreciated on a straight-line basis to a zero salvage value over its life. Alternatively, the firm can lease the machine for $6,500 per year for 5 years, with the first payment due in 1 year. The firm's tax rate is 34%, and its cost of debt is 10%. Calculate the NPV of the lease versus the purchase decision.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 22-06 Taxes and Leases Source : Chapter 22 Test Bank > TB 22-41 The Blank Button Company is considering the ...

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42) The Plastic Iron Company has decided to acquire a new electronic milling machine. Plastic

Iron can purchase the machine for $87,000 which has an expected life of 8 years and will be depreciated using 7 class ACRS rates of.1428,.2449,.1749,.125,.0892,.0892,.0892 and any remainder in year 8. Miller Leasing has offered to lease the machine to Plastic Iron for $14,000 a year for 8 years. Plastic Iron has an 18.64% cost of equity, 12% cost of debt, a 1:1 debt-equity ratio and faces a 34% marginal tax rate. What are the cash flows in years 1 through 8?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 22-04 Financial Leases Source : Chapter 22 Test Bank > TB 22-42 The Plastic Iron Company has decided to acqu...

43) The Plastic Iron Company has decided to acquire a new electronic milling machine. Plastic

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 22-06 Taxes and Leases Source : Chapter 22 Test Bank > TB 22-43 The Plastic Iron Company has decided to acqu...

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44) The Plastic Iron Company has decided to acquire a new electronic milling machine. Plastic

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 22-06 Taxes and Leases Source : Chapter 22 Test Bank > TB 22-44 The Plastic Iron Company has decided to acqu...

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

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38) B 39) D 40) Short Answer Operating:

Assets

$10 Million

Capital = $10 Million

Capital:

Assets

$10 Million

Obligations = $1 Million

Assets

$1 Million

Capital = $10 Million

Under Lease

41) Short Answer 0

After-tax Savings

$8,250

Dep. Tax Shield

2,040

$10,290

LEASE

-6,500

Lease Payments

2,210

Tax Benefits

8,250

After-tax Savings

$3,960

BUY Cost

-30,000

NPV of Lease Versus Buy: $30,000 - ($10,290 - $3,960) A5, 066 => $3,765.39 Prefer to Lease as the NPV of Lease Versus Buy is positive. 42) Short Answer

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Year at Lease

Payment

-9240.00

TC Depr.

-4224.02

-7244.14

-5173.54

-3697.50

-2638.54

-2638.58

-2638.54

-1325.18

-13464.02 -16484.14 -14413.54 -12937.50 -11878.54 -11878.54 -11878.54 -10565.18

43) Short Answer

KdAT =.12(1 -.34) =.12(.66) =.0792 = 7.92% 44) Short Answer

Yes, the asset should be leased NPV = $87000 - 13464.02/1.0792 - 16484.14/1.07922 - 14413.54/1.07924 - 12937.50/1.07924 - 11878.54/1.07925 - 11878.54/1.07926 - 11878.54/1.07927 - 10565.18/1.07928 = $87,000 75,976.79 = $11,024.21

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) A trading opportunity that offers a riskless profit is called a(n): 1) ______ A) put option. B) call option. C) market equilibrium. D) arbitrage. E) cross-hedge. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 23-01 Options Source : Chapter 23 Test Bank > TB 23-01 A trading opportunity that offers a riskless...

2) The special contractual nature giving the owner the right to buy or sell an asset at a fixed

price on or before a given date is the basis of: 2) ______ A) a common stock. B) a capital investment. C) a futures. D) an option. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 23-01 Options Source : Chapter 23 Test Bank > TB 23-02 The special contractual nature giving the ow...

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3) In general, an option gives the holder the right to exercise at the ______ price through the

______ date. 3) ______ A) strike; inception. B) American; inception. C) European; expiration. D) strike; expiration. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 23-01 Options Source : Chapter 23 Test Bank > TB 23-03 In general, an option gives the holder the r...

4) Which of the following statements is true? 4) ______ A) American options are options on securities of U.S. corporations, and the options are

traded on American exchanges. European options are options on securities of U.S. corporations, but the options are traded on European exchanges. B) American options are options on securities which are traded on American exchanges. European options, also traded on American exchanges, are options on European corporations. C) American options give the holder the right to the dividend payment. European options do not. D) American options may be exercised anytime up to expiration. European options may be exercised only at expiration. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 23-01 Options Source : Chapter 23 Test Bank > TB 23-04 Which of the following statements is true?

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5) Which one of the following statements correctly describes your situation as the owner of an

American call option? 5) ______ A) You are obligated to buy at a set price at any time up to and including the expiration

date. B) You have the right to sell at a set price at any time up to and including the expiration date. C) You have the right to buy at a set price only on the expiration date. D) You are obligated to sell at a set price if the option is exercised. E) You have the right to buy at a set price at any time up to and including the expiration date. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 23-01 Options Source : Chapter 23 Test Bank > TB 23-05 Which one of the following statements correc...

6) A call gives the owner the right: 6) ______ A) and the obligation to buy an asset at a given price. B) and the obligation to sell an asset at a given price. C) but not the obligation to buy an asset at a given price. D) but not the obligation to sell an asset at a given price. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 23-02 Call Options Source : Chapter 23 Test Bank > TB 23-06 A call gives the owner the right:

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7) Which of the following statements is true? 7) ______ A) Call options are issued by corporations and bought by investors. B) Call options are issued by investors and bought by corporations. C) Call options are issued by investors and bought by investors. D) Put options are issued by corporations and bought by investors. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 23-02 Call Options Source : Chapter 23 Test Bank > TB 23-07 Which of the following statements is true?

8) You own a call option with time to expiration. The common stock is selling for $15 and your

exercise price is $12, this option: 8) ______ A) must be sold to the writer. B) is in-the-money. C) is out-of-the-money. D) must be offset by a put. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 23-02 Call Options Source : Chapter 23 Test Bank > TB 23-08 You own a call option with time to expiratio...

9) You can realize the same value as that derived from stock ownership if you: 9) ______ A) sell a put option and invest at the risk-free rate of return. B) buy a call option and write a put option on a stock and also borrow funds at the risk-

free rate. C) sell a put and buy a call on a stock as well as invest at the risk-free rate of return. D) lend out funds at the risk-free rate of return and sell a put option on the stock. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 23-07 Stock Option Quotations Source : Chapter 23 Test Bank > TB 23-09 You can realize the same value as that deriv...

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10) The intrinsic value of a put is equal to the: 10) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 23-07 Stock Option Quotations Source : Chapter 23 Test Bank > TB 23-10 The intrinsic value of a put is equal to the...

11) Which one of the following will cause the value of a call to decrease? 11) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 23-07 Stock Option Quotations Source : Chapter 23 Test Bank > TB 23-11 Which one of the following will cause the va...

12) Pay-off diagrams for call options versus stock prices are called: 12) ______ A) vertical tower diagrams. B) hockey stick diagrams. C) fulcrum diagrams. D) cumulative frequency diagrams. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 23-02 Call Options Source : Chapter 23 Test Bank > TB 23-12 Pay-off diagrams for call options versus sto...

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13) The lowest value a call option can have is: 13) ______ A) zero, because it is a limited liability instrument. B) ST, because the basis of value is the stock price. C) ST - 0, because it is a limited liability instrument. D) X - ST, because the exercise price is the hurdle. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 23-02 Call Options Source : Chapter 23 Test Bank > TB 23-13 The lowest value a call option can have is:

14) Which of the following is not true concerning call option writers? 14) ______ A) Writers promise to deliver shares if exercised by the buyer. B) The writer has the option to sell shares but not an obligation. C) The writer's liability is zero if the option expires out-of-the-money. D) The writer receives a cash payment from the buyer at the time the option is

purchased. E) The writer has a loss if the market price rises substantially above the exercise price. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 23-02 Call Options Source : Chapter 23 Test Bank > TB 23-14 Which of the following is not true concernin...

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15) An in-the-money put option is one that: 15) ______ A) has an exercise price greater than the underlying stock price. B) has an exercise price less than the underlying stock price. C) has an exercise price equal to the underlying stock price. D) should not be exercised at expiration. E) should not be exercised at any time. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 23-03 The Value of a Call Option at Expiration Source : Chapter 23 Test Bank > TB 23-15 An in-the-money put option is one that:

16) An option that grants the right, but not the obligation, to sell shares of the underlying asset on

a particular date at a specified price is called: 16) ______ A) either an American or a European option. B) an American call. C) an American put. D) a European put. E) a European call. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 23-03 The Value of a Call Option at Expiration Source : Chapter 23 Test Bank > TB 23-16 An option that grants the right, but not the...

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17) Which one of the following provides the option of selling a stock anytime during the option

period at a specified price even if the market price of the stock declines to zero? 17) ______ A) American call B) European call C) American put D) European put Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 23-03 The Value of a Call Option at Expiration Source : Chapter 23 Test Bank > TB 23-17 Which one of the following provides the opti...

18) Which of the following statements is true? 18) ______ A) Both call and put options are in the money if the stock price is above the exercise

price. B) Both call and put options are in the money if the stock price is below the exercise price. C) Call options are in the money if the stock price is above the exercise price. Put options are in the money if the stock price is below the exercise price. D) Call options are in the money if the stock price is below the exercise price. Put options are in the money if the stock price is above the exercise price. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 23-02 Call Options Topic : 23-03 The Value of a Call Option at Expiration Source : Chapter 23 Test Bank > TB 23-18 Which of the following statements is true?

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19) Jeff opted to exercise his August option on August 10 and received $2,500 in exchange for

his shares. Jeff must have owned a (an): 19) ______ A) warrant. B) American call. C) American put. D) European call. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 23-01 Options Source : Chapter 23 Test Bank > TB 23-19 Jeff opted to exercise his August option on ...

20) A stock has both a call and a put option outstanding. The exercise price was set equal to the

stock price. If the option were to expire now what would be the minimum value of the call and the put respectively? 20) ______ A) (ST - E); ³ 0. B) 0; (ST - E). C) <0; >0. D) 0; 0. E) (E - ST); (ST - E). Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 23-02 Call Options Topic : 23-03 The Value of a Call Option at Expiration Source : Chapter 23 Test Bank > TB 23-20 A stock has both a call and a put option out...

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21) A put gives the owner the right: 21) ______ A) and the obligation to buy an asset at a given price. B) and the obligation to sell an asset at a given price. C) but not the obligation to buy an asset at a given price. D) but not the obligation to sell an asset at a given price. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 23-03 The Value of a Call Option at Expiration Source : Chapter 23 Test Bank > TB 23-21 A put gives the owner the right:

22) The payoff diagram for a put with the same exercise price and premium as the call on the

same underlying asset with the same maturity is: 22) ______ A) the inverse of the call diagram along the put price. B) unrelated to the call diagram no matter what the exercise price. C) the mirror image of the call diagram around the exercise price. D) exactly the same as the call diagram for the given exercise price. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Hard Topic : 23-03 The Value of a Call Option at Expiration Source : Chapter 23 Test Bank > TB 23-22 The payoff diagram for a put with the same e...

23) When reading option price quotes from the Wall Street Journal or National Post, a price of "-

" indicates that: 23) ______ A) the price is rapidly increasing. B) the price is rapidly decreasing. C) the option did not trade that day. D) the price is in error and needs recalculation. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 23-05 The Value of a Put Option at Expiration Source : Chapter 23 Test Bank > TB 23-23 When reading option price quotes from the Wa...

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24) The put option allows: 24) ______ A) the holder to sell shares if desired and requires the put seller to buy the shares at a

fixed price. B) the put seller to sell shares and requires the holder to buy shares at a fixed price. C) the holder to buy shares if desired and requires the put seller to sell the shares at a fixed price. D) the put seller to sell shares and allows the holder to sell shares at a fixed price. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 23-03 The Value of a Call Option at Expiration Source : Chapter 23 Test Bank > TB 23-24 The put option allows:

25) Calls on the King Co. closed trading at 2 5/8. You bought 3 call contracts at the close. The

cost of the 3 call options was: 25) ______ A) $2.6255 plus brokerage fees, etc. B) $7.875 plus brokerage fees, etc. C) $262.50 plus brokerage fees, etc. D) $787.50 plus brokerage fees, etc. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 23-05 The Value of a Put Option at Expiration Source : Chapter 23 Test Bank > TB 23-25 Calls on the King Co. closed trading at 2 5/...

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26) What is the cost of five November 25 call option contracts on KNJ stock given the following

price quotes? KNJ (KNJ) Underlying stock price: 30.86 Expiration

Strike

Call Last

Put Last

Aug

6.15

.05

Nov

6.60

.10

Aug

.10

4.60

Nov

.70

5.10 26) ______

A) $615 B) $660 C) $2,500 D) $3,075 E) $3,300 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 23-05 The Value of a Put Option at Expiration Source : Chapter 23 Test Bank > TB 23-26 What is the cost of five November 25 call op...

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27) What is the intrinsic value of the August 25 call?

KNJ (KNJ) Underlying stock price: 30.86 Expiration

Strike

Call Last

Put Last

Aug

6.15

.05

Nov

6.60

.10

Aug

.10

4.60

Nov

.70

5.10 27) ______

A) $0.10 B) $5.86 C) $6.15 D) $10.00 E) $25.00 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 23-05 The Value of a Put Option at Expiration Source : Chapter 23 Test Bank > TB 23-27 What is the intrinsic value of the August 25...

28) Put-Call Parity can be used to show: 28) ______ A) how far in-the-money put options can get. B) how far in-the-money call options can get. 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 23-07 Stock Option Quotations Source : Chapter 23 Test Bank > TB 23-28 Put-Call Parity can be used to show:

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29) Suppose a stock can be purchased for $8.00, a put option on the stock can be purchased for

$1.50, and a call option on the stock can be written (i.e., sold) for $1.00. If holding these positions in combination can guarantee a payoff of $10.00 at the end of the year, then what must be the risk-free rate if no arbitrage opportunities exist? 29) ______ A) 12.50%. B) 5.50%. C) 17.65%. D) 33.33%. E) 18.75%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 23-07 Stock Option Quotations Source : Chapter 23 Test Bank > TB 23-29 Suppose a stock can be purchased for...

30) You own five put option contracts on XYZ stock with an exercise price of $25.00. What is

the total intrinsic value of these contracts if XYZ stock is currently selling for $24.50 a share? 30) ______ A) -$250 B) -$50 C) $0 D) $50 E) $250 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 23-07 Stock Option Quotations Source : Chapter 23 Test Bank > TB 23-30 You own five put option contracts on XYZ sto...

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31) A stock is selling for $31. There is a call option on the stock with an exercise price of $27.

What is the approximate minimum value of the call option? 31) ______ A) $0 B) $4 C) $27 D) $31 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 23-07 Stock Option Quotations Source : Chapter 23 Test Bank > TB 23-31 A stock is selling for...

32) You hold a put option on a stock with a strike price of $23. The stock is selling for $25. What

is the approximate minimum value of the put option? 32) ______ A) $23 B) $25 C) $2 D) $0 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 23-07 Stock Option Quotations Source : Chapter 23 Test Bank > TB 23-32 You hold a put option on a stock with a stri...

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33) The higher the exercise price: 33) ______ A) the higher the call price. B) the lower the call price. C) has no effect on call price. D) the higher the stock price. E) the lower the stock price. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 23-07 Stock Option Quotations Source : Chapter 23 Test Bank > TB 23-33 The higher the exercise price:

34) Which of the following statements is true? 34) ______ A) For both calls and puts an increase in the exercise price will cause an increase in the

option price. B) For both calls and puts an increase in the time to expiration will cause an increase in the option price. C) For calls, but not for puts, an increase in the time to expiration will cause an increase in the option price. D) For puts, but not for calls, an increase in the time to expiration will cause an increase in the option price. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 23-07 Stock Option Quotations Source : Chapter 23 Test Bank > TB 23-34 Which of the following statements is true?

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35) If the volatility of the underlying asset decreases, then the: 35) ______ A) value of the put option will increase, but the value of the call option will decrease. B) value of the put option will decrease, but the value of the call option will increase. C) value of both the put and call option will increase. D) value of both the put and call option will decrease. E) value of both the put and call option will remain the same. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 23-07 Stock Option Quotations Source : Chapter 23 Test Bank > TB 23-35 If the volatility of the underlying asset de...

36) If the time to expiration of the underlying stock decreases, then the: 36) ______ A) value of the put option will increase, but the value of the call option will decrease. B) value of the put option will decrease, but the value of the call option will increase. C) value of both the put and call option will increase. D) value of both the put and call option will decrease. E) value of both the put and call option will remain the same. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 23-07 Stock Option Quotations Source : Chapter 23 Test Bank > TB 23-36 If the time to expiration of the underlying ...

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37) Tele-Tech Com announces a major expansion into internet services. This announcement

causes the price of Tele-Tech Com stock to increase but also causes an increase in price volatility of the stock. Which of the following correctly identifies the impact of these changes on the call option of Tele-Tech Com? 37) ______ A) Both changes cause the price of the call option to decrease. B) Both changes cause the price of the call option to increase. C) The greater uncertainty will cause the price of the call option to decrease. The higher price of the stock will cause the price of the call option to increase. D) The greater uncertainty will cause the price of the call option to increase. The higher price of the stock will cause the price of the call option to decrease. E) The greater uncertainty has no direct effect on the price of the call option. The higher price of the stock will cause the price of the call option to decrease. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 23-07 Stock Option Quotations Source : Chapter 23 Test Bank > TB 23-37 Tele-Tech Com announces a major expansion in...

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38) Tele-Tech Com announces a major expansion into internet services. This announcement

causes the price of Tele-Tech Com stock to increase but also causes an increase in price volatility of the stock. Which of the following correctly identifies the impact of these changes on the put option of Tele-Tech Com? 38) ______ A) Both changes cause the price of the put option to decrease. B) Both changes cause the price of the put option to increase. C) The greater uncertainty will cause the price of the put option to decrease. The higher price of the stock will cause the price of the put option to increase. D) The greater uncertainty will cause the price of the put option to increase. The higher price of the stock will cause the price of the put option to decrease. E) The greater uncertainty has no direct effect on the price of the put option. The higher price of the stock will cause the price of the put option to decrease. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 23-07 Stock Option Quotations Source : Chapter 23 Test Bank > TB 23-38 Tele-Tech Com announces a major expansion in...

39) Tele-Tech Com has announced a large loss in their online services division causing the price

of Tele-Tech Com stock to drop but the price volatility of the stock is not expected to drop. Which of the following correctly identifies the impact of these changes on the call option of Tele-Tech Com? 39) ______ A) Both changes cause the price of the call option to decrease. B) Both changes cause the price of the call option to increase. C) The volatility normally will have a negative effect on the price of the call option while the lower price of the stock will cause the price of the call option to increase. D) The volatility normally will have a positive effect on the price of the call option while the lower price of the stock will cause the price of the call option to decrease. E) Volatility has no direct effect on the price of the call option while the lower price of the stock will cause the price of the call option to decrease. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 23-07 Stock Option Quotations Source : Chapter 23 Test Bank > TB 23-39 Tele-Tech Com has announced a large loss in ...

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40) Tele-Tech Com has announced a large loss in their online services division causing the price

of Tele-Tech Com stock to drop but the price volatility of the stock is not expected to drop. Which of the following correctly identifies the impact of these changes on the put option of Tele-Tech Com? 40) ______ A) Both changes cause the price of the put option to decrease. B) Both changes cause the price of the put option to increase. C) The volatility normally will have a positive effect on the price of the put option, but the lower price of the stock will cause the price of the put option to increase. D) The volatility normally will have a negative effect on the price of the put option while the lower price of the stock will cause the price of the put option to decrease. E) Volatility has no direct effect on the price of the put option while the lower price of the stock will cause the price of the put option to decrease. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 23-07 Stock Option Quotations Source : Chapter 23 Test Bank > TB 23-40 Tele-Tech Com has announced a large loss in ...

41) The Federal Reserve Board decreases open-market purchases, which results in a general

increase in interest rates. As a result, the price of Specific Car stock drops. Which of the following correctly describes the impact of these changes on the price of the call option for Specific Car stock? 41) ______ A) Both changes cause the price of the call option to decrease. B) Both changes cause the price of the call option to increase. C) The higher interest rate will cause the price of the call option to decrease. The lower price of the stock will cause the price of the call option to increase. D) The higher interest rate will cause the price of the call option to increase. The lower price of the stock will cause the price of the call option to decrease. E) The higher interest rate has no direct effect on the price of the call option. The lower price of the stock will cause the price of the call option to decrease. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 23-07 Stock Option Quotations Source : Chapter 23 Test Bank > TB 23-41 The Federal Reserve Board decreases open-mar...

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42) The two-state OPM is so named because: 42) ______ A) there are only two specific outcomes in the future period. B) the probability of price increase equals the probability of a price decrease. C) only two interest rates are used. D) only two arbitrage positions can be established. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 23-08 Long-Term Equity Anticipation Securities Source : Chapter 23 Test Bank > TB 23-42 The two-state OPM is so named because:

43) The Black-Scholes OPM is dependent on which five parameters? 43) ______ A) Stock price, exercise price, risk free rate, probability, and time to maturity. B) Stock price, risk free rate, probability, time to maturity, and variance. C) Stock price, risk free rate, probability, variance and exercise price. D) Stock price, exercise price, risk free rate, variance and time to maturity. E) Exercise price, probability, stock price, variance and time to maturity. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 23-08 Long-Term Equity Anticipation Securities Source : Chapter 23 Test Bank > TB 23-43 The Black-Scholes OPM is dependent on which ...

44) You have entered into a call option contract for 1 period. The stock is selling for $28.00, you

borrowed $12.00 at 8% and the delta is 0.6. What is the value of the call? 44) ______ A) $8.89 B) $4.80 C) $5.69 D) $9.60 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 23-08 Long-Term Equity Anticipation Securities Source : Chapter 23 Test Bank > TB 23-44 You have entered into a call option contract...

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45) To compute the value of a put using the Black-Scholes option pricing model, you: 45) ______ A) first have to apply the put-call parity relationship. B) first have to compute the value of the put as if it is a call. C) compute the value of an equivalent call and then subtract that value from one. D) compute the value of an equivalent call and then subtract that value from the market

price of the stock. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 23-08 Long-Term Equity Anticipation Securities Source : Chapter 23 Test Bank > TB 23-45 To compute the value of a put using the Blac...

46) In terms of relating options to the value of the firm, the equity of the firm can be viewed as: 46) ______ A) a call option on the firm with the exercise price equal to the promised payments to the

bondholders. B) a call option on the firm with the exercise price equal to the firm's after-tax cash flow. C) a put option on the firm with the exercise price equal to the promised payments to the bondholders. D) a put option on the firm with an exercise price equal to the firm's after-tax cash flow. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 23-09 Combinations of Options Source : Chapter 23 Test Bank > TB 23-46 In terms of relating options to the value of...

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47) You own stock in a firm that has a pure discount loan due in six months. The loan has a face

value of $50,000. The assets of the firm are currently worth $62,000. The stockholders in this firm own a _____ option on the assets of the firm with a strike price of ______ 47) ______ A) put; $62,000. B) put; $50,000. C) warrant; $62,000. D) call; $62,000. E) call; $50,000. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 23-09 Combinations of Options Source : Chapter 23 Test Bank > TB 23-47 You own stock in a firm that has a pure disc...

48) Verma Violin Manufacturing Corporation has issued debt with $10 million of principal due.

In terms of viewing the equity of the firm as a call option, what happens to the equity of the firm if the cash flow of the firm is less than $10 million? 48) ______ A) The option is in-the-money and the stockholders earn the difference between the cash flow and the bondholder's promised payment. B) The option is in-the-money and the bondholders earn the entire cash flow. C) The option is out-of-the-money, the stockholders walk away, and the bondholders receive the entire cash flow. D) The option is out-of-the-money, and the stockholders make up the difference so that the bondholders receive full payment. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 23-09 Combinations of Options Source : Chapter 23 Test Bank > TB 23-48 Verma Violin Manufacturing Corporation has i...

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49) Verma Violin Manufacturing Corporation has issued debt with $10 million of principal due.

In terms of viewing the equity of the firm as a call option, what happens to the equity of the firm if the cash flow of the firm is greater than $10 million? 49) ______ A) The option is in-the-money and the stockholders earn the difference between the cash flow and the bondholder's promised payment. B) The option is in-the-money and the bondholders earn the entire cash flow. C) The option is out-of-the-money, the stockholders walk away, and the bondholders receive the entire cash flow. D) The option is out-of-the-money, and the stockholders make up the difference so that the bondholders receive full payment. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 23-09 Combinations of Options Source : Chapter 23 Test Bank > TB 23-49 Verma Violin Manufacturing Corporation has i...

50) In terms of relating options to firm value, if the stockholders have a call option on the firm,

what do the bondholders have? 50) ______ A) In addition to owning the firm, they have written a call option against the firm whose

exercise price equals the promised payment. B) In addition to owning the firm, they have bought a call option against the firm whose exercise price equals the promised payment. C) In addition to owning the firm, they have written a put option against the firm whose exercise price equals the promised payment. D) In addition to owning the firm, they have bought a put option against the firm whose exercise price equals the promised payment. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 23-09 Combinations of Options Source : Chapter 23 Test Bank > TB 23-50 In terms of relating options to firm value, ...

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51) In relating stockholder value in terms of put options, the stockholders own the firm, they owe

promised payments to the bondholders, and they have bought a put on the firm's assets with an exercise price equal to the promised payment to the bondholders. If the firm's cash flow is greater than these promised payments: 51) ______ A) the put is out-of-the-money, is not exercised, and the stockholders retain ownership. B) the put is out-of-the-money, is exercised, and the stockholders retain ownership. C) the put is in-the-money, is exercised, and the stockholders walk away from their promise to the bondholders. D) the put is in-the-money, is exercised, and the stockholders retain ownership. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 23-09 Combinations of Options Source : Chapter 23 Test Bank > TB 23-51 In relating stockholder value in terms of pu...

52) In relating stockholder value in terms of put options, the stockholders own the firm, they owe

promised payments to the bondholders, and they have bought a put on the firm's assets with an exercise price equal to the promised payment to the bondholders. If the firm's cash flow is less than these promised payments: 52) ______ A) the put is out-of-the-money, is not exercised, and the stockholders retain ownership. B) the put is out-of-the-money, is exercised, and the stockholders retain ownership. C) the put is in-the-money, is exercised, and the stockholders walk away from their promise to the bondholders. D) the put is in-the-money, is exercised, and the stockholders retain ownership. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 23-09 Combinations of Options Source : Chapter 23 Test Bank > TB 23-52 In relating stockholder value in terms of pu...

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53) When a firm in financial distress accepts very risky projects, the stockholders benefit at the

expense of the bondholders. In terms of option theory, the gain to the stockholders occurs because: 53) ______ A) the stock is a put option on the firm's assets, and risky projects decrease the exercise price of the option. B) the stock is a put option on the firm's assets, and risky projects increase the exercise price of the option. C) the stock is a call option on the firm's assets, and risky projects increase the volatility of those assets. D) the stock is a call option on the firm's assets, and risky projects decrease the volatility of those assets. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 23-09 Combinations of Options Source : Chapter 23 Test Bank > TB 23-53 When a firm in financial distress accepts ve...

54) An insight gained by bringing the theory of options into standard capital budgeting analysis

is: 54) ______ A) independent projects with positive NPVs should very often be rejected. B) independent projects with negative NPVs should very often be accepted. C) projects, as call options, can be more valuable if the decision to start up the project is

delayed until relevant information is released. D) projects, as call options, can be less valuable if the decision to start up the project is delayed until relevant information is released. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 23-10 Valuing Options Source : Chapter 23 Test Bank > TB 23-54 An insight gained by bringing the theory of ...

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55) If a firm with risky debt outstanding pays a large cash distribution, the value of the bonds: 55) ______ A) will be unaffected as payment is to the stockholders. B) will increase because the value of the call options increases. C) will increase because the value of the call option decreases. D) will decrease because the value of the put option will decrease. E) will decrease because the value of the put option will increase. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 23-09 Combinations of Options Source : Chapter 23 Test Bank > TB 23-55 If a firm with risky debt outstanding pays a...

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 56) Suppose a situation exists where you can purchase a share of stock for $25, purchase a put option on the stock for $3, and write a call option against the stock for $4. Also, suppose that holding these three positions guarantees a payoff of $30 one year from today. If the risk-free rate is 20%, does put-call parity hold? If not, then what new price of the put option would allow put-call parity to hold?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 23-07 Stock Option Quotations Source : Chapter 23 Test Bank > TB 23-56 Suppose a situation exists where you can pur...

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57) Use the Black-Scholes model to determine the option price for the May 35 call for Nibblers

as of April 18, 2015. The expiration date for this option is May 18, 2015. The annualized interest rate on a T-bill that matures that same day is 3.0%. Nibblers stock closed at 36. The historic variance for Nibblers is.25. Assume a 365 day year.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 23-07 Stock Option Quotations Source : Chapter 23 Test Bank > TB 23-57 Use the Black-Scholes model to determine the...

58) Use the Black-Scholes model to determine the option price for a call option which will expire

in one year. The strike price is $17.50, the stock pays no dividends and has a current market price of $20.00. The volatility of the stock has resulted in an annualized standard deviation of 10%. The interest rate on a T-bill that matures in one year is 7%.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 23-07 Stock Option Quotations Source : Chapter 23 Test Bank > TB 23-58 Use the Black-Scholes model to determine the...

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59) Explain how the value of a firm can be viewed as an option. How can the call and put views

be resolved?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 23-09 Combinations of Options Source : Chapter 23 Test Bank > TB 23-59 Explain how the value of a firm can be viewe...

60) Options can be used to explain how the choice of a project can determine investor value.

Options are also useful in evaluating alternatives open within a project choice, such as investing now or delaying. Give an example of how options can be used in investment timing.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 23-10 Valuing Options Source : Chapter 23 Test Bank > TB 23-60 Options can be used to explain how the choic...

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61) Suppose your wealthy Aunt Minnie has asked you to manage her large stock portfolio. You

would like to buy and/or sell options on many of the stocks she owns. Describe the types of options you would buy or sell, as well as your rationale, given the following circumstances: a. Aunt Minnie owns 10,000 shares of IBM common stock. You believe it is going to fall in price, but she won't let you sell it because her late husband told her never to let it go. How do you protect her from the impending price decline? b. Your analysis suggests that the common stock of Jet-Electro is poised to increase in value sharply over the next year. Aunt Minnie doesn't want to buy any of the stock but does want you to use options to profit if the price rises. What do you do? c. Although Aunt Minnie doesn't want you to sell any of the stocks she owns, she would like you to use options to generate a little extra income. How might you do this?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 23-02 Call Options Topic : 23-03 The Value of a Call Option at Expiration Source : Chapter 23 Test Bank > TB 23-61 Suppose your wealthy Aunt Minnie has asked y...

62) 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?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 23-09 Combinations of Options Source : Chapter 23 Test Bank > TB 23-62 Explain the rationale behind the statement t...

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63) What are the upper and lower bounds of an American call option? Explain what would

happen in each case if the bound was violated.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 23-07 Stock Option Quotations Source : Chapter 23 Test Bank > TB 23-63 What are the upper and lower bounds of an Am...

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

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38) D 39) D 40) C 41) D 42) A 43) D 44) B 45) B 46) A 47) E 48) C 49) A 50) A 51) A 52) C 53) C 54) C 55) E 56) Short Answer

Investment is $25 + $3 - $4 = $24. Guaranteed payoff = $30. Guaranteed return = ($24/$30) - 1 = 25% > 20%. P-C does not hold. The put price that would guarantee a return of 20% is $4. 57) Short Answer

d1 = {ln(36/35) + [.03 + (.5)(.25)] * (30/365)}/((.25)(30/365)).5 =.2854 d2 =.2854 - ((.25)(30/365)).5 =.1421 N(d1) =.6124; N(d1) =.5565 C = (36 * .6124) - 35e-(.030)(.082192) *.5565 = $2.75 58) Short Answer

d1 = [ln(20/17.5) + 0.07 + (0.5*(0.1^2))*1]/(SQRT((0.1^2)*1)) = (0.133531 + 0.075)/0.1 = 2.08531 d2 = 2.08531 - 0.1 = 1.98531 N(d1) = 0.9814796 N(d2) = 0.9764452 e^(-0.07*1) = 0.932394 Call = (20*0.98148) - (17.5*0.932394*0.97645) = 3.697 or $3.70 59) Short Answer

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Call - bondholders own firm - bondholders sold call to stockholders - stockholders exercise by paying debt amount Put - bondholders are owed interest and principal - bondholders sold put on the firm cash flow to stockholders - stockholders exercise put when cash flows less than amount owed Can be resolved by Put-Call Parity. These are equivalent positions; as the value of call rises, put falls and vice-versa. 60) Short Answer

- Every project can be viewed as an option--to invest or not to invest. If the NPV is positive, exercise the option to add value. - Timing of an investment can be critical to value--time is a positive factor to option value. - lengthening time to invest, delaying the choice until more information is revealed. - a negative NPV alternative may be clearly avoided or an alternative course of action presented. - Instructor should determine the reasonableness of an example. 61) Short Answer

Looking at each option, we see: a. To profit from an expected price decline, you can offset your loss (assuming you don't wish to simply sell the stock) by either buying puts or selling (writing) covered calls on the stock. In this case, you would probably buy puts and sell them before expiration. b. In this case, the obvious solution is to buy calls and hope to sell them at a higher price later. You could also write puts, but Aunt Minnie would be forced to buy shares if you are wrong about the direction of the price change. c. You could sell puts as long as you are willing to buy the underlying security if the market moves against you. You do not want to sell covered calls if you are unwilling to sell your shares if the option is exercised. You do not want to sell naked calls as they have unlimited risk. 62) Short Answer

The analogy only works for leveraged firms. At maturity of the firm's debt, the stockholders have the option to either pay the bondholders the par value of their debt or turn the firm's assets over to them. If the firm's assets are worth less than the par value of the debt, the stockholders will not exercise their call, that is, they will let the bondholders have the assets and the firm will be liquidated 63) Short Answer

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The upper bound on a call is the stock price. If the call price exceeded the stock price, you would be paying more for the option to buy an asset than the asset itself costs. The lower bound: C ≥ 0 if S - E < 0 and C ≥ (S - E) if (S - E) ≥ 0. In the first case, if the call exercise price exceeds the stock price, the call is out of the money and it will either be worthless or have a time premium. In the second case, if the call is in the money, the call must be worth at least the difference between the asset's value and the exercise price. If the call was worth less than this value, rational investors would purchase calls, immediately exercise them, and then sell the stock at the current market price, completing an arbitrage. If the stock price equals the exercise price, then the call is at the money and will have a value of zero or an amount equal to the time premium.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) The NPV approach must be: 1) ______ A) augmented by added analysis if there are a few embedded options. B) augmented by added analysis if a decision has significant embedded options. C) jettisoned if there are any embedded options. D) computed carefully to identify the options. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 24-01 Executive Stock Options Source : Chapter 24 Test Bank > TB 24-01 The NPV approach must be:

2) Options are granted to top corporate executives because: 2) ______ A) executives will make a better business decision in line with benefiting the

shareholders. B) executive pay is at risk and linked to firm performance. C) options are tax-efficient and taxed only when they are exercised. D) All of the choices are correct. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 24-01 Executive Stock Options Source : Chapter 24 Test Bank > TB 24-02 Options are granted to top corporate executi...

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3) Executives cannot exercise their options for a fixed period, this is the: 3) ______ A) investing period. B) freeze-out period. C) valuation period. D) guaranteed growth period. E) strike period. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 24-01 Executive Stock Options Source : Chapter 24 Test Bank > TB 24-03 Executives cannot exercise their options for...

4) The call option on a dividend-paying stock compared to a non-dividend-paying stock is: 4) ______ A) more valuable because of the extra dividend payment. B) equal in value because cash dividends are paid on stock. C) less valuable because cash dividends are paid on the stock. D) less valuable if the dividend paying stock is in-the-money while the non-dividend

paying stock if out-of-the-money. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 24-01 Executive Stock Options Source : Chapter 24 Test Bank > TB 24-04 The call option on a dividend-paying stock c...

5) If a project has optionality: 5) ______ A) the shorter the available life of the project the less valuable the project is. B) the longer the available life of the project the less valuable the project is. C) the shorter the available life of the project the more valuable the project is. D) available project life does not change optionality. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 24-02 Why Options? Source : Chapter 24 Test Bank > TB 24-05 If a project has optionality:

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6) Which of the following is not part of the Black Scholes option pricing model? 6) ______ A) Standard deviation B) Time to maturity C) Exercise price D) Par value of the company's stock Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 24-03 Executive Compensation: Where Are We Now? Source : Chapter 24 Test Bank > TB 24-06 Which of the following is not part of the Bl...

7) Corporations by rewarding executives with large option positions: 7) ______ A) cause the executives to hold highly undiversified portfolios. B) put the firm in a risky position to pay off the options. C) cause the value of the stock to fall because the options are theft. D) are really valueless because most options are never exercised. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 24-01 Executive Stock Options Source : Chapter 24 Test Bank > TB 24-07 Corporations by rewarding executives with la...

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8) Ima Greedy, the CFO of Financial Saving Techniques has been granted options on 200,000

shares. The stock is currently trading at $22 a share and the options are at the money. The volatility of the stock has been about 0.20 on an annual basis over the last several years. The option matures in 3 years and the risk-free rate is 4%. What is d1? 8) ______ A) .1842 B) .4102 C) .4583 D) 0.5196 E) .5412 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 24-01 Executive Stock Options Source : Chapter 24 Test Bank > TB 24-08 Ima Greedy, the CFO of Financial Saving Tech...

9) Ima Greedy, the CFO of Financial Saving Techniques has been granted options on 200,000

shares. The stock is currently trading at $22 a share and the options are at the money. The volatility of the stock has been about 0.20 on an annual basis over the last several years. The option matures in 3 years and the risk-free rate is 4%. What is d2? 9) ______ A) 0.0121 B) 0.0252 C) 0.1732 D) 0.0452 E) 0.0525 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 24-01 Executive Stock Options Source : Chapter 24 Test Bank > TB 24-09 Ima Greedy, the CFO of Financial Saving Tech...

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10) Ima Greedy, the CFO of Financial Saving Techniques has been granted options on 200,000

shares. The stock is currently trading at $22 a share and the options are at the money. The volatility of the stock has been about 0.20 on an annual basis over the last several years. The option matures in 3 years and the risk-free rate is 4%. Calculate N(d1). 10) ______ A) 0.5054 B) 0.6508 C) 0.6983 D) 0.7047 E) 0.8096 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 24-01 Executive Stock Options Source : Chapter 24 Test Bank > TB 24-10 Ima Greedy, the CFO of Financial Saving Tech...

11) Ima Greedy, the CFO of Financial Saving Techniques has been granted options on 200,000

shares. The stock is currently trading at $22 a share and the options are at the money. The volatility of the stock has been about 0.20 on an annual basis over the last several years. The option matures in 3 years and the risk-free rate is 4%. Calculate N(d2). 11) ______ A) 0.5688 B) 0.5278 C) 0.6085 D) 0.7085 E) 0.7142 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 24-01 Executive Stock Options Source : Chapter 24 Test Bank > TB 24-11 Ima Greedy, the CFO of Financial Saving Tech...

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12) Ima Greedy, the CFO of Financial Saving Techniques has been granted options on 200,000

shares. The stock is currently trading at $22 a share and the options are at the money. The volatility of the stock has been about 0.20 on an annual basis over the last several years. The option matures in 3 years and the risk-free rate is 4%. What is the value of a call option? 12) ______ A) $3.14 B) $5.86 C) $4.26 D) $5.62 E) $6.16 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 24-01 Executive Stock Options Source : Chapter 24 Test Bank > TB 24-12 Ima Greedy, the CFO of Financial Saving Tech...

13) Rejecting an investment today forever may not be a good choice because: 13) ______ A) the size of the firm will decline. B) there are always errors in the estimation of NPVs. C) the option value is negative. D) the company's foregoing the future rights or option to the investment. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 24-02 Why Options? Source : Chapter 24 Test Bank > TB 24-13 Rejecting an investment today forever may no...

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14) A financial manager who does not follow the general constraints of the NPV rule may: 14) ______ A) accept a negative project for fear of losing an investment opportunity. B) accept a marginally acceptable NPV project limiting the corporation's ability to

choose a competing project. C) option the project to another firm. D) not take a positive NPV project even if the NPV is adequate reward to forego the option. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 24-01 Executive Stock Options Source : Chapter 24 Test Bank > TB 24-14 A financial manager who does not follow the ...

15) The volatility of interest rates affects the value of the project by: 15) ______ A) increasing the value as volatility increase. B) increasing the value as volatility decrease. C) decreasing the value as volatility increase. D) Interest rate volatility does not affect value. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 24-02 Why Options? Source : Chapter 24 Test Bank > TB 24-15 The volatility of interest rates affects the...

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16) The risk-neutral probabilities for an asset, with a current value equal to the present value of

future payoffs, are: 16) ______ A) given by the probability of each state occurring. B) given by the value of the underlying asset under good news and the risk-free rate. C) given by the value of the underlying asset under good news and bad news. D) given by the value of the underlying asset under good news, bad news, and the risk-

free rate. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Hard Topic : 24-03 Executive Compensation: Where Are We Now? Source : Chapter 24 Test Bank > TB 24-16 The risk-neutral probabilities for an asset,...

17) What are u, the up-state multiplier, and d, the down-state multiplier, if there are monthly

intervals and the standard deviation is.38? 17) ______ A) 1.1159; 0.8961 B) 0.0317; 31.5789 C) 0.0317; 0.9683 D) 0.2193; 0.7807 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 24-03 Executive Compensation: Where Are We Now? Source : Chapter 24 Test Bank > TB 24-17 What are u, the up-state multiplier, and d, ...

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18) The Alger Co. operates a bauxite mine. The mine can produce 800,000 tons a year. The mine

is currently closed and will cost $12 million to open. When should the mine be opened? 18) ______ A) At a net bauxite price after extraction/production costs equal to $15.00 per ton before discounting and valuing extended options. B) At a net bauxite price after extraction/production costs greater than $15.00 per ton before discounting and valuing extended options. C) If the mineable bauxite is available then the mine should be open because the cash breakeven is less than $15.00 per ton. D) If mineable bauxite exists at any price close to $15.00 per ton if bauxite prices are high volatile. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 24-04 Valuing Executive Compensation Source : Chapter 24 Test Bank > TB 24-18 The Alger Co. operates a bauxite mine. The m...

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 19) Walter Maxim, the CEO of Digital Storage Devices has been granted options on 300,000 shares. The stock is currently trading at $27 a share and the options are at the money. The volatility of the stock has been about 0.15 on an annual basis over the last several years. The option matures in 5 years, becomes exercisable in 3 years, and the risk-free rate is 4%. What is the value of Mr. Maxim's options?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 24-01 Executive Stock Options Source : Chapter 24 Test Bank > TB 24-19 Walter Maxim, the CEO of Digital Storage Dev...

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20) Walter Maxim, the CEO of Digital Storage Devices has been granted options on 300,000

shares. The stock is currently trading at $27 a share and the options are at the money. The volatility of the stock has been about 0.15 on an annual basis over the last several years. The option matures in 5 years, becomes exercisable in 3 years, and the risk-free rate is 4%. If Mr. Maxim earned $500,000 in regular annual salary why might why might he prefer to have $1,500,000 in straight salary versus salary and options?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 24-01 Executive Stock Options Source : Chapter 24 Test Bank > TB 24-20 Walter Maxim, the CEO of Digital Storage Dev...

21) The CEO of NuValue was granted 1,000,000 options. The stock price at the time of the

granting of the options was $45 and the options are at the money. The risk-free rate was 5% and the options expire in 5 years. The variance on the stock is 0.04. What is the value of the options contract? If he had negotiated a larger salary and only 10,000 options, what would be the value of the options contract?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 24-02 Why Options? Source : Chapter 24 Test Bank > TB 24-21 The CEO of NuValue was granted 1,000,000 opt...

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22) The CFO of NuValue was granted 1,000,000 options. The stock price at the time of the

granting of the options was $20 and the options are at the money. The risk-free rate was 4% and the options expire in 5 years. The variance on the stock is 0.05. What is the value of her options contract? If she had negotiated a larger salary and only 10,000 options, what would be the value of the options contract?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 24-02 Why Options? Source : Chapter 24 Test Bank > TB 24-22 The CFO of NuValue was granted 1,000,000 opt...

23) The Nu-Tech Company has a new project available to it at a cost of $6 million. The project is

that they can sell 13,000 personal organizers at $172 in net cash flow for each of the next five years. Nu-Tech's discount rate is 15%. What is the NPV of the investment? The executives of Nu-Tech are concerned about the potential of future competition and a subsequent drop in sales and price. If after two years you can dispose of the asset for $1.0 million, at what price would it make sense to abandon the project?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 24-04 Valuing Executive Compensation Source : Chapter 24 Test Bank > TB 24-23 The Nu-Tech Company has a new project availa...

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24) Why would the company pay the executive in options as opposed to salary?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 24-01 Executive Stock Options Source : Chapter 24 Test Bank > TB 24-24 Why would the company pay the executive in o...

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Answer Key Test name: Chapter 24 1) B 2) D 3) B 4) C 5) A 6) D 7) A 8) D 9) C 10) C 11) A 12) C 13) D 14) B 15) A 16) D 17) A 18) B 19) Short Answer

Using B-S OPM, one C = 27(.74668) - 27 e-.20(.41992) = 10.88 Total Value = 300,000 (10.88) = $3,264,000 20) Short Answer

Mr. Maxim likely has a large portion of his wealth tied up in Digital Storage Devices. If he is in a very undiversified position and his pay-off is dependent on the firm stock doing well to make the options pay-off, he is exposed to a large amount of risk. If the stock price falls he will suffer a large decrease in wealth. Mr. Maxim must also wait the 3-year freeze-out period before exercising the options and while the price may rise it can also fall drastically. 21) Short Answer

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d1 = [.05 + (.50 ×.04)(5)]/√(.04)5 d1 = .35/.4472 = .7826 d2 = d1 - √σ2t = .7826 - √(.04)(5) = .7826 -.4472 = .3354 N(d1) = .50 +.2841 = .7841 N(d2) = .50 +.1314 = .6314 e-.05(5) = .7788 C = $45 (.7841) - $45(.7788)(.6314) = $35.2845 - $22.128 = $13.16 per share The value of the options contract for 1,000,000 options is 1,000,000($13.16) = $13,160,000 The value of the options contract for 10,000 options is 10,000($13.16) = $131,600 22) Short Answer

d1 = [.04 + (.50 ×.05)(5)]/√(.05)5 d1 = .3250/.50 = .65 d2 = d1 - √σ2t = .65 - √(.05)(5) = .65 -.50 = .15 N(d1) = .50 +.2422 = .7422 N(d2) = .50 +.0596 = .5596 e-.04(5) = .8187 C = $20 (.7422) - $20(.5596)(.8187) = $14.844 - $9.1629 = $5.68 per share The value of the options contract for 1,000,000 options is 1,000,000($5.68) = $5,680,000 The value of the options contract for 10,000 options is 10,000($5.68) = $56,800 23) Short Answer

NPV = -6,000,000 + (13,000 × 172) A.15,5 = -6,000,000 + 7,495,418.80 = 1,495,418.80 Abandon: 0 = -6,000,000 + 2,236,000 * A.15,2 + 1,000,000 * (1/1.15)2 + X (A.15,3)(1/1.15)2 X = 800,627.60; if they sell 13,000 units they should abandon the project if the price drops below $61.59 in years three and out. 24) Short Answer

There are several benefits to paying executives in options including alignment of executive and shareholder interest, reduced fixed cost of salary, aligning incentive to increase performance visà-vis stock price by lacing their pay at risk if the stock price does not rise, and delayed compensation. Finally, options are a tax-efficient way to pay employees. Currently, the money options are not considered taxable income, a huge incentive for the executive in a high tax bracket. The taxes are incurred when the options are exercised, thus giving a delay and choice in the timing of tax incurrence.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) A warrant gives the owner: 1) ______ A) the obligation to sell securities directly to the firm at a fixed price for a specified time. B) the right to purchase securities directly from the firm at a fixed price for a specified time. C) the obligation to purchase securities directly from the firm at a fixed price for a specified time. D) the right to sell securities directly to the firm at a fixed price for a specified time. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 25-01 Warrants Source : Chapter 25 Test Bank > TB 25-01 A warrant gives the owner:

2) Warrants are most often issued in combination with: 2) ______ A) new publicly placed common stock. B) new privately placed common stock. C) new publicly placed debt. D) new privately placed debt. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 25-01 Warrants Source : Chapter 25 Test Bank > TB 25-02 Warrants are most often issued in combinatio...

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3) An "equity kicker" most often refers to a: 3) ______ A) bond with conversion privileges. B) preferred stock offering with conversion privileges. C) warrant. D) lettered common stock. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 25-01 Warrants Source : Chapter 25 Test Bank > TB 25-03 An "equity kicker" most often refers to a:

4) Bright View Windows issued warrants with an exercise price of $17 for one share per

warrant. On May 1, Bright View's common stock is at $20 per share. The lower and upper limits on the warrant value on May 1 are: 4) ______ A) $0 and $17. B) $17 and $20. C) $3 and $17. D) $0 and $3. E) $3 and $20. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 25-01 Warrants Source : Chapter 25 Test Bank > TB 25-04 Bright View Windows issued warrants with an ...

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5) Which of the following would not describe the difference between warrants and call options? 5) ______ A) Warrants are issued by firms whereas call options are issued by individuals. B) Call options have an exercise price whereas warrants do not. C) Exercising of warrants creates dilution whereas exercising all options does not. D) When call options are exercised existing shares trade hands whereas if warrants are

exercised new stock must be issued. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 25-02 The Difference Between Warrants and Call Options Source : Chapter 25 Test Bank > TB 25-05 Which of the following would not describe th...

6) Diamond Drill Inc. has 150,000 shares and 15,000 warrants outstanding. A warrant holder

can purchase a new share of stock for five warrants and $5 per warrant. The stock is currently selling for $27 per share. If all warrants are exercised, what will your fraction of ownership be if you owned 20,000 shares originally? 6) ______ A) 13.33% B) 12.12% C) 13.07% D) 14.04% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 25-03 How the Firm Can Hurt Warrant Holders Source : Chapter 25 Test Bank > TB 25-06 Diamond Drill Inc. has 150,000 shares and 15...

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7) Diamond Drill Inc. has 150,000 shares and 15,000 warrants outstanding. A warrant holder

can purchase a new share of stock for five warrants and $5 per warrant. The stock is currently selling for $27 per share. If the warrants are all exercised immediately, what would be the market price of the stock? 7) ______ A) $27.00 B) $22.78 C) $25.13 D) $26.96 E) $29.00 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 25-03 How the Firm Can Hurt Warrant Holders Source : Chapter 25 Test Bank > TB 25-07 Diamond Drill Inc. has 150,000 shares and 15...

8) Diamond Drill Inc. has 150,000 shares and 15,000 warrants outstanding. A warrant holder

can purchase a new share of stock for five warrants and $5 per warrant. The stock is currently selling for $27 per share. What would your gain be from exercising the warrants, assuming all are exercised? 8) ______ A) $2.00 per share B) $1.96 per share C) $0.00 per share D) $25.00 per share E) $27.00 per share Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 25-03 How the Firm Can Hurt Warrant Holders Source : Chapter 25 Test Bank > TB 25-08 Diamond Drill Inc. has 150,000 shares and 15...

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9) A firm has 100 shares of stock and 40 warrants outstanding. The warrants are about to expire,

and all of them will be exercised. The market value of the firm's assets is $2,000, and the firm has no debt. Each warrant gives the owner the right to buy 2 shares at $15 per share. What is the price per share of the stock after dilution? 9) ______ A) $15.00 B) $17.78 C) $11.11 D) $20.00 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 25-03 How the Firm Can Hurt Warrant Holders Source : Chapter 25 Test Bank > TB 25-09 A firm has 100 shares of stock and 40 warran...

10) Concerning warrants and call options, which of the following statements generally is correct? 10) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 25-02 The Difference Between Warrants and Call Options Source : Chapter 25 Test Bank > TB 25-10 Concerning warrants and call options, which ...

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11) Which of the following would harm the position of a warrant holder? 11) ______ A) A stock split of 3 for 1. B) A large stock dividend of 20%. C) A large cash dividend. D) Listing of the warrants on the NYSE. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 25-03 How the Firm Can Hurt Warrant Holders Source : Chapter 25 Test Bank > TB 25-11 Which of the following would harm the positi...

12) The exercise of warrants creates new shares which: 12) ______ A) increases the total number of shares but does not affect share value. B) increases the total number of shares which reduces the individual share value. 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 25-03 How the Firm Can Hurt Warrant Holders Source : Chapter 25 Test Bank > TB 25-12 The exercise of warrants creates new shares ...

13) If a corporate security can be exchanged for a fixed number of shares of stock, the security is

said to be: 13) ______ A) callable. B) convertible. C) protected. D) putable. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 25-04 Warrant Pricing and the Black-Scholes Model (Advanced) Source : Chapter 25 Test Bank > TB 25-13 If a corporate security can be exchanged for...

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14) The holders of Mikayla Corporation's bond with a face value of $1,000 can exchange that

bond for 30 shares of stock. The stock is selling for $25.00. What is the conversion price? 14) ______ A) $25.00 B) $33.33 C) $35.00 D) $1,000.00 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 25-04 Warrant Pricing and the Black-Scholes Model (Advanced) Source : Chapter 25 Test Bank > TB 25-14 The holders of Mikayla...

15) The holders of Mikayla Corporation's bond with a face value of $1,000 can exchange that

bond for 30 shares of stock. The stock is selling for $25.00. What is the conversion premium? 15) ______ A) 10.00% B) 27.58% C) 33.33% D) 103.23% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 25-04 Warrant Pricing and the Black-Scholes Model (Advanced) Source : Chapter 25 Test Bank > TB 25-15 The holders of Mikayla...

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16) The holders of Mikayla Corporation's bond with a face value of $1,000 can exchange that

bond for 30 shares of stock. The stock is selling for $25.00. What would the conversion price and conversion ratio be if Mikayla had a 4 for 1 stock split? 16) ______ A) $5.33; 75 B) $8.33; 120 C) $22.00; 125 D) $27.50; 135 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 25-04 Warrant Pricing and the Black-Scholes Model (Advanced) Source : Chapter 25 Test Bank > TB 25-16 The holders of Mikayla...

17) The holder of a $1,000 face value bond has the right to exchange the bond anytime before

maturity for shares of stock priced at $50 per share. The $50 is called the: 17) ______ A) conversion price. B) stated price. C) exercise price. D) striking price. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 25-05 Convertible Bonds Source : Chapter 25 Test Bank > TB 25-17 The holder of a...

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18) The holder of a $1,000 face value bond can exchange the bond any time for 25 shares of

stock. The conversion price is: 18) ______ A) $25. B) $40. C) $100. D) $20. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 25-05 Convertible Bonds Source : Chapter 25 Test Bank > TB 25-18 The holder of a...

19) The holder of a $1,000 face value bond can exchange the bond any time for 25 shares of

stock. The conversion ratio is: 19) ______ A) 40. B) 25. C) 100. D) 50 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 25-05 Convertible Bonds Source : Chapter 25 Test Bank > TB 25-19 The holder of a...

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20) The holders of Xenron Corporation's bond with a face value of $1,000 can exchange that

bond for 35 shares of stock. The stock is selling for $22.00. What is the conversion price? 20) ______ A) $35.57 B) $770.00 C) $28.57 D) $1,000.00 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 25-05 Convertible Bonds Source : Chapter 25 Test Bank > TB 25-20 The holders of Xenron...

21) The holders of Xenron Corporation's bond with a face value of $1,000 can exchange that

bond for 35 shares of stock. The stock is selling for $22.00. What is the conversion premium? 21) ______ A) 29.87%. B) 106.61%. C) 0.00%. D) 59.01%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 25-05 Convertible Bonds Source : Chapter 25 Test Bank > TB 25-21 The holders of Xenron...

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22) The holders of Xenron Corporation's bond with a face value of $1,000 can exchange that

bond for 35 shares of stock. The stock is selling for $22.00. What would the conversion price and conversion ratio be if Xenron had a 3 for 1 stock split? 22) ______ A) $22; 25 B) $28.57; 35 C) $9.52; 105 D) $7.33; 75 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 25-05 Convertible Bonds Source : Chapter 25 Test Bank > TB 25-22 The holders of Xenron...

23) The holders of Xenron Corporation's bond with a face value of $1,000 can exchange that

bond for 35 shares of stock. The stock is selling for $22.00. What is the conversion value of the bond? 23) ______ A) $25 B) $770 C) $40 D) $1000 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 25-05 Convertible Bonds Source : Chapter 25 Test Bank > TB 25-23 The holders of Xenron...

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24) A convertible bond has an 8% coupon and 15 years to maturity. The face value is $1,000 and

the conversion ratio is 40. The stock currently sells for $20.875 per share. Similar nonconvertible bonds are priced to yield 9%. The value of the convertible bond is at least: 24) ______ A) $835.00. B) $919.39. C) $1,000.00. D) $1,570.11. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 25-05 Convertible Bonds Source : Chapter 25 Test Bank > TB 25-24 A convertible bond has an...

25) A convertible bond has a 7% coupon and 10 years to maturity. The face value is $1000 and

the conversion ratio is 35. The stock currently sells for $27.375 per share. Similar nonconvertible bonds are priced to yield 9%. The value of the convertible bond is at least: 25) ______ A) $869.92. B) $958.125. C) $1,000.00. D) $1,325.20. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 25-05 Convertible Bonds Source : Chapter 25 Test Bank > TB 25-25 A convertible bond has a...

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26) A convertible bond is selling for $800. It has 10 years to maturity, a $1000 face value, and a

10% coupon. Similar nonconvertible bonds are priced to yield 14%. The conversion price is $50 per share. The stock currently sells for $31.375 per share. The conversion premium is: 26) ______ A) 37.25%. B) 43.33%. C) 59.36%. D) 66.67%. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 25-05 Convertible Bonds Source : Chapter 25 Test Bank > TB 25-26 A convertible bond is selling for...

27) Concerning convertible bonds, which of the following statements is not correct? 27) ______ A) The value of a convertible bond will generally be greater than its straight bond value. B) The value of a convertible bond will generally be greater than its conversion value. C) The difference between the conversion value and the straight bond value is the

conversion or option premium. D) The coupon rate on a nonconvertible bond will generally exceed the coupon rate on an otherwise identical convertible bond. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 25-05 Convertible Bonds Source : Chapter 25 Test Bank > TB 25-27 Concerning convertible bonds, which of the f...

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28) Concerning convertible bonds, which of the following statements is not correct? 28) ______ A) A convertible bond issue would generally have fewer restrictive covenants than an

otherwise identical nonconvertible bond. B) Convertible bonds can be issued at a lower coupon compared with otherwise nonconvertible bonds. C) If the value of a convertible bond exceeds the maximum of its straight bond value or its conversion value, the difference would be referred to as the option value. D) Since convertible bonds will be exchanged for common stock, convertible bonds are generally not callable. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 25-05 Convertible Bonds Source : Chapter 25 Test Bank > TB 25-28 Concerning convertible bonds, which of the f...

29) A convertible bond has an option value that is equal to: 29) ______ A) the market value of the convertible bond minus the straight bond value. B) the market value of the convertible bond minus the conversion value. C) the market value of the convertible bond minus the conversion premium. D) the market value of the convertible bond minus the maximum of the straight bond

value or conversion value. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 25-05 Convertible Bonds Source : Chapter 25 Test Bank > TB 25-29 A convertible bond has an option value that ...

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30) A firm has experienced a significant increase in share value. In retrospect, which of the

following securities would have been best to have issued prior to the change in share value? 30) ______ A) Common stock B) Bond/warrant package C) Convertible preferred stock D) Straight bonds E) Convertible bonds Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 25-06 The Value of Convertible Bonds Source : Chapter 25 Test Bank > TB 25-30 A firm has experienced a significant increas...

31) A firm has experienced a significant decrease in share value. In retrospect, which of the

following securities would have been best to have issued prior to the change in share value? 31) ______ A) Convertible bonds B) Convertible preferred stock C) Common stock D) Straight debt Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 25-06 The Value of Convertible Bonds Source : Chapter 25 Test Bank > TB 25-31 A firm has experienced a significant decreas...

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32) Issuing convertible bonds or bonds with warrants is useful for a company of unknown risk

because: 32) ______ A) the effects of risk are opposite on the two value components and tend to cancel each

other out. B) if the firm is high risk, the option premium will be higher while the straight bond value is fixed. C) only risky companies issued these instruments. D) the equity value is dependent on current risks only, not the future risk at conversion. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 25-07 Straight Bond Value Source : Chapter 25 Test Bank > TB 25-32 Issuing convertible bonds or bonds with warr...

33) Transfer or expropriation of wealth from bondholders to stockholders is less likely to occur

when: 33) ______ A) subordinated straight debt is issued because there are other senior bondholders to

protect them. B) convertible debt is issued because the equity component will reduce these agency costs when value is shared. C) convertible debt is issued because the holders can more readily sue when a high-risk project is under taken. D) subordinated debt because monitoring is much easier with subordinated straight debt is issued. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 25-07 Straight Bond Value Source : Chapter 25 Test Bank > TB 25-33 Transfer or expropriation of wealth from bon...

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34) From the shareholder's point of view, the optimum time to call a convertible bond is when

the bond's conversion value is: 34) ______ A) less than the call price, but greater than the face value. B) greater than the call price, but less than straight debt's value. C) equal to the face value. D) less than straight debt's value, but greater than the call price. E) none of these options are correct. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 25-07 Straight Bond Value Source : Chapter 25 Test Bank > TB 25-34 From the shareholder&#39;s point of...

35) Based on empirical studies, firms tend to call convertible bonds when the conversion value

is: 35) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 25-07 Straight Bond Value Source : Chapter 25 Test Bank > TB 25-35 Based on empirical studies, firms tend to ca...

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36) Which of the following would not be a sensible explanation of why convertibles and warrants

are issued if markets are efficient? 36) ______ A) Cash flow from these securities best match cash flow of the firm. B) If the firm does well, convertible bonds will turn out to have been the better

alternative versus issuing common stock. 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 25-06 The Value of Convertible Bonds Source : Chapter 25 Test Bank > TB 25-36 Which of the following would not be a sensib...

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 37) A firm has 500 shares of stock and 100 warrants outstanding. The warrants are about to expire, and all of them will be exercised. The market value of the firm's assets is $25,000, and the market value of the debt is $8,000. Each warrant gives the owner the right to buy 5 shares at $25 per share. What is the value of a warrant?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 25-03 How the Firm Can Hurt Warrant Holders Source : Chapter 25 Test Bank > TB 25-37 A firm has 500 shares of stock and 100 warra...

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38) A firm has 2,000 shares of stock and 200 warrants outstanding. The warrants are about to

expire, and all of them will be exercised. The market value of the firm's assets is $14,000, and the firm has no debt. Each warrant gives the owner the right to buy 1 share at $5. What is the warrant's effective exercise price?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 25-03 How the Firm Can Hurt Warrant Holders Source : Chapter 25 Test Bank > TB 25-38 A firm has 2,000 shares of stock and 200 war...

39) Kida Consultants has 100,000 shares of stock outstanding. The firm's value net of debt is $2

million. Kida 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.

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40) Kida Consultants currently has 300,000 shares of common outstanding. Firm value net of

debt is $3,900,000. Kida 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 $8.25?

41) A convertible bond is selling for $993. It has 15 years to maturity, a $1,000 face value, and

an 8% coupon paid semi-annually. Similar non-convertible bonds are priced to yield 8.5%. The conversion ratio is 20. The stock currently sells for $47.50 per share. Calculate the convertible bond's option value.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 25-04 Warrant Pricing and the Black-Scholes Model (Advanced) Source : Chapter 25 Test Bank > TB 25-41 A convertible bond is selling for...

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42) A convertible bond is selling for $1222.70. It has 10 years to maturity, a $1,000 face value,

and a 10% coupon paid semi-annually. Similar non-convertible bonds are priced to yield 8%. The conversion ratio is 40. The stock currently sells for $30.125 per share. Calculate the convertible bond's option value.

43) A bond/warrant package is priced to sell at face value ($1,000). Each bond comes with 50

detachable warrants. A warrant gives the owner the right to buy 1 share of stock at $20 per share. The value of a warrant has been estimated at $2. The bonds mature in 20 years. Similar bonds without warrants yield 10%. What is the bond's annual coupon?

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44) A convertible bond is selling for $800. It has 10 years to maturity, a $1000 face value, and a

10% coupon paid semi-annually. Similar nonconvertible bonds are priced to yield 14%. The conversion price is $50 per share. The stock currently sells for $31.375 per share. Determine the bond's option premium.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 25-04 Warrant Pricing and the Black-Scholes Model (Advanced) Source : Chapter 25 Test Bank > TB 25-44 A convertible bond is selling for...

45) Explain why there is neither a "Free" nor "Expensive Lunch" when convertible bonds are

issued?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 25-06 The Value of Convertible Bonds Source : Chapter 25 Test Bank > TB 25-45 Explain why there is neither a Free nor...

46) Illustrate and explain how a convertible bond value is based on both debt and equity value.

What is the option value?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 25-04 Warrant Pricing and the Black-Scholes Model (Advanced) Source : Chapter 25 Test Bank > TB 25-46 Illustrate and explain how a convertible bon...

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47) Why are warrants and convertibles issued?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 25-06 The Value of Convertible Bonds Source : Chapter 25 Test Bank > TB 25-47 Why are warrants and convertibles issued?

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

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Value of a warrant to buy 1 share = {[($25,000 - $8,000) + $12,500]/1,000} - $25 + > $4.50 Value of a warrant to buy 5 shares = $4.50 * 5 + > $23.50 38) Short Answer

Value of the warrant = {[$14,000 + $1,000]/2,200} - $5.00 + > $1.82 Solve for the exercise price: $1.82 = (2,000/2,200) [(14,000/2,000) - Ex] => Ex = $5.00 39) Short Answer

(100,000/101,000) [(2,000,000/100,000) - $18] => $1.98 40) Short Answer

[300,000/(300,000 + X)] * $13.00 = $8.25 => X = 172,727. 41) Short Answer

Value of the Straight Bond = $958.05, s.a. pricing Value of the bond converted today = 20 * $47.50 => $950.00 The option value must be $993 - $958.05 = $34.95 42) Short Answer

Value of the Straight Bond = $1135.90 Value of the bond converted today = 40 * $30.125 = $1205.00 The option value must be $1222.7 - $1205.00 = $17.70 43) Short Answer

Set the price of bond/warrant package equal to the value of the straight bond plus the warrant value and solve for the coupon: $1,000 = Coupon x A20,.10 + 1000/(1.1)20 + (50 × 2) = Coupon = $88.25 44) Short Answer

Minimum Value: greater of CV = 20 * 31.375 = $627.50 or B0 = 50 * A.07,20 + 1000 PV.07,20 = $788.12 Option Premium = 800 - 788.12 = $11.88 45) Short Answer

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- Convertible bonds are no cheaper or expensive in an efficient market. - Must compare an equivalent basis in up and down market. - convertible debt versus straight debt - convertible debt versus common stock - not only one in each market condition - No single alternative will dominate convertibles in both markets. 46) Short Answer

The option value is the difference between market price and the highest conversion value or straight bond value. Indicated on diagrams (see Figure 25.3). 47) Short Answer

Warrants and convertibles are issued to add flexibility to the financial structure of the firm. In Section 25.6, there is a discussion of how these instruments will help with matching cash flows, matching risks of another company and reduction of agency costs. Finally, the use of convertibles as backdoor equity is a popular theory.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) A derivative is a financial instrument whose value is determined by: 1) ______ A) a regulatory body such as the FTC. B) a primitive or underlying asset. C) hedging a risk. D) hedging a speculation. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 26-02 The Impact of Financial Risk: The Credit Crisis of 2007-2009 Source : Chapter 26 Test Bank > TB 26-01 A derivative is a financial instrument whose...

2) Derivatives can be used to either hedge or speculate. These actions: 2) ______ 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 risk by speculating and increase risk by hedging. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 26-02 The Impact of Financial Risk: The Credit Crisis of 2007-2009 Source : Chapter 26 Test Bank > TB 26-02 Derivatives can be used to either hedge or s...

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3) A forward contract is described by: 3) ______ A) agreeing today to buy a product at a later date at a price to be set in the future. B) agreeing today to buy a product today at its current price. C) agreeing today to buy a product at a later date at a price set today. D) agreeing today to buy a product if and only if its price rises above the exercise price

today at its current price. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 26-02 The Impact of Financial Risk: The Credit Crisis of 2007-2009 Source : Chapter 26 Test Bank > TB 26-03 A forward contract is described by:

4) The buyer of a forward contract: 4) ______ A) will be taking delivery of the good(s) today at today's price. B) will be making delivery of the good(s) at a later date at that date's price. C) will be making delivery of the good(s) today at today's price. D) will be taking delivery of the good(s) at a later date at a pre-specified price. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 26-02 The Impact of Financial Risk: The Credit Crisis of 2007-2009 Source : Chapter 26 Test Bank > TB 26-04 The buyer of a forward contract:

5) The main difference between a forward contract and a cash transaction is: 5) ______ A) only the cash transaction creates an obligation to perform. B) a forward is performed at a later date while the cash transaction is performed

immediately. C) only one involves a deliverable instrument. D) neither allows for hedging. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 26-02 The Impact of Financial Risk: The Credit Crisis of 2007-2009 Source : Chapter 26 Test Bank > TB 26-05 The main difference between a forward contra...

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6) In the practical use of credit default swaps, there: 6) ______ A) is no organized exchange or template for the agreement. B) is an organized exchange or template for the agreement. C) are laws making them illegal in Canada. D) are limits to the amount of borrowing of both parties. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 26-07 Interest Rate Futures Contracts Source : Chapter 26 Test Bank > TB 26-06 In the practical use of credit default swaps...

7) You have taken a short position in a futures contract on corn at $2.60 per bushel. Over the

next 5 days, the contract settled at $2.52, $2.57, $2.62, $2.68, $2.70. You then decide to reverse your position in the futures market on the fifth day at the close. What is the net amount you receive at the end of 5 days? 7) ______ A) $2.70 B) $2.60 C) $2.80 D) $0.00 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 26-03 Forward Contracts Source : Chapter 26 Test Bank > TB 26-07 You have taken a short position in a futures...

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8) You have taken a short position in a futures contract on corn at $2.60 per bushel. Over the

next 5 days, the contract settled at $2.52, $2.57, $2.62, $2.68, $2.70. Before you can reverse your position in the futures market on the fifth day you are notified to accept delivery. What will you receive on delivery and what is the net amount you receive in total? 8) ______ A) $2.60; $2.70 B) $2.70; -$0.10 C) $2.70; $2.60 D) $2.60; $0.10 E) $2.60; -$0.10 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 26-03 Forward Contracts Source : Chapter 26 Test Bank > TB 26-08 You have taken a short position in a futures...

9) If you bought a futures contract for $2.60 per bushel and the contract ended at $2.70 after

several days of trading of $2.52, $2.57, $2.62, $2.68, and $2.70. What would the mark-tomarket sequence be? 9) ______ A) -.08,.05,.05,.06,.02 B) B..08, -.05, -.05, -.06, -.02 C) C..08,.03, -.02, -.06, -.10 D) -.08, -.03,.02,.06,.10 E) E..10 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 26-03 Forward Contracts Source : Chapter 26 Test Bank > TB 26-09 If you bought a futures contract for...

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10) Suppose you agree to purchase one ounce of gold for $382 any time over the next month.

The current price of gold is $380. The spot price of gold then falls to $377 the next day. If the agreement is represented by a futures contract marking to market daily as the price changes, what is your cash flow at the end of the business on the next day? 10) ______ A) $0.00. B) $3.00. C) $5.00. D) -$3.00. E) -$5.00. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 26-03 Forward Contracts Source : Chapter 26 Test Bank > TB 26-10 Suppose you agree to purchase one ounce of g...

11) On March 1, your contract to take delivery of 1 ounce of gold for $415. The agreement is

good for any day up to April 1. Throughout March, the price of gold hit a low of $385 and hit a high of $435. The price settled on March 31 at $420, and on April 1st you settle your futures agreement at that price. Your net cash flow is: 11) ______ A) -$30.00. B) $20.00. C) $5.00. D) -$15.00. E) -$20.00. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 26-03 Forward Contracts Source : Chapter 26 Test Bank > TB 26-11 On March 1, your contract to take delivery o...

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12) A futures contract on gold states that buyers and sellers agree to make or take delivery of an

ounce of gold for $400 per ounce. The contract expires in 3 months. The current price of gold is $350 per ounce. If the price of gold rises and continues to rise by $1 every day over the 3 month period, then when the contract is settled, the buyer will _____ and the seller will ____. 12) ______ A) lose; gain B) gain; lose C) gain; break even D) gain; gain E) lose; lose Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 26-03 Forward Contracts Source : Chapter 26 Test Bank > TB 26-12 A futures contract on gold states that buyer...

13) On March 1, your contract to take delivery of 1 ounce of gold for $495. The agreement is

good for any day up to April 1. Throughout March, the price of gold hit a low of $425 and hit a high of $535. The price settled on March 31 at $505, and on April 1st you settle your futures agreement at that price. Your net cash flow is: 13) ______ A) -$30. B) -$20. C) -$15. D) $10. E) $20. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 26-03 Forward Contracts Source : Chapter 26 Test Bank > TB 26-13 On March 1, your contract to take delivery o...

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14) Suppose you agree to purchase one ounce of gold for $984 any time over the next month.

The current price of gold is $970. The spot price of gold then falls to $960 the next day. If the agreement is represented by a futures contract marking to market daily as the price changes, what is your cash flow at the end of the next business day? 14) ______ A) $10 B) $5 C) $0 D) -$5 E) -$10 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 26-03 Forward Contracts Source : Chapter 26 Test Bank > TB 26-14 Suppose you agree to purchase one ounce of g...

15) Credit default swaps: 15) ______ A) will pay the holder the LIBOR interest rate. B) pay the borrower the LIBOR interest rate. C) are like insurance against a loss of value if the firm defaults on a bond. D) limit the amount of borrowing of all parties in the credit default swap. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 26-07 Interest Rate Futures Contracts Source : Chapter 26 Test Bank > TB 26-15 Credit default swaps:

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16) There are always _______ counterparties in a credit default swap. 16) ______ A) zero B) one C) two D) three Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 26-07 Interest Rate Futures Contracts Source : Chapter 26 Test Bank > TB 26-16 There are always _______ counterparties in a...

17) If the producer of a product has entered into a fixed price sale agreement for that output, the

producer faces: 17) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 26-04 Futures Contracts Source : Chapter 26 Test Bank > TB 26-17 If the producer of a product has entered int...

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18) You hold a forward contract to take delivery of Government of Canada bonds in 9 months. If

the entire term structure of interest rates shifts down over the 9-month period, the value of the forward contract will have _____ on the date of delivery. 18) ______ A) risen B) fallen C) not changed D) either risen or fallen, depending on the maturity of the T-bond E) collapsed Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 26-05 Hedging Source : Chapter 26 Test Bank > TB 26-18 You hold a forward contract to take delivery...

19) Two key features of futures contracts that make them more in demand than the forward

contracts are: 19) ______ A) futures are traded on exchanges and must be marked to the market. B) futures contracts allow flexibility in delivery dates and provide a liquid market for

netting positions. C) futures are marked to the market and allow delivery flexibility. D) futures are traded in liquid markets and are marked to the market. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 26-03 Forward Contracts Source : Chapter 26 Test Bank > TB 26-19 Two key features of futures contracts that m...

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20) If rates in the market fall between now and one month from now, the mortgage banker: 20) ______ A) loses as the mortgages are sold at a discount. B) gains as the mortgages are sold at a discount. C) loses as the mortgages are sold at a premium. D) gains as the mortgages are sold at a premium. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 26-05 Hedging Source : Chapter 26 Test Bank > TB 26-20 If rates in the market fall between now and ...

21) To protect against interest rate risk, the mortgage banker should: 21) ______ A) buy futures, as this position will hedge loses 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 26-05 Hedging Source : Chapter 26 Test Bank > TB 26-21 To protect against interest rate risk, the m...

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22) A bank has a $50 million mortgage bond risk position which it hedges in the Treasury bond

futures markets at the Chicago Board of Trade. Approximately how many contracts are needed to be held in the hedge? 22) ______ A) 5 contracts. B) 50 contracts. C) 500 contracts. D) 5,000 contracts. E) 50,000 contracts. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 26-03 Forward Contracts Source : Chapter 26 Test Bank > TB 26-22 A bank has a $50 million...

23) A mortgage banker had made loan commitments for $10 million in 3 months. How many

contracts on Treasury bonds futures must the banker write or buy? 23) ______ A) Go short 10. B) Go short 100. C) Go long 10. D) Go long 100. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 26-05 Hedging Source : Chapter 26 Test Bank > TB 26-23 A mortgage banker had made loan commitments ...

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24) Hedging in the futures markets can reduce all risks if: 24) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 26-05 Hedging Source : Chapter 26 Test Bank > TB 26-24 Hedging in the futures markets can reduce al...

25) Comparing long-term bonds with short-term bonds, long-term bonds are _____ volatile and

therefore experience _____ price change compared with short-term bonds for the same interest rate shift. 25) ______ A) less; less B) less; more C) more; more D) more; less E) more; the same Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 26-06 Hedging with Futures versus Hedging with Options Source : Chapter 26 Test Bank > TB 26-25 Comparing long-term bonds with short-term bo...

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26) Duration of a pure discount bond: 26) ______ A) is equal to its half-life. B) is less than a zero-coupon bond. C) is equal to the liabilities hedged. D) equal to its maturity. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 26-06 Hedging with Futures versus Hedging with Options Source : Chapter 26 Test Bank > TB 26-26 Duration of a pure discount bond:

27) In percentage terms, higher coupon bonds experience a ______ price change compared with

lower coupon bonds of the same maturity given a change in yield to maturity. 27) ______ A) greater B) smaller C) similar D) smaller or greater Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 26-06 Hedging with Futures versus Hedging with Options Source : Chapter 26 Test Bank > TB 26-27 In percentage terms, higher coupon bonds exp...

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28) A bond manager who wishes to hold the bond with the greatest potential volatility would

wise to hold: 28) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 26-06 Hedging with Futures versus Hedging with Options Source : Chapter 26 Test Bank > TB 26-28 A bond manager who wishes to hold the bond w...

29) The duration of a 2-year annual 10% bond that is selling for par is: 29) ______ A) 2.00 years B) 1.00 years C) 1.91 years D) 2.09 years Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 26-06 Hedging with Futures versus Hedging with Options Source : Chapter 26 Test Bank > TB 26-29 The duration of a 2-year annual...

30) The duration of a 15-year zero coupon bond priced at $182.70 is: 30) ______ A) 15 years. B) 2.74 years. C) 17.74 years. D) Cannot determine without the interest rate. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 26-06 Hedging with Futures versus Hedging with Options Source : Chapter 26 Test Bank > TB 26-30 The duration of a 15-year zero coupon bond p...

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31) Duration is a measure of: 31) ______ A) the yield to maturity of a bond. B) the coupon yield of a bond. C) the price of a bond. D) the effective maturity of a bond. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 26-06 Hedging with Futures versus Hedging with Options Source : Chapter 26 Test Bank > TB 26-31 Duration is a measure of:

32) A set of bonds all have the same maturity. Which one has the least percentage price changes

for given shifts in interest rates: 32) ______ A) zero coupon bonds. B) high coupon bonds. C) low coupon bonds. D) pure discount bonds. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 26-06 Hedging with Futures versus Hedging with Options Source : Chapter 26 Test Bank > TB 26-32 A set of bonds all have the same maturity. W...

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33) A financial institution can hedge its interest rate risk by: 33) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 26-06 Hedging with Futures versus Hedging with Options Source : Chapter 26 Test Bank > TB 26-33 A financial institution can hedge its intere...

34) A pure discount bond pays: 34) ______ A) no coupons, therefore its duration equal to its maturity. B) discounted coupons, therefore its duration is greater than its maturity. C) level coupons, therefore its duration is equal to its maturity. D) declining coupons, therefore its duration is less than its maturity. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 26-06 Hedging with Futures versus Hedging with Options Source : Chapter 26 Test Bank > TB 26-34 A pure discount bond pays:

35) Duration of a coupon paying bond with the same maturity is: 35) ______ A) equal to its number of payments. B) less than a zero-coupon bond. C) equal to the zero-coupon bond. D) equal to its maturity. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 26-06 Hedging with Futures versus Hedging with Options Source : Chapter 26 Test Bank > TB 26-35 Duration of a coupon paying bond with the sa...

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36) Calculate the duration of a 4-year $1,000 face value bond, which pays 8% coupons annually

throughout maturity and has a yield to maturity of 9%. 36) ______ A) 3.29 years B) 3.57 years C) 3.69 years D) 3.89 years E) 4.00 years Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 26-06 Hedging with Futures versus Hedging with Options Source : Chapter 26 Test Bank > TB 26-36 Calculate the duration of a 4-year...

37) 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: 37) ______ A) decrease the duration of its assets. B) increase the duration of its assets. C) decrease the duration of its liabilities. D) do nothing, i.e., keep the duration of its liabilities equal to the duration of its assets. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 26-06 Hedging with Futures versus Hedging with Options Source : Chapter 26 Test Bank > TB 26-37 A financial institution has equity equal to ...

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38) If a financial institution has equated the dollar effects of interest rate risk on the assets with

the dollar effects on the liabilities, it has engaged in: 38) ______ A) a long hedge. B) a short hedge. C) a protected swap. D) immunizing interest rate risk. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Hard Topic : 26-06 Hedging with Futures versus Hedging with Options Source : Chapter 26 Test Bank > TB 26-38 If a financial institution has equated the d...

39) Firm A is paying $750,000 in interest payments a year while Firm B is paying LIBOR plus

75 basis points on $10,000,000 loans. The current LIBOR rate is 6.5%. Firm A and B have agreed to swap interest payments, how much will be paid, to which Firm this year? 39) ______ A) $750,000 to Firm B. B) $725,000 to Firm A. C) $25,000 to Firm A. D) $25,000 to Firm B. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 26-07 Interest Rate Futures Contracts Source : Chapter 26 Test Bank > TB 26-39 Firm A is paying $750,000 in...

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40) Interest rate and currency swaps allow one party to exchange a: 40) ______ A) floating interest rate or currency value for a fixed interest or value over the contract

term. B) fixed interest rate or currency value for a lower fixed value over the contract term. C) floating interest rate or currency value for a lower floating value over the contract term. D) a fixed interest rate position for a currency position over the contract term. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 26-07 Interest Rate Futures Contracts Source : Chapter 26 Test Bank > TB 26-40 Interest rate and currency swaps allow one p...

41) LIBOR stands for: 41) ______ A) Luasanne Interest Basis Offered Rate B) Libido Over Redline. C) London Interbank Offered Rate. D) London Interagency Overt Rate. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 26-07 Interest Rate Futures Contracts Source : Chapter 26 Test Bank > TB 26-41 LIBOR stands for:

42) An inverse floater and a super-inverse floater are more valuable to a purchaser if: 42) ______ A) interest rates stay the same. B) interest rates fall. C) interest rates rise. D) if held for a long time. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 26-07 Interest Rate Futures Contracts Source : Chapter 26 Test Bank > TB 26-42 An inverse floater and a super-inverse float...

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43) If a firm purchases a cap at 10% this will: 43) ______ A) limit the amount of borrowing to 10% of assets. B) pay the firm 10% on their purchase. C) pay the holder the LIBOR interest above 10%. D) pay the holder the LIBOR interest below the 10%. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 26-07 Interest Rate Futures Contracts Source : Chapter 26 Test Bank > TB 26-43 If a firm purchases a cap at...

44) If a firm sells a floor at 6% this will: 44) ______ A) will pay the holder the LIBOR interest below 6%. B) pay the firm 6% on their purchase. C) will pay the holder the LIBOR interest above 6%. D) limit the amount of borrowing to 6% of assets. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 26-07 Interest Rate Futures Contracts Source : Chapter 26 Test Bank > TB 26-44 If a firm sells a floor...

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SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 45) A Treasury Note with a maturity of 2 years pays interest semi-annually on a 9 percent annual coupon rate. The $1,000 face value is returned at maturity. If the effective annual yield for all maturities is 7 percent annually, what is the current price of the Treasury Note?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 26-04 Futures Contracts Source : Chapter 26 Test Bank > TB 26-45 A Treasury Note with a maturity of 2 years p...

46) Calculate the duration of a 7-year $1,000 zero-coupon bond with a current price of $399.64

and a yield to maturity of 14%.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 26-06 Hedging with Futures versus Hedging with Options Source : Chapter 26 Test Bank > TB 26-46 Calculate the duration of a 7-year...

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47) Calculate the duration of a 4-year $1,000 face value bond, which pays 8% coupons annually

throughout maturity and has a yield to maturity of 9%.

48) Assets

Duration

Market Value

Overnight Money

0.0

$3 Million

1-year T-Bonds

0.6

$8 Million

Loans

2.20

$20 Million

Mortgages

7.50

$8 Million

Liabilities

Duration

Market Value

Checking Accounts

0.0

$20 Million

Short-term CD’s

0.4

$4 Million

Long-term CD’s

3.20

$12 Million

Equity

$3 million

Calculate the duration of Tiger State Bank's assets and liabilities.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 26-06 Hedging with Futures versus Hedging with Options Source : Chapter 26 Test Bank > TB 26-48 A table showing Assets, Duration...

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49) Assets

Duration

Market Value

Overnight Money

0.0

$3 Million

1-year T-Bonds

0.6

$8 Million

Loans

2.20

$20 Million

Mortgages

7.50

$8 Million

Liabilities

Duration

Market Value

Checking Accounts

0.0

$20 Million

Short-term CD’s

0.4

$4 Million

Long-term CD’s

3.20

$12 Million

Equity

$3 million

What new asset duration will immunize the statement of financial position if the duration of the liabilities is 1.111?

50) Duration is defined as the weighted average time to maturity of a financial instrument.

Explain how this knowledge can help protect against interest rate risk.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 26-06 Hedging with Futures versus Hedging with Options Source : Chapter 26 Test Bank > TB 26-50 Duration is defined as the weighted average ...

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51) The futures markets are labeled as pure speculation and even gambling. Why is this an

inaccurate portrayal of the market's function.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 26-03 Forward Contracts Source : Chapter 26 Test Bank > TB 26-51 The futures markets are labeled as pure spec...

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

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38) D 39) D 40) A 41) C 42) B 43) C 44) A 45) Short Answer

The semi-annual spot rates are (1.070.5) = 1.0344 P = 45 A3,3.44 + 10454,3.44 PV = $1,038.99 46) Short Answer

Duration of a zero is always equal to its maturity = 7 years. 47) Short Answer

D = [80/(1.09 + 160/(1.09)2 + 240/(1.09)3 + 4,320/(1.09)4]/967.60 = 3453.78/967.60 = 3.569 years. 48) Short Answer

DA = (20/39)(0) + (8/39)(.6) + (20/39)(2.2) + (8/39)(7.5) = 2.79 DL = (20/36)(0) + (4/36)(.4) + (12/36)(3.2) = 1111 49) Short Answer

Given DL = 1.111, then DA * 39 = 1.111 * 36; DA = 1.0255 50) Short Answer

Duration measures effective time to recoup your investment. Bond prices rise and fall with interest rate changes. Two elements of risk i) reinvestment risk: may earn less $ when reinvesting ii) price: the current value of bond moves inversely to interest rates. By setting duration equal to holding horizon reinvestment and price risk offset each other. By setting the duration of assets equal to the duration of liabilities, both move up and down together. 51) Short Answer

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Market to set (discover) prices for assets. Future positions are for performance at a later date, not a spot transaction. Earnest money as the margin is a performance guarantee not borrowing. Speculators bear the risk for hedgers. Hedgers are spreading/reducing their risk. The market is a zero-sum game. Positions can be netted easily and marking to market takes place daily.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Net working capital is defined as: 1) ______ A) the current assets in a business. B) the difference between current assets and current liabilities. C) the present value of short-term cash flows. D) the difference between all assets and liabilities. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 27-01 Tracing Cash and Net Working Capital Source : Chapter 27 Test Bank > TB 27-01 Net working capital is defined as:

2) A fraction of the available credit on a loan agreement deposited by the borrower with the

bank in a low or non-interest-bearing account is called a: 2) ______ A) compensating balance. B) cleanup loan. C) letter of credit. D) line of credit. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 27-06 Some Aspects of Short-Term Financial Policy Source : Chapter 27 Test Bank > TB 27-02 A fraction of the available credit on a loan...

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3) Which of the following statements is not true? 3) ______ A) Net working capital is the difference between short-term assets and short term

liabilities. B) Short-term financing deals with the management of short-term liabilities and shortterm assets. C) Short-term financing is concerned with determining reasonable amounts of cash to hold, which customers should get credit and others related issues. D) Net working capital does not utilize the concept of present value since all flows are short-term. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 27-01 Tracing Cash and Net Working Capital Source : Chapter 27 Test Bank > TB 27-03 Which of the following statements is not tru...

4) Which of the following is not included in current assets? 4) ______ A) Accounts receivable. B) Accrued wages. C) Cash. D) Inventories. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 27-01 Tracing Cash and Net Working Capital Source : Chapter 27 Test Bank > TB 27-04 Which of the following is not included in cu...

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5) Which of the following is not included in current liabilities? 5) ______ A) Accounts payable B) Prepaid insurance C) Accrued wages D) Taxes E) Notes payable Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 27-01 Tracing Cash and Net Working Capital Source : Chapter 27 Test Bank > TB 27-05 Which of the following is not included in cu...

6) Assets are classified as current or long term based on: 6) ______ A) age of the asset. B) whether the asset is a physical good or not. C) the liquidity of the asset. D) whether the asset is based on fair market value or not. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 27-01 Tracing Cash and Net Working Capital Source : Chapter 27 Test Bank > TB 27-06 Assets are classified as current or long ter...

7) Which one of the following will decrease the net working capital of a firm? Assume that the

current ratio is greater than 1.0. 7) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 27-02 Defining Case in Terms of Other Elements Source : Chapter 27 Test Bank > TB 27-07 Which one of the following will decrease the...

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8) The definition of cash in terms of other statement of financial position items is: 8) ______ A) long term debt minus equity minus net working capital (excluding cash) minus fixed

assets. B) long term debt minus equity plus net working capital (excluding cash) minus fixed assets. C) long term debt minus equity plus net working capital (excluding cash) plus fixed assets. D) long term debt plus equity minus net working capital (excluding cash) minus fixed assets. E) long term debt plus equity minus net working capital (excluding cash) plus. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 27-02 Defining Case in Terms of Other Elements Source : Chapter 27 Test Bank > TB 27-08 The definition of cash in terms of other sta...

9) Cash flow from operations equals: 9) ______ A) net income minus change in net working capital. B) net income minus depreciation. C) net income minus taxes. D) net income plus change in net working capital. E) net income plus depreciation. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 27-02 Defining Case in Terms of Other Elements Source : Chapter 27 Test Bank > TB 27-09 Cash flow from operations equals:

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10) Sources of cash do not include: 10) ______ A) increases in net income. B) increases in depreciation. C) decreases in accounts payable. D) increases in notes payable. E) increases in taxes payable. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 27-03 The Sources and Uses of Cash Statement Source : Chapter 27 Test Bank > TB 27-10 Sources of cash do not include:

11) Which of the following would not be a short-run operating activity or decision? 11) ______ A) Buying raw materials with cash or bank loan. B) Selling product on credit. C) Increasing inventory safety stock. D) Investing in a new process machine. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 27-03 The Sources and Uses of Cash Statement Source : Chapter 27 Test Bank > TB 27-11 Which of the following would not be a short-...

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12) A firm currently has a 36-day cash cycle. Assume that the firm changes its operations such

that it decreases its receivables period by 4 days, increases its inventory period by 1 day and decreases its payables period by 2 days. What will the length of the cash cycle be after these changes? 12) ______ A) 31 days B) 33 days C) 35 days D) 37 days E) 38 days Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 27-03 The Sources and Uses of Cash Statement Source : Chapter 27 Test Bank > TB 27-12 A firm currently has a 36-day cash cycle. As...

13) The cash cycle is defined as the time between: 13) ______ A) the arrival of inventory in stock and when the cash is collected from receivables. B) selling the product and posting the accounts receivable. C) selling the product and collecting the accounts receivable. D) cash disbursements and cash collection. E) the arrival of inventory and cash collection. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 27-03 The Sources and Uses of Cash Statement Source : Chapter 27 Test Bank > TB 27-13 The cash cycle is defined as the time betwee...

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14) The inventory turnover for the Sneeky Company is 8 times and its day's sales outstanding is

55. What is the operating cycle for Sneeky given a 365-day year? 14) ______ A) 63.00 B) 6.86 C) 100.63 D) 46.98 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 27-03 The Sources and Uses of Cash Statement Source : Chapter 27 Test Bank > TB 27-14 The inventory turnover for the Sneeky Compan...

15) The inventory turnover for the Sneeky Company is 8 times and its day's sales outstanding is

55. The average payables deferral period (or turnover) is 7.5. What is the cash cycle for Sneeky given a 365-day year? 15) ______ A) 149.29 days. B) 51.96 days. C) 58.04 days. D) 115.00 days. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 27-03 The Sources and Uses of Cash Statement Source : Chapter 27 Test Bank > TB 27-15 The inventory turnover for the Sneeky Compan...

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16) If the average accounts receivable that a firm holds decreases without any decrease in credit

sales, the operating cycle will: 16) ______ A) stay the same because of no sales change. B) stay the same because cash collections are sooner and it will affect the cash cycle

only. C) decreases because days sales outstanding decreased. D) stay the same because accounts receivable are not in the operating cycle. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 27-03 The Sources and Uses of Cash Statement Source : Chapter 27 Test Bank > TB 27-16 If the average accounts receivable that a fi...

17) If the use of supplier financing decreases and is replaced by cash financing for the same level

of business activity, the cash cycle will: 17) ______ A) increase because days in payables decrease. B) stay the same because the change is only on the operating cycle. C) decrease because days in payables decrease. D) stay the same because the business activity does not change. E) stay the same because cash is used for payment. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 27-03 The Sources and Uses of Cash Statement Source : Chapter 27 Test Bank > TB 27-17 If the use of supplier financing decreases a...

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18) Flexible short term financial policies are not characterized by: 18) ______ A) liberal credit policies. B) large amounts of inventory held. C) quick delivery services for customers. D) high levels of production stoppages. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 27-04 The Operating Cycle and the Cash Cycle Source : Chapter 27 Test Bank > TB 27-18 Flexible short term financial policies are n...

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19) StarrKnight Corporation's statement of financial position and Income Statement as shown

below: BALANCE SHEET (in thousands of dollars ) ASSETS

2018

2017

Cash

21,113

19,930

Receivables

7,336

3,275

Inventories

25,135

24,270

Total

53,584

47,475

Fixed Assets

25,767

19,720

Total Assets

79,351

67,195

LIABILITIES

2018

2017

Current Assets

Current Liabilities Accounts Payable

9,493

7,273

Notes Payable

429

416

Other

3,990

3,180

Total

13,912

10,869

Long-term Liabilities

7,796

6,088

Stockholder’s Equity

57,643

50,238

Total Liabilities and Equity

79,351

67,195

NET INCOME (in thousands of dollars ) 2018

2017

Net Sales

113,260

96,695

Cost of Goods Sold

75,586

65,039

Other Operating Expenses

25,832

26,208

Operating Profit

11,842

5,448

Other Income

7,061

6,280

Interest

658

520

Tax

3,924

3,362

Net Profit

14,321

7,846

Dividends

460

441

Retained Earnings

13,861

7,405

(all sales and purchases are credit) The average inventory in 2018 is (in thousands of dollar): 19) ______

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A) $12,567.50. B) $12,883.50. C) $23,837.50. D) $24,702.50. E) $25,567.50. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 27-03 The Sources and Uses of Cash Statement Source : Chapter 27 Test Bank > TB 27-19 StarrKnight Corporation&#39;s statement...

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20) StarrKnight Corporation's statement of financial position and Income Statement as shown

below: BALANCE SHEET (in thousands of dollars ) ASSETS

2018

2017

Cash

21,113

19,930

Receivables

7,336

3,275

Inventories

25,135

24,270

Total

53,584

47,475

Fixed Assets

25,767

19,720

Total Assets

79,351

67,195

LIABILITIES

2018

2017

Current Assets

Current Liabilities Accounts Payable

9,493

7,273

Notes Payable

429

416

Other

3,990

3,180

Total

13,912

10,869

Long-term Liabilities

7,796

6,088

Stockholder’s Equity

57,643

50,238

Total Liabilities and Equity

79,351

67,195

NET INCOME (in thousands of dollars ) 2018

2017

Net Sales

113,260

96,695

Cost of Goods Sold

75,586

65,039

Other Operating Expenses

25,832

26,208

Operating Profit

11,842

5,448

Other Income

7,061

6,280

Interest

658

520

Tax

3,924

3,362

Net Profit

14,321

7,846

Dividends

460

441

Retained Earnings

13,861

7,405

(all sales and purchases are credit) The inventory turnover ratio for 2018 is (use average inventory): 20) ______

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A) 2.96. B) 3.06. C) 3.17. D) 5.87. E) 6.01. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 27-03 The Sources and Uses of Cash Statement Source : Chapter 27 Test Bank > TB 27-20 StarrKnight Corporation&#39;s statement...

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21) StarrKnight Corporation's statement of financial position and Income Statement as shown

below: BALANCE SHEET (in thousands of dollars ) ASSETS

2018

2017

Cash

21,113

19,930

Receivables

7,336

3,275

Inventories

25,135

24,270

Total

53,584

47,475

Fixed Assets

25,767

19,720

Total Assets

79,351

67,195

LIABILITIES

2018

2017

Current Assets

Current Liabilities Accounts Payable

9,493

7,273

Notes Payable

429

416

Other

3,990

3,180

Total

13,912

10,869

Long-term Liabilities

7,796

6,088

Stockholder’s Equity

57,643

50,238

Total Liabilities and Equity

79,351

67,195

NET INCOME (in thousands of dollars ) 2018

2017

Net Sales

113,260

96,695

Cost of Goods Sold

75,586

65,039

Other Operating Expenses

25,832

26,208

Operating Profit

11,842

5,448

Other Income

7,061

6,280

Interest

658

520

Tax

3,924

3,362

Net Profit

14,321

7,846

Dividends

460

441

Retained Earnings

13,861

7,405

(all sales and purchases are credit) The inventory period for 2018 is (use average inventory): 21) ______

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A) 60.73 days. B) 62.18 days. C) 115.14 days. D) 123.31 days. E) 119.3 days. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 27-03 The Sources and Uses of Cash Statement Source : Chapter 27 Test Bank > TB 27-21 StarrKnight Corporation&#39;s statement...

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22) StarrKnight Corporation's statement of financial position and Income Statement as shown

below: BALANCE SHEET (in thousands of dollars ) ASSETS

2018

2017

Cash

21,113

19,930

Receivables

7,336

3,275

Inventories

25,135

24,270

Total

53,584

47,475

Fixed Assets

25,767

19,720

Total Assets

79,351

67,195

LIABILITIES

2018

2017

Current Assets

Current Liabilities Accounts Payable

9,493

7,273

Notes Payable

429

416

Other

3,990

3,180

Total

13,912

10,869

Long-term Liabilities

7,796

6,088

Stockholder’s Equity

57,643

50,238

Total Liabilities and Equity

79,351

67,195

NET INCOME (in thousands of dollars ) 2018

2017

Net Sales

113,260

96,695

Cost of Goods Sold

75,586

65,039

Other Operating Expenses

25,832

26,208

Operating Profit

11,842

5,448

Other Income

7,061

6,280

Interest

658

520

Tax

3,924

3,362

Net Profit

14,321

7,846

Dividends

460

441

Retained Earnings

13,861

7,405

(all sales and purchases are credit) The accounts receivable turnover ratio for 2018 is (use average accounts receivable): 22) ______

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A) 2.88. B) 21.35. C) 15.43. D) 29.53. E) 34.58. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 27-03 The Sources and Uses of Cash Statement Source : Chapter 27 Test Bank > TB 27-22 StarrKnight Corporation&#39;s statement...

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23) StarrKnight Corporation's statement of financial position and Income Statement as shown

below: BALANCE SHEET (in thousands of dollars ) ASSETS

2018

2017

Cash

21,113

19,930

Receivables

7,336

3,275

Inventories

25,135

24,270

Total

53,584

47,475

Fixed Assets

25,767

19,720

Total Assets

79,351

67,195

LIABILITIES

2018

2017

Current Assets

Current Liabilities Accounts Payable

9,493

7,273

Notes Payable

429

416

Other

3,990

3,180

Total

13,912

10,869

Long-term Liabilities

7,796

6,088

Stockholder’s Equity

57,643

50,238

Total Liabilities and Equity

79,351

67,195

NET INCOME (in thousands of dollars ) 2018

2017

Net Sales

113,260

96,695

Cost of Goods Sold

75,586

65,039

Other Operating Expenses

25,832

26,208

Operating Profit

11,842

5,448

Other Income

7,061

6,280

Interest

658

520

Tax

3,924

3,362

Net Profit

14,321

7,846

Dividends

460

441

Retained Earnings

13,861

7,405

(all sales and purchases are credit) The average collection period for 2018 is (use average accounts receivable): 23) ______

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A) 10.56 days. B) 12.36 days. C) 23.66 days. D) 17.10 days. E) 126.74 days. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 27-03 The Sources and Uses of Cash Statement Source : Chapter 27 Test Bank > TB 27-23 StarrKnight Corporation&#39;s statement...

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24) StarrKnight Corporation's statement of financial position and Income Statement as shown

below: BALANCE SHEET (in thousands of dollars ) ASSETS

2018

2017

Cash

21,113

19,930

Receivables

7,336

3,275

Inventories

25,135

24,270

Total

53,584

47,475

Fixed Assets

25,767

19,720

Total Assets

79,351

67,195

LIABILITIES

2018

2017

Current Assets

Current Liabilities Accounts Payable

9,493

7,273

Notes Payable

429

416

Other

3,990

3,180

Total

13,912

10,869

Long-term Liabilities

7,796

6,088

Stockholder’s Equity

57,643

50,238

Total Liabilities and Equity

79,351

67,195

NET INCOME (in thousands of dollars ) 2018

2017

Net Sales

113,260

96,695

Cost of Goods Sold

75,586

65,039

Other Operating Expenses

25,832

26,208

Operating Profit

11,842

5,448

Other Income

7,061

6,280

Interest

658

520

Tax

3,924

3,362

Net Profit

14,321

7,846

Dividends

460

441

Retained Earnings

13,861

7,405

(all sales and purchases are credit) The accounts payable deferred period for 2018 is (use average payables): 24) ______

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A) 10.39. B) 9.02. C) 8.94. D) 7.96. E) 7.75. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 27-03 The Sources and Uses of Cash Statement Source : Chapter 27 Test Bank > TB 27-24 StarrKnight Corporation&#39;s statement...

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25) StarrKnight Corporation's statement of financial position and Income Statement as shown

below: BALANCE SHEET (in thousands of dollars ) ASSETS

2018

2017

Cash

21,113

19,930

Receivables

7,336

3,275

Inventories

25,135

24,270

Total

53,584

47,475

Fixed Assets

25,767

19,720

Total Assets

79,351

67,195

LIABILITIES

2018

2017

Current Assets

Current Liabilities Accounts Payable

9,493

7,273

Notes Payable

429

416

Other

3,990

3,180

Total

13,912

10,869

Long-term Liabilities

7,796

6,088

Stockholder’s Equity

57,643

50,238

Total Liabilities and Equity

79,351

67,195

NET INCOME (in thousands of dollars ) 2018

2017

Net Sales

113,260

96,695

Cost of Goods Sold

75,586

65,039

Other Operating Expenses

25,832

26,208

Operating Profit

11,842

5,448

Other Income

7,061

6,280

Interest

658

520

Tax

3,924

3,362

Net Profit

14,321

7,846

Dividends

460

441

Retained Earnings

13,861

7,405

(all sales and purchases are credit) The days in payable for 2018 is (use average payables): 25) ______

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A) 47.10 days. B) 40.48 days. C) 45.85 days. D) 40.82 days. E) 35.13 days. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 27-03 The Sources and Uses of Cash Statement Source : Chapter 27 Test Bank > TB 27-25 StarrKnight Corporation&#39;s statement...

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26) StarrKnight Corporation's statement of financial position and Income Statement as shown

below: BALANCE SHEET (in thousands of dollars ) ASSETS

2018

2017

Cash

21,113

19,930

Receivables

7,336

3,275

Inventories

25,135

24,270

Total

53,584

47,475

Fixed Assets

25,767

19,720

Total Assets

79,351

67,195

LIABILITIES

2018

2017

Current Assets

Current Liabilities Accounts Payable

9,493

7,273

Notes Payable

429

416

Other

3,990

3,180

Total

13,912

10,869

Long-term Liabilities

7,796

6,088

Stockholder’s Equity

57,643

50,238

Total Liabilities and Equity

79,351

67,195

NET INCOME (in thousands of dollars ) 2018

2017

Net Sales

113,260

96,695

Cost of Goods Sold

75,586

65,039

Other Operating Expenses

25,832

26,208

Operating Profit

11,842

5,448

Other Income

7,061

6,280

Interest

658

520

Tax

3,924

3,362

Net Profit

14,321

7,846

Dividends

460

441

Retained Earnings

13,861

7,405

(all sales and purchases are credit) The operating cycle for 2018 is: 26) ______

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A) 187.37 days. B) 85.84 days. C) 127.50 days. D) 135.04 days. E) 133.87 days. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 27-03 The Sources and Uses of Cash Statement Source : Chapter 27 Test Bank > TB 27-26 StarrKnight Corporation&#39;s statement...

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27) StarrKnight Corporation's statement of financial position and Income Statement as shown

below: BALANCE SHEET (in thousands of dollars ) ASSETS

2018

2017

Cash

21,113

19,930

Receivables

7,336

3,275

Inventories

25,135

24,270

Total

53,584

47,475

Fixed Assets

25,767

19,720

Total Assets

79,351

67,195

LIABILITIES

2018

2017

Current Assets

Current Liabilities Accounts Payable

9,493

7,273

Notes Payable

429

416

Other

3,990

3,180

Total

13,912

10,869

Long-term Liabilities

7,796

6,088

Stockholder’s Equity

57,643

50,238

Total Liabilities and Equity

79,351

67,195

NET INCOME (in thousands of dollars ) 2018

2017

Net Sales

113,260

96,695

Cost of Goods Sold

75,586

65,039

Other Operating Expenses

25,832

26,208

Operating Profit

11,842

5,448

Other Income

7,061

6,280

Interest

658

520

Tax

3,924

3,362

Net Profit

14,321

7,846

Dividends

460

441

Retained Earnings

13,861

7,405

(all sales and purchases are credit) The cash cycle for 2018 is: 27) ______

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A) 140.27 days. B) 50.71 days. C) 94.55 days. D) 81.65 days. E) 98.74 days. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 27-03 The Sources and Uses of Cash Statement Source : Chapter 27 Test Bank > TB 27-27 StarrKnight Corporation&#39;s statement

28) Which one of the following will decrease the operating cycle? 28) ______ A) Paying accounts payable faster. B) Discontinuing the discount given for early payment of an accounts receivable. C) Decreasing the inventory turnover rate. D) Collecting accounts receivable faster. E) Increasing the accounts payable turnover rate. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 27-03 The Sources and Uses of Cash Statement Source : Chapter 27 Test Bank > TB 27-28 Which one of the following will decrease the...

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29) ABC Manufacturing historically produced products that were held in inventory until they

could be sold to a customer. The firm is now changing its policy and only producing a product when it receives an actual order from a customer. All else equal, this change will: 29) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 27-03 The Sources and Uses of Cash Statement Source : Chapter 27 Test Bank > TB 27-29 ABC Manufacturing historically produced prod...

30) Costs that rise with increases in the level of investment in current assets are called: 30) ______ A) capital costs. B) carrying costs. C) commitment costs. D) liquid capital costs. E) short-term capital costs. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 27-04 The Operating Cycle and the Cash Cycle Source : Chapter 27 Test Bank > TB 27-30 Costs that rise with increases in the level ...

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31) Costs that fall with increases in the level of investment in current assets are called: 31) ______ A) current asset costs. B) fixed costs. C) flexible costs. D) liquid capital costs. E) shortage costs. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 27-04 The Operating Cycle and the Cash Cycle Source : Chapter 27 Test Bank > TB 27-31 Costs that fall with increases in the level ...

32) Managing current assets involves a trade-off between two types of costs. These costs are: 32) ______ A) carrying costs and opportunity costs. B) shortage costs and cash-out costs. C) cash-out costs and stock-out costs. D) carrying costs and shortage costs. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 27-04 The Operating Cycle and the Cash Cycle Source : Chapter 27 Test Bank > TB 27-32 Managing current assets involves a trade-off...

33) The minimum total cost of holding current assets occurs at the: 33) ______ A) intersection of the carrying costs and shortage costs curves. B) intersection of the marginal cost and average variable costs curves. C) minimum for both the carrying costs and shortage costs curve. D) minimum of the average variable cost curve. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 27-04 The Operating Cycle and the Cash Cycle Source : Chapter 27 Test Bank > TB 27-33 The minimum total cost of holding current as...

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34) The two kinds of shortage costs are: 34) ______ A) commitment costs and costs related to safety reserves. B) commitment costs and costs related to supply factors. C) commitment costs and order costs. D) order costs and costs related to safety reserves. E) order costs and costs related to supply factors. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 27-04 The Operating Cycle and the Cash Cycle Source : Chapter 27 Test Bank > TB 27-34 The two kinds of shortage costs are:

35) In an "ideal" economy: 35) ______ A) cash is zero. B) long-term debt is zero. C) net working capital could be zero. D) short-term debt is zero. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 27-04 The Operating Cycle and the Cash Cycle Source : Chapter 27 Test Bank > TB 27-35 In an "ideal" economy:

36) A flexible short-term financial policy: 36) ______ 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 of its assets. E) utilizes short-term financing to fund all of the firm's assets. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 27-04 The Operating Cycle and the Cash Cycle Source : Chapter 27 Test Bank > TB 27-36 A flexible short-term financial policy:

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37) Firms that use maturity hedging as a guide to financing policy: 37) ______ A) try to hedge with futures contracts. B) hold excess cash balances to reduce risk. C) will finance long-term assets with long-term financing. D) rely on government policy to keep interest rates low. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 27-05 Interpreting the Cash Cycle Source : Chapter 27 Test Bank > TB 27-37 Firms that use maturity hedging as a guide t...

38) The forecast of cash receipts and disbursements for the next planning period is called a: 38) ______ A) pro forma income statement. B) statement of cash flows. C) cash budget. D) receivables analysis. E) credit analysis. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 27-05 Interpreting the Cash Cycle Source : Chapter 27 Test Bank > TB 27-38 The forecast of cash receipts and disburseme...

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39) Which of the following statements is not true? 39) ______ A) A flexible policy toward total asset requirement involves cash surplus. B) A flexible policy toward total asset requirement involves a permanent need for short-

term borrowing. C) A restrictive policy toward total asset requirement involves a large investment in net working capital. D) Maturity hedging seeks to avoid financing long-term assets with short-term borrowing. E) Usually, long-term borrowing costs are lower than short-term borrowing costs. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 27-05 Interpreting the Cash Cycle Source : Chapter 27 Test Bank > TB 27-39 Which of the following statements is not tru...

40) The Impromptu Party Company has estimated all their cash inflows and outflows for the

coming quarter. The quarterly income statement indicates a strong profit but the cash budget indicates a problem with operations giving a shortfall in the cash balance. Why might there be a problem and how might it be solved? 40) ______ A) cash inflows are too large and they will need to invest in marketable securities. B) cash inflows and outflows are not synchronized with outflows occurring before the inflows. They should arrange a line of credit with the bank. C) quarterly taxes are making the company unprofitable and siphoning off all the cash. They need to charge more expenses to reduce taxes. D) the company has too many loans outstanding requiring several different payments. They should a new long-term loan and consolidate all the others. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 27-05 Interpreting the Cash Cycle Source : Chapter 27 Test Bank > TB 27-40 The Impromptu Party Company has estimated al...

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41) Firms hold cash, in part, to satisfy compensating balances.

Compensating balances are: 41) ______ A) cash balances held at the firm in excess of its transactions needs. B) cash balances held at the firm, that are below that of its transactions needs. C) cash balances held at the firm in excess of its cash inflows. D) cash balances held at commercial banks to pay implicitly for bank services. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 27-06 Some Aspects of Short-Term Financial Policy Source : Chapter 27 Test Bank > TB 27-41 Firms hold cash, in part, to satisfy compens...

42) The most common way to finance a temporary cash deficit is the use of: 42) ______ A) banker's acceptances. B) call options. C) commercial paper. D) unsecured bank loans. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 27-05 Interpreting the Cash Cycle Source : Chapter 27 Test Bank > TB 27-42 The most common way to finance a temporary c...

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43) Compensating balances: 43) ______ A) are used to finance inventories. B) earn high rates of interest for the firm. C) are ordered monthly (or quarterly) following forecasts based on cash budget analysis

to compensate for shortfalls. D) increase the effective interest earned by banks on credit lines. E) requirea commitment fee. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 27-06 Some Aspects of Short-Term Financial Policy Source : Chapter 27 Test Bank > TB 27-43 Compensating balances:

44) The three basic forms of inventory loans include: 44) ______ A) blanket inventory lien, field warehouse financing, and line of credit. B) blanket inventory lien, line of credit, and trust receipt. C) blanket inventory lien, field warehouse financing, and trust receipt. D) field warehouse financing, line of credit, and trust receipt. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 27-06 Some Aspects of Short-Term Financial Policy Source : Chapter 27 Test Bank > TB 27-44 The three basic forms of inventory loans inc...

45) In a loan arranged through the assignment of accounts receivable the lender: 45) ______ A) accepts the actual receivable to be collected. B) has a lien on the receivables and recourse to the borrower. C) assumes full risk of default. D) All of these are correct. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 27-06 Some Aspects of Short-Term Financial Policy Source : Chapter 27 Test Bank > TB 27-45 In a loan arranged through the assignment of...

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46) A firm that is buying something from a supplier may effectively arrange for the bank to pay

the outstanding bill using a: 46) ______ A) banker's acceptance. B) certificate of deposit. C) letter of payment. D) forward option. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 27-06 Some Aspects of Short-Term Financial Policy Source : Chapter 27 Test Bank > TB 27-46 A firm that is buying something from a suppl...

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 47) Sales for the Popson Pool Company for 2014 are forecasted at $7 million in the 1st quarter, $9 million in the 2nd quarter, $11 million in the 3rd quarter, and $5 million in quarter 4. All sales are for credit, and Popson has a 90-day (i.e., 1 quarter) collection period such that 100% of sales are collected in the following quarter. Assume sales from the 4th quarter of 2013 at $1 million. Calculate Popson's ending receivables balance for the 4th quarter of 2014.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 27-05 Interpreting the Cash Cycle Source : Chapter 27 Test Bank > TB 27-47 Sales for the Popson Pool Company for 2014 a...

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48) The Soppy's Pool Company forecasts total cash receipts in 2014 at $9 million in the 1st

quarter, $11 million in the 2nd quarter, $3 million in the 3rd quarter, and $2 million in the 4th quarter. Cash disbursements are forecasted at $4 million in quarter 1, $7 million in quarter 2, $7 million in quarter 3, and $2 million in quarter 4. Soppy's establishes a minimum cash balance of $5 million to facilitate transactions. Calculate Soppy's cumulative finance surplus or deficit over each quarter in 2014.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 27-05 Interpreting the Cash Cycle Source : Chapter 27 Test Bank > TB 27-48 The Soppy&#39;s Pool Company forecasts...

49) A firm borrows $7 million through a credit line and is required to keep $350,000 as a

compensating balance. The credit line carries an 11% interest rate. Calculate the effective interest rate on the loan if it is repaid after 1 year.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 27-05 Interpreting the Cash Cycle Source : Chapter 27 Test Bank > TB 27-49 A firm borrows $7 million...

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50) A. What is the operating cycle for White Bluffs, Inc. if all sales are on credit?

B. If you knew that Accounts Receivables were $3,250 the prior year, what effect would this have on your estimate of the operating cycle. Show and explain why.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 27-03 The Sources and Uses of Cash Statement Source : Chapter 27 Test Bank > TB 27-50 A. What is the operating cycle for White Blu...

51) A. What is the cash cycle for White Bluffs, Inc. if all sales are credit sales.

B. If you knew that Accounts Payables were $4884 last year, what effect would this have on your estimate of the cash cycle. Show and explain why.

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52) It has been argued that if one could perfectly synchronize a firm's cash inflows and outflows,

short-term financial planning would be unnecessary. Do you agree? What actions can the firm's financial decision-makers take to reduce the degree of asynchronization? Why should this be a concern?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 27-03 The Sources and Uses of Cash Statement Source : Chapter 27 Test Bank > TB 27-52 It has been argued that if one could perfect...

53) Restrictive short-term financial policies regarding current asset management include three

basic actions. List and briefly describe each action.

Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 27-04 The Operating Cycle and the Cash Cycle Source : Chapter 27 Test Bank > TB 27-53 Restrictive short-term financial policies re...

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

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38) C 39) E 40) B 41) D 42) D 43) D 44) C 45) B 46) A 47) Short Answer 1st Q

2nd Q

3rd Q

4th Q

Sales

Cash Collection

Starting Receivables

Ending Receivables

48) Short Answer 1st Q

2nd Q

3rd Q

4th Q

Total Cash Receipts

Total Cash Disbursements

Net Cash Flow

Cumulative Excess Cash Balance

Minimum Cash Balance

Cumulative surplus or deficit

49) Short Answer

$Interest =.11(7,000,000) = $770,000 Effective Rate = $770,000/$6,650,000 = 11.578947% = 11.58%. 50) Short Answer

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A. Inventory Turnover = CGS/Inventory = 28461/7280 = 3.909. Days in Inventory = 365/3.909 = 93.37 days. Accounts Receivable Turnover = Sales/A/R = 44,466/3779 = 11.767. Days in Receivables = 365/11.767 = 31.02. Operating Cycle = Days in Inventory + Days in Receivable = 93.37 + 31.02 = 124.39. B. Average Accounts Receivable = 3779 + 3250/2 = 3514.50 A/R Turnover = 44,466/3514.50 = 12.652. Days in Receivables = 365/12.652 = 28.85. Operating Cycle = 93.37 + 28.85 = 122.22. - Operating Cycle falls because of a smaller average tied up in receivables to generate sales. 51) Short Answer

A. See answer for question 52 for Days in Inventory and Receivables. Accounts Payables Turnover = CGS/Accounts Payables = 28461/2754 = 10.334. Days in Payables = 365/10.334 = 35.32. Cash Cycle = 124.39 - 35.32 = 89.07. B. Average Accounts Payable = (4884 + 2754)/2 = 3819. Accounts Payable Turnover = 28461/3819 = 7.452 Days in Accounts Payable = 365/7452 = 48.98. Cash Cycle = 124.39 - 48.98 = 75.41. - Cash Cycle would be lower, which is better because White Bluffs has greater use of trade financing. 52) Short Answer

This question asks the student to note the impact of the differential timing of the cash and operating cycles. We sometimes explain this to students in terms of a simple analogy. If we could arrange our finances so that our bills all came due on the day after we got paid, our checking account balance could be kept at a low level throughout the month. The fact that bills come due throughout the month, however, necessitates the maintenance of a greater level of spendable funds. The opportunity cost of this balance can be substantial for a firm with millions of dollars of inflows and outflows monthly. Financial decision-makers can influence the lengths of the cash and operating cycles by adjusting credit terms and making payments at different points as well as, from a longer-term perspective, investing in equipment that utilizes different production technologies and, therefore, different production times. 53) Short Answer

The three actions are: Keep cash low with little invested in marketable securities, keep inventory low and minimize accounts receivable.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) A sensible cash management policy would be to: 1) ______ A) have enough cash on hand to meet the ordinary course of business and some excess cash to invest in marketable securities as a precautionary measure. B) have nearly enough cash on hand to meet the ordinary course of business. C) have enough cash on hand to meet any potential demand for cash. D) have a zero cash balance and charge all expenditures. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 28-01 Reasons for Holding Cash Source : Chapter 28 Test Bank > TB 28-01 A sensible cash management policy would be t...

2) If a firm has achieved its target cash balance the net present value is: 2) ______ A) positive because the cash balance is positive. B) zero because increasing the cash balance increases the interest cost. C) negative because the cash balance has a financing cost. D) positive because decreasing the cash decreases the cost of illiquidity. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 28-01 Reasons for Holding Cash Source : Chapter 28 Test Bank > TB 28-02 If a firm has achieved its target cash balan...

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3) The target cash balance is reached when: 3) ______ A) the interest on any marketable security throw-off is maximized. B) the interest foregone from not investing in an equivalent amount of Treasury bills is

minimized. C) the value of cash liquidity equals interest foregone on an equivalent amount of Treasury bills. D) the liquidity value is greater than interest foregone on an equivalent amount of Treasury bills. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 28-01 Reasons for Holding Cash Source : Chapter 28 Test Bank > TB 28-03 The target cash balance is reached when:

4) Firms would need to hold zero cash when: 4) ______ A) transactions related needs are greater than cash inflows. B) transactions related needs are less than cash inflows. C) transactions related needs are not perfectly synchronized with cash inflows. D) transactions related needs are perfectly synchronized with cash inflows. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 28-01 Reasons for Holding Cash Source : Chapter 28 Test Bank > TB 28-04 Firms would need to hold zero cash when:

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5) Examples of cash disbursements do not include: 5) ______ A) wages. B) payment of raw materials. C) taxes. D) dividends. E) sales of assets. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 28-01 Reasons for Holding Cash Source : Chapter 28 Test Bank > TB 28-05 Examples of cash disbursements do not includ...

6) Financial managers broaden their definition of cash to include: 6) ______ A) currency, bank deposits, stocks and bonds. B) currency, checking deposits, undeposited checks, and bonds. C) cash, bonds, bank deposits and short-term marketable securities. D) currency, checking deposits, undeposited checks and short-term marketable

securities. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 28-01 Reasons for Holding Cash Source : Chapter 28 Test Bank > TB 28-06 Financial managers broaden their definition ...

7) Most large firms hold a cash balance greater than most models imply because: 7) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 28-02 The Speculative and Precautionary Motives Source : Chapter 28 Test Bank > TB 28-07 Most large firms hold a cash balance greater...

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8) The difference between bank cash and book cash is called: 8) ______ A) float. B) disbursement float. C) net float. D) collection float. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 28-02 The Speculative and Precautionary Motives Source : Chapter 28 Test Bank > TB 28-08 The difference between bank cash and book ca...

9) Checks written by the firm are said to generate: 9) ______ A) collection float. B) ledger float. C) disbursement float. D) book float. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 28-02 The Speculative and Precautionary Motives Source : Chapter 28 Test Bank > TB 28-09 Checks written by the firm are said to gener...

10) When a firm writes a check, there is an immediate decrease in _____ cash, but no immediate

change in _____ cash. 10) ______ A) bank; collected B) ledger; book C) bank; ledger D) book; bank Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 28-02 The Speculative and Precautionary Motives Source : Chapter 28 Test Bank > TB 28-10 When a firm writes a check, there is an imme...

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11) Collection float increases book cash immediately but: 11) ______ A) decreases disbursement float. B) decreases bank cash. C) does not immediately change bank cash. D) offsets net float. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 28-02 The Speculative and Precautionary Motives Source : Chapter 28 Test Bank > TB 28-11 Collection float increases book cash immedia...

12) A financial manager should be concerned about bank cash and net float; which is: 12) ______ A) the difference between collection and book cash. B) the difference between collection float and disbursement float. C) the difference between disbursement float and book cash. D) the difference between disbursement float and bank credit. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 28-02 The Speculative and Precautionary Motives Source : Chapter 28 Test Bank > TB 28-12 A financial manager should be concerned abou...

13) Which of the following is not true of float management? 13) ______ A) Float management involves controlling the collection and disbursement of cash. B) An objective of float management is to speed up the collection float. C) An objective of float management is to slow down disbursement float. D) Float management will succeed if the firm can collect late and pay early. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 28-02 The Speculative and Precautionary Motives Source : Chapter 28 Test Bank > TB 28-13 Which of the following is not true of float ...

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14) The BM firm expects a total need of $12,500 over the next 3 months. They have a beginning

cash balance of $1500, and cash is replenished when it hits zero. The fixed cost of selling securities to replenish cash balances is $3.50. The interest rate on marketable securities is 8% per annum. There is a constant rate of cash disbursement and no cash receipts during the month. On an average day, a company writes checks totaling $1,500. These checks take 7 days to clear. The company receives checks totaling $1,800. These checks take 4 days to clear. The cost of debt is 9%. What is the firm's disbursement float? 14) ______ A) $10,500 B) -$8,700 C) $1,800 D) -$10,500 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 28-02 The Speculative and Precautionary Motives Source : Chapter 28 Test Bank > TB 28-14 The BM firm expects a total need of...

15) On an average day, a company writes checks totaling $1,500. These checks take 7 days to

clear. The company receives checks totaling $1,800. These checks take 4 days to clear. The cost of debt is 9%. What is the firm's collection float? 15) ______ A) $10,500 B) -$7,200 C) $1,800 D) -$1,800 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 28-02 The Speculative and Precautionary Motives Source : Chapter 28 Test Bank > TB 28-15 On an average day, a company writes checks t...

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16) On an average day, a company writes checks totaling $1,500. These checks take 7 days to

clear. The company receives checks totaling $1,800. These checks take 4 days to clear. The cost of debt is 9%. What is the firm's net float? 16) ______ A) $300 B) -$3,300 C) $3,300 D) -$300 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 28-02 The Speculative and Precautionary Motives Source : Chapter 28 Test Bank > TB 28-16 On an average day, a company writes checks t...

17) On an average day, a company writes checks totaling $1,500. These checks take 7 days to

clear. The company receives checks totaling $1,800. These checks take 4 days to clear. The cost of debt is 9%. If the average daily float is $3,300, what is the net present value per day? 17) ______ A) -282.48 B) -79.41 C) -297.00 D) -0.81 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 28-02 The Speculative and Precautionary Motives Source : Chapter 28 Test Bank > TB 28-17 On an average day, a company writes checks t...

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18) By getting closer to the source of payment, lockboxes can be used to reduce: 18) ______ A) availability or clearing float. B) mail float. C) in-house processing float. D) disbursement float. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 28-02 The Speculative and Precautionary Motives Source : Chapter 28 Test Bank > TB 28-18 By getting closer to the source of payment, ...

19) The most common cash management technique used to speed up collections is: 19) ______ A) concentration banking. B) wire transfers. C) lockbox systems. D) in-house processing. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 28-02 The Speculative and Precautionary Motives Source : Chapter 28 Test Bank > TB 28-19 The most common cash management technique us...

20) A common cash management technique used to speed up collections from a customer's bank

account to a retailer's bank account is: 20) ______ A) a lockbox system. B) a mail float system. C) a point-of-sale system using debit cards. D) an in-house processing float system. E) an availability float system. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 28-02 The Speculative and Precautionary Motives Source : Chapter 28 Test Bank > TB 28-20 A common cash management technique used to s...

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21) Your firm has average daily receipts of $2,500. These receipts are available after 6 days on

average. The interest rate that could be earned is 0.02% per day. What is the approximate cost of the float per day? 21) ______ A) $50 B) $30 C) $2.5 D) $3.0 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 28-02 The Speculative and Precautionary Motives Source : Chapter 28 Test Bank > TB 28-21 Your firm has average daily receipts of...

22) Efficient funds management attempts to reduce mailing and clearing time. Two methods do

this by: 22) ______ A) moving collections and deposits closer together in concentration banks; and moving

surplus funds quickly by wire transfers. B) moving mailing points to cross country locations and using depository drafts to transfer funds. C) drawing checks against zero balance accounts and using cross country mailing. D) wiring funds to zero balance accounts and using lockboxes in many cities. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 28-02 The Speculative and Precautionary Motives Source : Chapter 28 Test Bank > TB 28-22 Efficient funds management attempts to reduc...

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23) If the total long term financing of the firm is greater than the total financing needs for part of

the year and less than the needs for some of the year, due to seasonal fluctuations, the company will most likely: 23) ______ A) hold excess cash. B) borrow short term and hold excess cash. C) hold excess cash and reduce business activities. D) invest in marketable securities and borrow short term. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 28-03 The Transaction Motive Source : Chapter 28 Test Bank > TB 28-23 If the total long term financing of the firm...

24) Marketability risk is synonymous with: 24) ______ A) maturity risk. B) default risk. C) liquidity risk. D) interest rate risk. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 28-03 The Transaction Motive Source : Chapter 28 Test Bank > TB 28-24 Marketability risk is synonymous with:

25) Which of the following money-market securities has no active secondary market? 25) ______ A) Certificates of deposit (CD's) B) Commercial paper C) Banker's acceptances D) Treasury bills Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 28-03 The Transaction Motive Source : Chapter 28 Test Bank > TB 28-25 Which of the following money-market securiti...

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26) Short-term marketable securities generally have: 26) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 28-03 The Transaction Motive Source : Chapter 28 Test Bank > TB 28-26 Short-term marketable securities generally h...

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 27) The Smythe firm expects a total cash need of $9,000 over the next 4 months. They have a beginning cash balance of $1,000, and cash is replenished when it hits zero. The fixed cost of selling securities to replenish cash balances is $4.00. The interest rate on marketable securities is 8% per annum. There is a constant rate of cash disbursement and no cash receipts during the month. Based on the firm's current practice, what is the average daily cash balance (a month has 30 days)?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 28-01 Reasons for Holding Cash Source : Chapter 28 Test Bank > TB 28-27 The Smythe firm expects a total cash need of...

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28) Aesbrook Airlines currently has $2.4 million on deposit with its bank. Aesbrook pays its fuel

bill by writing a check for $1.1 million. Calculate the company's book cash and bank cash after it writes the check.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 28-02 The Speculative and Precautionary Motives Source : Chapter 28 Test Bank > TB 28-28 Aesbrook Airlines currently has...

29) Sigma Plus Corporation has a variance of daily cash flow of $8. The daily interest rate

is.021% (.00021). Sigma desires a minimum cash balance of $80. The fixed cost of a security transaction is $2.00. Using the Miller-Orr model, calculate Sigma's target cash balance, the upper limit on cash balances, and the average daily cash balance. Explain how this is used to manage cash.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 28-02 The Speculative and Precautionary Motives Source : Chapter 28 Test Bank > TB 28-29 Sigma Plus Corporation has a variance of dai...

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30) Your firm receives 10 checks per month. Of these, 6 are for $1,000 and 4 are for $500. The

delay for the $1,000 checks is 5 days, and the $500 checks are delayed 8 days.

31) Your firm receives 40 checks per month. Of these, 10 are for $1,200 and 30 are for $500. The

delay for the $1,200 checks is 4 days; the $500 checks are delayed 6 days. What is the weighted average delay?

32) During the month you receive 4 checks, one for $100, two for $200, and one for $500. They

are delayed for 2 days, 4 days, and 8 days respectively. What is your average daily collection float (a month has 30 days)?

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33) The Mesa Bank is offering your company the 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. The firm receives 320 checks a day on average written for $2500. The current T-Bill rate is 4% or.0107% per day. What is the savings float and what can you earn if the firm takes Mesa's lockbox service?

34) The Mesa Bank is offering your company the 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. The firm receives 320 checks a day on average written for $2500. The current T-Bill rate is 4% or.0107% per day. If Mesa will charge your firm an annual fee of $35,000 and $.20 per check handled will you accept Mesa's services?

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35) The net float of a firm is made up of disbursement float and collection float. Discuss the three

components of collection float and how they would work against the firm.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 28-02 The Speculative and Precautionary Motives Source : Chapter 28 Test Bank > TB 28-35 The net float of a firm is made up of disbur...

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

Average daily cash balance = [(($9,000/4) + $1,000)/2]/30 = $54.17 28) Short Answer

Book Cash = $2.4 - $1.1 = $1.3 million. Bank Cash = $2.4 - $0.0 = $2.4 million. 29) Short Answer

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Z* = [(3) (2) (8)/(4) (.00021)].33 + 80 = 118.52 H* = 3 (118.52) - 2(80) => 195.56 Average Daily Cash Balance = [(4) (118.52) - 80]/3 => 131.36 If cash rises above 195.56 Mkt. Securities are bought to bring the cash down to 118.52. If cash fall below 80 then mkt. Securities are sold to bring the cash balance up to 118.52. 30) Short Answer

Total Float = $1,000 (6) (5) + $500 (4) (8) = $46,000 Average Daily Float = $46,000/30 = $1,533.33 31) Short Answer

(4/10) (4 days) + (6/10) (6 days) = 5.2 days. 32) Short Answer

[100 (2) + 200 (4) (2) + 500 (8)]/30 = 5800/30 = $193.33 33) Short Answer

Total days of float saved = 2 + 1.5 = 3.5. Dollars of float saved = 3.5(800,000) = $2,800,000. Earnings = 2,800,000(.000107)(365) = $109,354. 34) Short Answer

Cost of services: Annual fee = 35,000. Variable fee (.20)(320)(365) = 23,360. Total fees = $58,360. Total earnings = $109,354. [< = 2,800,000(.000107)(365)]. Net earnings = $50,994. 35) Short Answer

1) Mail Float--based on time checks pass through the postal system. 2) in-house processing float--time receiver takes to process and deposit check in the bank. 3) Availability Float--time to clear banking system and have use of funds. Work against the firm by increasing the time until final payment and use of funds. The system can be placed internally and through external services to move checks into the clearing system faster.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Selling goods and services on credit is: 1) ______ A) an investment in a customer. B) necessary because customers cannot pay for the goods. C) a decision independent of customers. D) permissible if your bank lends the money. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 29-01 Terms of the Sale Source : Chapter 29 Test Bank > TB 29-01 Selling goods and services on credit is:

2) When credit is granted to another firm this gives rise to a(n): 2) ______ A) accounts receivable and is called a consumer credit. B) credit due and is called an installment note. C) accounts receivable and is called trade credit. D) trade receivable and is called an installment note. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 29-01 Terms of the Sale Source : Chapter 29 Test Bank > TB 29-02 When credit is granted to another firm this ...

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3) The carrying value of its account receivable is $700,000 and the average collection period is

45 days. The firm's credit sales per day are: 3) ______ A) $15,555.56. B) $23,333.33. C) $4,666,666.67. D) $700,000.00. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 29-01 Terms of the Sale Source : Chapter 29 Test Bank > TB 29-03 The carrying value of its account receivable...

4) The three components of credit policy are: 4) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 29-01 Terms of the Sale Source : Chapter 29 Test Bank > TB 29-04 The three components of credit policy are:

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5) If a firm grants credit with terms of 2/10 net 45, September 1 dating the creditor: 5) ______ A) must pay a penalty of 2% when payment is made later than September 1st. B) must pay a penalty of 10% when payment is made later than 2 days after September

1st. C) receives a discount of 2% when payment is made at least 10 days before September 1st. D) receives a discount of 2% when payment is made before September 1stand pays a penalty of 10% if payment is made after September 1st. E) receives a discount of 2% when payment is made within 10 days after the effective invoice date of September 1st. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Easy Topic : 29-01 Terms of the Sale Source : Chapter 29 Test Bank > TB 29-05 If a firm grants credit with terms of 2/10 n...

6) Which of the following is not true concerning considerations in setting a credit policy? 6) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 29-01 Terms of the Sale Source : Chapter 29 Test Bank > TB 29-06 Which of the following is not true concernin...

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7) Lengthening the credit period _____ the price paid by the customer. Generally, this acts to

_____ sales. 7) ______ A) increases; increase B) increases; decrease C) decreases; decrease D) decreases; increase E) increases; have no effect on Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 29-01 Terms of the Sale Source : Chapter 29 Test Bank > TB 29-07 Lengthening the credit period _____ the pric...

8) When analyzing the decision to change the cash discount policy, the firm should: 8) ______ A) choose the policy with the highest order size. B) choose the policy with the lowest variable cost. C) choose the policy with the lowest NPV. D) choose the policy with the highest NPV. E) choose the policy offering the lowest cash discount. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 29-01 Terms of the Sale Source : Chapter 29 Test Bank > TB 29-08 When analyzing the decision to change the ca...

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9) When credit is offered with only the invoice as a formal instrument of credit, the credit

procedure is called: 9) ______ A) invoice account. B) open account. C) unsecured account. D) unsecured note. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 29-01 Terms of the Sale Source : Chapter 29 Test Bank > TB 29-09 When credit is offered with only the invoice...

10) Which of the following statements is not true? 10) ______ A) Commercial drafts represent a way to obtain a credit commitment from a customer

before the goods are delivered. B) When a trade acceptance is discounted in the secondary market it becomes a market acceptance. C) Sight drafts require immediate payment. D) Trade acceptances arise when a bank guarantees payment on a commercial draft. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 29-01 Terms of the Sale Source : Chapter 29 Test Bank > TB 29-10 Which of the following statements is not tru...

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11) If a firm refuses to offer credit the NPV of the transaction is: 11) ______ A) the cash revenues received minus the cost paid at time 0. B) the discounted value of the revenues from time 0. C) the net cash flow from the future payments to be received. D) determined by all of these factors. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 29-02 Why Trade Credit Exists Source : Chapter 29 Test Bank > TB 29-11 If a firm refuses to offer credit the NPV of...

12) Risk is incorporated into the decision to grant credit by: 12) ______ A) decreasing the discount rate. B) altering the credit period. C) decreasing the cash inflows, or the numerator of the NPV formula. D) increasing the cash inflows, or the numerator of the NPV formula. E) increasing costs per unit. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 29-02 Why Trade Credit Exists Source : Chapter 29 Test Bank > TB 29-12 Risk is incorporated into the decision to gr...

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13) The Torval Company made a credit sale of $15,000. The invoice was sent today with the

terms, 3/15 net 60. This customer normally pays at the net date. If your opportunity cost of funds is 9% the expected payment is worth how much today? 13) ______ A) $13,761.47 B) $14,789.00 C) $15,000.00 D) $15,214.47 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 29-02 Why Trade Credit Exists Source : Chapter 29 Test Bank > TB 29-13 The Torval Company made a credit sale of...

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14) Edgeworth Heating is selling a commercial heating unit at the price of $100,000 per unit. The

variable cost of producing this unit is $75,000. Edgeworth is considering offering credit terms to their customers, which would allow payment to be delayed one month. Edgeworth predicts that offering these terms will increase monthly sales from 50 units to 60 units. Edgeworth does not expect the increased production to change variable cost and Edgeworth does not expect to charge a higher price. The default rate on credit customers is predicted to be 2.25%. Which of the following statements is true? 14) ______ A) At a monthly interest rate of 1%, Edgeworth is indifferent between extending credit and continuing current policies. At higher interest rates Edgeworth would prefer granting credit. B) At a monthly interest rate of 1%, Edgeworth is indifferent between extending credit and continuing current policies. At lower interest rates Edgeworth would prefer granting credit. C) At a monthly interest rate of 2%, Edgeworth is indifferent between extending credit and continuing current policies. At higher interest rates Edgeworth would prefer granting credit. D) At a monthly interest rate of 2%, Edgeworth is indifferent between extending credit and continuing current policies. At lower interest rates Edgeworth would prefer granting credit. E) At a monthly interest rate of 3%, Edgeworth is indifferent between extending credit and continuing current policies. At lower or higher interest rates Edgeworth would prefer granting credit. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 29-02 Why Trade Credit Exists Source : Chapter 29 Test Bank > TB 29-14 Edgeworth Heating is selling a commercial he...

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15) The credit decision usually includes riskier customers. The credit decision should adjust for

this by: 15) ______ A) determining the probability that customers will pay, reducing the expected cash flow. B) discounting the net cash flows at a higher discount rate. C) discounting the cash inflow at a higher discount rate. D) delaying collections on these customers. E) speeding up deliveries to riskier customers. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 29-02 Why Trade Credit Exists Source : Chapter 29 Test Bank > TB 29-15 The credit decision usually includes riskier...

16) Collegiate Tuxedo rents apparel throughout the year. They have experienced non-payment by

about 15% of their customers with an average loss of $200. Collegiate wants to stem their losses by using an instant electronic credit check on the customer. These checks will cost them $7 for each of the 1000 customers. The opportunity cost is 1.5% for the credit period. Should they pursue the credit check? 16) ______ A) No, because the $7000 cost is too high. B) No, because a $200 loss is minor. C) Yes, because the net gain is $30,000. D) Yes, because the net gain is $23,000. E) Yes, because the net gain is $193,000. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 29-02 Why Trade Credit Exists Source : Chapter 29 Test Bank > TB 29-16 Collegiate Tuxedo rents apparel throughout t...

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17) Which of the following statements is true? 17) ______ A) Customers in high tax brackets would be more likely to take cash discounts and

corporations in high tax brackets would be more likely to offer credit. B) Customers in high tax brackets would be more likely to take cash discounts and corporations in low tax brackets would be more likely to offer credit. C) Customers in low tax brackets would be more likely to take cash discounts and corporations in high tax brackets would be more likely to offer credit. D) Customers in low tax brackets would be more likely to take cash discounts and corporations in low tax brackets would be more likely to offer credit. E) Taxes have an effect on the propensity to grant credit, but no effect on the propensity to use credit. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 29-03 The Basic Form Source : Chapter 29 Test Bank > TB 29-17 Which of the following statements is true?

18) Which of the following is not one of the "five Cs of Credit" for credit scoring? 18) ______ A) Capability B) Capacity C) Capital D) Character E) Conditions Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 29-04 Credit Period Source : Chapter 29 Test Bank > TB 29-18 Which of the following is not one of the...

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19) Collegiate Tuxedo rents apparel throughout the year. They have experienced non-payment by

about 20% of their customers with an average loss of $300. Collegiate wants to stem their losses by using an instant electronic credit check on the customer. These checks will cost them $12 for each of the 1,000 customers. The opportunity cost is 2.0% for the credit period. Should they pursue the credit check? 19) ______ A) No, because the $24,000 cost is too high. B) No, because a $300 loss is minor. C) Yes, because the net gain is $30,000. D) Yes, because the net gain is $48,000. E) Yes, because the net gain is $60,000. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 29-04 Credit Period Source : Chapter 29 Test Bank > TB 29-19 Collegiate Tuxedo rents apparel throughout t...

20) Delta PDA Distributors has an investment in accounts receivable of $2,750,000. Daily credit

sales are $118,280. If 30% of Delta's credit customers receive a discount by paying within 10 days and the remainder of Delta's customers pay in 40 days, what is the Average collection period that Delta maintains? 20) ______ A) 31 days B) 40 days C) 37 days D) 19 days Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 29-05 Cash Discounts Source : Chapter 29 Test Bank > TB 29-20 Delta PDA Distributors has an investment in ...

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21) Delta PDA Distributors has an investment in accounts receivable of $2,750,000. Daily credit

sales are $118,280. Delta's cost of goods sold represent 75% of the sales price. What is the level of accounts receivable? 21) ______ A) $2,750,00 B) $3,666,667 C) $2,062,500 D) $1,925,000 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 29-05 Cash Discounts Source : Chapter 29 Test Bank > TB 29-21 Delta PDA Distributors has an investment in ...

22) The net credit period for a company with terms of 3/10 net 60 is: 22) ______ A) 50 days B) 60 days C) 10 days D) 57 days Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 29-05 Cash Discounts Source : Chapter 29 Test Bank > TB 29-22 The net credit period for a company with ter...

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23) Which of the following statements is not true? 23) ______ A) An aging schedule shows only overdue accounts. B) An aging schedule shows the probability that a 67-day account will be unpaid when it

is a 68-day account. C) Average collection period data is somewhat flawed if sales are seasonal. D) Collection efforts may involve legal action. E) Investments in accounts receivable equal average daily sales times average collection period. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 29-05 Cash Discounts Source : Chapter 29 Test Bank > TB 29-23 Which of the following statements is not tru...

24) Factoring refers to: 24) ______ A) determining the aging schedule of the firm's accounts receivable. B) the sale of a firm's accounts receivable to a financial institution. C) the determination of the average collection period. D) scoring a customer based on the 5 C's of credit. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 29-06 Credit Instruments Source : Chapter 29 Test Bank > TB 29-24 Factoring refers to:

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SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 25) Robinson Rolling pin Corporation has been asked by its customers to please grant them a 2% discount if they pay their bill within 15 days. The purchase size of each order is $75,000. Normally, the customer pays within 30 days with no discount. Robinson's cost of debt capital is 12%. Should the request be granted?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 29-01 Terms of the Sale Source : Chapter 29 Test Bank > TB 29-25 Robinson Rolling pin Corporation has been ask...

26) Robinson Rolling pin Corporation has a variable cost per unit of $.35 per $1 of sales. The

firm offers a 2% discount for orders paid within 15 days if the customer increases their order size by 5%. A customer normally orders $75,000 and is considering the discount. Normally, the customer pays within 30 days with no discount. Robinson's cost of debt capital is 12%. Would Robinson be wise to offer the discount? Calculate the NPV of the decision.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 29-01 Terms of the Sale Source : Chapter 29 Test Bank > TB 29-26 Robinson Rolling pin Corporation has a variab...

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27) Edgeworth Heating is selling a commercial heating unit at the price of $100,000 per unit. The

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 29-02 Why Trade Credit Exists Source : Chapter 29 Test Bank > TB 29-27 Edgeworth Heating is selling a commercial he...

28) Ali Storage Company projects 800 customers next year. Of these, 600 have been profitable

and have never defaulted on past obligations, while 200 have not been profitable. All of the unprofitable accounts are expected to default if given credit. Ali can pay $0.40 to an agency that will tell them whether a customer has been profitable. If Ali's price per unit is $10, and its cost per unit is $6, should they allow the credit check to be performed? Assume a discount rate of 1%.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 29-02 Why Trade Credit Exists Source : Chapter 29 Test Bank > TB 29-28 Ali Storage Company projects 800 customers n...

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29) Frank's Formals rents apparel throughout the year. They have experienced non-payment by

about 15% of their customers with an average loss of $400. Frank's wants to stem their losses by using an instant electronic credit check on the customer. These checks will cost them $15 for each of the 1,000 customers. The opportunity cost is 2.0% for the credit period. Should they pursue the credit check?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 29-04 Credit Period Source : Chapter 29 Test Bank > TB 29-29 Frank&#39;s Formals rents apparel throughout

30) Delta PDA Distributors has an investment in accounts receivable of $2,750,000. Costs of

goods sold represent 75% of the sales price. Daily credit sales are $118,280. If 30% of Delta's credit customers receive a discount by paying within 10 days. The firm's terms are net 30. How is the other 70% of customers paying; are they meeting the terms

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 29-05 Cash Discounts Source : Chapter 29 Test Bank > TB 29-30 Delta PDA Distributors has an investment in ...

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31) The Rapid Roller Co. offers terms of 3/15 net 45. The aging schedule for their customers is

as follows: Aging Schedule Age of Account of Accounts Receivable

Percentage of Total Value

0-15 days

15-30 days

30-45 days

45-60 days

Past 60 days

5 100

Total credit sales are $2,500,000. How does the aging schedule provide more information to Rapid Roller's management on credit behavior?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 29-05 Cash Discounts Source : Chapter 29 Test Bank > TB 29-31 The Rapid Roller Co. offers terms of 3/15 ne...

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Answer Key Test name: Chapter 29 1) A 2) C 3) A 4) B 5) E 6) D 7) D 8) D 9) B 10) B 11) A 12) C 13) B 14) D 15) A 16) D 17) A 18) A 19) D 20) A 21) B 22) A 23) A 24) B 25) Short Answer

Compound method: Current Policy: PV = $75,000/(1.00031054) ^ 30 = $74304.64 Proposed Policy: PV = $73,500/(1.00031054) ^ 15 = $73158.48. Arithmetic method: Current Policy: PV = $75,000/[1 + (.12 (30/365))] = $74,267.50 Proposed Policy: PV = $73,500/[1 + (.12 (15/365))] = $73,139.31 26) Short Answer

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Compound method: Current Policy: PV = -$26,250 + 75,000/(1.00031054) ^ 30 = $48054.64 Proposed Policy: PV = $27,562.50 + 77,175/(1.00031054) ^ 15 = $49253.90. Arithmetic method: Current Policy: PV = -$26,250 + 75,000/[1 + (.12 (30/365))] = $48,017.50. Proposed Policy: PV = $27,562.50 + 77,175/[1 + (.12 (15/365))] = $49,233.78. 27) Short Answer

Strategy 1 - Refuse Credit: Profit = 100(50) - 75 (50) => $1,250 Strategy 2 - Grant Credit: [(b) (100) (60)/1.01]-75(60) = $1,250 Solving for B. b =.968 28) Short Answer

NPV of Granting Credit to Customers Who Default = $0 - 200(6) = -$1200. Cost of Determining Who is Credit worthy =.4(800) = $320.00. NPV saving of by not granting credit = $1200 - $320 = $880.00. The credit check is worth undertaking. 29) Short Answer

NPV of the defaulting customers = 0 - [(400)(.15)(1000)] = $-60,000 Net Gain = gain from not granting - cost of credit check = $60,000 - $15(1000) = $45,000 30) Short Answer

Other 70% paying in: A/R = 2,750,000/.75 = 3,666,667 ACP = 3,666,667/118,280. = 31 days 31 = 3(10) + 7(X) 31 = 3 +.7X 28 = 7X X = 40 days. Other 780% are paying in 40 days on average and implying some customers are stretching their payables and exceeding the net period. 31) Short Answer

ACP =.2(15) +.2(30) +.5(37.5) +.05(52.5) +.05(60) = 3 + 6 + 18.75 + 2.625 + 3.0 = 33.375 As an estimate the ACP would appear to be within terms of 45 days, and ruled as favorable. The Aging Schedule will help focus on the customers above 45 days. In this case the problem is minimal since 10% are above. Provide added information, by tracking customers on slippage in payment and possibility of default.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) In a merger or acquisition, a firm should be acquired if: 1) ______ A) it generates a positive net present value to the shareholders of an acquiring firm. B) it is a firm in the same line of business, in which the acquirer has expertise. C) it is a firm in a totally different line of business which will diversify the firm. D) it pays a large dividend which will provide cash pass through to the acquirer. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 30-01 The Basic Forms of Acquisitions Source : Chapter 30 Test Bank > TB 30-01 In a merger or acquisition, a firm should be...

2) One company wishes to acquire another. Which of the following forms of acquisition does

not require a formal vote by the shareholders of the acquired firm? 2) ______ A) Merger B) Acquisition of stock C) Acquisition of assets D) Consolidation Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 30-01 The Basic Forms of Acquisitions Source : Chapter 30 Test Bank > TB 30-02 One company wishes to acquire another. Which...

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3) Firm A and Firm B merge to form firm AB. This is an example of: 3) ______ A) a tender offer. B) an acquisition of assets. C) an acquisition of stock. D) a consolidation. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 30-01 The Basic Forms of Acquisitions Source : Chapter 30 Test Bank > TB 30-03 Firm A and Firm B merge to form firm AB. Thi...

4) When evaluating an acquisition, you should: 4) ______ A) concentrate on book values and ignore market values. B) focus on the total cash flows of the merged firm. C) apply the rate of return that is relevant to the incremental cash flows. D) ignore any one-time acquisition fees or transaction costs. E) ignore any potential changes in management. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 30-01 The Basic Forms of Acquisitions Source : Chapter 30 Test Bank > TB 30-04 When evaluating an acquisition, you should:

5) Which of the following is not true of mergers? 5) ______ A) Mergers are legally simple. B) Mergers must be approved by a vote of the stockholders of each firm. C) In a merger, the acquiring firm retains its name and identity. D) Mergers represent a public offer to buy shares directly from the stockholders of

another firm. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 30-01 The Basic Forms of Acquisitions Source : Chapter 30 Test Bank > TB 30-05 Which of the following is not true of merger...

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6) The complete absorption of one firm by another is called a: 6) ______ A) merger. B) consolidation. C) takeover. D) spin-off. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 30-01 The Basic Forms of Acquisitions Source : Chapter 30 Test Bank > TB 30-06 The complete absorption of one firm by anoth...

7) The positive incremental net gain associated with the combination of two firms through a

merger or acquisition is called: 7) ______ A) goodwill. B) the merger cost. C) the consolidation effect. D) synergy. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 30-04 Acquisition of Assets Source : Chapter 30 Test Bank > TB 30-07 The positive incremental net gain associated...

8) Suppose that Verizon and Sprint were to merge. Ignoring potential antitrust problems, this

merger would be classified as a: 8) ______ A) horizontal merger. B) vertical merger. C) conglomerate merger. D) monopolistic merger. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 30-01 The Basic Forms of Acquisitions Source : Chapter 30 Test Bank > TB 30-08 Suppose that Verizon and Sprint were to merg...

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9) Suppose that General Motors has made an offer to acquire General Mills. Ignoring potential

antitrust problems, this merger would be classified as a: 9) ______ A) monopolistic merger. B) horizontal merger. C) vertical merger. D) conglomerate merger. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 30-01 The Basic Forms of Acquisitions Source : Chapter 30 Test Bank > TB 30-09 Suppose that General Motors has made an offe...

10) If the All-Star Fuel Filling Company, a chain of gasoline stations, acquires the Mid-States

Refining Company, a refiner of oil products, this would be an example of a: 10) ______ A) conglomerate acquisition. B) white knight. C) vertical acquisition. D) going-private transaction. E) horizontal acquisition. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 30-01 The Basic Forms of Acquisitions Source : Chapter 30 Test Bank > TB 30-10 If the All-Star Fuel Filling Company, a chai...

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11) Which of the following is not true of acquisition of stock or tender offers? 11) ______ A) No stockholder meetings need to be held. B) No vote is required. C) The bidding firm deals directly with the stockholders of the target firm. D) In most cases, 100% of the stock of the target firm is tendered. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 30-01 The Basic Forms of Acquisitions Source : Chapter 30 Test Bank > TB 30-11 Which of the following is not true of acquis...

12) If the acquiring firm and acquired firm are not related to each other, then the acquisition is

known as a(an): 12) ______ A) consolidation. B) aggregation. C) takeover. D) conglomerate acquisition. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 30-01 The Basic Forms of Acquisitions Source : Chapter 30 Test Bank > TB 30-12 If the acquiring firm and acquired firm are ...

13) Following an acquisition, the acquiring firm's statement of financial position shows an asset

labeled "goodwill." What form of merger accounting is being used? 13) ______ A) Consolidation B) Aggregation C) Purchase D) Pooling Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 30-03 Acquisition of Stock Source : Chapter 30 Test Bank > TB 30-13 Following an acquisition, the acquiring firm&#39;s...

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14) Turner, Inc. has $4.2 million in net working capital. The firm has fixed assets with a book

value of $48.6 million and a market value of $53.4 million. Martin & Sons are buying Turner, Inc. for $60 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? 14) ______ A) $0 B) $2.4 million C) $6.6 million D) $7.2 million E) $11.4 million Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 30-03 Acquisition of Stock Source : Chapter 30 Test Bank > TB 30-14 Turner, Inc. has $4.2 million...

15) Synergy occurs when the: 15) ______ A) added value is positive from the combination. B) sum of the parts is greater than the whole. C) premium paid to the acquired shareholders equals the NPV. D) standstill agreement is affected. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 30-04 Acquisition of Assets Source : Chapter 30 Test Bank > TB 30-15 Synergy occurs when the:

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16) If Microsoft were to acquire Air Canada, the acquisition would be classified as a _____

acquisition. 16) ______ A) horizontal B) longitudinal C) conglomerate D) vertical Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 30-01 The Basic Forms of Acquisitions Source : Chapter 30 Test Bank > TB 30-16 If Microsoft were to acquire Air Canada, the...

17) The synergy of an acquisition between Firm A and Firm B can be determined by: 17) ______ A) subtracting the change in cost from the change in revenue. B) subtracting the change in taxes from the change in revenue. C) subtracting the change in capital requirements from the change in revenues. D) discounting the change in the cash flows of the combined firm by the risk-adjusted

discount rate. E) discounting the change in the revenues of the combined firm by the risk-adjusted discount rate. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 30-04 Acquisition of Assets Source : Chapter 30 Test Bank > TB 30-17 The synergy of an acquisition between Firm A...

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18) The value of synergy is estimated by the equation: 18) ______ A) VA + VB- ΔRevenue. B) VAB- VA- VB. C) VAB- VB- Taxes. D) VA- VB- ΔCosts. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 30-03 Acquisition of Stock Source : Chapter 30 Test Bank > TB 30-18 The value of synergy is estimated by the equ...

19) An important reason for acquisitions is that the combined firm may generate greater revenue

than the two separate firms could. Examples of revenue enhancement would not include: 19) ______ A) an elimination of a previously ineffective media effort. B) an elimination of a previously ineffective advertising effort. C) an elimination of a weak existing distribution effort. D) economies of scale. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 30-05 A Classification Scheme Source : Chapter 30 Test Bank > TB 30-19 An important reason for acquisitions is that...

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20) An acquisition may take place because of a real or perceived strategic advantage. An

example of a strategic advantage would be: 20) ______ A) an aircraft manufacturer buying a laser guidance company for possible advanced

flight control without pilots. B) a manufacturer integrating their supply by acquiring downline. C) a corporation completing a spin-off. D) a corporation out-sourcing to achieve cost economies. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 30-05 A Classification Scheme Source : Chapter 30 Test Bank > TB 30-20 An acquisition may take place because of a r...

21) Which of the following is not true regarding monopoly power as it relates to acquisitions that

reduce competition? 21) ______ A) The U.S. Justice Department may challenge a merger if it is not determined to benefit

society. B) Empirical evidence suggests that increased monopoly power is a significant reason for firms to consider merging. C) If monopoly power is measured through an acquisition, all firms in an industry should benefit as the industry's price is increased. D) Empirical evidence finds no consistent tendency for share prices of rival firms to rise. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 30-05 A Classification Scheme Source : Chapter 30 Test Bank > TB 30-21 Which of the following is not true regarding...

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22) A merger that improves the use of one company's design team and the other company's

testing group is evidence of: 22) ______ A) replacement of inefficient management. B) one company exercising monopoly power. C) complementary resources. D) minimizing the net operating losses. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 30-05 A Classification Scheme Source : Chapter 30 Test Bank > TB 30-22 A merger that improves the use of one compan...

23) The market for corporate control is a phrase that would not describe: 23) ______ A) a shift in management motivated to increase the value of the firm. B) top management restructuring of the company. C) an elimination of managerial inefficiency. D) the system where corporate insiders trade personal stock holdings. E) alternative management teams competing for the rights to management. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 30-06 A Note on Takeovers Source : Chapter 30 Test Bank > TB 30-23 The market for corporate control is a phrase...

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24) The Albatross Co. has accumulated net operating losses of $70 million and is likely to enter

bankruptcy. The Zephyr Co. has earnings of $200 million and is in the 36% marginal tax bracket. Zephyr is considering buying Albatross and liquidating the company and retaining a few of the assets. What is the minimum value of Albatross to Zephyr? 24) ______ A) $25.2 million. B) $72.0 million. C) $70.0 million. D) Not enough information to calculate. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 30-06 A Note on Takeovers Source : Chapter 30 Test Bank > TB 30-24 The Albatross Co. has accumulated net operat...

25) Cowboy Curtiss' Cowboy Hat Company recently completed a merger. When valuing the

combined firm after the merger, which of the following is an example of the type of common mistake that can occur? 25) ______ A) The use of market values in valuing either of the new firm. B) The inclusion of cash flows that are incremental to the decision. C) The use of its correct discount rate when valuing the cash flows of the entire company. D) The inclusion of all relevant transactions cost associated with the acquisition. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 30-07 The Tax Forms of Acquistions Source : Chapter 30 Test Bank > TB 30-25 Cowboy Curtiss&#39; Cowboy Hat Company

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26) Firm A is going to acquire Firm B by selling bonds and using the proceeds to purchase (for

cash) the stock of Firm B. What is the appropriate discount rate for use in valuing the benefits of the merger? 26) ______ A) Firm A's cost of debt. B) Firm A's weighted average cost of capital. C) Firm A's cost of equity. D) Firm B's weighted average cost of capital. E) None of these choices are correct. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 30-07 The Tax Forms of Acquistions Source : Chapter 30 Test Bank > TB 30-26 Firm A is going to acquire Firm B by selling...

27) When two firms merge and there is no synergy gain but the only change is a reduction in

risk: 27) ______ A) there is no effect on the bondholders or stockholders. B) both the bondholders and stockholders are made better off. C) the bondholders gain in value while the stockholders lose value. D) the stockholders gain in value while the bondholders lose value. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 30-07 The Tax Forms of Acquistions Source : Chapter 30 Test Bank > TB 30-27 When two firms merge and there is no synergy...

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28) If two leveraged firms merge, the cost of debt for the new firm will generally be lower than it

was for the two firms as separate entities. One reason for this is: 28) ______ A) strategic fits. B) net operating losses. C) surplus funds. D) co-insurance. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 30-07 The Tax Forms of Acquistions Source : Chapter 30 Test Bank > TB 30-28 If two leveraged firms merge, the cost of de...

29) What is the synergy from the merger of V and A? V was worth $450 and A had a market

value of $375. V acquired A for $425 because they thought the combination of VA was worth $925. 29) ______ A) $50 B) $100 C) $500 D) $475 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 30-04 Acquisition of Assets Source : Chapter 30 Test Bank > TB 30-29 What is the synergy from the merger of V and...

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30) What is the NPV from the merger of V and A? V was worth $450 and A had a market value

of $375. V acquired A for $425 because they thought the combination of VA was worth $925. 30) ______ A) $0 B) $50 C) $450 D) $425 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 30-09 Taxable Versus Tax-Free Acquistions Source : Chapter 30 Test Bank > TB 30-30 What is the NPV from the merger of V and A? ...

31) What is the cost of acquiring A if the V and A merge? V is worth $450 and has 100 shares

outstanding. A has a market value of $375 and has 40 shares outstanding. V to acquire A will swap 80 shares of V for the 40 shares of A. V believes the combination of VA was worth $925. 31) ______ A) $325 B) $100 C) $36 D) $0 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 30-09 Taxable Versus Tax-Free Acquistions Source : Chapter 30 Test Bank > TB 30-31 What is the cost of acquiring A if the V and...

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32) What is the market value exchange ratio of V acquiring A in a merger? V is worth $450 and

has 100 shares outstanding. A has a market value of $375 and has 40 shares outstanding. V to acquire A will swap 80 shares of V for the 40 shares of A. V believes the combination of VA was worth $925. 32) ______ A) 1:1 B) 1.20:1 C) 1.37:1 D) 1.10:1 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 30-09 Taxable Versus Tax-Free Acquistions Source : Chapter 30 Test Bank > TB 30-32 What is the market value exchange ratio of V...

33) In a merger with an exchange of stock, when the premerger prices are used to calculate the

exchange ratio, the true cost of the merger: 33) ______ A) is less than the number of shares received times the original market price. B) is equal to the number of shares received times the original market price. C) is greater than the number of shares received times the original market price. D) Unchanged from the premerger value. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 30-09 Taxable Versus Tax-Free Acquistions Source : Chapter 30 Test Bank > TB 30-33 In a merger with an exchange of stock, when ...

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34) Rudy's, Inc. and Blackstone, Inc. are all-equity firms. Rudy's has 1,500 shares outstanding at

a market price of $22 a share. Blackstone has 2,500 shares outstanding at $38 a share. Blackstone is acquiring Rudy's for $36,000 in cash. What is the merger premium per share? 34) ______ A) $2.00 per share B) $4.25 per share C) $6.50 per share D) $8.00 per share E) $14.00 per share Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 30-09 Taxable Versus Tax-Free Acquistions Source : Chapter 30 Test Bank > TB 30-34 Rudy&#39;s, Inc. and Blackstone, Inc. are...

35) Firm A is acquiring Firm B for $25,000 in cash. Firm A has 2,000 shares of stock

outstanding at a market value of $21 a share. Firm B has 1,200 shares of stock outstanding at a market price of $17 a share. Neither firm has any debt. The net present value of the acquisition is $1,500. What is the price per share of Firm A after the acquisition? 35) ______ A) $21.00 B) $21.25 C) $21.75 D) $22.00 E) $22.50 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 30-09 Taxable Versus Tax-Free Acquistions Source : Chapter 30 Test Bank > TB 30-35 Firm A is acquiring Firm B for...

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36) Principal, Inc. is acquiring Secondary Companies for $29,000 in cash. Principal has 2,500

shares of stock outstanding at a market price of $30 a share. Secondary has 1,600 shares of stock outstanding at a market price of $15 a share. Neither firm has any debt. The net present value of the acquisition is $4,500. What is the price per share of Principal after the acquisition? 36) ______ A) $30.00 B) $30.70 C) $31.80 D) $32.10 E) $32.50 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 30-09 Taxable Versus Tax-Free Acquistions Source : Chapter 30 Test Bank > TB 30-36 Principal, Inc. is acquiring Secondary Compa...

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37) Firm A does well in a boom economy. Firm B does well in a bust economy. The probability

of a boom is 50%. The end of period values of the two firms depend on the economy as shown below: Economy

Probability

Value of A

Value of B

Boom

$1,600

800

Bust

800

2,000

$1200

$1400

Expected Value

Both firms have debt outstanding with a face value of $1,000. To diversify, the two firms have proposed a merger. The NPV of the merger is zero. Which of the following statements is correct? 37) ______ A) The stockholders are indifferent to merger since the NPV is zero. B) The bondholders are indifferent to merger since the NPV is zero. C) The bondholders stand to gain because the risk of the combined firm is less. D) The stockholders stand to gain because the probability of bankruptcy becomes zero after the merger. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 30-07 The Tax Forms of Acquistions Source : Chapter 30 Test Bank > TB 30-37 Firm A does well in a boom economy. Firm B d...

38) A merger should not take place simply for: 38) ______ A) diversification if shareholders can accomplish the same result on their own portfolios. B) increasing the debt capacity for the tax shield gain. C) acquiring free cash flow to be put to use by the acquirer. D) reducing the cost of production. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 30-08 Determinants of Tax Status Source : Chapter 30 Test Bank > TB 30-38 A merger should not take place simply for:

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39) A modification to the corporate charter that requires 80% shareholder approval for a takeover

is called a(n): 39) ______ A) repurchase standstill provision. B) exclusionary self-tender. C) supermajority amendment. D) tender offer. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 30-09 Taxable Versus Tax-Free Acquistions Source : Chapter 30 Test Bank > TB 30-39 A modification to the corporate charter that...

40) Which of the following is the opposite of a targeted repurchase? 40) ______ A) Repurchase standstill provision B) Exclusionary self-tender C) Super majority amendment D) Tender offer Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 30-09 Taxable Versus Tax-Free Acquistions Source : Chapter 30 Test Bank > TB 30-40 Which of the following is the opposite of a ...

41) When the management and/or a small group of investors takeover a firm and the shares of the

firm are delisted and no longer publicly available, this action is known as: 41) ______ A) a consolidation. B) a vertical acquisition. C) a proxy contest. D) a going-private transaction. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 30-09 Taxable Versus Tax-Free Acquistions Source : Chapter 30 Test Bank > TB 30-41 When the management and/or a small group of ...

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42) Which of the following defensive tactics eliminates the possibility of a takeover via tender

offer? 42) ______ A) Leveraged buyout (LBO) B) Exclusionary self-tender C) Targeted repurchase D) Super majority amendment Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 30-09 Taxable Versus Tax-Free Acquistions Source : Chapter 30 Test Bank > TB 30-42 Which of the following defensive tactics eli...

43) Compensation paid to top management in the event of a takeover is called a: 43) ______ A) poison pill. B) golden parachute. C) self-tender. D) buyout. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 30-09 Taxable Versus Tax-Free Acquistions Source : Chapter 30 Test Bank > TB 30-43 Compensation paid to top management in the e...

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SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 44) Firm A does well in a boom economy. Firm B does well in a bust economy. The probability of a boom is 50%. The end of period values of the two firms depend on the economy as shown below: Economy

Probability

Value of A

Value of B

Boom

$1,600

800

Bust

800

2,000

$1,200

$1,400

Expected Value

Both firms have debt outstanding with a face value of $1,000. To diversify, the two firms have proposed a merger. The NPV of the merger is zero. Determine the gain or loss under each state of economy for the stockholders of A and B separately and for the combined firm AB. Should either the stockholders or bondholders be willing to support the merger (prove and state why)?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 30-07 The Tax Forms of Acquistions Source : Chapter 30 Test Bank > TB 30-44 Firm A does well in a boom economy. Firm B d...

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45) Chucky Chester Inc. takes over Billy Bob Burgers from Billy himself for $1 million in cold

cash. Billy started the company years ago on an investment of $50,000 in plant and equipment which has long been paid off. The machinery has no accounting value today. Consider the takeover price as fair market value for the equipment. Calculate the tax consequences of the merger, assuming that Chucky Chester decides not to write-up the machinery. Both Billy and Chucky are in the 28% tax bracket.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 30-02 Merger or Consolidation Source : Chapter 30 Test Bank > TB 30-45 Chucky Chester Inc. takes over Billy Bob Bur...

46) Shuster merges with Leverne. Shuster agrees to exchange 25 of its shares for every 50 of

Leverne's old shares, so that Shuster will have 75 shares available after the merger. There is no synergy. Calculate the EPS along with other information below for the combined firm in two cases; one where the market is smart, and another when the market is fooled.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 30-08 Determinants of Tax Status Source : Chapter 30 Test Bank > TB 30-46 Shuster merges with Leverne. Shuster agrees ...

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47) Firms A and B, both of which are 100% equity, are going to merge. Before the merger, Firm

A (100 shares outstanding) is worth $15,000. Firm B (50 shares outstanding) is worth $10,000. The combined firm is worth $30,000. Firm A will pay $11,500 in cash for Firm B. What is the NPV of the merger to Firm A?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 30-09 Taxable Versus Tax-Free Acquistions Source : Chapter 30 Test Bank > TB 30-47 Firms A and B, both of which are...

48) The Turf-Top Lawn Mower Company has acquired the Quick Clean Power Snow Shovel

Company. Turf-Top has agreed to pay $600 in cash, the money was raised through a new debt issue. All liabilities will be paid off. The statements of financial position of both companies are at market values which are also the book values before the combination. Construct the new statement of financial position for this purchase. How has the position of TTLM shareholders changed?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 30-07 The Tax Forms of Acquistions Source : Chapter 30 Test Bank > TB 30-48 The Turf-Top Lawn Mower Company has acquired...

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49) The Turf-Top Lawn Mower Company has acquired the Quick Clean Power Snow Shovel

Company. Turf-Top has agreed to pay $400 in stock through a tender offer. All liabilities will be assumed. The statements of financial position of both companies are at market values which are also the book values before the combination. Construct the new statement of financial position for this tax-free acquisition. How has the position of TTLM shareholders changed?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 30-07 The Tax Forms of Acquistions Source : Chapter 30 Test Bank > TB 30-49 The Turf-Top Lawn Mower Company has acquired...

50) Bondholders can be made better off in a merger, this is known as the co-insurance effect.

Explain how this can happen using an example.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 30-07 The Tax Forms of Acquistions Source : Chapter 30 Test Bank > TB 30-50 Bondholders can be made better off in a merg...

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51) Dexter Department Stores has a market value of $400 million and 20 million shares

outstanding. Walnut Stores has a market value of $134 million and 13.4 million shares outstanding. Dexter is deciding to acquire Walnut Stores. The top management of Dexter's has determined that due to the synergies between the firms the combination will be worth $667 million. Dexter expects to pay a $67 million premium for Walnut Stores. If Dexter offers 10 million shares in exchange for the 13.4 million shares of Walnut, what will the exchange ratio and the equivalent cash value be?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 30-09 Taxable Versus Tax-Free Acquistions Source : Chapter 30 Test Bank > TB 30-51 Dexter Department Stores has a market value ...

52) Dexter Department Stores has a market value of $400 million and 20 million shares

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53) Dexter Department Stores has a market value of $400 million and 20 million shares

outstanding. Walnut Stores has a market value of $134 million and 13.4 million shares outstanding. Dexter is deciding to acquire Walnut Stores. The top management of Dexter's has determined that due to the synergies between the firms the combination will be worth $667 million. Dexter expects to pay a $67 million premium for Walnut Stores. If Dexter were to make an offer of $201 million in stock for Walnut what would the exchange ratio be?

54) The empirical evidence strongly indicates that the stockholders of the target firm realize large

wealth gains as a result of a takeover bid but the stockholders in the acquiring firm gain little, if anything. Although no definitive answer exists as to why this is the case, several possible explanations have been proposed. List and explain three of these possible explanations for the minimal returns to the acquiring firm's stockholders.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 30-10 Accounting for Acqusitions Source : Chapter 30 Test Bank > TB 30-54 The empirical evidence strongly indicates th...

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55) Describe the three basic legal procedures that one firm can use to acquire another and briefly

discuss the advantages and disadvantages of each.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 30-01 The Basic Forms of Acquisitions Source : Chapter 30 Test Bank > TB 30-55 Describe the three basic legal procedures th...

56) 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?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 30-04 Acquisition of Assets Source : Chapter 30 Test Bank > TB 30-56 Sometimes the management of a target firm fi...

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

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38) A 39) C 40) B 41) D 42) A 43) B 44) Short Answer Payoff to Shareholders

Boom

Bust

$1,600 – 1,000 = 600

$800 – 800 = 0.00

800 – 800 = 0

$2,000 – 1,000 = 1,000

2,400 – 2,000 = 400

2,800 – 2,000 = 800

Loss to shareholders:

Of A = 200

Of B = 200

Neither share holders will want to support the merger but bondholders would as their risk is lower and potential gain under a bust is $200.00. 45) Short Answer

Billy Bob: Taxable income = $1,000,000 - $50,000 > $950,000 Taxes paid = $950,000 (.28) > $266,000 > $734,000 After-tax cash = $1,000,000 - $266,000 Chuck Chester: Does not recognize any additional taxable income. Depreciation remains at zero. 46) Short Answer

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Shuster

Leverne

Smart Market

Fooled Market

EPS

$1.50

Price Per

$8.00

$5.00

P/E

$5.33

$3.33

Earnings

Values

250

Shuster

Leverne

Smart Market

Fooled Market

EPS

$1.50

$2.00

Price Per

$8.00

$5.00

$8.00

$10.66

P/E

$5.33

$3.33

$4.00

$5.33

Earnings

150

Values

250

600

799.5

47) Short Answer

Synergy = $30,000 - 15,000 - 10,000 = 5,000 NPV = Synergy - Premium = $5,000 - 1,500 = $3,500. Value of Firm A After the Acquisition: $30,000 - 11,500 = $18,500 NPV to Firm A = $18,500 - 15,000 = $3,500 48) Short Answer

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Repay CL & LTD = 240; leaves $360 for equity implies $60 in goodwill. Combined (Purchase ) statement of financial position Current Assets

$800

Current Liabilities

$400

Other Assets & Investments

140

Long Term Debt

750

Net Fixed Assets

1,200

Equity

1,050

Goodwill

Total Assets

$2,200

Turf-Top Lawn Mower shareholders are in a much riskier position now due to the added leverage; was D/E =.524; D/V =.344 which increased to D/E = 1.095; D/V =.523. 49) Short Answer Combined (Purchase ) statement of financial position Current Assets

$800

Current Liabilities

$520

Other Assets & Investments

140

Long Term Debt

270

Net Fixed Assets

1,200

Equity

1,350

Total Assets

$2,140

Total Liabilities & S.E.

$2,140

The $100 difference in market value of stock paid to Quick Clean shareholders does not appear on the statement of financial position as goodwill in pooling. They also become TurfTop shareholders. Change in shareholder position based on book value. Before: D/E =.524; D/V =.344 After: D/E = 790/1350 =.585; D/V = 790/2140 =.369 Total Debt relative to equity and the total value have increased slightly indicating a small increase in risk based on book values. Actually, the risk may not have increased if based on market values. 50) Short Answer

Co-insurance effect--transfer of wealth to bondholders from stockholders. In a combination that reduces risk to debtholders due to diversification with no net gains to shareholders, bondholders are better off. Lower risk because of a better chance of payment under all economic outcomes. Lower risk implies lower discount and higher value. 51) Short Answer

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Market Value exchange ratio = (.746(20))/10 = 1.49:1 or (10(20))/13.4 = 1.49:1 Share exchange ratio = 10/13.4 =.746 52) Short Answer

Price = Total Value/Total # of shares = 667/(20 + 10) = 667/30 = 22.23. 53) Short Answer

Exchange Fraction of Total Value = 201/667 Total Shares for Ownership fraction =.301 = X/(X + 20) X = 6.02/.699 = 8.6123 Value per Share = 667/(20 + 8.6123) = 23.3117 Proof: 8.6123(23.3117) = 200.77 = 201 QED. 54) Short Answer

Size differentials, competition in the takeover market, lack of achieving merger gains, management goals other than the best interests of the shareholders, and early announcements of corporate acquisition intent are all presented as possible explanations in the textbook. 55) Short Answer

The three forms are merger, acquisition of stock, and acquisition of assets. A merger has the advantage that it is legally simple and therefore low cost but it has the disadvantage that it must be approved by the shareholders of both firms. Acquisition by stock requires no shareholder meetings and management of the target firm can be bypassed. However, it can be a costly form of acquisition and minority shareholders may hold out, thereby raising the cost of the purchase. Acquisition of assets requires the vote of the target firm's shareholders. However, it can become quite costly to transfer title to all of the assets. 56) Short Answer

Often, the management of the target firm is replaced after an acquisition. If management believes this may be the case, they may fight the takeover to maintain their current positions. In other cases, management may fight the attempt if they feel that by doing so, they may increase the amount paid by the acquiring firm.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Financial distress can be best described by which of the following situations in which the firm is forced to take corrective action? 1) ______ A) Cash payments are delayed to creditors. B) The market value of the stock declines by 50%. C) The firm's operating cash flows are insufficient to pay current obligations. D) Cash distributions are eliminated because the board of directors considers the surplus account to be low. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 31-01 What is Financial Distress? Source : Chapter 31 Test Bank > TB 31-01 Financial distress can be best described by ...

2) A firm that has a series of negative earnings, sales declines and workforce reductions is likely

to head: 2) ______ A) a change in management. B) a merger. C) a financial distress. D) a new financing. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 31-01 What is Financial Distress? Source : Chapter 31 Test Bank > TB 31-02 A firm that has a series of negative earning...

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3) One of the various events which typically occurs around the period of financial distress for a

firm is: 3) ______ A) continued earning losses. B) steady growth. C) dividend reductions. D) dividend increases. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 31-01 What is Financial Distress? Source : Chapter 31 Test Bank > TB 31-03 One of the various events which typically oc...

4) Insolvency can be defined as: 4) ______ A) not having cash. B) being illiquid. 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. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 31-01 What is Financial Distress? Source : Chapter 31 Test Bank > TB 31-04 Insolvency can be defined as:

5) Stock-based insolvency is a(an): 5) ______ A) income statement measurement. B) balance sheet measurement. C) book value measurement. D) income statement and balance sheet measurement. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 31-01 What is Financial Distress? Source : Chapter 31 Test Bank > TB 31-05 Stock-based insolvency is a(an):

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6) Bankruptcy reorganizations are used by management to: 6) ______ A) forest all the inevitable liquidation in all cases. B) provide time to turn the business around. C) allow the courts' time to set up an administrative structure. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 31-03 Bankruptcy Liquidation and Reorganization Source : Chapter 31 Test Bank > TB 31-06 Bankruptcy reorganizations are used by manag...

7) Whether bankruptcy is entered either voluntarily or involuntarily, the major difference by

between CCCA and Bankruptcy and Insolvency Act is: 7) ______ A) that liquidation occurs in CCCA but reorganization is the objective under Bankruptcy

and Insolvency Act. B) that there is no priority of claims under Chapter CCCA. C) that liquidation occurs in Bankruptcy and Insolvency Act but reorganization is the objective under CCCA. D) that no lawyers fees are necessary under Bankruptcy and Insolvency Act. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 31-03 Bankruptcy Liquidation and Reorganization Source : Chapter 31 Test Bank > TB 31-07 Whether bankruptcy is entered either volunta...

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8) A corporation is adjudged bankrupt. When do the shareholders receive any payment? 8) ______ A) After the trustee liquidates the assets and pays the administrative expenses, the

shareholders are paid before the creditors. B) After the trustee liquidates the assets, the administrative expenses and secured creditors are paid, then the unsecured creditors, and, then the shareholders divide any remainder. C) After the trustee liquidates the assets, the shareholders are paid, next the administrative expenses, the secured creditors, and then the unsecured creditors divide any remainder. D) After the trustee liquidates the assets, the shareholders are paid first because they are the owners of the firm and have the principal stake. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 31-03 Bankruptcy Liquidation and Reorganization Source : Chapter 31 Test Bank > TB 31-08 A corporation is adjudged bankrupt. When do ...

9) What is the correct priority of the following claims, once a corporation is determined to be

bankrupt? 9) ______ A) Administrative expenses, wages claims not exceeding $2,000, government tax claims,

debtholder and then equity holder claims. B) Administrative expenses, wages claims not exceeding $2,000, government tax claims, equity holder and then debtholder claims. C) All wage claims, administrative expenses, debtholder claims, government tax claims and equity holder claims. D) All wage claims, administrative expenses, debtholder claims, equity holder claims and government tax claims. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 31-03 Bankruptcy Liquidation and Reorganization Source : Chapter 31 Test Bank > TB 31-09 What is the correct priority of the followin...

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10) Magic Mobile Homes Inc. is to be liquidated. All creditors, both secured and unsecured, are

owed $2 million. Administrative costs of liquidation and wages payments are expected to be $0.5 million. A sale of assets is expected to bring $1.8 million after all costs and taxes. Secured creditors have a mortgage lien for $1.2million on the factory which will be liquidated for $0.9 million out of the sale proceeds. The corporate tax rate is 34%. How much and what percentage of their claim will the unsecured creditors receive, in total? 10) ______ A) $290,909; 36.36% B) $300,000; 37.50% C) $600,000; 75.00% D) $100,000; 12.50% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 31-03 Bankruptcy Liquidation and Reorganization Source : Chapter 31 Test Bank > TB 31-10 Magic Mobile Homes Inc. is to be liquidated....

11) Magic Mobile Homes Inc. is to be liquidated. All creditors, both secured and unsecured, are

owed $2.0 million. Administrative costs of liquidation and wages payments are expected to be $0.5 million. A sale of assets is expected to bring $1.8 million after all costs and taxes. Secured creditors have a mortgage lien for $1.2 million on the factory which will be liquidated for $0.9 million out of the sale proceeds. The corporate tax rate is 34%. How much and what percentage of their claim will the secured creditors receive, in total? 11) ______ A) $1,200,000; 100.00% B) $1,009,091; 84.10% C) $900,000.00; 75.00% D) $981,818; 81.82% Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 31-03 Bankruptcy Liquidation and Reorganization Source : Chapter 31 Test Bank > TB 31-11 Magic Mobile Homes Inc. is to be liquidated....

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12) The management of Magic Mobile Homes has proposed reorganizing the firm. The proposal

is based on a going-concern value of $2.0 million. The proposed financial structure is $0.75 million in new mortgage debt, $0.25 million in subordinated debt and $1 million in new equity. All creditors, both secured and unsecured, are owed $2.5 million dollars. Secured creditors have a mortgage lien for $1.5 million on the factory. The corporate tax rate is 34%. How much should the secured creditors receive? 12) ______ A) $1,000,000 B) $1,500,000 C) $1,250,000 D) $1,333,333 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 31-03 Bankruptcy Liquidation and Reorganization Source : Chapter 31 Test Bank > TB 31-12 The management of Magic Mobile Homes has pro...

13) The management of Magic Mobile Homes has proposed reorganizing the firm. The proposal

is based on a going-concern value of $2.0 million. The proposed financial structure is $0.75 million in new mortgage debt, $0.25 million in subordinated debt and $1 million in new equity. All creditors, both secured and unsecured, are owed $2.5 million dollars. Secured creditors have a mortgage lien for $1.5 million on the factory. The corporate tax rate is 34%. How much should the unsecured creditors receive? 13) ______ A) $1,000,000 B) $500,000 C) $750,000 D) $667,000 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 31-03 Bankruptcy Liquidation and Reorganization Source : Chapter 31 Test Bank > TB 31-13 The management of Magic Mobile Homes has pro...

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14) The management of Magic Mobile Homes has proposed reorganizing the firm. The proposal

is based on a going-concern value of $2.0 million. The proposed financial structure is $0.75 million in new mortgage debt, $0.25 million in subordinated debt and $1 million in new equity. All creditors, both secured and unsecured, are owed $2.5 million dollars. Secured creditors have a mortgage lien for $1.5 million on the factory. The corporate tax rate is 34%. What will the equity holders receive if they had 5 million shares with a par value of $0.50 each? 14) ______ A) $1,000,000 B) $583,333 C) $35,714 D) $0 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 31-03 Bankruptcy Liquidation and Reorganization Source : Chapter 31 Test Bank > TB 31-14 The management of Magic Mobile Homes has pro...

15) The management of Schroeder Books has proposed to reorganize the company. The proposal

is based on a going-concern value of $2.3 million. The proposed financial structure is $500,000 in new mortgage debt, $0.3 million in subordinated debt and $1.5 million in new equity. All creditors, both secured and unsecured, are owed $3 million dollars. Secured creditors have a mortgage lien for $2 million on the book bindery. The corporate tax rate is 34%. How much should the secured creditors receive? 15) ______ A) $1,500,000 B) $2,000,000 C) $2,300,000 D) $3,000,000 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 31-03 Bankruptcy Liquidation and Reorganization Source : Chapter 31 Test Bank > TB 31-15 The management of Schroeder Books has propos...

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16) The management of Schroeder Books has proposed to reorganize the company. The proposal

is based on a going-concern value of $2.3 million. The proposed financial structure is $0.5 million in new mortgage debt, $0.3 million in subordinated debt and $1.5 million in new equity. All creditors, both secured and unsecured, are owed $3 million dollars. Secured creditors have a mortgage lien for $2 million on the book bindery. The corporate tax rate is 34%. How much should the unsecured creditors receive? 16) ______ A) $300,000 B) $500,000 C) $1,000,000 D) $2,300,000 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 31-03 Bankruptcy Liquidation and Reorganization Source : Chapter 31 Test Bank > TB 31-16 The management of Schroeder Books has propos...

17) The management of Schroeder Books has proposed to reorganize the company. The proposal

is based on a going-concern value of $2.3 million. The proposed financial structure is $0.5 million in new mortgage debt, $0.3 million in subordinated debt and $1.5 million in new equity. All creditors, both secured and unsecured, are owed $3 million dollars. Secured creditors have a mortgage lien for $2 million on the book bindery. The corporate tax rate is 34%. What will the equity holders receive if they had 5 million shares with a par value of $0.50 each? 17) ______ A) $0 B) $35,714 C) $583,333 D) $1,000,000 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 31-03 Bankruptcy Liquidation and Reorganization Source : Chapter 31 Test Bank > TB 31-17 The management of Schroeder Books has propos...

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18) Which of the following statements about private workouts of financial distress is NOT true? 18) ______ A) Senior debt is replaced with junior debt. B) Debt may be replaced by equity. C) Private workouts account for about three-quarters of all reorganizations. D) Top management is dismissed or take pay reduction many times. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 31-03 Bankruptcy Liquidation and Reorganization Source : Chapter 31 Test Bank > TB 31-18 Which of the following statements about priv...

19) Most firms in financial distress do not fail or cease to exist. In fact, many firms can benefit

from financial distress by: 19) ______ A) re-evaluating their core operations and restructuring their assets. B) selectively ceasing payment on some of their outstanding debts. C) filing for bankruptcy. D) liquidating. E) increasing their debt load. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 31-02 What Happens in Financial Distress? Source : Chapter 31 Test Bank > TB 31-19 Most firms in financial distress do not fail...

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SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 20) The Steel Pony Company a maker of all-terrain recreational vehicles is having financial difficulties due to high-interest payments. The estimated "going concerned" value of Steel Pony is $4.0 million. The statement of financial position of the firm is as shown: Current Assets

$1,100,000

Current Liabilities

$600,000

Fixed Assets

2,900,000

Senior Debt

2,200,000

Subordinated Debt

3,200,000

Stockholders’ Equity

-2,000,000

The senior debt claim is on all fixed assets. Steel Pony decides to file for formal bankruptcy and expects to sell the firm for the "going concern" value and pay administrative fees which amounts to 5%. Determine the distribution of the proceeds under the rules of absolute priority.

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 31-03 Bankruptcy Liquidation and Reorganization Source : Chapter 31 Test Bank > TB 31-20 The Steel Pony Company a maker of all-terrai...

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21) The Steel Pony Company a maker of all-terrain recreational vehicles is having financial

difficulties due to high-interest payments. The estimated "going concerned" value of Steel Pony is $4.0 million. The statement of financial position of the firm is as shown: Current Assets

$1,100,000

Current Liabilities

$600,000

Fixed Assets

2,900,000

Senior Debt

2,200,000

Subordinated Debt

3,200,000

Stockholders’ Equity

-2,000,000

The senior debt claim is on all fixed assets. Steel Pony decides to reorganize and assumes the "going concern" value of the firm is a strong and reliable estimate. Management feels that for the firm to have a stable financial structure and for any plan to be acceptable to the current senior debtholders the new debt cannot represent more than twice equity and be made up of 40% senior debt. Determine the distribution of new securities under the reorganization. Assuming all creditors are treated according to APR.

22) There are several ways firms can deal with financial distress. Identify at least 5 of these.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 31-02 What Happens in Financial Distress? Source : Chapter 31 Test Bank > TB 31-22 There are several ways firms can deal with f...

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Answer Key Test name: Chapter 31 1) C 2) C 3) C 4) C 5) B 6) B 7) C 8) B 9) A 10) A

Creditors (secured and Unsecured) = $2,000,000 Secured Creditors = $1,200,000 therefore Unsecured creditors = $800,000 Assets sales = $1,800,000 - $500,000 = $1,300,000 Secured creditors get the first dib on Factory sale of $900,000: $1,300,000 - $900,000 = $400,000 remaining for remaining creditors. Secured Creditors still owed $300,000 ($1,200,000 $900,000 they received) and get the rest proportionately: $400,000 x [300,000/(300,000 + 800,000)] = 400,000 x 27.27% = $109,091 Unsecured creditors get the proportion: $400,000 x (800,000/(300,000 + 800,000)) = 400,000 x 72.727% = $290,909 Percentage = $290,909 / 800,000 = 36.36%. 11) B

Secured Creditors will receive. $900,000 + $109,091 = $1,009,091 Percentage received = $1009091/1200000 = 0.8409 or approx. 84.10%. 12) B

Full Payment of $1,500,000 As the company is not liquidated. 13) B

$500,000 Since in total proceed from reorganization, $1.5 million is paid to Secured Creditors So the balance of $500,000 will be paid to Unsecured creditors. 14) D

$0 As there will be no balance remaining after paying both the secured and unsecured creditors.

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15) B

$2,000,000. 16) A

$300,000 Since in total proceed from reorganization, $2 million is paid to Secured Creditors So the balance of $300,000 will be paid to Unsecured creditors. 17) A

$0. 18) C 19) A 20) Short Answer

Senior debt (secured) receives $2,500,000. Administrative expenses.05(2,500,000) = $125,000. Total available to current liabilities and subordinated debt = $2,375,000. Current Liabilities receive =.175(2,375,000) = $415,625. Subordinated Debt =.825(2,375,000) = $1,959,375. 21) Short Answer

New equity 1,666,666. New debt made up of 40% senior debt = $1,333,334. 60% subordinate debt = $2,000,000. Distribution: Old Senior Debt ≥ $1,333,334 senior debt. 1,666,666 subordinated debt. Subordinated debt and current liabilities As: Subordinated Debt³ (.825) 2,500,000 = $2,062,500 from 687,500.5 sub debt and 1,374,999.5 equity. Current liabilities³ (.175) 2,500,000 = $437,500 from 145,833.5 sub. Debt and 291,666.5 equity. 22) Short Answer

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Firms can deal with financial distress by: 1. selling major assets. 2. merging with another firm. 3. reducing capital spending on R&D 4. issuing new securities 5. negotiating with banks and creditors 6. exchanging debt for equity 7. filing for bankruptcy.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Which one of the following statements is correct assuming that exchange rates are quoted as units of foreign currency per dollar? 1) ______ A) The exchange rate moves opposite to the value of the dollar. B) The exchange rate rises when the U.S. inflation rate is higher than the foreign country's. C) When a foreign currency appreciates it strengthens relative to the dollar. D) The exchange rate falls as the dollar strengthens. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 32-02 Foreign Exchange Markets and Exchange Rates Source : Chapter 32 Test Bank > TB 32-01 Which one of the following statements is cor...

2) The cross rate is the: 2) ______ A) exchange rate between the US dollar and other currency. B) exchange rate between two currencies generally other than the US dollar. C) rate converting the direct rate into the indirect rate. D) the attitude of the agent at the exchange kiosk. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 32-01 Terminology Source : Chapter 32 Test Bank > TB 32-02 The cross rate is the:

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3) Dollar-denominated bonds issued in several European countries by a U.S. company are

called: 3) ______ A) Eurobonds. B) American Depository Bonds (ADBs). C) Foreign bonds. D) European Original Issue (EOI) bonds. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 32-01 Terminology Source : Chapter 32 Test Bank > TB 32-03 Dollar-denominated bonds issued in several E...

4) The European Currency Unit (ECU) is (a): 4) ______ A) measure of how well the European Community keeps up with the times. B) basket of 30 European currencies. C) money on deposit in financial centers outside the country whose currency is involved. D) the nickname for NATO troops from Europe. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 32-01 Terminology Source : Chapter 32 Test Bank > TB 32-04 The European Currency Unit (ECU) is (a):

5) The forward rate market is dependent upon: 5) ______ A) current forward rates exceeding current spot rates. B) current spot rates exceeding current forward rates over time. C) current spot rates equaling current forward rates on average over time. D) forward rates equaling the actual future spot rates on average over time. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 32-04 Types of Transactions Source : Chapter 32 Test Bank > TB 32-05 The forward rate market is dependent upon:

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6) Swiss franc denominated bonds issued in Switzerland by a French company are called: 6) ______ A) Eurobonds. B) Foreign bonds. C) European Original Issue (EOI) bonds. D) American Depository Bonds (ADBs). Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 32-01 Terminology Source : Chapter 32 Test Bank > TB 32-06 Swiss franc denominated bonds issued in Swit...

7) The Deutschemark is currently selling for.72 U.S. dollars and also for.87 Canadian dollars. If

you determined the rate of exchange between U.S. and Canadian dollars from this information you would have calculated: 7) ______ A) the ECU value. B) interest rate parity. C) the cross rate. D) the indirect rate. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 32-01 Terminology Source : Chapter 32 Test Bank > TB 32-07 The Deutschemark is currently selling for.72...

8) A Yankee bond is a: 8) ______ A) dollar-denominated Eurobond issued by a non-U.S. company. B) a foreign bond issued in the U.S. by a foreign entity. C) Eurobond issued by a U.S. company. D) ECU-denominated bond issued by a non-U.S. company. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 32-01 Terminology Source : Chapter 32 Test Bank > TB 32-08 A Yankee bond is a:

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9) The acronym LIBOR stands for: 9) ______ A) London Interbank Offered Rate. B) Lending Institution Bank Receipt. C) Leading Indicator Borrowing Rate. D) Loan Interest Bank Order Receipt. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 32-01 Terminology Source : Chapter 32 Test Bank > TB 32-09 The acronym LIBOR stands for:

10) Triangular arbitrage would take place if the _____ rate between two currencies was not

_____ to the ratio of the two direct rates. 10) ______ A) cross; equal. B) spot; equal. C) cross; less than. D) spot; less than. E) cross; greater than. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 32-01 Terminology Source : Chapter 32 Test Bank > TB 32-10 Triangular arbitrage would take place if the...

11) When the German mark is quoted as $.52 this quote is a(n): 11) ______ A) triangular rate. B) indirect rate. C) direct rate. D) cross rate. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 32-02 Foreign Exchange Markets and Exchange Rates Source : Chapter 32 Test Bank > TB 32-11 When the German mark is quoted as...

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12) When the German mark is quoted as 1.923 mark this quote is a(n): 12) ______ A) indirect rate. B) direct rate. C) cross rate. D) triangular rate. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 32-02 Foreign Exchange Markets and Exchange Rates Source : Chapter 32 Test Bank > TB 32-12 When the German mark is quoted as 1.923 mark...

13) You want to import $45,000 worth of rugs from India. How many rupees will you need to

pay for this purchase if one rupee is worth $.0218? 13) ______ A) 1,843,010Rs B) 2,032,018Rs C) 2,064,220Rs D) 2,075,002Rs E) 2,076,289Rs Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 32-02 Foreign Exchange Markets and Exchange Rates Source : Chapter 32 Test Bank > TB 32-13 You want to import...

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14) Assume that the Euro is selling in the spot market for $1.10. Simultaneously, in the 3-month

forward market, the Euro is selling for $1.12. Which one of the following statements correctly describes this situation? 14) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 32-02 Foreign Exchange Markets and Exchange Rates Source : Chapter 32 Test Bank > TB 32-14 Assume that the Euro is selling in the spot ...

15) How many euros can you get for $2,500 given the following exchange rates? Country

U.S. $ Equivalent

Currency per U.S. $

Euro

1.0606

.9426 15) ______

A) €2,306 B) €2,357 C) €2,451 D) €2,652 E) €2,675 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 32-02 Foreign Exchange Markets and Exchange Rates Source : Chapter 32 Test Bank > TB 32-15 How many euros can you get for...

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16) If the direct rate for French francs (FF) is $.143 and the direct rate for Australian dollars (A$)

is $0.44, what must the cross rate between A$ and FF be to prevent triangular arbitrage? 16) ______ A) FF3.08 B) FF0.063 C) FF15.89 D) FF0.325 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 32-02 Foreign Exchange Markets and Exchange Rates Source : Chapter 32 Test Bank > TB 32-16 If the direct rate for French francs (FF) is...

17) Currently, $1 will buy C$1.36 while $1.10 will buy €1. What is the exchange rate between

the Canadian dollar and the euro? 17) ______ A) C$1 = €1.10 B) C$1 = €.9091 C) C$1 = €1.2364 D) C$1.36 = €1.10 E) C$1.36 = €.9091 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 32-02 Foreign Exchange Markets and Exchange Rates Source : Chapter 32 Test Bank > TB 32-17 Currently, $1 will buy...

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18) In foreign exchange markets the swap rate is: 18) ______ A) the volume of currency traded in a day. B) the rate of profit made on any transaction. C) the nightlife of the stereotypical Frenchman. D) the difference in the foreign exchange rates on a roundtrip agreement to buy and sell a

currency. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 32-02 Foreign Exchange Markets and Exchange Rates Source : Chapter 32 Test Bank > TB 32-18 In foreign exchange markets the swap rate is...

19) What kind of trade involves agreeing today on an exchange rate for settlement in future? 19) ______ A) Spot trade. B) Futures trade. C) Forward trade. D) Triangle trade. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 32-02 Foreign Exchange Markets and Exchange Rates Source : Chapter 32 Test Bank > TB 32-19 What kind of trade involves agreeing today o...

20) What kind of trade would involve settling a foreign exchange transaction in two days? 20) ______ A) Spot trade. B) Futures trade. C) Forward trade. D) Triangle trade. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 32-02 Foreign Exchange Markets and Exchange Rates Source : Chapter 32 Test Bank > TB 32-20 What kind of trade would involve settling a ...

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21) Suppose it takes 3.2 DM francs to buy 1 U.S. dollar. The direct exchange rate, on dollars, is: 21) ______ A) .3125. B) .4550. C) 2.20. D) 3.20. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 32-02 Foreign Exchange Markets and Exchange Rates Source : Chapter 32 Test Bank > TB 32-21 Suppose it takes 3.2 DM francs to buy 1 U.S....

22) The direct rate exchange for D-marks is.56. The indirect exchange rate for pounds is.61. If

there is no triangle arbitrage, how many pounds does it take to buy a D-mark? 22) ______ A) 0.340. B) 3.400. C) 0.920. D) 1.090. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 32-02 Foreign Exchange Markets and Exchange Rates Source : Chapter 32 Test Bank > TB 32-22 The direct rate exchange for D-marks is.56. ...

23) "A commodity costs the same regardless of what currency is used to purchase it." This is a

statement of: 23) ______ A) the law of one price (LOP). B) relative purchasing power parity (RPPP). C) the first principle of international finance. D) the conservation of currency value. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 32-03 Exchange Rates Source : Chapter 32 Test Bank > TB 32-23 "A commodity costs the same regardless of wh...

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24) The idea that the exchange rate adjusts to keep buying power constant among currencies is

called: 24) ______ A) the unbiased forward rates condition. B) uncovered interest rate parity. C) the international Fisher effect. D) purchasing power parity. E) interest rate parity. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 32-03 Exchange Rates Source : Chapter 32 Test Bank > TB 32-24 The idea that the exchange rate adjusts to k...

25) "The rate of change in commodity price levels between two countries determines the rate of

change in exchange rates between the two countries." This is a statement of: 25) ______ A) absolute purchasing power parity (APPP). B) relative purchase power parity (RPPP). C) international fisher effect (IFE). D) interest rate parity (IRP). E) unbiased forward exchange rates (UFER). Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 32-03 Exchange Rates Source : Chapter 32 Test Bank > TB 32-25 "The rate of change in commodity price level...

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26) Relative purchasing power parity (RPPP) is different than purchasing power parity (PPP)

because: 26) ______ A) PPP is based on the idea that LOP does not hold while it does for RPPP. B) under PPP exchange rates adjust so that the market basket of goods cost the same

regardless of country while for RPPP the LOP does not hold. C) PPP is based on the idea that LOP does not hold while for RPPP the rate of change in the price level in one country relative the rate of change in the price level of another country determines the change in the exchange rate. D) for RPPP the rate of change in the price level in one country relative the rate of change in the price level of another country determines the change in the exchange rate while under PPP exchange rates adjust so that the market basket of goods cost the same regardless of country. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 32-03 Exchange Rates Source : Chapter 32 Test Bank > TB 32-26 Relative purchasing power parity (RPPP) is d...

27) A bottle of Dom Perignon is selling for 550FF in Paris and the exchange rate is $0.167/FF.

The champagne is selling for $95 on average in the U.S. exclusive of transportation costs. The price in the U.S. is: 27) ______ A) priced just right. B) is $3.15 undervalued. C) is $3.15 overvalued. D) the Law of One Price does not hold for special commodities like champagne. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Hard Topic : 32-03 Exchange Rates Source : Chapter 32 Test Bank > TB 32-27 A bottle of Dom Perignon is selling for 550F...

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28) Suppose the spot exchange rate is 2 U.S. dollars per British pound. The forward exchange

rate is 1.9 dollars per pound. Which of the following is true? 28) ______ A) The U.S. inflation rate is higher. B) The pound is selling at a premium. C) The pound is selling at a discount. D) U.S. interest rates are lower. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 32-03 Exchange Rates Source : Chapter 32 Test Bank > TB 32-28 Suppose the spot exchange rate is 2 U.S. dol...

29) If a country is experiencing higher inflation than another country, in general, the currency of

the first country will _______ with respect to the currency of the second country. 29) ______ A) do nothing B) appreciate C) depreciate D) impossible to tell without values E) stabilize. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 32-02 Foreign Exchange Markets and Exchange Rates Source : Chapter 32 Test Bank > TB 32-29 If a country is experiencing higher inflatio...

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30) The Peruvian economy is predicted to average double-digit inflation over the next three years

of 40% per annum. The forecast for the U.S. is 3% per annum. If the current exchange rate is $.2777/Sol, how much will a Sol cost you in three years? 30) ______ A) $.1986 B) $.1421 C) $.1016. D) $.1928 E) $.2334 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 32-03 Exchange Rates Source : Chapter 32 Test Bank > TB 32-30 The Peruvian economy is predicted to average...

31) The Brazilian inflation rate is expected to be 30% per year for the next 4 years. The U.S.

inflation rate is expected to be 3% per year over the same period. A Brazilian real currently costs 87.36 cents. Assuming RPPP holds, how many reals will you need to buy a dollar in four years? 31) ______ A) 11.447. B) 2.905. C) 2.862. D) 1.676. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 32-03 Exchange Rates Source : Chapter 32 Test Bank > TB 32-31 The Brazilian inflation rate is expected to ...

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32) _____ holds because of the possibility of covered interest arbitrage. 32) ______ A) Uncovered interest parity B) Interest rate parity C) The international Fisher effect D) Unbiased forward rates E) Purchasing power parity Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 32-04 Types of Transactions Source : Chapter 32 Test Bank > TB 32-32 _____ holds because of the possibility of co...

33) The direct spot exchange rate for British pounds is 1.4329. The 180-day risk-free rates in the

U.S. and Britain are 4.5% and 5.2%, respectively. What is the direct forward exchange rate? 33) ______ A) 1.4281 B) 1.4234 C) 1.4425 D) 1.4368 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 32-04 Types of Transactions Source : Chapter 32 Test Bank > TB 32-33 The direct spot exchange rate for British po...

34) Interest rate parity: 34) ______ 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. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 32-04 Types of Transactions Source : Chapter 32 Test Bank > TB 32-34 Interest rate parity:

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35) Suppose that the one-year forward rate on pounds is $1.75≤. Given no arbitrage

opportunities, this implies that traders expect: 35) ______ A) the spot rate to be $1.75≤ in one year. B) the spot rate to be greater than $1.75≤ in one year. C) the spot rate to be less than $1.75≤ in one year. D) the spot rate to be greater than or equal to $1.75≤ in one year. E) the spot rate to be less than or equal to $1.75≤ in one year. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 32-04 Types of Transactions Source : Chapter 32 Test Bank > TB 32-35 Suppose that the one-year forward rate on po...

36) Suppose that the Greer Company knows that it must pay ≤7 million for goods that it will

receive in England. The current exchange rate is $1.75≤. The risk that the corporate Treasurer faces is that: 36) ______ A) the pound exchange rate falls in a month's time to $1.50≤. B) the pound exchange rate rises in a month's time to $2.00≤. C) the pound exchange rate does not change from its current position. D) the pound exchange rate falls in a month's time to $1.25≤. Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 32-05 The Law of One Price and Purchasing Power Parity Source : Chapter 32 Test Bank > TB 32-36 Suppose that the Greer Company knows that it...

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37) Remitting cash flows is a term used to describe: 37) ______ A) cash flows earned in a foreign country. B) moving cash flows from the foreign subsidiary to the parent firm. C) forecasting the value of foreign currency one-year hence. D) forecasting the value of U.S. currency one-year hence. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 32-05 The Law of One Price and Purchasing Power Parity Source : Chapter 32 Test Bank > TB 32-37 Remitting cash flows is a term used to descr...

38) The NPV of a foreign investment will be lower if: 38) ______ A) not all cash flows are remitted to the parent and unremitted cash flows are reinvested

at a rate equal to the domestic cost of capital. B) not all cash flows are remitted to the parent and unremitted cash flows are reinvested at a rate less than the domestic cost of capital. C) all cash flows are remitted to the parent and are reinvested at a rate equal to the domestic cost of capital. D) Remittance rates nor foreign reinvestment rates do not affect the NPV. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 32-05 The Law of One Price and Purchasing Power Parity Source : Chapter 32 Test Bank > TB 32-38 The NPV of a foreign investment will be lowe...

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39) If financial markets are segmented, and if firms in the U.S. are not subject to the same

barriers of international investment, then this could lead to _____ risk premiums on international projects. 39) ______ A) higher B) zero C) negative D) lower E) infinite Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 32-05 The Law of One Price and Purchasing Power Parity Source : Chapter 32 Test Bank > TB 32-39 If financial markets are segmented, and if f...

40) International corporations that borrow capital in a foreign country for investment face: 40) ______ A) exchange rate risk on the investment. B) exchange rate risk on the residual financing. C) cross rate risk on exports. D) exchange rate risk on the borrowing. E) swap rate risk on the repurchase. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 32-05 The Law of One Price and Purchasing Power Parity Source : Chapter 32 Test Bank > TB 32-40 International corporations that borrow capit...

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41) You want to invest in a riskless project in Sweden. The project has an initial cost of SKr2.1

million and is expected to produce cash inflows of SKr810,000 a year for 3 years. The project will be worthless after the first 3 years. The expected inflation rate in Sweden is 2 percent while it is 5 percent in the U.S. A risk-free security is paying 6 percent in the U.S. The current spot rate is $1 = SKr7.55. What is the net present value of this project in Swedish krona using the foreign currency approach? Assume that the international Fisher effect applies. 41) ______ A) SKr185,607 B) SKr192,434 C) SKr196,910 D) SKr197,867 E) SKr202,818 Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 32-05 The Law of One Price and Purchasing Power Parity Source : Chapter 32 Test Bank > TB 32-41 You want to invest in a riskless project in ...

42) Eurocurrency loans are made to: 42) ______ A) individuals as any retail bank does. B) corporations and governments as any retail bank does. C) stock market investors only as brokers do. D) corporations and governments solely, unlike a retail bank. Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Easy Topic : 32-06 Interest Rates and Exchange Rates Source : Chapter 32 Test Bank > TB 32-42 Eurocurrency loans are made to:

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43) A Eurobond investor prefers this market to the Yankee bond market because: 43) ______ A) these bonds are registered. B) the bonds are in bearer form. C) an agent is used to transfer ownership. D) income is taxed directly. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Easy Topic : 32-06 Interest Rates and Exchange Rates Source : Chapter 32 Test Bank > TB 32-43 A Eurobond investor prefers this market to t...

44) Underwriters of Eurobonds sell the bonds on a: 44) ______ A) best-efforts basis. B) best-efforts, all or none basis. C) firm-commitment basis. D) regular basis to governments. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 32-06 Interest Rates and Exchange Rates Source : Chapter 32 Test Bank > TB 32-44 Underwriters of Eurobonds sell the bonds on ...

45) When a multinational consolidates the financial statements, the foreign business values must

be converted to domestic values. If the exchange rate of the domestic currency has appreciated relative to the foreign currency, there will be a resultant: 45) ______ A) accounting gain in translation. B) real income gain in translation. C) accounting loss in translation. D) real income loss in translation. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 32-07 The Dollar Investment Source : Chapter 32 Test Bank > TB 32-45 When a multinational consolidates the financ...

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46) Financial Accounting Standard Statement Number 52 requires that most assets and liabilities

be translated at the current exchange rate. Gains and losses are recorded: 46) ______ A) against shareholder's equity. B) as a normal part of income. C) as an extraordinary item against income. D) as a footnote to the statements. E) only on the income tax statements. Question Details Accessibility : Keyboard Navigation Bloom's : Remember Difficulty : Medium Topic : 32-07 The Dollar Investment Source : Chapter 32 Test Bank > TB 32-46 Financial Accounting Standard Statement Numb...

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 47) Suppose that Walkman stereos sell in the U.S. for $40, but sell in Germany for DM 87.5. Under the law of one price, what must be the number of dollars needed to purchase a D mark?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 32-03 Exchange Rates Source : Chapter 32 Test Bank > TB 32-47 Suppose that Walkman stereos sell in the U.S...

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48) The U.S. inflation rate for the coming year is 2%. The German inflation rate for the coming

year is 42%. You can buy 1.7 D-marks with 1 U.S. dollar today. Based on relative purchase power parity, how many D-marks will you be able to buy with 1 dollar in 1 year?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 32-03 Exchange Rates Source : Chapter 32 Test Bank > TB 32-48 The U.S. inflation rate for the coming year ...

49) The inflation rates in the U.S. and Canada are predicted to be 3 and 5%, respectively, in the

coming year. The exchange rate is currently 1.44 Canadian dollars for 1 U.S. dollar. Assuming RPPP holds, how many U.S. dollars will it take to buy 1 Canadian dollar at the end of the year? What will it cost to buy a U.S. dollar?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 32-03 Exchange Rates Source : Chapter 32 Test Bank > TB 32-49 The inflation rates in the U.S. and Canada a...

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50) The 90-day risk-free rate in the U.S. is 3%. The spot exchange rate between the U.S. and

Japan is 1 dollar for 133 yen. The 90-day forward exchange rate is 1 dollar for 135 yen. What is the Japanese 90-day risk-free rate?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Medium Topic : 32-04 Types of Transactions Source : Chapter 32 Test Bank > TB 32-50 The 90-day risk-free rate in the U.S. is....

51) Newsat Telco is planning on investing $40 billion in Europe this year for a satellite

communications systems. The expected cash flow over the next three years is 20.6 billion Euros per year growing at the rate of inflation. After three years they will abandon the system as worthless. The European current and expected inflation rate is 5.2% per annum over this period and the U.S. inflation rate is expected to be 2.8% per annum. The current exchange rate is $.9/Euro. Newsat has a U.S. cost of capital of 15%. Should Newsat invest?

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Hard Topic : 32-05 The Law of One Price and Purchasing Power Parity Source : Chapter 32 Test Bank > TB 32-51 Newsat Telco is planning on investing...

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52) The two terms Purchasing Power Parity (PPP) and Relative Purchasing Power Parity (RPPP)

are similar but not synonymous. Explain these two, their differences and why differences in exchange rates in the market may vary from the values implied by PPP or RPPP.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 32-03 Exchange Rates Source : Chapter 32 Test Bank > TB 32-52 The two terms Purchasing Power Parity (PPP) ...

53) You are considering a project in Poland that has an initial cost of 250,000PLN. The project is

expected to return a one-time payment of 400,000PLN 5 years from now. The risk-free rate of return is 3 percent in the U.S. and 4 percent in Poland. The inflation rate is 2 percent in the U.S. and 5 percent in Poland. Currently, you can buy 375PLN for 100USD. How much will the payment 5 years from now be worth in U.S. dollars?

Question Details Accessibility : Keyboard Navigation Bloom's : Analyze Difficulty : Hard Topic : 32-04 Types of Transactions Source : Chapter 32 Test Bank > TB 32-53 You are considering a project in Poland that...

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54) 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.

Question Details Accessibility : Keyboard Navigation Bloom's : Understand Difficulty : Medium Topic : 32-05 The Law of One Price and Purchasing Power Parity Source : Chapter 32 Test Bank > TB 32-54 Describe the foreign currency and home curre...

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

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38) B 39) D 40) B 41) B 42) D 43) B 44) C 45) C 46) A 47) Short Answer

PUS = SDM (t). pGER (t) $40 = SDN (t). DM 87.5 SDM (t) = $0.457/DM 48) Short Answer

(1 + πUS) SDM (1 + t) (1 + πDM) SDM(t) [1.02/1.04] = [SDM (1 + t)/.5882] => SDM(1 + t) = 1.667 49) Short Answer

[1.03/1.05] = [SCD (1 + t)/0.6944] = SCD (1 + t) = $0.6812 ≈ $.68 Cost about $1.4679 or $1.47 per U.S. $. 50) Short Answer

[1.03/X] = [135/133] ≥ X = 144.2/142 = 1.01549296, or 1.55%. 51) Short Answer

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Calculate cash flows for each year and convert back with the yearly exchange rate based on RPPP Year

0 = -40 already US $ cost

Period

Euro Cf

21.67

22.8

23.99

FX rate

.8795

.8584

.8393

$ Cf

19.06

19.59

20.17

Disc. Cf

16.57

14.81

13.26

NPV

= -40 + 44.649 = 4.649

(rounded only for table)

Should invest, the high growth rate is enough to offset the higher inflation rate and the cost of capital. 52) Short Answer

Law of One Price explains PPP, the price level in each country should be reflected in the exchange rate to have goods priced the same. RPPP is change in price levels determine change in exchange rates. Different in that RPPP explains the change in exchange rates by the movement in price levels while PPP measures levels (as if at equilibrium). Market exchange rates vary from these due to several factors. Forecasts of inflation rates vary considerable for some countries, interest rates are adjusted by monetary authorities causing Interest Rate Parity Adjustments, all currencies do not float nor cleanly. 53) Short Answer

E(S5) = (375PLN ÷ 100USD. × [1 + (.04 -.03)]5 = 3.941288PLN; 400,000PLN × ($1 ÷ 3.941288PLN) = $101,489.67 = $101,490 54) Short Answer

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In the home currency approach, you must forecast both the foreign cash flows and the future expected exchange rates, convert the foreign currency cash flows into dollars, and discount those dollar cash flows at the cost of capital for dollar-denominated investments. In the foreign currency approach, you forecast the foreign cash flows, determine the discount rate appropriate for cash flows denominated in the foreign currency and discount those cash flows to the present. You then convert the NPV to dollars using the current exchange rate. If done properly, both approaches give identical results. However, the foreign currency approach is computationally somewhat more straightforward.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 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: 1) ______ A) decrease. B) change, but can either increase or decrease. C) increase. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Cost of Capital Source : Corporate Finance > Corporate Finance Question 1

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: 2) ______ A) $1,551. B) $6,604. C) $7,240. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Cost of Capital Source : Corporate Finance > Corporate Finance Question 2

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3) Which of the following stakeholders are most likely to benefit from a company’s growth and

excellent financial performance? 3) ______ A) Governments. B) Creditors. C) Customers. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Corporate Governance and Other ESG Considerations Source : Corporate Finance > Corporate Finance Question 3

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? 4) ______ A) $376,872. B) $280,913. C) $325,859. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Capital Budgeting Source : Corporate Finance > Corporate Finance Question 4

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5) Which of the following statements about corporate governance is most accurate? Corporate

governance: 5) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Corporate Governance and Other ESG Considerations Source : Corporate Finance > Corporate Finance Question 5

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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

Amount of New Equity (in millions) $0 to $99 $100 to $199 $200 to $299

4.0% 4.2% 4.5%

Cost of Equity

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 6) ______

A) Option A B) Option B C) Option C Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Cost of Capital Source : Corporate Finance > Corporate Finance Question 6

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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: 7) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Capital Budgeting Source : Corporate Finance > Corporate Finance Question 7

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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% 8) ______

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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?

A) B) C)

Statement 1

Statement 2

Incorrect Correct Correct

Correct Correct Incorrect 9) ______

A) Option A B) Option B C) Option C Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Capital Budgeting Source : Corporate Finance > Corporate Finance Question 9

10) The stakeholders most likely to be concerned with their legal liabilities are: 10) ______ A) directors. B) regulators. C) creditors. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Corporate Governance and Other ESG Considerations Source : Corporate Finance > Corporate Finance Question 10

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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)

Project 1 NPV

Project 2 NPV

Understated Understated Overstated

Understated Overstated Overstated 11) ______

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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: 12) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Cost of Capital Source : Corporate Finance > Corporate Finance Question 12

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: 13) ______ A) More than 5.0%. B) Between 3.3% and 5.0%. C) 5.0%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Cost of Capital Source : Corporate Finance > Corporate Finance Question 13

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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? 14) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Cost of Capital Source : Corporate Finance > Corporate Finance Question 14

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? 15) ______ A) 6.66%; −$64,170. B) 7.01%; −$53,765. C) 13.99%; $166,177. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Capital Budgeting Source : Corporate Finance > Corporate Finance Question 15

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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%? 16) ______ A) 13.34%. B) 12.11%. C) 11.50%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Cost of Capital Source : Corporate Finance > Corporate Finance Question 16

17) The stakeholder theory of corporate governance is primarily focused on: 17) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Corporate Governance and Other ESG Considerations Source : Corporate Finance > Corporate Finance Question 17

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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? 18) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Capital Budgeting Source : Corporate Finance > Corporate Finance Question 18

19) Which of the following steps is least likely to be an administrative step in the capital

budgeting process? 19) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Capital Budgeting Source : Corporate Finance > Corporate Finance Question 19

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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? 20) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Cost of Capital Source : Corporate Finance > Corporate Finance Question 20

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: 21) ______ A) 9.2%. B) 8.8%. C) 9.0%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Cost of Capital Source : Corporate Finance > Corporate Finance Question 21

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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: 22) ______ A) $400 million and $700 million. B) $500 million and $700 million. C) $500 million and $1,000 million. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Cost of Capital Source : Corporate Finance > Corporate Finance Question 22

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: 23) ______ A) machine 2 should be chosen. B) neither project is preferred to the other. C) machine 1 should be chosen. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Capital Budgeting Source : Corporate Finance > Corporate Finance Question 23

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24) Which of the following is most accurate for two independent projects with conventional cash

flows? 24) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Capital Budgeting Source : Corporate Finance > Corporate Finance Question 24

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: 25) ______ A) 27.9%. B) 43.5%. C) 44.6%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Working Capital Management Source : Corporate Finance > Corporate Finance Question 25

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: 26) ______ A) 1.2. B) 1.6. C) 2.1. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Measures of Leverage Source : Corporate Finance > Corporate Finance Question 26

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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: 27) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Working Capital Management Source : Corporate Finance > Corporate Finance Question 27

28) An investment policy statement for a firm’s short-term cash management function would

least appropriately include: 28) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Working Capital Management Source : Corporate Finance > Corporate Finance Question 28

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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: 29) ______ A) prefer the time deposit. B) prefer the banker’s acceptance. C) prefer the U.S. Treasury bill. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Working Capital Management Source : Corporate Finance > Corporate Finance Question 29

30) Which of the following strategies is most likely to be considered good payables management? 30) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Working Capital Management Source : Corporate Finance > Corporate Finance Question 30

31) Which of the following is least likely an indicator of a firm’s liquidity? 31) ______ A) Cash as a percentage of sales. B) Amount of credit sales. C) Inventory turnover. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Working Capital Management Source : Corporate Finance > Corporate Finance Question 31

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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: 32) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Working Capital Management Source : Corporate Finance > Corporate Finance Question 32

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: 33) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Working Capital Management Source : Corporate Finance > Corporate Finance Question 33

34) A banker’s acceptance that is priced at $99,145 and matures in 72 days at $100,000 has a(n): 34) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Working Capital Management Source : Corporate Finance > Corporate Finance Question 34

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35) With respect to inventory management,: 35) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Working Capital Management Source : Corporate Finance > Corporate Finance Question 35

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Answer Key Test name: Corporate Finance 1) A

A break point refers to a level of new investment at which a component’s cost of capital changes. The formula for break point is:

As indicated, as the weight of a capital component in the capital structure increases, the break point at which a change in the component’s cost will decline. No computation is necessary, but when Hardcastle has 40% debt, the breakpoint is $600,000,000 / 0.4 = $1.5 billion. If Hardcastle’s debt increases to 50%, the breakpoint will decline to $600,000,000 / 0.5 = $1.2 billion. 2) A

WACC = (wd)(kd)(1 − t) + (wce)(kce) WACC = (0.5)(6%)(1 − 0.33) + (0.5)(12%) = 8.0% The increase in after-tax cash flows for each year is 3,000 × (1 − 0.33) = $2,010. I = 8; N = 8; PMT = $2,010; CPT→PV = $11,550.74 NPV = PV income − cost = $11,550.74 − $10,000 = $1,550.74 3) A

Governments receive greater tax revenues when financial performance is excellent and profits are higher. Creditors do not receive extra returns for performance better than that is adequate to repay debt. Customers seek company stability and ongoing relationships with the company. 4) B

The key to this problem is identifying this as a NPV problem even though the first cash flow will not occur until the following year. Next, the year of each cash flow must be property identified; specifically: CF0 = $0; CF1 = −430,000; CF2−8 = +$200,000; CF9 = −$170,000. One simply has to discount all of the cash flows to today at a 16% rate. NPV = $280,913. 5) C

Under the shareholder theory of corporate governance, practices are primarily those that support shareholder interests, while under the stakeholder theory of corporate governance, the interests of various affected groups are considered and balanced. Corporate governance practices and definitions vary across countries.

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6) C

Marian’s first statement is correct. A breakpoint calculated as (amount of capital where component cost changes / weight of component in the WACC). The component cost of equity for Arlington will increase when the amount of new equity raised is $200 million, which will occur at ($200 million / 0.70) = $285.71 million, or $286 million of new capital. Marian’s second statement is also correct. If Arlington wants to finance $600 million of total assets, the firm will need to raise $600 − $300 = $300 million of additional capital. Using the target capital structure of 70% equity and 30% debt, Arlington will need to raise $300 × 0.70 = $210 million in new equity and $300 × 0.30 = $90 million in new debt. Looking at the capital schedules, these levels of new financing correspond with rates of 9.0% and 4.2% for costs of equity and debt respectively, and the WACC is equal to (9.0% × 0.70) + (4.2% × 0.30) = 7.56%. 7) A

Stock prices reflect investor expectations for future investment and growth. A new positive-NPV project will increase stock price only if it was not previously anticipated by investors. 8) C

Debt break point #2 = $60 million / 0.30 = $200 million. $135 million × 30% = $40.5 million new debt $135 million × 70% = $94.5 million new equity MCC = 4.0%(0.30) + 12.5%(0.70) = 9.95%. 9) C

Lutz’s first statement is correct. The timing of cash flows is important for making correct capital budgeting decisions. Capital budgeting decisions account for the time value of money. Lutz’s second statement is incorrect. Capital budgeting decisions should be based on incremental aftertax cash flows, not net (accounting) income. 10) A

Directors are legally responsible for their decisions and actions as board members. Neither regulators nor creditors face significant legal liabilities for their actions. 11) C

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The incorrect method of accounting for flotation costs spreads the flotation cost out over the life of the project by a fixed percentage that does not necessarily reflect the present value of the flotation costs. The impact on project evaluation depends on the length of the project and magnitude of the flotation costs, however, for most projects that are shorter, the incorrect method will overstate NPV, and that is exactly what we see in this problem. Correct method of accounting for flotation costs: After-tax cost of debt = 8.0% (1 − 0.30) = 5.60% Cost of equity = ($1.80 / $40.00) + 0.05 = 0.045 + 0.05 = 9.50% WACC = 0.50(5.60%) + 0.50(9.50%) = 7.55% Flotation costs Project 1 = $200,000 × 0.5 × 0.04 = $4,000 Flotation costs Project 2 = $100,000 × 0.5 × 0.04 = $2,000 NPV Project 1 = −$200,000 − $4,000 + (N = 8, I = 7.55%, PMT = $55,000, FV = 0 →CPT PV = $321,535) = $117,535 NPV Project 2 = −$100,000 − $2,000 + (N = 4, I = 7.55%, PMT = $40,000, FV = 0 →CPT PV = $133,823) = $31,823 Incorrect Adjustment for cost of equity method for accounting for flotation costs: After-tax cost of debt = 8.0% (1 − 0.30) = 5.60% Cost of equity = [$1.80 / $40.00(1 − 0.04)] + 0.05 = 0.0469 + 0.05 = 9.69% WACC = 0.50(5.60%) + 0.50(9.69%) = 7.65% NPV Project 1 = −$200,000 + (N = 8, I = 7.65%, PMT = $55,000, FV = 0 →CPT PV = $320,327) = $120,327 NPV Project 2 = −$100,000 + (N = 4, I = 7.65%, PMT = $40,000, FV = 0 →CPT PV = $133,523) = $33,523 12) A

The firm will reject profitable, low-risk projects because it will use a hurdle rate that is too high. The firm should lower the required rate of return for lower risk projects. The firm will accept unprofitable, high- risk projects because the hurdle rate of return used will be too low relative to the risk of the project. The firm should increase the required rate of return for high-risk projects. 13) A

The after-tax cost of debt similar to Savanna’s existing debt iskd(1 − t) = 8.33% (1 − 0.4) = 5.0%. Because the anticipated new debt will be subordinated in the company’s debt structure, investors will demand a higher yield than the existing debt carries. Therefore, the appropriate after-tax cost of the new debt is more than 5.0%. 14) B

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The marginal (or weighted average) cost of capital is the appropriate discount rate for projects that have the same level of risk as the firm’s existing projects. For a project with a higher degree of risk, cash flows should be discounted at a rate higher than the firm’s WACC. Since this project’s IRR is equal to the company’s WACC, its NPV must be zero if the cash flows are discounted at the WACC. If the cash flows are discounted at a rate higher than the WACC to account for the project’s higher risk, the NPV must be negative. Therefore, the project would reduce the value of the company, so management should reject it. A company considers its capital raising and budgeting decisions independently. Each investment decision must be made assuming a WACC which includes each of the different sources of capital and is based on the long-run target weights. 15) B

IRR Keystrokes: CF0 = −$550,000; CF1 = $65,000; F1 = 5; CF2 = $50,000; F2 = 3; CF3 = $350,000; F3 = 1. NPV Keystrokes: CF0 = −$550,000; CF1 = $65,000; F1 = 5; CF2 = $50,000; F2 = 3; CF3 = $350,000; F3 = 1. Compute NPV, I = 9. Note: Although the rate of return is positive, the IRR is less than the required rate of 9%. Hence, the NPV is negative. 16) B

If the bonds are trading at $98, the required yield is 8.11%, and the market value of the issue is $3.92 million. To calculate this rate using a financial calculator (and figuring the rate assuming a $100 face value for each bond), N = 4; PMT = 7.5 = (0.075 × 100); FV = 100; PV = −98; CPT → I/Y = 8.11. By adding the equity risk factor of 4%, we compute the cost of equity as 12.11%. 17) C

Resolving the conflicting interests of both shareholders and other stakeholders is the focus of corporate governance under stakeholder theory. Shareholders are among the groups whose interests are considered under stakeholder theory. 18) C

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If the total undiscounted cash flows from two projects are equal, their NPV profiles intersect the vertical axis at the same value. The NPV profile will have a steeper slope for Project Smith, which has more of its cash inflows occurring later in its life, and therefore the IRR of Project Smith (its intersection with the horizontal axis) must be less than the IRR of Project Jones. The NPV for Project Jones will be greater at any rate of discount, and Project Jones will be preferred over the entire range. However, if the discount rate applied to the cash flows is greater than the IRR of Project Jones, both projects will have negative NPVs and the company should reject both of them. 19) C

Arranging financing is not one of the administrative steps in the capital budgeting process. The four administrative steps in the capital budgeting process are: 2. Idea generation 3. Analyzing project proposals 4. Creating the firm-wide capital budget 5. Monitoring decisions and conducting a post-audit 20) C

The internal rate of return is independent of the firm’s cost of capital. It is a function of the amount and timing of a project’s cash flows. 21) A

We can estimate the company’s expected growth rate as ROE × (1 − payout ratio): g = 15% × (1 − 2.40/3.00) = 3% The expected dividend next period is then £2.40(1.03) = £2.47. Based on dividend discount model pricing, the required return on equity is 2.47 / 40 + 3% = 9.18%. 22) C

Stolzenbach will have a break point each time a component cost of capital changes, for a total of three marginal cost of capital schedule breakpoints. Break pointDebt > $200mm = ($200 million ÷ 0.4) = $500 million Break pointDebt > $400mm = ($400 million ÷ 0.4) = $1,000 million Break pointEquity > $300mm = ($300 million ÷ 0.6) = $500 million Break pointEquity > $700mm = ($700 million ÷ 0.6) = $1,167 million 23) A

The NPV of purchasing machine 1 is 1.20(5 million) − 5 million = 1 million. The NPV of purchasing machine 2 is 1.17(6 million) − 6 million = 1.02 million. Parker should choose machine 2 because it has the higher NPV.

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24) A

The problem of multiple IRRs is encountered only when the cash flows have an unconventional pattern. 25) C

"2/10 net 30" is a discount of 2% of the invoice amount for payment within 10 days, with full payment due in 30 days. Cost of trade credit on day 30 =

26) C

Operating earnings = EBIT = Sales − TVC − Fixed operating costs

27) B

The policy statement is inappropriate because it is too restrictive. A policy statement should focus on meeting the specific safety and liquidity needs of the firm but should also allow the flexibility to increase yield within these constraints. There are many other securities potentially suitable for cash management that would provide equivalent or better liquidity and safety of principal at least equivalent to that of the securities issued by A+ rated banks. 28) C

An investment policy statement typically begins with a statement of the purpose and objective of the investment portfolio, some general guidelines about the strategy to be employed to achieve those objectives, and the types of securities that will be used. A list of permitted securities for investment would be limited and likely too restrictive. A list of permitted security types is appropriate and can provide the necessary flexibility to increase yield within the safety and liquidity constraints appropriate for the firm. 29) B

We can compare the yields of these securities on any single basis. The preferred basis is the bond equivalent yield. Security 1 = discount is 3.6% (30 / 360) = 0.3% BEY = (0.3 / 99.7) (365 / 30) = 3.661% BEY of Security 2 = (0.35 / 99.65) × (365 / 30) = 4.273% BEY of Security 3 = 3.65% 30) C

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Paying invoices on the last day to get a discount (for early payment) is likely the most advantageous strategy for a firm. If the annualized percentage cost of not taking advantage of the discount is less than the firm’s short-term cost of funds, it would be advantageous to pay on the due date. However, the discount percentage is not an annualized rate, so it cannot be compared directly to the firm's annual return on short-term investments. Paying prior to the discount cutoff date or prior to the due date sacrifices interest income for no advantage. 31) B

No inferences about liquidity are warranted based on this measure. A firm may have higher credit sales than another simply because it has more sales overall. Cash as a proportion of sales and inventory turnover are indicators of liquidity. 32) A

Treasury notes have maturities between 2 and 10 years and, thus, have maturities longer than those of securities suitable for cash management. Allowing short-term securities to mature without reinvesting the cash generated would be one way to meet seasonal cash needs. Shortterm bank borrowing or issuing commercial paper that can be paid off when holiday sales generate cash would be appropriate strategies for dealing with a predictable short-term need for cash. 33) C

The firm’s average days of receivables should be close to the industry average. A significantly lower average days receivables outstanding, compared to its peers, is an indication that the firm’s credit policy may be too strict and that sales are being lost to peers because of this. We can not assume that stricter credit controls than the average for the industry are “better.” We cannot conclude that credit sales are less, they may be more, but just made on stricter terms. The average days of receivables are only one component of the cash conversion cycle. 34) B

The money market yield is the holding period yield times 360/72 and is always greater than the discount yield which is the actual discount from face value times 360/72, since the holding period yield is always greater than the percentage discount from face value. A security’s discount yield and its money market yield are always less than its bond equivalent yield, and its effective annual yield is always greater than its bond equivalent yield. 35) B

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An increase in inventory could indicate poor sales and an accumulation of obsolete items or could be the result of a conscious effort to have adequate supplies to avoid losses from not having items to satisfy customer orders (stock outs). Higher-than-average inventory turnover could indicate better inventory management or could indicate that a less than optimal inventory is being maintained by the company.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) The process that ensures that two securities positions with identical future payoffs, regardless of future events, will have the same price is called: 1) ______ A) the law of one price. B) arbitrage. C) exchange parity. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Derivative Markets and Instruments Source : Derivatives > Derivatives Question 1

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: 2) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Basics of Derivative Pricing and Valuation Source : Derivatives > Derivatives Question 2

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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: 3) ______ A) 7%. B) 6%. C) 5%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Derivative Markets and Instruments Source : Derivatives > Derivatives Question 3

4) Which of the following is an example of an arbitrage opportunity? 4) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Derivative Markets and Instruments Source : Derivatives > Derivatives Question 4

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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: 5) ______ A) efficient markets. B) inefficient markets. C) speculation. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Derivative Markets and Instruments Source : Derivatives > Derivatives Question 5

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: 6) ______ A) 66.6 B) 65.8 C) 59.7 Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Basics of Derivative Pricing and Valuation Source : Derivatives > Derivatives Question 6

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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: 7) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Basics of Derivative Pricing and Valuation Source : Derivatives > Derivatives Question 7

8) A net benefit from holding the underlying asset of a forward contract will: 8) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Basics of Derivative Pricing and Valuation Source : Derivatives > Derivatives Question 8

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: 9) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Basics of Derivative Pricing and Valuation Source : Derivatives > Derivatives Question 9

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10) Derivatives valuation is based on risk-neutral pricing because: 10) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Basics of Derivative Pricing and Valuation Source : Derivatives > Derivatives Question 10

11) Which of the following is the best interpretation of the no-arbitrage principle? 11) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Derivative Markets and Instruments Source : Derivatives > Derivatives Question 11

12) Which of the following statements about arbitrage opportunities is most accurate? 12) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Derivative Markets and Instruments Source : Derivatives > Derivatives Question 12

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13) The price of a pay-fixed receive-floating interest rate swap is: 13) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Basics of Derivative Pricing and Valuation Source : Derivatives > Derivatives Question 13

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: 14) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Basics of Derivative Pricing and Valuation Source : Derivatives > Derivatives Question 14

15) The calculation of derivatives values is based on an assumption that: 15) ______ A) arbitrage opportunities do not arise in real markets. B) arbitrage opportunities are exploited rapidly. C) investors are risk neutral. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Basics of Derivative Pricing and Valuation Source : Derivatives > Derivatives Question 15

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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: 16) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Basics of Derivative Pricing and Valuation Source : Derivatives > Derivatives Question 16

17) Which of the following portfolios has the same future cash flows as a protective put? 17) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Basics of Derivative Pricing and Valuation Source : Derivatives > Derivatives Question 17

18) For a European style put option: 18) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Basics of Derivative Pricing and Valuation Source : Derivatives > Derivatives Question 18

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19) The time value of a European call option with 30 days to expiration will most likely be: 19) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Basics of Derivative Pricing and Valuation Source : Derivatives > Derivatives Question 19

20) The value of a European put option at expiration is most likely to be increased by: 20) ______ A) a lower risk-free interest rate. B) a higher exercise price. C) higher volatility of the underlying asset price. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Derivative Markets and Instruments Source : Derivatives > Derivatives Question 20

21) Other things equal, a short put position would become more valuable as a result of an

increase in: 21) ______ A) the price of the underlying asset. B) the volatility of the price of the underlying asset. C) the time to expiration. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Derivative Markets and Instruments Source : Derivatives > Derivatives Question 21

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22) The time value of an option is most accurately described as: 22) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Basics of Derivative Pricing and Valuation Source : Derivatives > Derivatives Question 22

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Answer Key Test name: Derivatives 1) B

If two securities have identical payoffs regardless of events, the process of arbitrage will move prices toward equality. Arbitrageurs will buy the lower priced position and sell the higher priced position, for an immediate profit without any future liability. The law of one price (for securities with identical payoffs) is not a process; it is ‘enforced’ by arbitrage. 2) A

When interest rates and futures prices are uncorrelated the prices of forward and futures on the same asset will be equal. Liquidity is not an issue as no-arbitrage prices are based on riskless hedges that are held until settlement of the derivative security. 3) C

If the no-arbitrage condition is met, a riskless portfolio (a portfolio with zero standard deviation of returns) will yield the risk-free rate of return. 4) B

An arbitrage opportunity exists when a combination of two securities will produce a certain payoff in the future that produces a return that is greater than the risk-free rate of interest. Borrowing at the riskless rate to purchase the position will produce a certain future amount greater than the amount required to repay the loan. 5) B

A critical element of efficient markets is that asset prices respond immediately to any new information that will affect their value. Large numbers of traders responding in similar fashion to the new information will create a temporary imbalance in supply and demand, and this will adjust asset market values. 6) B

F0(T) = [S0 − net cost of carry] × (1 + Rf)T = [62 − (−3)] × (1.025)6/12 = 65.81 7) B

An opportunity for arbitrage exists if the forward price is not equal to the future value of the spot price, compounded at the risk-free rate over the period of the forward contract. 8) C

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Compared to an underlying asset with no net holding cost or benefit, a net benefit from holding the underlying asset will decrease the no-arbitrage forward price at initiation and the value of a forward contract during its life. Holding costs and benefits have no effect on the value of a forward contract at expiration. 9) B

Differences may exist between forward and futures prices for otherwise identical contracts if futures prices are correlated with interest rates. If futures prices are negatively correlated with interest rates, daily settlement of long futures contracts will require cash when interest rates are increasing and produce cash when interest rates are decreasing. As a result the futures price will be lower than the forward price. The difference in price does not provide an arbitrage opportunity or suggest that investors should prefer forward or futures contracts. 10) B

Because the risk of a derivative is based entirely on the risk of its underlying asset, we can construct a perfectly hedged portfolio of a derivative and its underlying asset. The future payoff of a perfectly hedged position is certain and can therefore be discounted at the risk-free rate. 11) C

An arbitrage opportunity is the chance to make a riskless profit with no investment. In essence, finding an arbitrage opportunity is like finding free money. As you recall, in arbitrage, you observe two identical assets with different prices. Your immediate response should be to buy the cheaper one and sell the expensive one short. You can then deliver the cheap one to cover your short position. Once you take the initial arbitrage position, your arbitrage profit is locked in. The no-investment statement referenced in the text refers to the assumption that when you short the expensive asset, you will be given access to the cash created by the short sale. With this cash, you now have the money to buy the cheaper asset. The no-investment assumption means that the first person to observe a market pricing error will have the financial resources to correct the pricing error instantaneously all by themselves. 12) C

Arbitrage is often referred to as the law of one price. Because when exploiting an arbitrage opportunity an arbitrageur will often simultaneously sell the higher-priced asset and buy the lower-priced asset, no capital may be required. Price differences may persist when short sales are not possible of because the difference is not great enough to outweigh the transaction costs of exploiting it. 13) A

The price of an interest rate swap refers to the fixed rate specified in the swap. This price is calculated as a function of expected future short-term rates.

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14) A

Early exercise of an in-the-money American put option is valuable when the asset value is significantly below the exercise price (i.e. they are deep in-the money). The payment of interest or dividends from the underlying asset increases put values, so it does not make early exercise valuable as it does with call options. 15) B

Derivatives valuation is based on the assumption that any arbitrage opportunities in financial markets are exploited rapidly so that assets with identical cash flows are forced toward the same price. It does not assume arbitrage opportunities do not arise or that investors are risk neutral. 16) C

For European puts, it is possible that the longer term option can be less valuable than a shorterterm option. 17) B

The put-call parity relationship shows that a protective put (long put, long underlying asset) has the same future payoff as a fiduciary call (long call, long risk-free bond). 18) C

The time value of an option (either a put or a call) is equal to its market price minus its exercise value. A put's exercise value is the maximum of zero or its exercise price minus the stock price. Intrinsic value is another term for exercise value. 19) A

The option premium is made up of time value and intrinsic value. Intrinsic value is positive if an option is in-the-money and zero otherwise. Time value is always positive for call options. If the option still has 30 days until expiration and is in-the-money, the option premium will be the positive intrinsic value, plus the positive time value. Hence, the time value will be less than the premium. If the option is out-of-the-money, the intrinsic value will be zero, and the option premium will be equal to the time value. If the exercise price is greater than the current spot price, the call option is out-of-the-money and hence the intrinsic value again is zero. But as the call option still has time to expiration, the time value will be positive. 20) B

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The value of an option at expiration is the greater of zero or its exercise value. A higher exercise price increases the exercise value of a put option because it gives the holder the right to sell the underlying asset for a higher price. The risk-free interest rate and volatility of the underlying asset price only affect the time value of options, which is zero at expiration. 21) A

An increase in the price of the underlying asset would decrease the value of a put option, which would make a long position in the put less valuable and a short position more valuable. An increase in either the volatility of the underlying asset price or time to expiration would increase the put value and decrease the value of a short position. 22) C

The price (or premium) of an option is its intrinsic value plus its time value. An out-of-themoney option has an intrinsic value of zero, so its entire premium consists of time value. Time value is zero at an option’s expiration date. Time value is the amount by which an option's premium exceeds its intrinsic value.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) If money wages increase, other things equal, the most likely result is a: 1) ______ A) short-run inflationary gap. B) long-run inflationary gap. C) short-run recessionary gap. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Aggregate Output, Prices, and Economic Growth Source : Economics > Economics Question 1

2) When demand for a good is inelastic, a higher price will: 2) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Topics in Demand and Supply Analysis Source : Economics > Economics Question 2

3) Which of the following is least relevant when explaining why monopoly firms can earn

positive economic profits over the long term? 3) ______ A) The existence of economies of scale. B) Control over production input resources. C) The ability to use price discrimination. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Firm and Market Structures Source : Economics > Economics Question 3

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4) A price index that is calculated using the current weights of the index’s basket of goods and

services is known as a: 4) ______ A) hedonic price index. B) chained price index. C) Laspeyres price index. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Business Cycles Source : Economics > Economics Question 4

5) Which of the following is least accurate regarding the allocative efficiency associated with

price discrimination? Price discrimination: 5) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Firm and Market Structures Source : Economics > Economics Question 5

6) The current annual inflation rate, as measured by using the Consumer Price Index (CPI), is

best defined as: 6) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Business Cycles Source : Economics > Economics Question 6

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7) Which of the following is least likely to be considered a reason why regulation of monopolies

is not effective? 7) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Firm and Market Structures Source : Economics > Economics Question 7

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? Exports relative to imports exports < imports exports < imports exports > imports

A) B) C)

Savings relative to investment private savings > private investment private savings < private investment private savings < private investment 8) ______

A) Option A B) Option B C) Option C Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Aggregate Output, Prices, and Economic Growth Source : Economics > Economics Question 8

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9) Which of the following is least accurate with regard to advertising for firms operating under

monopolistic competition? 9) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Firm and Market Structures Source : Economics > Economics Question 9

10) In order for effective price discrimination to occur the seller must: 10) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Firm and Market Structures Source : Economics > Economics Question 10

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? 11) ______ A) P = MR. B) MR = MC. C) MR < ATC. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Firm and Market Structures Source : Economics > Economics Question 11

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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)

12) ______ A) Option A B) Option B C) Option C Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Business Cycles Source : Economics > Economics Question 12

13) In a perfectly competitive industry, the short-run supply curve for the market is the: 13) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Firm and Market Structures Source : Economics > Economics Question 13

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14) If private saving equals private business investment, a trade surplus implies that there is: 14) ______ A) no fiscal surplus or deficit. B) a fiscal surplus. C) a fiscal deficit. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Aggregate Output, Prices, and Economic Growth Source : Economics > Economics Question 14

15) In the long-run, after all firms in a perfectly competitive industry have adopted new

technology, the: 15) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Firm and Market Structures Source : Economics > Economics Question 15

16) For price discrimination to work, the seller must face a market with all of the following

characteristics EXCEPT: 16) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Firm and Market Structures Source : Economics > Economics Question 16

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17) Which of the following amounts is least likely to be subtracted from gross domestic product

in order to calculate national income? 17) ______ A) Statistical discrepancy. B) Indirect business taxes. C) Capital consumption allowance. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Aggregate Output, Prices, and Economic Growth Source : Economics > Economics Question 17

18) Based on the concept of diminishing returns, as the quantity of output increases, the short-run

marginal costs of production eventually: 18) ______ A) rise at an increasing rate. B) fall at a decreasing rate. C) rise at a decreasing rate. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Topics in Demand and Supply Analysis Source : Economics > Economics Question 18

19) Manufacturing and trade sales are best described as a: 19) ______ A) leading indicator. B) lagging indicator. C) coincident indicator. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Business Cycles Source : Economics > Economics Question 19

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20) What is the relationship between price and marginal revenue for a price searcher? 20) ______ A) Marginal revenue = price. B) Marginal revenue < price. C) Marginal revenue > price. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Firm and Market Structures Source : Economics > Economics Question 20

21) When potential real GDP is less than actual real GDP, the economy is most likely

experiencing: 21) ______ A) underemployment. B) recession. C) inflation. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Aggregate Output, Prices, and Economic Growth Source : Economics > Economics Question 21

22) Even though the producer surplus increases under a monopoly scenario, relative to one of

perfect competition, the consumer surplus decreases by: 22) ______ A) an equal amount. B) a greater amount. C) a lesser amount. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Firm and Market Structures Source : Economics > Economics Question 22

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23) If a fiscal budget deficit increases, which of the following factors must also increase if all

other factors are held constant? 23) ______ A) Trade surplus. B) Savings. C) Investment. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Aggregate Output, Prices, and Economic Growth Source : Economics > Economics Question 23

24) In the dominant firm model of oligopoly, it is least likely that one firm: 24) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Firm and Market Structures Source : Economics > Economics Question 24

25) The kinked demand model assumes that below the current price, the demand curve becomes: 25) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Firm and Market Structures Source : Economics > Economics Question 25

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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: 26) ______ A) both are correct. B) only one is correct. C) both are incorrect. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Firm and Market Structures Source : Economics > Economics Question 26

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 27) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Firm and Market Structures Source : Economics > Economics Question 27

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28) Average weekly initial claims for unemployment insurance are classified as a: 28) ______ A) coincident indicator. B) leading indicator. C) lagging indicator. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Business Cycles Source : Economics > Economics Question 28

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: 29) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Topics in Demand and Supply Analysis Source : Economics > Economics Question 29

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: 30) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Aggregate Output, Prices, and Economic Growth Source : Economics > Economics Question 30

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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: 31) ______ A) disposable income. B) GDP. C) personal income. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Aggregate Output, Prices, and Economic Growth Source : Economics > Economics Question 31

32) In the short run, will an increase in the money supply increase the price level and real output? 32) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Aggregate Output, Prices, and Economic Growth Source : Economics > Economics Question 32

33) Which of the following events is most likely to increase short-run aggregate supply (shift the

curve to the right)? 33) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Aggregate Output, Prices, and Economic Growth Source : Economics > Economics Question 33

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34) With respect to the IS-LM model, a change in the price level will shift: 34) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Aggregate Output, Prices, and Economic Growth Source : Economics > Economics Question 34

35) Compared to a competitive market result, a single-price monopoly will most likely: 35) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Firm and Market Structures Source : Economics > Economics Question 35

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: 36) ______ A) 138.10 JPY/GBP. B) 138.44 JPY/GBP. C) 138.95 JPY/GBP. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Currency Exchange Rates Source : Economics > Economics Question 36

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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: 37) ______ A) 6.436 CNY/CAD. B) 6.475 CNY/CAD. C) 6.452 CNY/CAD. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Currency Exchange Rates Source : Economics > Economics Question 37

38) If households are holding larger real money balances than they desire, which of the following

is least likely? 38) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Monetary and Fiscal Policy Source : Economics > Economics Question 38

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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: 39) ______ A) 7.0. B) 10.5. C) 4.7. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Monetary and Fiscal Policy Source : Economics > Economics Question 39

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: 40) ______ A) 1.5788. B) 1.5621. C) 1.5762. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Currency Exchange Rates Source : Economics > Economics Question 40

41) Participants in foreign exchange markets that can be characterized as "real money accounts"

most likely include: 41) ______ A) insurance companies. B) hedge funds. C) central banks. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Currency Exchange Rates Source : Economics > Economics Question 41

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42) Which of the following relationships in regard to the quantity theory of money is least

accurate? 42) ______ A) Nominal GDP = Price × Money Supply. B) Nominal GDP = Money Supply × Velocity = Price × Real Output. C) Money × Velocity = Money Supply × Velocity. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Monetary and Fiscal Policy Source : Economics > Economics Question 42

43) In the context of the foreign exchange market, investment accounts are said to be leveraged if

they: 43) ______ A) buy currencies on margin. B) use derivatives. C) borrow and sell foreign currencies. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Currency Exchange Rates Source : Economics > Economics Question 43

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: 44) ______ A) prime rate. B) discount rate. C) federal funds rate. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Monetary and Fiscal Policy Source : Economics > Economics Question 44

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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)

45) ______ A) Option A B) Option B C) Option C Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Monetary and Fiscal Policy Source : Economics > Economics Question 45

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: 46) ______ A) premium of 1% to the GHI. B) discount of 1% to the JKL. C) premium of 1% to the DEF. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Currency Exchange Rates Source : Economics > Economics Question 46

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47) Frequent changes in advertised prices are one of the costs of: 47) ______ A) unexpected inflation only. B) both expected and unexpected inflation. C) expected inflation only. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Monetary and Fiscal Policy Source : Economics > Economics Question 47

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: 48) ______ A) depreciation of 9.2%. B) appreciation of 10.1%. C) depreciation of 10.1%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Currency Exchange Rates Source : Economics > Economics Question 48

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49) Which of the following statements about the demand and supply of money is most accurate?

People who are: 49) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Monetary and Fiscal Policy Source : Economics > Economics Question 49

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: 50) ______ A) 1.2022. B) 0.8313. C) 1.2029. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Currency Exchange Rates Source : Economics > Economics Question 50

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51) Contractionary monetary policy is least likely to decrease consumption spending by

decreasing: 51) ______ A) the foreign exchange value of the currency. B) securities prices. C) expectations for economic growth. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Monetary and Fiscal Policy Source : Economics > Economics Question 51

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: 52) ______ A) nominal exchange rate (domestic/foreign). B) domestic price level. C) foreign price level. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Currency Exchange Rates Source : Economics > Economics Question 52

53) In the balance of payments accounts, goods and financial assets that migrants bring to a

country are included in the: 53) ______ A) financial account. B) capital account. C) current account. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : International Trade and Capital Flows Source : Economics > Economics Question 53

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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: 54) ______ A) vertical. B) downward sloping to the lower right. C) upward sloping to the upper right. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Monetary and Fiscal Policy Source : Economics > Economics Question 54

55) According to the Fisher effect, which of the following interest rates includes a premium for

the expected rate of inflation? 55) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Monetary and Fiscal Policy Source : Economics > Economics Question 55

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: 56) ______ A) the foreign exchange value of the country’s currency. B) short-term interest rates. C) GDP growth in the short run. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Monetary and Fiscal Policy Source : Economics > Economics Question 56

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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? 57) ______ A) Current account surplus. B) Balance of trade surplus. C) Capital account surplus. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : International Trade and Capital Flows Source : Economics > Economics Question 57

58) The least likely result of import quotas and voluntary export restraints is: 58) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : International Trade and Capital Flows Source : Economics > Economics Question 58

59) The USD/EUR spot exchange rate is 1.3500 and 6-month forward points are −75. The 6-

month forward exchange rate is: 59) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Currency Exchange Rates Source : Economics > Economics Question 59

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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: 60) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Monetary and Fiscal Policy Source : Economics > Economics Question 60

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Answer Key Test name: Economics 1) C

An increase in the wage rate decreases short-run aggregate supply, leading to a short-run recessionary gap. 2) B

When demand is relatively inelastic, consumers do not reduce their quantity demanded very much when the price increases. That is, a given percentage increase in price results in a smaller percentage reduction in quantity demanded. Thus, total expenditures on the good increase. "Fail to reduce the quantity demanded for the good" is inaccurate because that would only be true if demand was perfectly inelastic. 3) C

High entry barriers due to economies of scale, government licensing, resource controls, and patents prevent new firms from entering the market to exploit positive economic profit opportunities. 4) B

A chained or chain-weighted price index uses updated weights for each good and service in its market basket. A price index that is not chain-weighted, such as a Laspeyres index, is calculated using weights for each good and service in the market basket as of the index’s base period. Hedonic pricing is a technique used to adjust a price index for upward bias from quality changes of goods in its market basket. 5) C

Allocative efficiency occurs when the quantity produced maximizes the sum of consumer and producer surplus. That is, where marginal benefit equals marginal cost. Price discrimination reduces the allocative inefficiency that exists when prices are greater than marginal cost by increasing output toward the quantity where price equals marginal cost. Firms gain by selling to customers with inelastic demand while still providing goods to customers with more elastic demand. This may even cause production to take place at a level where it would not take place otherwise. 6) B

The inflation rate is the percentage change in the price index from a year earlier. 7) B 8) C

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A government budget deficit, a trade surplus, and an excess of private investment over private savings cannot all occur at the same time. If the government runs a budget deficit, the deficit must be financed by a trade deficit (exports < imports), surplus private savings (private savings > private investment), or both. 9) C

Advertising expenses are high for firms in monopolistic competition. Not only because firms need to inform consumers about the unique features of a firm’s products, but also to create or increase a perception of differences between products that are actually quite similar. Advertising costs increase average total costs, but the increase to average total cost attributable to advertising decreases as output increases because more fixed advertising dollars are being averaged over a larger quantity. If advertising increases output (sales) significantly, it can actually decrease a firm’s average total cost if there are economies of scale. 10) B

In order for effective price discrimination to occur, the seller must have a downward sloping demand curve. The seller must also have at least two identifiable groups of customers with price elasticities of demand for the product, and the seller must be able to prevent customers from reselling the product. 11) A

To maximize profit, all firms expand output until marginal revenue equals marginal cost. Price is determined from the demand curve, which is above the marginal revenue curve since a monopoly faces a downward sloping demand curve. 12) A

Walker should disagree with both statements. Price changes resulting from increases in the quality of goods, do not represent inflation. However, the Consumer Price Index is affected by biases from product quality, as well as new goods and substitution, causing it to overstate the rate of inflation. As a result, increases in wages that are based on CPI will more than compensate for actual increases in the cost of living. 13) B

The short-run supply curve for a firm is its marginal cost curve above the average variable cost curve. The short-run supply curve of the market is the sum of the supply curves for all firms in the industry. 14) B

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The fundamental relationship among saving, investment, the fiscal balance, and the trade balance is stated as: (G − T) = (S − I) − (X − M). If S = I, this equation becomes (G − T) = − (X − M), or (T − G) = (XM). In this case, if the trade balance is in surplus (exports are greater than imports), the fiscal balance must also be in surplus (taxes are greater than government spending). 15) A

After some firms in an industry adopt a technological change, the existing firms that use the old technology will experience losses and either adopt the technology or exit the industry. Long-run equilibrium with price equal to minimum average total cost for the new technology will be established. 16) B

Price discrimination is the practice of charging different consumers different prices for the same product or service. For price discrimination to work the seller must: 1) have a downward sloping demand curve, 2) have at least two identifiable groups of customers with different price elasticities of demand, 3) must be able to prevent customers in the lower-price group from reselling the product to customers in the higher-price group. 17) B

Indirect business taxes are not subtracted because they are included in national income. 18) A

The law of diminishing returns states that as more variable resources are a production process combined with a fixed input, output will eventually increase at a decreasing rate. In the short run, as the quantity produced rises, costs rise at an increasing rate. 19) C

Manufacturing and trade sales are a coincident indicator that generally reflects the current phase of the business cycle. 20) B

For a price searcher, demand is downward sloping, marginal revenue is less than price since price must be reduced to sell additional units of output. 21) C

The economy is in an inflationary phase if actual real GDP is greater than potential real GDP. When actual real GDP equals potential real GDP, the economy is said to be at full employment. The economy is in a recessionary phase if real GDP is less than potential GDP. 22) B

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The consumer surplus decreases by a greater amount than the producer surplus increases, with the difference representing a deadweight loss. 23) B

The relationship between the fiscal balance, savings, investment, and the trade balance is (G − T) = (S − I) − (X − M). An increase in a fiscal budget deficit (G − T) must be funded by an increase in savings (S), a decrease in investment (I), or a decrease in net exports (X − M), which would decrease a trade surplus or increase a trade deficit. 24) C

The dominant firm model of oligopoly is based on the assumption that one firm has a significant cost advantage which allows it to set the price in the market and control a relatively large share of the industry’s production and sales. It does not assume that the firm will be the innovation leader in product development. In fact, being more innovative is one of the factors that allow smaller competitors that work at a cost disadvantage to survive. 25) B

The kinked demand model of oligopoly behavior assumes that a firm’s competitors will not match a price increase, but will match the price of a competitor that offers a lower price. The result is a demand curve that is more elastic above the current price, but less elastic below it. 26) B

With a price-fixing agreement, producers in an oligopoly market restrict output to increase price and joint profits just as a monopoly producer does. Such agreements decrease economic efficiency. When these agreements are violated, quantity produced increases, increasing economic efficiency. Therefore Statement 1 is accurate. The efficiency of monopolistic competition is not clear. While increased opportunity cost is associated with the intensive marketing and advertising activities that are characteristic of monopolistic competition, consumers definitely benefit from these selling activities because they receive information that often enables them to make better purchasing decisions. Hence the advertising and marketing costs may be more than the efficient amount, but do not represent a deadweight loss. Therefore Statement 2 is inaccurate. 27) C

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Papyrus Company is an example of a price searcher engaged in monopolistic competition (low barriers to entry). Thus, the company faces a downward sloping demand curve and highly elastic demand. An increase in price will result in fewer units sold. Wudden Floss is an example of a price taker operating in a purely competitive market. Thus, the firm faces a horizontal demand curve and perfectly elastic demand. An increase in price will result in no units sold. In a purely competitive market, the firm must take the market price. 28) B

Initial claims for unemployment insurance are considered a leading indicator. 29) B

Price elasticity of −1.1 tells us that a 5% increase in price will reduce sales by more than 5%, so total revenue will decrease. Whether profits increase or decrease will depend on whether the cost reduction from producing less output is greater or less than the decrease in total revenue. 30) B

The fundamental relationship among saving, investment, the fiscal balance and the trade balance is expressed as (S − I) = (G − T) + (X − M). If domestic savings (S) are not sufficient to finance private investment (I), then (S − I) is negative and the sum (G − T) + (X − M) must also be negative. With exports greater than imports, (X − M) is positive so (G − T) must be negative and larger than (X − M). If (G − T) is negative, taxes (T) are greater than government spending (G) and the government has a fiscal surplus. 31) C

Personal income is calculated by adding transfer payments to national income and subtracting indirect business taxes, corporate income taxes, and undistributed corporate profits. Disposable income is personal income minus personal taxes. GDP is national income plus a capital consumption allowance and an adjustment for statistical discrepancy between the income and expenditure approaches. 32) B

In the short run, an increase in the money supply will increase aggregate demand. The new shortrun equilibrium will be at a higher price level and a greater level of real output (GDP). 33) C

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Falling money wages would cause businesses to increase (profit-maximizing) output levels at each price level for final goods and services. Changes in the price level of goods and services are represented by a movement along a short-run aggregate supply curve, not a shift in the curve. A rise in resource prices will decrease aggregate supply. An increase in government spending will shift the aggregate demand curve but not the aggregate supply curve. 34) A

Because an LM curve is constructed for a given level of the real money supply, a change in the price level (which affects the real money supply) will shift the LM curve. The aggregate demand curve is determined by changing the price level, which produces alternative LM curves. Changing price levels determines the aggregate demand curve from the intersections of alternative LM curves with the IS curve. 35) C

A firm in a monopoly position will reduce output to where MC = MR, which will increase price, decrease consumer surplus, and increase producer surplus. A marginal cost pricing strategy refers to regulation which requires a firm to set price equal to marginal cost. 36) B

The calculation is as follows:

37) C

The calculation is as follows:

38) C

If households' real money balances are larger than they desire, the interest rate (opportunity cost of holding money balances) is higher than its equilibrium rate. Households will use their undesired cash to buy securities, bidding up securities prices and reducing the interest rate until the equilibrium rate is achieved. This market process does not require any action by the central bank. 39) A

The equation of exchange is MV = PY. Nominal GDP = PY, so that MV = nominal GDP. Therefore, ($1.0 trillion)(V) = $7.0 trillion. V = $7.0 trillion / $1.0 trillion. V = 7.0.

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40) C

Forward USD/GBP = spot USD/GBP × (1 + U.S. interest rate) / (1 + UK interest rate) = 1.5775 × [(1 + 0.015/12) / (1 + 0.025/12)] = 1.5762 41) A

Real money accounts are foreign exchange buy-side investors that do not use derivatives. Many mutual funds, pension funds, and insurance companies can be classified as real money accounts. Hedge funds typically use derivatives. Central banks usually do not act as investors in foreign exchange markets but may intervene in foreign exchange markets to achieve monetary policy objectives. 42) A

The quantity theory of money holds that: Money Supply × Velocity = Nominal GDP = Price × Real Output. 43) B

Leveraged accounts in the foreign exchange market refer to investment accounts that use derivatives. 44) B

Banks are able to borrow from the Fed at the discount rate. The federal funds rate is the interest rate banks charge other banks to borrow reserves from other banks. The prime rate is the rate that commercial banks charge their best customers. 45) A

The amount of the spending program exactly offsets the amount of the tax increase, leaving the budget unaffected (balanced budget). The multiplier effect is stronger for government spending versus the tax increase. Therefore, the balanced budget multiplier will be positive. All of the government spending enters the economy as increased expenditure, whereas only a portion of the tax increase results in lessened expenditure (determined by the marginal propensity to consume), because part of the tax increase will come from the savings of the taxpayer (determined by the marginal propensity to save). 46) A

The EUR is at a forward premium to the GHI because the EUR/GHI forward rate is less than the EUR/GHI spot rate. The base currency, GHI, is at a forward discount of forward/spot − 1 = 4.2800 / 4.3250 − 1 = −1.04%. The EUR is at a forward discount to the DEF and a forward premium to the JKL.

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47) B

Inflation imposes "menu costs" on an economy as businesses must frequently change their advertised prices, regardless of whether inflation is expected or unexpected. 48) A

To correctly calculate the percentage change in AUD relative to GBP, convert the exchange rates so that AUD is the base currency: 1 / 1.4800 = 0.6757 GBP/AUD five years ago and 1 / 1.6300 = 0.6135 GBP/AUD today. The percentage change in the Australian dollar against the British pound is 0.6135 / 0.6757 − 1 = −9.2%. Note that the GBP has appreciated against the AUD by 1.6300 / 1.4800 − 1 = 10.1% over the same period. 49) C

Buying bonds would drive bond prices up and interest rates down. Selling bonds would have the opposite effect; driving bond prices down and interest rates up. When interest rates are lower, there is an excess demand for money. The supply of money is determined by the monetary authorities. 50) C

The forward rate for CHF/EUR is 0.8342 × (1 − 0.00353) = 0.8313. The 1-year forward EUR/CHF exchange rate is 1 / 0.8313 = 1.2030. 51) A

Contractionary monetary policy is likely to increase the value of the domestic currency in the foreign exchange market, which decreases foreign demand for the country's exports. Contractionary monetary policy should cause both securities prices and expectations for economic growth to decrease, each of which is likely to cause consumers to decrease spending. 52) B

An increase in the domestic price level, other things equal, will decrease a real exchange rate. Increases in the nominal exchange rate or the foreign price level, other things equal, will increase a real exchange rate. 53) B

The capital account includes goods and financial assets that migrants bring when they come to a country or take with them when they leave. 54) A

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The money supply schedule is vertical because it is not affected by changes in the interest rate but is determined by the monetary authorities such as the Federal Reserve System (Fed) in the United States. 55) B

The Fisher effect holds that all nominal interest rates include a premium for expected inflation. 56) C

If the central bank has a price stability mandate, it will most likely respond to the above-target inflation rate by decreasing the money supply, even though GDP growth is in a recessionary phase. Decreasing the money supply will result in higher short-term interest rates and appreciation of the currency, but will likely cause GDP growth to decrease further in the short run. 57) C

If a country is running a current account deficit, it must have an inflow of foreign capital, creating a surplus in the capital account. 58) B

Import quotas and voluntary export restraints, unlike tariffs, do not necessarily generate tax revenue. The other choices describe effects that result from tariffs, quotas, and VERs. 59) C

For an exchange rate quoted to four decimal places, each forward point represents 0.0001. The 6month forward exchange rate is 1.3500 − 0.0075 = 1.3425 USD/EUR. The USD is expected to appreciate against the EUR and is trading at a forward premium. 60) C

At interest rates below 4% (the long-term equilibrium rate), the quantity of money demanded exceeds the quantity of money supplied. At below-equilibrium rates, investors will sell bonds to obtain the desired extra cash. As they sell more bonds, the prices of bonds fall, and interest rates start to move back towards the 4% equilibrium.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) A portfolio manager who adds commodities to a portfolio of traditional investments is most likely seeking to: 1) ______ A) both increase expected returns and decrease portfolio variance. B) decrease portfolio variance only. C) increase expected returns only. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Alternative Investments Source : Alternative Investments > Alternative Investments Question 1

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: 2) ______ A) 8.1%. B) 13.6%. C) 7.9%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Alternative Investments Source : Alternative Investments > Alternative Investments Question 2

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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: 3) ______ A) 10%. B) 9%. C) 8%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Alternative Investments Source : Alternative Investments > Alternative Investments Question 3

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): 4) ______ A) REIT trading price index. B) appraisal index. C) repeat sales index. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Alternative Investments Source : Alternative Investments > Alternative Investments Question 4

5) An example of a relative value hedge fund strategy is: 5) ______ A) convertible arbitrage. B) merger arbitrage. C) market neutral. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Alternative Investments Source : Alternative Investments > Alternative Investments Question 5

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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: 6) ______ A) hard hurdle rate. B) high water mark. C) soft hurdle rate. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Alternative Investments Source : Alternative Investments > Alternative Investments Question 6

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: 7) ______ A) $1.10 million. B) $1.70 million. C) $1.15 million. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Alternative Investments Source : Alternative Investments > Alternative Investments Question 7

8) Relatively infrequent valuations of private equity portfolio companies most likely cause: 8) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Alternative Investments Source : Alternative Investments > Alternative Investments Question 8

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9) Adjusted funds from operations (AFFO) is best described as an estimate of a real estate

investment trust's: 9) ______ A) free cash flow. B) net operating income. C) operating cash flow. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Alternative Investments Source : Alternative Investments > Alternative Investments Question 9

10) To exit an investment in a portfolio company through a trade sale, a private equity firm sells: 10) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Alternative Investments Source : Alternative Investments > Alternative Investments Question 10

11) If a commodity futures market is in backwardation: 11) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Alternative Investments Source : Alternative Investments > Alternative Investments Question 11

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Answer Key Test name: Alternative Investments 1) B

Unlike most alternative investments, expected returns on commodities are typically less than expected returns on traditional investments. However, because their returns typically have a low correlation with returns on traditional investments, adding commodities to a portfolio of traditional investments can decrease portfolio variance. 2) C

Management fee is HK$480 million × 0.02 = HK$9.6 million. Incentive fee is (HK$480 million − HK$400 million) × 0.20 = HK$16.0 million. Total fee is HK$9.6 million + HK$16.0 million = HK$25.6 million. Net of fee: HK$480.0 − HK$25.6 = HK$454.4 million Net return: (HK$454.4 / HK$400.00) − 1 = 13.6% Two year annualized return is(1.136 × 1.025)1/2 − 1 = 7.9% (Study Session 17, Module 50.2, LOS 50.d) 3) A

Management Fee: C$100.0 × 2.0% = C$2.0 million Gross value at end of year (given) = C$112.0 million Incentive fee = [(C$112.0 − C$100.0 − C$2.0 − (C$100.0 × 10.0%)] × 20% = C$0 Total fee = C$2.0 million Net of fee: C$112.0 − C$2.0 = C$110.0 million Net return = (C$110.0 / C$100.0) − 1 =10.0% (Study Session 17, Module 50.2, LOS 50.d) 4) B

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Appraisal index returns are based on estimates of property values. Because estimating values tends to introduce smoothing into returns data, appraisal index returns are likely to have lower standard deviations than index returns based on repeat sales or trading prices of REIT shares. (Study Session 17, Module 50.1, LOS 50.e) 5) A

Relative value strategies include convertible arbitrage fixed income, asset-backed fixed income, general fixed income, volatility, and multi-strategy. Market neutral is an equity hedge strategy. Merger arbitrage is an event driven strategy. 6) C

With a soft hurdle rate, a hedge fund charges an incentive fee on all profits, but only if the fund's rate of return exceeds a stated benchmark. With a hard hurdle rate, a hedge fund charges an incentive fee only on the portion of returns that exceed a stated benchmark. With a high water mark, a fund's value must exceed its highest previous value before the fund may charge an incentive fee. 7) B

Year 1: Management fee = $60.0 million × 2% = $1.2 million. No incentive fee is charged because the fund decreased in value. Value after fees = $56.2 million − $1.2 million = $55.0 million. Year 2: Management fee = $55.0 million × 2% = $1.1 million. Year 2 return = $58.0 million / $55.0 million − 1 = 5.45% which is greater than the hurdle rate. With a soft hurdle rate and no high water mark provision, the entire gain is eligible for incentive fees: ($58.0 million − $55.0 million) × 20% = $0.6 million. Total fees in Year 2 = $1.1 million + $0.6 million = $1.7 million. 8) A

Infrequent valuation results in downward bias in both standard deviations and correlations. 9) A

AFFO equals funds from operations minus recurring capital expenditures and is analogous to free cash flow. 10) A

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A trade sale involves selling a portfolio company to a competitor or another strategic buyer. An IPO involves selling all or some shares of a portfolio company to the public. A secondary sale involves selling a portfolio company to another private equity firm or a group of investors. 11) C

Backwardation refers to a situation where the futures price is less than the spot price for a commodity. Because commodities have no monetary yield, only a convenience yield greater than the opportunity (interest) cost and storage costs of holding the commodity can lead to backwardation. When a futures market is in backwardation, the roll yield is positive because the futures price moves towards the spot price over the life of the contract.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Which of the following statements best describes the overreaction effect? 1) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Market Efficiency Source : Equity Investments > Equity Investments Question 1

2) Equal weighting is the most common weighting methodology for indexes of which of the

following types of assets? 2) ______ A) Hedge funds. B) Equities. C) Fixed income securities. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Security Market Indexes Source : Equity Investments > Equity Investments Question 2

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3) Which of the following option positions is said to be a long position? 3) ______ A) Writer of a put option. B) Buyer of a put option. C) Writer of a call option. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Market Organization and Structure Source : Equity Investments > Equity Investments Question 3

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? 4) ______ A) 73.8%. B) 60.6%. C) 67.7%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Market Organization and Structure Source : Equity Investments > Equity Investments Question 4

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: 5) ______ A) only one of these objectives B) both of these objectives. C) neither of these objectives. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Market Organization and Structure Source : Equity Investments > Equity Investments Question 5

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6) The idea that uninformed traders, when faced with unclear information, observe the actions

of informed traders to make decisions, is referred to as: 6) ______ A) narrow framing. B) herding behavior. C) information cascades. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Market Efficiency Source : Equity Investments > Equity Investments Question 6

7) Which of the following statements least likely describes the role of a portfolio manager in

perfectly efficient markets? Portfolio managers should: 7) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Market Efficiency Source : Equity Investments > Equity Investments Question 7

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8) Which of the following conditions is most likely necessary for capital to be allocated to its

most valuable uses? 8) ______ 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). Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Market Organization and Structure Source : Equity Investments > Equity Investments Question 8

9) The value of a total return index: 9) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Security Market Indexes Source : Equity Investments > Equity Investments Question 9

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10) Which of the following statements about indexes is CORRECT? 10) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Security Market Indexes Source : Equity Investments > Equity Investments Question 10

11) If the momentum effect persists over time, it would provide evidence against which of the

following forms of market efficiency? 11) ______ A) Weak form only. B) Both weak form and semi strong form. C) Semi strong form only. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Market Efficiency Source : Equity Investments > Equity Investments Question 11

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12) Which of the following statements concerning market efficiency is least accurate? 12) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Market Efficiency Source : Equity Investments > Equity Investments Question 12

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? 13) ______ A) Strong, semi strong, and weak forms. B) Weak form only. C) Semi strong and strong forms only. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Market Efficiency Source : Equity Investments > Equity Investments Question 13

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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: 14) ______ A) 15%. B) 25%. C) 20%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Equity Valuation: Concepts and Basic Tools Source : Equity Investments > Equity Investments Question 14

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? 15) ______ A) $133.75. B) $149.80. C) $153.13. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Equity Valuation: Concepts and Basic Tools Source : Equity Investments > Equity Investments Question 15

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16) Which of the following industries is most likely to operate in a fragmented market? 16) ______ A) Pharmaceuticals. B) Oil services. C) Confections. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Industry and Company Analysis Source : Equity Investments > Equity Investments Question 16

17) When constructing a peer group of firms, an analyst should least appropriately consider the

firms’: 17) ______ A) industry classification. B) cost structures. C) business cycle sensitivity. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Industry and Company Analysis Source : Equity Investments > Equity Investments Question 17

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? 18) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Overview of Equity Securities Source : Equity Investments > Equity Investments Question 18

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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: 19) ______ A) $102.80. B) $92.90. C) $55.70. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Equity Valuation: Concepts and Basic Tools Source : Equity Investments > Equity Investments Question 19

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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.) 20) ______ A) $17.91. B) $26.86. C) $30.89. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Equity Valuation: Concepts and Basic Tools Source : Equity Investments > Equity Investments Question 20

21) Because of dividend displacement of earnings, the net effect on firm value of increasing the

dividend payout ratio is: 21) ______ A) to increase firm value. B) indeterminate. C) to decrease firm value. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Equity Valuation: Concepts and Basic Tools Source : Equity Investments > Equity Investments Question 21

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22) The experience curve, which illustrates the cost per unit relative to output: 22) ______ A) slopes upward. B) slopes downward. C) slopes upward in the early years and downward in the later years. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Industry and Company Analysis Source : Equity Investments > Equity Investments Question 22

23) Which of the following is least likely a reason the price to cash flow (P/CF) model has grown

in popularity? 23) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Equity Valuation: Concepts and Basic Tools Source : Equity Investments > Equity Investments Question 23

24) Declining prices that result from the development of substitute products are most likely to

characterize an industry in the: 24) ______ A) shakeout stage. B) mature stage. C) decline stage. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Industry and Company Analysis Source : Equity Investments > Equity Investments Question 24

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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? 25) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Equity Valuation: Concepts and Basic Tools Source : Equity Investments > Equity Investments Question 25

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. 26) ______ A) $9.08. B) $14.29. C) $8.11. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Equity Valuation: Concepts and Basic Tools Source : Equity Investments > Equity Investments Question 26

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27) Which of the following is least likely an advantage of using price/sales (P/S) multiple? 27) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Equity Valuation: Concepts and Basic Tools Source : Equity Investments > Equity Investments Question 27

28) Industry analysis is most likely to provide an analyst with insight about a company's: 28) ______ A) pricing power. B) financial performance. C) competitive strategy. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Industry and Company Analysis Source : Equity Investments > Equity Investments Question 28

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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? 29) ______ A) 26%. B) 14%. C) 20%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Equity Valuation: Concepts and Basic Tools Source : Equity Investments > Equity Investments Question 29

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: 30) ______ A) industrials. B) financial services. C) consumer discretionary. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Industry and Company Analysis Source : Equity Investments > Equity Investments Question 30

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Answer Key Test name: Equity Investments 1) A

The overreaction effect refers to stocks with poor returns over three to five-year periods that had higher subsequent performance than stocks with high returns in the prior period. The result is attributed to overreaction in stock prices that reverses over longer periods of time. Stocks with high previous short- term returns that have high subsequent returns show a momentum effect. 2) A

Most hedge fund indexes are equal-weighted. Equity and fixed income indexes are predominately market capitalization weighted. 3) B

The buyer of an option (either a call or put) is said to be long the option and the writer of an option is said to be short the option. Note that with put options, the long (put option holder) benefits when the price of the underlying asset decreases, while the short (put option writer) benefits when the price of the underlying asset increases. We say that a put buyer is long the option but has short exposure to the underlying asset price. 4) A

Margin debt = 40% × $50 = $20; Interest = $20 × 0.05 = $1. Equity % = [Value − (margin debt + interest)] / Value $80 − $21 / $80 = 73.8% 5) B

CFA Institute attempts to address both of these objectives of market regulation. The CFA Program is part of the effort to encourage minimum standards of competency among finance professionals. Global Investment Performance Standards are part of the effort to make performance evaluation easier for investors. 6) C

“Information cascades” refers to uninformed traders watching the actions of informed traders when making investment decisions. Herding behavior is when trading occurs in clusters, not necessarily driven by information. Narrow framing refers to investors viewing events in isolation. 7) A

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A portfolio manager should quantify each client's risk tolerance and communicate portfolio policies and strategies. However, portfolio managers should monitor client's needs and changing circumstances and make appropriate changes to the portfolio. Adhering to a strict buy and hold policy would not be in the client's best interest. Portfolios need to be rebalanced and changed to meet client’s changing needs. 8) B

Capital will flow to its most valuable uses if markets function well and investors are well informed about the risk and return characteristics of various investments. Allocation of capital to its most valuable uses does not require that all investors have complete information or that financial markets are frictionless. 9) B

The value of a total return index can be calculated by multiplying the beginning value by the geometrically linked series of index total returns. The value of a total return index includes both the price changes of the securities that constitute the index and any cash flows from the securities (dividends, interest, and other distributions). A total return index cannot increase at a slower rate (or decrease at a faster rate) than an otherwise identical price return index because cash flows from the securities cannot be negative. 10) C

The descriptions of value weighted and unweighted indexes are switched. The denominator of a price- weighted index must be adjusted to reflect stock splits and changes in the sample over time. A market value-weighted series assumes you make a proportionate market value investment in each company in the index. 11) B

The momentum effect suggests it is possible to earn abnormal returns using market data. All three forms of market efficiency (weak form, semi strong form, and strong form) assume that market prices fully reflect market data. 12) B

Market efficiency does not assume that individual market participants correctly estimate asset prices, but does assume that their estimates are unbiased. That is, some agents will over-estimate and some will under-estimate, but they will be correct, on average. 13) C

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The semi strong form of EMH states that security prices rapidly adjust to reflect all publicly available information. If the analyst can use his model, which is based on publicly available information, to earn above average returns, the semi strong form of the EMH has been violated. If the semi strong form of EMH is violated, the strong form of EMH is also violated. 14) B

The forecast year-end price, P, is: P = EPS × (P/E) = 10(12) = 120

15) C

16) B

Most areas of the oil services industry are characterized by many small competitors. The confections and pharmaceutical industries each have a small number of very large firms. 17) C

A peer group should consist of firms that are alike in their principal lines of business, along with other similarities such as cost structures and access to capital. Firms can be similar in business cycle sensitivity but dissimilar in terms of their business activities (e.g., a firm in the home building industry and a firm in the heavy equipment manufacturing industry). 18) A

Sources of return on equity securities include price appreciation or depreciation, dividend income, and foreign exchange gains or losses for investors outside the country. In an increasing equity market, reinvesting dividends is likely to increase returns compared to not reinvesting dividends. If the currency is depreciating, investors from outside the country will experience foreign exchange losses that decrease their returns. 19) A

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First, calculate the dividends in years 0 through 3:(We need D3 to calculate the value in Year 2) D0 = (0.4)(5) = 2 D1 = (2)(1.2) = 2.40 D2 = (2.4)(1.2) = 2.88 D3 = E3 = 5(1.2)3 = 8.64 BecauseD3 will grow at a constant rate, we can use it to estimate a terminal value for the stock at t = 2: P2 = D3 / (k − g) = 8.64 / (0.12 − 0.05) = $123.43 Present value of the cash flows = value of stock =2.4 / (1.12)1 + 2.88 / (1.12)2 + 123.43 / (1.12)2 = 102.83 20) B

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Here, we are given all the inputs we need. Use the following steps to calculate the value of the stock: First, expand the infinite period DDM: DDM formula:P0 = D1 / (ke − g) D1 = (Earnings × Payout ratio) / average number of shares outstanding = ($150,000 × 0.60) / 75,000 = $1.20 ke = nominal risk free rate + [beta × (expected market return − nominal risk free rate)] Note: Nominal risk-free rate = (1 + real risk free rate) × (1 + expected inflation) − 1 = (1.04) × (1.03) − 1 = 0.0712, or 7.12%. ke = 7.12% + [2.1 × (13.0% – 7.12%)] = 0.19468 g = (retention rate × ROE) Retention = (1 − Payout) = 1 − 0.60 = 0.40. ROE = (net income / sales)(sales / total assets)(total assets / equity) = (150,000 / 1,000,000)(1,000,000 / 800,000)(800,000 / 400,000) = 0.375 g = 0.375 × 0.40 = 0.15 Then, calculate:P0 = D1 / (ke − g) = $1.20 / (0.19468 − 0.15) = 26.86. 21) B

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The net effect on firm value of increasing the dividend payout ratio is ambiguous because the positive effect of larger dividends may be offset by a negative effect on the firm's sustainable growth rate. If increasing the payout ratio always increased firm value, all firms would have 100% payout ratios. 22) B

The experience curve, which shows the cost per unit relative to output, slopes downward because of increases in productivity and economies of scale, especially in industries with high fixed costs. 23) B 24) C

The decline stage of the industry life cycle is often characterized by declining prices as substitute products or global competition emerge, or as a result of decreasing demand due to societal changes. 25) C

The dividends for years 1, 2, and 3 are expected to be ($1.62)(1.12) = $1.81; ($1.81)(1.12) = $2.03; and ($2.03)(1.12) = $2.27. At the end of year 2, the stock should sell for $2.27 / (0.15 − 0.04) = $20.64. The stock should sell currently for ($20.64 + $2.03) / (1.15)2 + ($1.81) / (1.15) = $18.71. 26) A

P4 = D5/(k − g) = 1/(.12 − .05) = 14.29 P0 = [FV = 14.29; n = 4; i = 12] = $9.08. 27) C

Accounting data on sales is used to calculate the P/S multiple. The P/S multiple is thought to be more reliable because sales figures are not as easy to manipulate as the earnings and book value, both of which are significantly affected by accounting conventions. However, it is not true that "sales data cannot be distorted by management" because aggressive revenue recognition practices can influence reported sales. 28) A

Industry analysis provides a framework for an analyst to understand a firm in relation to its competitive environment, which determines how much pricing power a firm has. Competitive strategy and financial performance are aspects of company analysis. 29) A

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The dividend can be of any size. Suppose it is $1.00. The purchase price is 1.00 / 0.06 = 16.667. The sale price is 1.00 / 0.05 = 20. Kim pays 16.667 and receives 20.00 plus a 1.00 dividend one year later. The rate of return is [(20 + 1) / 16.667] − 1 = 26%. 30) C

Automobiles and apparel are classified as consumer discretionary; banking is classified as financial services; and heavy machinery is classified as industrials. Based on revenues, a majority of the firm’s sales (55%) are derived from the consumer discretionary sector.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 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: 1) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 1

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: 2) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Source : Ethical and Professional Standards > Ethical and Professional Standards Question 2

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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: 3) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 3

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: 4) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Source : Ethical and Professional Standards > Ethical and Professional Standards Question 4

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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: 5) ______ A) violated Standard IV(A) Loyalty. B) Standard VI(B) Priority of Transactions. C) violated Standard II(A) Material Nonpublic Information. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Code of Ethics and Standards of Professional Conduct Topic : Ethics and Trust in the Investment Profession Source : Ethical and Professional Standards > Ethical and Professional Standards Question 5

6) Which of the following actions would be a violation of the Standard VII(A) Conduct as

Participants in CFA Institute Programs? 6) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 6

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7) Which of the following statements is least accurate regarding being a part of Standard III(B),

Fair Dealing? 7) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 7

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: 8) ______ 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." Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Source : Ethical and Professional Standards > Ethical and Professional Standards Question 8

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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? 9) ______ A) Ackert: No. Brown: Yes. B) Ackert: Yes. Brown: No. C) Ackert: No. Brown: No. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 9

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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: 10) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 10

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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: 11) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 11

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: 12) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Source : Ethical and Professional Standards > Ethical and Professional Standards Question 12

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13) An analyst preparing a report needs to cite which of the following? 13) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 13

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): 14) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 14

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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: 15) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 15

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): 16) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 16

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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: 17) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 17

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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: 18) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 18

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: 19) ______ A) Standard VI(B), Priority of Transactions. B) Standard IV(A), Loyalty to Employer. C) Standard II(A), Material Nonpublic Information. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 19

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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: 20) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 20

21) In accordance with Standard III (A) Loyalty, Prudence and Care, which of the following

statements is not a required or recommended action? 21) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Topic : Ethics and Trust in the Investment Profession Source : Ethical and Professional Standards > Ethical and Professional Standards Question 21

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22) Regarding (1) not voting all client proxies, and (2) using a directed brokerage arrangement, a

member would violate the Standards by: 22) ______ A) engaging in neither of these practices. B) using a directed brokerage arrangement. C) not voting all proxies for client stocks. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 22

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: 23) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 23

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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: 24) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Code of Ethics and Standards of Professional Conduct Topic : Ethics and Trust in the Investment Profession Source : Ethical and Professional Standards > Ethical and Professional Standards Question 24

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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: 25) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 25

26) Member compliance on issues relating to corporate governance or to soft dollars is primarily

addressed by the Standard concerning: 26) ______ A) Disclosure of Conflicts to Clients and Prospects. B) Loyalty, Prudence, and Care. C) Disclosure of Referral Fees. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 26

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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: 27) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Source : Ethical and Professional Standards > Ethical and Professional Standards Question 27

28) A code of ethics: 28) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Ethics and Trust in the Investment Profession Source : Ethical and Professional Standards > Ethical and Professional Standards Question 28

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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: 29) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 29

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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: 30) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 30

31) Recommended procedures to comply with the Standard concerning priority of transactions

are least likely to include: 31) ______ A) limited front-running by employees. B) disclosure to clients of the firm’s policies in regard to personal investing. C) blackout periods. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Source : Ethical and Professional Standards > Ethical and Professional Standards Question 31

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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: 32) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 32

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: 33) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 33

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34) Which of the following statements about a code of ethics is most accurate? A code of ethics: 34) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Ethics and Trust in the Investment Profession Source : Ethical and Professional Standards > Ethical and Professional Standards Question 34

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: 35) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 35

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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: 36) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 36

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: 37) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 37

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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: 38) ______ 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). Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Source : Ethical and Professional Standards > Ethical and Professional Standards Question 38

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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: 39) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 39

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: 40) ______ A) both of these. B) Standard III(C), Suitability. C) Standard III(B), Fair Dealing. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 40

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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: 41) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 41

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? 42) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 42

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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: 43) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Source : Ethical and Professional Standards > Ethical and Professional Standards Question 43

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? 44) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Source : Ethical and Professional Standards > Ethical and Professional Standards Question 44

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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: 45) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 45

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: 46) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 46

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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: 47) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 47

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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: 48) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Source : Ethical and Professional Standards > Ethical and Professional Standards Question 48

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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: 49) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Source : Ethical and Professional Standards > Ethical and Professional Standards Question 49

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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? 50) ______ A) Standard III(C)—Suitability. B) Standard V(A)—Diligence and Reasonable Basis. C) Standard IV(C)—Responsibilities of Supervisors. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 50

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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: 51) ______ 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). Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Source : Ethical and Professional Standards > Ethical and Professional Standards Question 51

52) Which of the following statements regarding allocating trades is CORRECT? It is

permissible under the Standards to allocate trades: 52) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Source : Ethical and Professional Standards > Ethical and Professional Standards Question 52

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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: 53) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 53

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: 54) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Source : Ethical and Professional Standards > Ethical and Professional Standards Question 54

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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: 55) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 55

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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: 56) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 56

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: 57) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Source : Ethical and Professional Standards > Ethical and Professional Standards Question 57

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58) The CFA Institute Professional Conduct Program may impose sanctions on: 58) ______ A) CFA charterholders, member firms, and candidates for the CFA designation. B) CFA charterholders and candidates for the CFA designation. C) CFA charterholders only. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 58

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? 59) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 59

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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: 60) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Source : Ethical and Professional Standards > Ethical and Professional Standards Question 60

61) A profession is most accurately described as an occupational group that requires its members

to: 61) ______ A) put client interests first. B) have specialized expert knowledge. C) abide by a code of ethical conduct. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Ethics and Trust in the Investment Profession Source : Ethical and Professional Standards > Ethical and Professional Standards Question 61

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62) Which of the following is least likely to be a reason for imposing a suspension on a member

or candidate? 62) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Code of Ethics and Standards of Professional Conduct Topic : Ethics and Trust in the Investment Profession Source : Ethical and Professional Standards > Ethical and Professional Standards Question 62

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: 63) ______ A) not violated the Standards. B) violated the Standard concerning loyalty to employer. C) violated the Standard concerning disclosure of conflicts. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 63

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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: 64) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Source : Ethical and Professional Standards > Ethical and Professional Standards Question 64

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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: 65) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 65

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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: 66) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 66

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: 67) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 67

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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: 68) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Source : Ethical and Professional Standards > Ethical and Professional Standards Question 68

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? 69) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Source : Ethical and Professional Standards > Ethical and Professional Standards Question 69

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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: 70) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Source : Ethical and Professional Standards > Ethical and Professional Standards Question 70

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? 71) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Guidance for Standards I-VII Source : Ethical and Professional Standards > Ethical and Professional Standards Question 71

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72) Recommended procedures to comply with the Standard related to fair dealing are most likely

to include: 72) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Code of Ethics and Standards of Professional Conduct Source : Ethical and Professional Standards > Ethical and Professional Standards Question 72

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Answer Key Test name: Ethical and Professional Standards 1) A

Using reasonable judgment, an analyst may exclude certain factors from research reports. Since the report will be delivered to clients with well-diversified portfolios, total risk is not as important as beta. Given that the total risk has been only commensurate with historical return, furthermore, then the analyst is not negligent by not mentioning it. 2) B

From the given information, there is no conflict of interest and no violation of Standard VI(A), Disclosure of Conflicts. A conflict could arise if the board were to ask Hirsh what the effect on the college’s endowment would be if they were to divest. At that time she would have to reveal her ownership in the stocks to make known the possible conflict of interest. 3) A

There is no violation. It is in the best interest of the client to be diversified and selling via a series of cross trades will likely reduce price impact costs when compared to selling directly into the market. The analyst appears to have reasonable basis for putting the securities in the accounts of other clients. 4) C

Hull would not violate Standard III(C), Suitability, by managing Peters’ account without knowledge of his risk preferences. She made a reasonable inquiry into Peters’ investment experience, risk and return objectives, and financial constraints, as the Standard requires. If a client chooses not to provide some of this information, the member or candidate can only be responsible for assessing the suitability of investments based on the information the client does provide. 5) A

By expressing his investment analysis on his personal blog ahead of his employer, Malone deprived his employer of the benefits of his skills and abilities and therefore violated Standard IV(A) Loyalty. Malone did not possess material nonpublic information about WestAir and no transactions have taken place. 6) A

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Misrepresenting information on the Professional Conduct Statement is a direct violation of Standard VII(A) Conduct as Participants in CFA Institute Programs. The other choices are violations of Standard VII(B) Reference to CFA Institute, the CFA Designation, and the CFA Program. 7) A

All of these are part of Standard III(B) except notifying clients at the same time. Standard III(B) states that clients for whom the investment is suitable should be notified at approximately the same time. 8) C

Perez should decline the invitation as it creates the impression of lack of independence. If he does not accept the free continuing education courses, he would have to pay for them some other way so the free courses are a form of compensation. Nothing in the vignette suggests the free classes are illegal. 9) C

Neither statement is fully consistent with Standard VII(B), Reference to CFA Institute, the CFA Designation, and the CFA Program. The CFA designation must always be used as an adjective and never as a noun as Ackert used in her promotional description. Correct use of the CFA designation would be: “Lucy Ackert is one of five CFA charterholders at Lofton Securities.” No designation exists for someone who has passed Level I of the CFA examination. Thus, Brown’s statement saying that he “holds a CFA Level I designation” represents incorrect use. A correct statement would be: “Chris Brown passed Level I of the CFA examination in 2001.” 10) A

Because the research is thoroughly conducted, and Logan has authority to make individual security selection decisions, Logan is not violating the Standards by applying his model. However, Logan is violating the Standard on communication with clients and prospective clients by excluding relevant factors of the investment process. The use of his model is an important aspect of the investment process and should be disclosed to clients. Brisco is not violating the Standards by not considering Logan’s research. 11) C

Standard I(A) says that when a member feels a law has been broken, the member should seek advice from the firm’s counsel. If the member feels the advice is unbiased and competent, the member should follow it. If the member knows a law has been violated, the member should contact a supervisor. 12) C

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Lang violates Standard III(B), Fair Dealing, which imposes the requirement to start trading on the clients’ portfolios only after the information is disseminated to all clients. We don't know if the information is non-public which would make it insider information if it were. 13) A

Statistics provided by a recognized agency, such as Standard and Poor’s, do not need to be cited. Charts, quotes, and algorithms developed by the firm would need to be cited when they are used but the individual(s) who developed the materials within the firm do not need to be cited. 14) A

Standard IV(A), Loyalty to Employer, requires that Parsons obtain written consent only from her employer before she undertakes independent practice that could result in compensation or other benefit in competition with Malloy. It is not required to get permission from your employer when only preparing to go into independent practice. 15) B

Standard II(A), Material Nonpublic Information, says that a member must be careful about handling material non-public information. As a member of CFA Institute, the CFO must limit the people who see important information before it is released. It would not be appropriate to involve an intern or a relative in the process. 16) A

According to Standard I(B) Independence and Objectivity, the analyst should refuse the invitation if it is from a firm the analyst covers for his employer. The analyst can accept the invitation if it is from a client but the analyst must get written consent from his employer if the offer is contingent on future performance, to comply with Standard IV(B) Additional Compensation Arrangements. 17) A

Jason must inform her supervisor of the conflict, but she cannot violate the terms of the confidentiality agreement and she cannot work on the portfolio. 18) B

O’Donnell is required to obtain consent from his employer if he is attempting to practice in competition with his employer. Merely undertaking preparations to leave, which do not violate a duty, is not a violation of the Code and Standards. 19) A

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Standard VI(B), Priority of Transactions, applies. If an analyst decides to make a recommendation about the purchase or sale of a security, he must give his customers or employer adequate opportunity to act on this recommendation before acting on his own behalf. Personal transactions include those made for the member's own account and family accounts. Here, McKinney violated Standard VI(B) by acting on his mother-in-law's behalf and then waiting until the end of the day to act on his employer's behalf. Explanations for other responses: Standard IV(A), Loyalty to Employer, does not apply. This standard concerns a member competing with his/her employer (independent practice), for example a member who engages in outside consulting. Standard II(A), Material Nonpublic Information, does not apply. The question does not indicate that the information is not public. 20) C

Standard II(A), Material Nonpublic Information, states “a member cannot trade or cause others to trade in a security while the member possesses material nonpublic information” A tender offer would certainly be material nonpublic information. Knowing that the meeting took place, and nothing else, does not restrict the broker. A reasonable investor would need to know more to determine if the information was material. 21) B

Because of the time and expense involved in voting a proxy, Members and Candidates are not required to vote every proxy. A cost benefit analysis can be performed to determine if it is necessary to vote a proxy. Standard III(A) requires that client brokerage be used to benefit the client. Quarterly statements to clients are recommended. 22) A

Proxies have economic value to the client. To comply with Standard III(A) Loyalty, Prudence, and Care, the analyst is obligated to vote proxies in an informed and responsible manner. A cost benefit analysis may show that voting all proxies may not benefit the client, so voting proxies may not be necessary in all instances. Directed brokerage occurs when the client requests that a portion of the client's brokerage be used to purchase services that directly benefit the client. Although this may prevent best execution, it does not violate the Standards as it was directed by the client, not the brokerage firm. 23) A

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Proxies should be taken seriously, and although it is likely that Griffith can understand some of the issues, it is likely that she is not capable of making responsible decisions on all potential proxy issues. Proxies for a pension plan should be voted in the best interests of the beneficiaries, not the plan sponsor. The sponsor's interests will not always be the same as the beneficiary's interest. 24) A

Standard V(C) Record Retention requires that Members and Candidates document all recommendation and communications with clients. McCoy should document the details of the conversation, including any resulting investment decisions and/or actions. The suitability of the investment should have already been considered before the recommendation and McCoy should not execute the order until the client instructs him to. Identifying other clients for this investment would fall under Standard III(B) Fair Dealing. 25) B

Standard V(B), Communication with Clients and Prospective Clients, requires analysts to use reasonable judgment regarding the inclusion or exclusion of relevant factors in their research reports. It would not be unreasonable to exclude the temporary credit downgrade from 3 years earlier. 26) B

Fiduciary duty on issues relating to corporate governance or to soft dollars is primarily addressed by Standard III(A), Loyalty, Prudence, and Care. 27) B

Jones and Gregg are using reasonable judgment in not continually disclosing all of the alterations of the model. It is acceptable to use a pure quantitative model as a sole basis for purchasing stocks, as long as it is thoroughly researched. 28) C

A code of ethics may be rules-based or principles-based. There can be no assurance that none of a group or professionals will violate a code of ethics. There is no requirement that a group of professionals agreeing to a code of ethics cannot be held out to the public as a positive thing for clients. 29) C

The fact that the company officers met is not material nonpublic information. As long as she bases her investment recommendation on her own independent research, Jennings will not violate any Standards if she uses this additional information to support it. 30) A

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This question is related to Standard V(B) which states that CFA Institute members should use reasonable judgment regarding the inclusion or exclusion of relevant factors in research reports. The change in management was a relevant factor and must be disclosed before dissemination. 31) A

Standard VI(B) Priority of Transactions. Front-running is the purchase or sale of securities in advance of client trades to take advantage of knowledge of client activity and should be completely prohibited, not simply limited. Blackout periods and pre-clearance of employee trades are ways of accomplishing this. 32) A

Recommending a stock whose return is uncorrelated with interest rate changes is appropriate for the clients described in the problem. Emphasizing the lack of correlation is appropriate as long as the analyst makes no guarantees concerning the relationship in the future. Reporting historical correlation is a presentation of fact, and is not in violation. The analyst is free to show the report only to investors for whom the investment is appropriate. 33) A

Despite the fact the addition of the fund was successful, Hoolihan acted improperly in not conducting the same degree of research as she did for the other funds on her list. 34) B

A code of ethics may include standards of conduct, but does not require them. 35) A

If the analyst had been an investment manager, it would have been inappropriate for him to make a blanket recommendation for all of his clients without considering the unique needs of each. However, the analyst is merely stating that given the qualities of the investment, it is an attractive buy. He has kept adequate records, and made fair disclosure of his rating decision. 36) B

The possibility of employment with Paulsen creates a potential conflict of interest which Flome must disclose. Standard VI(A) Disclosure of Conflicts does not require disclosure of his brotherin-law’s ownership of Paulsen stock. 37) A

Both Standard III(C) Suitability and Standard V(A) Diligence and Reasonable Basis were violated. Tuipulotu must perform a full IPS review to determine the appropriateness of the new portfolio allocations. Submanagers should not be selected by cost structure alone, as the quality and appropriateness of the submanager is Tuipulotu’s responsibility.

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38) A

Abbott violated Standard V(A), Diligence and Reasonable Basis, because she did not have a reasonable and adequate basis to support the $1.10 EPS without further investigation. By including the $1.10 EPS in her report, she did not exercise diligence and thoroughness to ensure that any research report finding is accurate. If Abbott suspects that any information in a source is not accurate, she should refrain from relying on that information. Abbott did not violate Standard I(B), Independence and Objectivity, because the gift from Carter would not reasonably be expected to compromise her independent judgment. 39) A

Use of the CFA designation must be stopped immediately, however, the receipt of the Charter is a matter of fact. 40) A

It is a violation of Standard III(B) because the advisor should act first on behalf of existing clients whose needs and characteristics she already knows. It is a violation of Standard III(C) because she has never met the prospect and does not know if the new ideas are appropriate for the prospect. Thus, “both of these” is the best response. 41) A

Hurst is most likely in violation of Standard V(C) Record Retention because the supporting documentation is unavailable. He needs to recreate the supporting records based on information gathered through public sources or the covered company. He may have a reasonable basis for his recommendations and have been diligent in his analysis, but must reconstruct the records of this analysis before issuing the reports. 42) C

Standard IV(C) Responsibilities of Supervisors permits Tripp to delegate supervisory duties to Green, Brown, or both, but such delegation does not relieve Tripp of his supervisory responsibility. 43) B

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Family accounts that are client accounts should be treated like any other firm account and should neither be given special treatment nor be disadvantaged because of an existing family relationship with the member or candidate. Members or candidates may undertake transactions in accounts for which they are a beneficial owner only after their clients and employers have had adequate opportunity to act on the recommendation. Personal transactions include those made for the member or candidate's own account, for family (including spouse, children, and other immediate family members) accounts, and for accounts in which the member or candidate has a direct or indirect pecuniary interest, such as a trust or retirement account. It could be argued that Rock is a beneficial owner of his wife's account and the reason why his wife's account should be treated like any other client account is because it does not state that Rock makes the trades in his wife's account. From that we are to infer that another person other than Rock is managing his wife's account thus she should be treated like any other client. 44) A

Allen’s notes from his research are employer records and even though he prepared them, it is a violation to take them from his employer without permission. Soliciting former clients’ business is not, in itself, a violation as long has Allen has not misappropriated client information from his former employer. Preparations to start a new business are not necessarily a violation of the Standard, although soliciting current clients or recruiting other firm personnel for the new venture, before formally leaving his employer, would be violations of the Standards. 45) A

According to Standard V(B), an analyst can use reasonable judgment regarding the exclusion of some facts and should include more basic facts for reports to wider audiences. The key issue is that analysts should tailor their reports to the intended audience. 46) B

Standard VII(A) Conduct as Participants in CFA Institute Programs does not prohibit expressing opinions about the program or the CFA Institute. Thus, Vasquez is not in violation. Nothing in the facts indicates a violation of Standard I(D, Misconduct. Standard I(D) deals with professional conduct involving dishonesty, fraud, or deceit. 47) B

By not returning the bottle she would be violating the Standard on disclosure of conflicts to the employer, which states that employees must comply with prohibitions imposed by their employer. 48) B

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Sanchez is in violation of the Standard III(B), Fair Dealing, since he has disseminated his recommendation preferentially to the portfolio managers in advance of making the report available to all clients who hold shares of ChemStar. The portfolio managers are in violation of the Standard since they are effectively giving preferential treatment to the trading accounts over the buy-and-hold accounts in the placement of orders based upon the change in recommendation. 49) A

In no case should information be disclosed to a reporter before all clients are provided with the research—doing so will violate the Standard on fair dealing. However, once clients have been informed, there is no violation in releasing the information to the reporter, and in doing so Phillips might obtain information that can further help his clients. 50) B

Standard V(A)—Diligence and Reasonable Basis was not broken because Smithson conducted thorough and diligent research. Standard III(C)—Suitability, Smithson failed to consider the needs of his conservative and aggressive clients. Standard IV(C)—Responsibilities of Supervisors, Preston Partners didn't have policies explaining how to allocate shares among clients. 51) A

Blackwell violated Standard I, Professionalism. Jameson must comply with the strictest requirements among the laws of the country where his firm is based, the CFA Institute Code and Standards, and the laws of the country where he is doing business. Because the applicable laws in Mega Capital’s home country are stricter than the Code and Standards, Jameson must additionally adhere to that more strict law. 52) A

It is permissible to allocate trades on a pro-rata basis over all suitable accounts. It is not permissible to base allocations upon compensation arrangements. Any method is not necessarily suitable, and disclosure does not absolve the member from ensuring that the allocation is necessarily fair. 53) A

Although Drake is paid by the company, his fiduciary duty is to the plan participants. His advice cannot be compromised by business considerations, otherwise he will be violating the Standard on loyalty, prudence, and care. 54) A

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Standard I(C) Misrepresentation. Members should not copy or use material prepared by others without acknowledging and identifying the source of such material. Using charts and graphs without stating their source is a violation of the Standard. Data from recognized statistical reporting services may be used without attribution, but charts, analysis, and other such creative content may not. 55) B

Even though the information is false, this fact is known only to Fox and is thus nonpublic information. Since such recommendations have in the past had a significant effect on the price of the security in question, the information is clearly material. Fox is in violation of Standard II(A) Material Nonpublic Information. 56) C

Standard III(B) – Fair Dealing requires dealing fairly and objectively with all clients and prospects when disseminating material changes in prior investment recommendations. Note that the standard requires the dissemination be fair, but not necessarily equal due to the impossibility of contacting all clients simultaneously. A change of recommendation from “buy” to “sell” is generally material. 57) C

Standard VI(A) requires members to disclose all matters that could reasonably be expected to impair the member’s ability to make unbiased and objective recommendations. Compensation based on a percentage of fees generated does not create an inherent bias. If, however, a performance bonus is paid for investment results, it may unduly encourage the manager to take more risk than is proper and prudent, and so the existence of the bonus opportunity must be disclosed to the client. 58) B

The CFA Institute Professional Conduct Program may impose sanctions on CFA charterholders and candidates for the CFA designation. Firms are not members of CFA Institute. 59) A

An employee/employer relationship does not necessarily mean monetary compensation for services. If the analyst is performing services for the organization, then the analyst must treat the position as if he were an employee. 60) B

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Standard III(B) Fair Dealing requires that members deal fairly with all clients in disseminating investment recommendations. It does not require uniform or equal treatment. Sandvik’s approach in sending e-mail correspondence to those of his clients who had given him their e-mail addresses, having made the request to all of his clients, and sending regular mail correspondence the same day, is fair to all of his clients. 61) B

A profession is an occupational group (e.g., doctors or lawyers) that has requirements of specialized expert knowledge, and often a focus on ethical behavior and service to the larger community or society. While many professions require their members to put clients first or encourage them to serve the wider community, these are not defining characteristics of a profession. 62) B

A misdemeanor charge not related to professional conduct is not grounds for a suspension. The other choices are violations of the Code and Standards and may result in CFA Institute imposing a suspension of membership or participation. 63) A

Based on the information here, Hill has done nothing wrong. He took a call at his home, presumably on his own time, and the client made it clear that he would never be a client of Advisors. Therefore, there was no breach of loyalty to Advisors by Hill, nor is there a conflict of interest. 64) C

According to Standard II(A) Material Nonpublic Information, an analyst must not act or cause others to act on material nonpublic information. The information is material to the company’s future profitability, and is nonpublic because the lawsuit has not yet been filed and is not yet a matter of public record. 65) A

The investment manager is in violation of the Standard requiring him to make a reasonable inquiry into the client’s financial situation and update the investment policy statement since such a dramatic change in the client’s circumstances would undoubtedly alter the investment policy statement and would probably eliminate the need to hold a short position in Oracle. The investment manager is not in violation of the Standard concerning additional compensation, since the gift has been reported to his supervisor and has come from a client. If there was a failure to report such a gift, if the firm had a rule in place against the acceptance of gifts from clients, or if the gift had come from a non-client, there would be a violation of the standard.

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66) A

According to Standard V(B), the analyst must inform the clients of the change and tell them it is based upon an opinion and not a fact. Making an identical change in two portfolios may be a violation of this standard if the needs of the clients are not identical. 67) A

According to Standard IV(A), Loyalty to Employer, Valley must inform Advisors of his outside consultation even if it is not for monetary compensation. According to Standard VI(A), Disclosure of Conflicts, Valley must also disclose possible conflicts of interest, and his sister’s position qualifies. 68) B

Because the itinerary required charter flights due to a lack of commercial transportation, River Casino can appropriately provide them. While Standard I(B) Independence and Objectivity recommends that members pay their own room costs, it is not required and it is not unusual for members to accept accommodations. 69) A

Standard II(A) Material Nonpublic Information requires that members and candidates who possess material nonpublic information not act or cause others to act on the information. Refusing the trade would violate this Standard because it would be acting or causing others to act on the nonpublic information. Dean should seek to have East Street make the information public. If East Street does not do so, Dean must act as he would have acted if he did not possess the information. Refusing to make the trade he was instructed to make would be “acting” on the information in this case. The obligation here is to the integrity of financial markets. 70) A

Carson has not violated either Standard based on the information given. The suitability of an investment is to be determined based on the risk and return characteristics of the portfolio and not on the risk and return characteristics of each individual security. The fact that a security does not pay a dividend and has a beta higher than the market is not enough to determine its suitability in a portfolio context. The fact that regulators have called previously reported earnings into question does not necessarily mean that Carson’s analysis was not diligent or that he did not have a reasonable basis for his selection of this security. 71) B

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Standard I(A) Knowledge of the Law requires members and candidates to comply with the strictest requirement among the law where they reside, the law in the area where they do business, and the Code and Standards. In this case, the Code and Standards is the strictest. Standard III(B) Fair Dealing prohibits members and candidates from withholding shares in oversubscribed IPOs from clients for their own benefit. 72) A

Recommended procedures for compliance with Standard III(B) Fair Dealing include limiting the number of people in the firm who know that a change in recommendation will be made. Requiring investment committee approval for all recommendation changes is not among the recommended procedures.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Which of the following is a company least likely required to present according to International Accounting Standard (IAS) No. 1? 1) ______ A) Statement of changes in owners’ equity. B) A summary of accounting policies. C) Disclosures of material events. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Financial Reporting Standards Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 1

2) According to IFRS guidance for management’s commentary, addressing the company’s key

relationships is: 2) ______ A) neither recommended nor required. B) required. C) recommended. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Financial Statement Analysis Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 2

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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 3) ______

A) Option A B) Option B C) Option C Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Income Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 3

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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? 4) ______ A) 1,200,000. B) 1,000,000. C) 1,100,000. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Income Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 4

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? 5) ______ A) Both ratios will decrease. B) Neither ratio will decrease. C) Only one ratio will decrease. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Financial Analysis Techniques Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 5

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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: 6) ______ A) $2,900. B) $2,260. C) $2,640. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Cash Flow Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 6

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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

Fixed asset turnover

Lower Higher Higher

Higher Unchanged Higher

A) B) C)

7) ______ A) Option A B) Option B C) Option C Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Financial Analysis Techniques Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 7

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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

Characteristic #2

No Yes No

No No Yes

A) B) C)

8) ______ A) Option A B) Option B C) Option C Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Balance Sheets Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 8

9) Which of the following transactions would least likely be reported in the cash flow statement

as investing cash flows? 9) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Cash Flow Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 9

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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. 10) ______ A) 2.89. B) 3.25. C) 3.71. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Financial Analysis Techniques Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 10

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. 11) ______ A) $80 million increase. B) $50 million increase. C) $150 million increase. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Financial Analysis Techniques Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 11

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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.

A) B) C)

Transaction #1

Transaction #2

Higher Higher Lower

Lower Higher Higher 12) ______

A) Option A B) Option B C) Option C Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Financial Analysis Techniques Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 12

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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? 13) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Balance Sheets Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 13

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: 14) ______ A) $3.80. B) $3.45. C) $3.40. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Income Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 14

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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 B) Subtract decrease in unearned Add an inventory writedown revenue C) Subtract decrease in unearned Subtract an inventory writedown revenue 15) ______ A) Option A B) Option B C) Option C Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Cash Flow Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 15

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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 16) ______

A) Option A B) Option B C) Option C Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Cash Flow Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 16

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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)

17) ______ A) Option A B) Option B C) Option C Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Balance Sheets Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 17

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)? 18) ______ A) $2.50. B) $1.00. C) $1.15. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Income Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 18

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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.

A) B) C)

Liabilities

Stockholders' equity

$3,790 million $3,550 million $3,790 million

$3,420 million $7,840 million $7,420 million 19) ______

A) Option A B) Option B C) Option C Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Balance Sheets Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 19

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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) 33

(5) (8) 27

Interest Expense

(15) 18

(6) 21

Income Tax Expense

(6) 12

(7) 14

Analysis of this data indicates that from 20X1 to 20X2: 20) ______ A) the effective tax rate increased. B) interest expense per dollar of sales declined. C) cost of goods sold increased. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Income Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 20

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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? 21) ______ A) $8,000,000. B) $11,000,000. C) $13,000,000. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Cash Flow Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 21

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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: 22) ______ A) $66 million. B) $24 million. C) $16 million. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Cash Flow Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 22

23) What is the appropriate measurement basis for equipment used in the manufacturing process? 23) ______ A) Historical cost B) Fair value C) Lower of cost or net realizable value Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Balance Sheets Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 23

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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? 24) ______ A) $1,200,000. B) $900,000. C) $800,000. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Cash Flow Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 24

25) A firm’s balance sheet prepared under IFRS is least likely to include: 25) ______ A) market value of inventory. B) fair value of firm PPE. C) market value of the firm’s equity. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Balance Sheets Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 25

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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

Acquisition of treasury stock

No No Yes

No Yes No

A) B) C)

26) ______ A) Option A B) Option B C) Option C Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Income Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 26

27) To convert an indirect statement of cash flows to a direct basis, the analyst would: 27) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Cash Flow Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 27

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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? 28) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Income Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 28

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? 29) ______ A) $1,000,000. B) $1,050,000. C) $1,015,000. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Cash Flow Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 29

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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% 30) ______

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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: 31) ______ A) $1.19. B) $1.23. C) $1.50. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Income Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 31

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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 Net income Increase in accounts receivable Decrease in inventory Increase in short-term notes payable Decrease in accounts payable

$ 100,000 (40,000) (20,000) (5,000) (3,000) $ 32,000 $ 7,500 $ 2,500 $ 3,000 $ 1,000

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 32) ______

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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? 33) ______ A) −$300,000. B) −$500,000. C) −$400,000. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Cash Flow Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 33

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: 34) ______ A) $2,200. B) $1,000. C) $1,200. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Cash Flow Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 34

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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)

35) ______ A) Option A B) Option B C) Option C Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Balance Sheets Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 35

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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 36) ______

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. 37) ______ A) $300,000 outflow. B) $40,000 outflow. C) $360,000 inflow. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Cash Flow Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 37

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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? 38) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Income Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 38

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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

Preferred dividends

Yes Yes No

Yes No Yes

A) B) C)

39) ______ A) Option A B) Option B C) Option C Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Income Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 39

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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: 40) ______ A) $5.32. B) $5.87. C) $4.91. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Income Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 40

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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? 41) ______ A) Only statement #1 is correct. B) Both statements are correct. C) Only statement #2 is correct. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Cash Flow Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 41

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: 42) ______ A) both are incorrect. B) both are correct. C) only one is correct. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Financial Analysis Techniques Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 42

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43) A common-size cash flow statement is least likely to provide payments to employees as a

percentage of: 43) ______ A) total cash outflows for the period. B) revenues for the period. C) operating cash flow for the period. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Cash Flow Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 43

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)

44) ______ A) Option A B) Option B C) Option C Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Income Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 44

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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: 45) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Income Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 45

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? 46) ______ A) Gross profit margin has improved. B) Leverage has declined. C) Return on equity has improved. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Financial Analysis Techniques Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 46

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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: 47) ______ A) may shorten or lengthen. B) lengthens. C) shortens. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Financial Analysis Techniques Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 47

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: 48) ______ A) $14.67. B) $18.38. C) $20.00. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Income Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 48

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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: 49) ______ A) $0.261. B) $0.289. C) $0.197. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Income Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 49

50) 50. Which of the following statements about a firm with convertible preferred stock

outstanding is most accurate? 50) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Income Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 50

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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

Total stockholders' equity

No effect No effect Increase

No effect Increase Increase

A) B) C)

51) ______ A) Option A B) Option B C) Option C Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Income Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 51

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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 52) ______

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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? 53) ______ A) −$1,300. B) $11,200. C) −$300. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Cash Flow Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 53

54) Which costs are least likely to be reported as an expense in the current accounting period? 54) ______ A) Period costs. B) Loan interest that has not yet been paid. C) Costs of producing inventory. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Income Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 57

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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 55) ______

A) $20. B) $45. C) $35. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Cash Flow Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 55

56) For a manufacturing company reporting under U.S. GAAP, interest received is most likely

reported as: 56) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Income Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 56

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57) Which costs are least likely to be reported as an expense in the current accounting period? 57) ______ A) Period costs. B) Loan interest that has not yet been paid. C) Costs of producing inventory. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Income Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 57

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: 58) ______ A) trading securities. B) available-for-sale. C) held-to-maturity. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Balance Sheets Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 58

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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: 59) ______ A) decrease both CFO and CFI. B) increase CFO and decrease CFI. C) decrease CFO and increase CFI. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Cash Flow Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 59

60) A common-size cash flow statement is least likely to show each cash inflow as a percentage

of: 60) ______ A) revenue. B) total cash flows. C) all cash inflows. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Cash Flow Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 60

61) Which of the following items would affect owners’ equity and also appear on the income

statement? 61) ______ A) Unrealized gains and losses on available-for-sale securities. B) Dividends paid to shareholders. C) Unrealized gains and losses on trading securities. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Income Statements Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 61

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62) The revaluation model for investment property is permitted under: 62) ______ A) both IFRS and U.S. GAAP. B) neither IFRS nor U.S. GAAP. C) IFRS, but not U.S. GAAP. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Long-Lived Assets Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 62

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: 63) ______ A) $21 million. B) $14 million. C) $22 million. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Long-Lived Assets Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 63

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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? 64) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Long-Lived Assets Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 64

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: 65) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Long-Lived Assets Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 65

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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: 66) ______ A) U.S. GAAP, but not IFRS. B) both IFRS and U.S. GAAP. C) IFRS, but not U.S. GAAP. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Income Taxes Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 66

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? 67) ______ A) Selling cost. B) Administrative overhead. C) Allocation of fixed production overhead. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Inventories Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 67

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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? 68) ______ A) Decrease income tax expense by $5,000. B) Increase income tax expense by $5,000. C) Increase income tax expense by $25,000. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Income Taxes Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 68

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: 69) ______ A) both IFRS and U.S. GAAP. B) IFRS only. C) U.S. GAAP only. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Income Taxes Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 69

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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? 70) ______ A) $106.40. B) $116.29. C) $66.29. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Non-Current (Long-Term) Liabilities Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 70

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: 71) ______ A) selling an asset. B) abandoning an asset. C) exchanging an asset. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Long-Lived Assets Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 71

72) The inventory turnover ratio and the number of days in inventory are least likely used to

evaluate the: 72) ______ A) age of a firm's inventory. B) effectiveness of a firm's inventory management. C) stability of a firm's inventory levels. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Inventories Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 72

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73) Which of the following statements regarding the disclosure of deferred taxes in a company’s

balance sheet is most accurate? 73) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Income Taxes Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 73

74) Which set of accounting standards requires firms to disclose estimated amortization expense

for the next five years on intangible assets? 74) ______ A) U.S. GAAP. B) Both IFRS and U.S. GAAP. C) IFRS. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Long-Lived Assets Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 74

75) Which of the following factors is least likely to cause a difference between a firm’s effective

tax rate and statutory rate? 75) ______ A) Tax credits. B) Non-deductible expenses. C) Deductible expenses. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Income Taxes Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 75

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76) When bonds are issued at a premium: 76) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Non-Current (Long-Term) Liabilities Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 76

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? 77) ______ A) IFRS, but not U.S. GAAP. B) U.S. GAAP, but not IFRS. C) Neither IFRS nor U.S. GAAP. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Income Taxes Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 77

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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? 78) ______ A) $78. B) $73. C) $74. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Inventories Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 78

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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: 79) ______ A) 31.1%. B) 35.6%. C) 38.9%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Long-Lived Assets Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 79

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80) Under U.S. GAAP, a lessee must recognize a balance sheet liability for: 80) ______ A) finance leases, but not operating leases. B) operating leases, but not finance leases. C) both finance leases and operating leases. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Non-Current (Long-Term) Liabilities Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 80

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: 81) ______ A) lower net income; lower working capital. B) higher net income; higher working capital. C) higher net income; lower working capital. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Inventories Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 81

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82) A reconciliation of beginning and ending carrying values for each class of property, plant,

and equipment is required for firms reporting under: 82) ______ A) U.S. GAAP. B) both U.S. GAAP and IFRS. C) IFRS. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Long-Lived Assets Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 82

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: 83) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Long-Lived Assets Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 83

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: 84) ______ A) $35,000. B) $31,500. C) $3,500. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Income Taxes Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 84

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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: 85) ______ A) $967. B) $935. C) $923. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Non-Current (Long-Term) Liabilities Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 85

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: 86) ______ A) $1,040. B) $2,080. C) $1,570. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Income Taxes Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 86

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87) The effect of an inventory writedown on a firm’s return on assets (ROA) is most accurately

described as: 87) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Inventories Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 87

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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: 88) ______ A) increase to 21.1%. B) decrease to 18.3%. C) increase to 23.0%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Inventories Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 88

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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

$ 400,000 700,000

Retained Earnings Total Liabilities & Equity

1,500,000 11,800,000

8,200,000 1,000,000

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: 89) ______ A) 3.73 B) 4.06 C) 4.18 Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Inventories Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 89

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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 90) ______

A) Option A B) Option B C) Option C Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Income Taxes Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 90

91) U.S. GAAP least likely requires property, plant, and equipment to be tested for impairment: 91) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Long-Lived Assets Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 91

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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: 92) ______ A) $730. B) $790. C) $810. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Inventories Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 92

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: 93) ______ A) net realizable value minus selling costs. B) market price minus selling costs minus normal profit margin. C) net realizable value. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Inventories Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 93

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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: 94) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Income Taxes Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 94

95) Capitalizing interest costs related to a company’s construction of assets for its own use is

required by: 95) ______ A) U.S. GAAP only. B) IFRS only. C) both IFRS and U.S. GAAP. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Long-Lived Assets Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 95

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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: 96) ______ 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). Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Inventories Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 96

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: 97) ______ A) $3,000.00 B) $2,200.00 C) $2,880.00 Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Long-Lived Assets Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 97

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: 98) ______ A) $10,100,000 CFO outflow. B) 10,100,000 CFF outflow. C) $10,000,000 CFF outflow and $100,000 CFO outflow. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Non-Current (Long-Term) Liabilities Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 98

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99) For a lessor that reports under U.S. GAAP, a lease is classified as an operating lease if: 99) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Non-Current (Long-Term) Liabilities Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 99

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: 100) ______ A) have no effect on income tax expense. B) decrease income tax expense. C) increase income tax expense.

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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? 101) ______ A) Cash flow from financing. B) Interest paid. C) Debt-to-equity ratio.

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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: 102) ______ 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? 103) ______ A) No effect. B) Increase. C) Decrease.

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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? 104)

______

105)

______

A) $1,209. B) $1,750. C) $499. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Non-Current (Long-Term) Liabilities Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 104

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.

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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: 106) ______ A) $8,640. B) $6,910. C) $1,600.

Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Long-Lived Assets Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 106

107)

In analyzing disclosures related to the financing liabilities of a company, which of the following disclosures would be least helpful to the analyst? 107) ______ 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.

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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: 108) ______ 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: 109) ______ 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: 110) ______ A) neither IFRS nor U.S. GAAP. B) U.S. GAAP only. C) both IFRS and U.S. GAAP.

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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: 111) ______ 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: 112) ______ A) $98.1 million. B) $98.0 million. C) $97.9 million.

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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? 113) ______ 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.

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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)

114)

______

A) Option A B) Option B C) Option C Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Applications of Financial Statement Analysis Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 114

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115)

Mechanisms that enforce discipline over financial reporting quality least likely include: 115) ______ A) government securities regulators. B) counterparties to private contracts. C) accounting standard-setting bodies.

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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: 116) ______ 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.

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117)

A significant increase in days payables above historical levels is most likely associated with: 117) ______ A) an unsustainable increase in reported earnings. B) an increase in net working capital. C) low quality of the cash flow statement.

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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. 118) ______ A) $80 million. B) $30 million. C) $40 million. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Applications of Financial Statement Analysis Source : Financial Reporting and Analysis > Financial Reporting and Analysis Question 118

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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: 119) ______ 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 120)

______

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121)

The most likely problem with using financial statement ratios to screen for stocks to include in a portfolio is that: 121) ______ 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.

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Answer Key Test name: Financial Reporting and Analysis 1) C

International Accounting Standard (IAS) No. 1 defines which financial statements are required and how they must be presented. The required financial statements are: Balance sheet. Statement of comprehensive income. Cash flow statement. Statement of changes in equity. Explanatory notes, including a summary of accounting policies. Disclosures of material events that affect the company are required by the Securities and Exchange Commission (Form 8-K) for firms that are publicly traded in the United States. 2) C

IFRS recommends that management commentary address the company’s key relationships, resources, and risks, as well as the nature of the business, management’s objectives, the company’s past performance, and the performance measures used. Securities regulators may impose requirements for publicly traded firms to address certain topics in management’s commentary, but accounting standards do not. 3) B

Able’s basic earnings per share ((Net Income − Preferred Stock Dividends) / weighted average shares outstanding) for 2004 was [($720,000 − ($500 × 6,000 × 0.03) − ($1,000 × 1,000 × 0.08)] / 1,000,000 =$0.55. If the convertible preferred were converted to common stock on January 1, 6,000 × 40 = 240,000 additional shares would have been issued. Also, dividends on the convertible preferred would not have been paid. So diluted EPS was ($720,000 − 80,000) / (1,000,000 + 240,000) = $0.52. 4) A

1,000,000(12) = 12,000,000 100,000(12) = 1,200,000 400,000(3) = 1,200,000 Total = 14,400,000 / 12 = 1,200,000

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5) A

As an example, start with CA = 2, CL = 1, and Inv = 1.2. We begin with a current ratio of 2 and a quick ratio of 0.8. If the firm increases short-term bank debt (a current liability) by 1 to buy inventory (a current asset) of 1, both the numerator and denominator increase by 1, resulting in 3 / 2 = 1.5 (new current ratio) and (3 − 2.2) / 2 = 0.4 (new quick ratio). 6) A

7) B

The restructuring charge and asset write-down are non-recurring transactions; thus, net income will be higher in 20X8, all else equal. In 20X8, fixed asset turnover will be the same as 20X7, all else equal. The asset impairment charge is a one-time charge, so fixed assets will not be reduced further in 20X8. 8) A

A current liability is expected to be settled within one year or operating cycle, whichever is greater. It is not necessary to settle a current liability with cash. There are a number of ways to settle a current liability. For example, unearned revenue is a liability that is settled by providing goods or services. 9) B

The purchase of plant and equipment with financing provided by the seller is a non-cash transaction. Non-cash transactions are disclosed separately in a note or supplementary schedule to the cash flow statement. 10) B

First, calculate beginning inventory given COGS, purchases, and ending inventory. Beginning inventory was $35 million [$130 million COGS + $45 million ending inventory – $140 million purchases]. Next, calculate average inventory of $40 million [($35 million beginning inventory + $45 million ending inventory) / 2]. Finally, calculate inventory turnover of 3.25 [$130 million COGS / $40 million average inventory]. 11) B

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20X7, gross profit is equal to $100 million ($1 × 250 million units sold × 40% gross profit margin). The 10% price cut to $0.90 will increase cost of goods sold to 67% of sales [COGS = 0.6($1) = $0.60; $0.60 / $0.90 = 67%.]. As a result, gross profit will decrease to 33% of sales. If unit sales double in 20X8, gross profit will equal $150 million ($0.90 × 500 million units × 33% gross profit margin). Therefore, gross profit will increase $50 million ($150 million 20X8 gross profit – $100 million 20X7 gross profit). 12) B

Available-for-sale securities are reported on the balance sheet at fair value and any unrealized gains and losses bypass the income statement and are reported as an adjustment to equity. Thus, a decrease in fair value will result in a higher ROA ratio (lower assets). Trading securities are also reported on the balance sheet at fair value; however, the unrealized gains and losses are recognized in the income statement. Therefore, an increase in fair value will result in higher ROA. In this case, both the numerator and denominator are higher; however, since the ratio is less than one, the percentage change of the numerator is greater than the percentage change of the denominator, so the ratio will increase. 13) A

Common-size balance sheets express each balance sheet item as a percentage of total assets. Contributed capital from issuing common shares may be included in common stock (at par value) or additional paid-in capital (for proceeds in excess of par value). Shareholders’ equity is unlikely to consist only of common and preferred stock, as it also includes components such as retained earnings and accumulated other comprehensive income. 14) C

Orange’s basic EPS ((net income − preferred dividends) / weighted average common shares outstanding) is [($7,600,000 − (10,000 × $1,000 × 0.08)] / 2,000,000 = $3.40. To check for dilution, EPS is calculated under the assumption that the convertible preferred shares are converted into common shares at the beginning of the year. The preferred dividends paid are added back to the numerator of the Diluted EPS equation, and the additional common shares are added to the denominator of the equation. Orange’s if-converted EPS is $7,600,000 / (2,000,000 + 200,000) = $3.45. Because if- converted EPS is higher than basic EPS, the preferred stock is antidilutive and no adjustment is made to basic EPS. 15) C

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Beginning with net sales, calculating cash collected from customers requires the addition (subtraction) of any increase (decrease) in unearned revenue. Cash advances from customers represent unearned revenue and are not included in net sales, so any advances must be added to net sales in order to calculate cash collected. An inventory writedown, as a result of applying the lower of cost or market rule, will reduce ending inventory and increase COGS for the period. However, no cash flow is associated with the writedown, so COGS is reduced by the amount of the writedown in calculating cash paid to suppliers. 16) B

Investing Activities: $10,000 − $180,000 = −$170,000 cash flow from investing or $170,000 used Financing Activities: $38,000 − $75,000 = −$37,000 cash flow from financing or $37,000 used Note that the question asked for net cash used therefore this is a positive cash outflow. 17) C

Dividends received from trading securities and available-for-sale securities are recognized in the income statement. The difference in trading and available-for-sale classifications relates to the treatment of any unrealized gains and losses. 18) B

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Number of average common shares: 1/1 5,500 shares issued (includes 10% stock dividend on 6/1) × 12 = 66,000 7/1 1,000 shares repurchased × 6 months = −6,000 = 60,000 60,000 shares / 12 months = 5,000 average shares Preferred dividends = ($10) (1,000) = $10,000 Number of shares from the conversion of the preferred shares = (1,000 preferred shares) (8 × 1.1 shares of common/share of preferred) = 8,800 common Diluted EPS = [$15,000(NI) − $10,000(pfd) + $10,000(pfd)] / (5,000 common shares + 8,800 shares from the convertible preferred) = $15,000 / 13,800 shares = $1.09/share This number needs to be compared to basic EPS to see if the preferred shares are antidilutive. Basic EPS = [$15,000(NI) − $10,000(preferred dividends)] / 5,000 shares = $5,000 / 5,000 shares = $1/share Since the EPS after the conversion of the preferred shares is greater than before the conversion the preferred shares are antidilutive and they should not be treated as common in computing diluted EPS. Therefore diluted EPS is the same as basic EPS or $1/share. 19) A

Liabilities are equal to $3,790 million ($240 million unearned revenue + $1,570 long-term debt + $1,150 accounts payable + $830 accrued expenses). Stockholders’ equity is equal to $3,420 million ($30 common stock at par + $440 capital in excess of par − $2,000 treasury stock + $5,160 retained earnings − $210 accumulated other comprehensive loss). 20) B

On a common size income statement, all amounts are stated as a percentage of sales. Interest expense per dollar of sales has declined from 0.15 to 0.06. The other interpretations listed are not necessarily correct. COGS increased as a percentage of sales, but if sales decreased, COGS may have decreased as well. The company's effective tax rate (income tax expense / pretax income) can be calculated from a common-size income statement. Here the effective tax rate was 33% in both years. 21) A

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Using the indirect method, CFO is net income increased by 20X5 depreciation ($1,000,000) and decreased by the gain recognized on the sale of the plane [$10,000,000 sale price − ($15,000,000 original cost − $10,000,000 accumulated depreciation including 20X5) = $5,000,000]. $12,000,000 + $1,000,000 − $5,000,000 = $8,000,000. 22) C

Operating cash flow is equal to $36.1 million ($43.7 million net income + $4.2 million depreciation expense − $8 million gain on sale − $1.5 million increase in receivables − $2.3 million decrease in payables). Net capital expenditures are equal to $20 million ($35 million equipment purchased − $15 million proceeds from sale). Free cash flow to the firm is equal to $16.1 million ($36.1 million operating cash flow − $20 million net capital expenditures). 23) A

Equipment is reported in the balance sheet at historical cost less accumulated depreciation. 24) B

CFO = sales $3,000,000 − change in accounts receivable ($200,000 − $300,000) − purchases $1,800,000 − other cash operating expenses $400,000 = $900,000. Note that no adjustment for inventories is necessary because purchases are given. From the inventory equation, P = COGS + EI − BI. 25) C

The market value of the firm’s common equity (common stock) is not included on the balance sheet. IFRS allows some PP&E assets to be carried at fair value and some types of inventory to be carried at their market values. 26) C

Comprehensive income includes all transactions that affect shareholders’ equity except transactions with shareholders. Thus, any transaction that affects net income would also affect comprehensive income. Since the inventory write-down is included in net income, it is part of comprehensive income. The acquisition of treasury stock is a transaction with shareholders; thus, it is not a part of comprehensive income. 27) A

Decreases in inventory represent a source of cash so these would be subtracted from cost of goods sold. Any depreciation and/or amortization included in the cost of goods sold does not represent an actual use of cash, so this amount should be subtracted from cost of goods sold. Decreases in accounts payable represent a use of cash so these should be added to cost of goods sold.

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28) B

Both items are included in comprehensive income. Comprehensive income includes all items that affect owners’ equity except transactions with the company’s owners. Any items that are included in net income are also included in comprehensive income. The gain on sale is reported in net income. The foreign currency translation loss is taken directly to owners’ equity (i.e., not reported in the income statement). 29) A

Cash flow from operations (CFO) using the indirect method is computed by taking net income plus non- cash expenses (i.e. depreciation) less gains from the equipment sale. Note that cash flow from operations must be adjusted downward for the amount of the gain on the sale of the equipment. Cash flow from operations is ($850,000 + $200,000 – ($100,000 – $50,000)) = $1,000,000. The other information relates to financing cash flows. 30) C

The current ratio is equal to 2.4 [(4.8% cash + 14.9% accounts receivable + 49.4% inventory) / (15.0% accounts payable + 13.8% accrued liabilities)]. This ratio can be calculated from the common size balance sheet because the percentages are all on the same base amount (total). Return on equity is equal to net income divided by average total equity. Since this ratio mixes an income statement item and a balance sheet item, it is necessary to convert the common-size inputs to dollars. Net income is $11,211,200 ($215,600,000 × 5.2%) and average equity is $41,772,000 [($95,300,000 × 48.0%) + $37,800,000] / 2. Thus, 2007 ROE is 26.8% ($11,211,200 net income / $41,772,000 average equity). 31) A

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Only the options and convertible preferred stock are dilutive. First, calculate basic EPS to use as a benchmark to determine dilutive capital components. Basic EPS = (net income − preferred dividends) / weighted average common shares outstanding = (9.0 − 1.5) / 5.0 = $1.50. Next, check for dilution. The stock options are dilutive because the exercise price is less than the average stock price. There is no numerator impact from the options. The denominator impact = # options − [(# options × exercise price) / average stock price)] = 400,000 − [(400,000 × 32) / 35] = 34,286 or 0.034 million. To check whether the convertible preferred stock is dilutive we need to determine whether it decreases EPS. To the numerator, we add back the preferred dividend. The denominator impact = (# preferred shares × conversion rate) = 500,000 × 5 = 2,500,000, or 2.5 million. Then, EPS = (9.0 − 1.5 + 1.5) / (5.0 + 2.5) = $1.20. Thus the convertible preferred stock is dilutive. To check whether the convertible bonds are dilutive we need to determine whether they decrease EPS. To the numerator, we add back the after-tax impact of the coupon, or (face value × coupon × (1 − t)), or (10,000 bonds × 1,000 par × 0.06 coupon × 0.6 ) = 360,000, or $0.360 million. The denominator impact = (# convertible bonds × conversion rate) = 10,000 × 8 = 80,000, or 0.080 million. Then, EPS = (9.0 − 1.5 + 0.360) / (5.0 + 0.080) = $1.55. Thus the bonds are antidilutive. Finally, calculate diluted EPS: Diluted EPS = (9.0 − 1.5 + 1.5) / (5.0 + 2.5 + 0.034) = $1.1946. 32) C

CFO is the same under both methods, the only difference is presentation. Direct method: $92,500 cash collections ($100,000 revenue − $7,500 increase in receivables) − $38,500 cash paid to suppliers (− $40,000 COGS + $2,500 decrease in inventory − $1,000 decrease in payables) − $20,000 cash operating expenses − $3,000 tax expense = $31,000. Indirect method: $32,000 net income + $5,000 depreciation expense − $7,500 increase in receivables + $2,500 decrease in inventory − $1,000 decrease in payables = $31,000. The increase in short-term notes payable is a financing activity. 33) C

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Dividends declared are net income less the increase in retained earnings ($800,000 − $300,000 = $500,000). Dividends declared less the increase in dividends payable is dividends paid ($500,000 − ($300,000 − $200,000) = $400,000). This is a cash outflow so it is a negative number. Dividends paid are always cash flow from financing under U.S. GAAP. Note that accounts payable changes are included in cash flow from operations (CFO). 34) B

Net income is ($6,000 − 3,200 − 800)(1 − 0.4) = $1,200. Adjustments to reconcile net income to cash flow from operating activities will require that depreciation ($800) be added back, and increase in accounts receivable ($1,000) be subtracted: $1,200 + 800 − 1,000 = $1,000. 35) B

The recognition of bad debt expense has no effect on liabilities, current revenues are reduced by the expected amount of uncollectable accounts. Bad debt expense reduces net income and reduces assets. The recognition of expected warranty expense decreases net income (following the matching principle), and since it is not currently paid (doesn’t reduce assets) it creates or increases a liability at the time of sale. 36) C

The interest expense for three months net of tax is added to the numerator (12% × $100,000 × 3/12 × 60 %) = $1,800. The number of shares added to the denominator are 4,500. (18,000 × 3 / 12). 37) B

Given the gain of $100,000 and book value of the machinery sold of $260,000 ($500,000 original cost −$240,000 accumulated depreciation), the proceeds from the sale of the machinery were $360,000 ($100,000 gain + $260,000 book value). For 20X7, CFI was an outflow of $40,000 ($360,000 sale proceeds − $400,000 machinery purchase). The $600,000 financed by the seller is a non-cash transaction and is reported in the notes to the cash flow statement. 38) B

Restructuring and plant shutdown costs are considered part of a company’s normal operations. Gains and losses related to discontinued operations are reported separately in the income statement because these activities are no longer included as part of the company’s continuing operations. 39) B

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Since Red Oak is a nonfinancial firm, the accrued interest is considered a nonoperating activity, related to how the firm is financed. Dividends paid to preferred shareholders do not affect net income. 40) A

Feder’s basic earnings per share ((net income − preferred dividends) / weighted average shares outstanding) was (($7,650,000 − ($1,000 × 10,000 × 0.06)) / 1,100,000 =) $6.41. If the convertible preferred stock was converted to common stock at January 1, (10,000 × 20 =) 200,000 additional common shares would have been issued, dividends on the preferred stock would not have been paid, and Diluted EPS would have been ($7,650,000 / (1,100,000 + 200,000) = $5.88. Because $5.88 is less than basic EPS of $6.41, the preferred shares are dilutive. Using the treasury stock method, if the options were exercised cash inflow would be (70,000 × 10 × $50 =) $35,000,000. The number of Feder shares that can be purchased with the inflow (cash inflow divided by the average share price) is ($35,000,000 / $62 =) 564,516. The number of shares that would have been created is (700,000 − 564,516 =) 135,484. Diluted EPS was [($7,650,000 − ($1,000 × 10,000 × 0.06)] / (1,100,000 + 135,484) =) $5.71. Because this is less than the EPS of $6.41, the options are dilutive. Combining the calculations, Diluted EPS was (($7,650,000) / (1,100,000 + 200,000 + 135,484) = $5.32. (Study Session 7, Module 21.4, LOS 21.h) 41) B

A cash flow statement can be presented in common-size format by expressing each line item as a percentage of total revenue or by expressing each inflow of cash as a percentage of total cash inflows and each outflow as a percentage of total cash outflows. Expressing each line item of the cash flow statement as a percentage of revenue is useful in forecasting future cash flows since revenue usually drives the forecast. 42) A

Although manipulation of cash flow can occur, the P/E ratio is easier to manipulate because earnings are based on the numerous estimates and judgments of accrual accounting. EPS does not facilitate direct comparisons of profitability. Two firms may have the same amount of earnings but their number of shares outstanding may differ significantly. 43) C

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There are two formats for a common-size cash flow statement, expressing each type of outflow as a percentage of total cash outflows or as a percentage of total revenue for the period. Operating cash flow for the period mixes inflows and outflows and is not used to calculate percentage flows for payment made. 44) C

Interest received from customers and interest received from investments are a part of normal operations of a financial institution. Thus, the First National Bank will report the interest income from both sources as components of operating income. 45) C

Average stock price is not a factor in determining whether convertible bonds are dilutive or antidilutive. If Young redeemed the bonds, they would have no potentially dilutive securities outstanding in 20X5 and diluted EPS, if the company reported it, would equal basic EPS. Basic and diluted EPS would also be equal in 20X5 if the bonds were antidilutive in that year. 46) C

Leverage increased as measured by the debt-to-equity ratio from 2.25 in 2005 to 3.68 in 2007. Gross profit margin declined from 20.0% in 2005 to 18.5% in 2007. Return on equity has improved since 2005. One measure of ROE is ROA × financial leverage. Financial leverage (assets / equity) can be derived by adding 1 to the debt-to-equity ratio. In 2005, ROE was 23.4% [7.2% ROA × (1 + 2.25 debt- to-equity)]. In 2007, ROE was 27.6% [5.9% ROA × (1 + 3.68 debt-to-equity)]. 47) B

CCC = collection period + Inv Period − Payment period. Payment period = (365 / payables turnover) = (365 / 11) = 33; (365 / 12) = 30. This means the CCC actually increased to 83. 48) A

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To compute Hampshire’s basic EPS ((net income − preferred dividends) / weighted average common shares outstanding), the weighted average common shares must be computed. 100,000 shares were outstanding from January 1, and 30,000 shares were issued on September 1, so the weighted average is 100,000 + (30,000 × 4 / 12) = 110,000. Basic EPS is ($2,800,000 − (10,000 × $1,000 × 0.06)) / 110,000 = $20.00. If the warrants were exercised, cash inflow would be 10,000 × $150 × 10 = $15,000,000 for 10 × 10,000 = 100,000 shares. Using the treasury stock method, the number of Hampshire shares that can be purchased with the cash inflow (cash inflow / average share price) is $15,000,000 / $250 = 60,000. The number of shares that would be created is 100,000 − 60,000 = 40,000. Diluted EPS is $2,200,000 / (110,000 + 40,000) = $14.67. 49) A

To compute Gerrard’s basic earnings per share (EPS) ((net income − preferred dividends) / weighted average common shares outstanding), the weighted average common shares outstanding must be computed. 700,000 shares were outstanding from January 1, and 200,000 shares were issued on March 1, so the weighted average is 700,000 + (200,000 × 10 / 12) = 866,667. Basic EPS was $330,000 − (2,000 × $500 × 0.08)) / 866,667 = $0.289. If the convertible preferred shares were converted to common stock, 2,000 × 200 = 400,000 additional common shares would have been issued and dividends on the preferred stock would not have been paid. Diluted EPS was $330,000 / (866,667 + 400,000) = $0.261. 50) C

A firm with any potentially dilutive securities outstanding must report both basic and diluted EPS, even if the two are equal. If convertible preferred stock is dilutive to earnings per share, the preferred dividend is added back to the numerator as if the preferred has been converted to common shares. If diluted EPS is less than basic EPS then the convertible preferred is said to be dilutive. 51) B

Unrealized foreign currency translation gains and losses are not reported in the income statement; thus, retained earnings are unaffected. However, unrealized foreign currency gains and losses are included in comprehensive income. Comprehensive income includes all changes in equity except those that result from transactions with shareholders. So, the translation gain increases stockholders’ equity by increasing comprehensive income. 52) A

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During the first year, the revenue was 700,000 / 1,300,000 × 2,000,000 = 1,076,923 The total revenue for both years = $2,000,000 The second year revenue was 2,000,000 − 1,076,923 = $923,077 The second year income = revenues − costs = 923,077 − 1,000,000 = $−76,923 53) A

The format of the question information suggests the use of the direct cash flow method. In this method, depreciation is not a component of cash flow from operations. Cash flow from operations = (all numbers in thousands of dollars) 45 − 17 − 22 − 6.3 − 1.0 = −1.3, or −$1,300. 54) C

Inventory costs are expensed when items are sold under the matching principle. As an extreme example, if no sales are made, no costs of inventory production are expensed for the period. Period costs are expensed during the period. Under the accrual method, interest accrued during the period is expensed, regardless of whether it has been paid during the period. 55) C

Using the indirect method, CFO = Net income 25 + increase in accounts payable 20 + increase in deferred taxes 5 − profit on sale of equipment 15 = $35. Increases in accounts payable and deferred taxes are sources of operating cash that are not included in net income and must be added. Profit on sale of equipment is a CFI item that must be removed from net income. No adjustment needs to be made for cash payment of dividends (CFF), sale of preferred stock (CFF), or purchase of land (CFI) because they are not included in net income. Only the profit on sale of equipment, not the full proceeds from sale, is included in net income. 56) B

Under U.S. GAAP, interest received is reported as an operating cash flow. For a non-financial services company, interest received is typically reported as non-operating income. 57) C

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58) A

The trading securities classification includes the unrealized gain from the bond in net income, which increases retained earnings. Unrealized gains on available-for-sale securities are reported as other comprehensive income for the period and are recorded in accumulated other comprehensive income, a component of owner's equity. Unrealized gains on held-to-maturity securities are not reported on the financial statements. 59) C

The analyst believes an expenditure the firm classified as an investing cash outflow should have been classified as an operating cash outflow. Thus, the analyst should adjust CFO downward and CFI upward. 60) B

Common-size cash flow statements show each cash flow item as a percentage of revenue or show each cash flow outflow as a percentage of all cash outflows and each cash inflow as a percentage of all cash inflows. 61) C

Unrealized gains and losses from trading securities are reflected in the income statement and affect owners' equity. However, unrealized gains and losses from available-for-sale securities are included in other comprehensive income. Transactions included in other comprehensive income affect equity but not net income. Dividends paid to shareholders reduce owners' equity but not net income. 62) B

For long-lived assets classified as investment property, IFRS allows either the cost model or the fair value model. The revaluation model is permitted for long-lived assets that are not classified as investment property. U.S. GAAP only permits the cost model for valuation of long-lived assets and does not identify investment property as a specific subset of long-lived assets. 63) C

If Train decided to amortize the cost, the franchise would be capitalized as a balance sheet asset and the cash outflow would have been classified as CFI. As a result CFO would have been $8 million higher, or $14 million + $8 million = $22 million. Amortization would be a non-cash expense. 64) C

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According to IFRS, property held for the purpose of earning rental income is classified as investment property. However, when a property is transferred from owner-occupied to investment property, a firm using the fair value model must treat any increase in the property's value as a revaluation. That is, the firm may only recognize a gain on the income statement to the extent that it reverses a previously recognized loss. 65) B

Under the fair value model, all gains and losses from changes in the value of investment property are recognized on the income statement. The firm will recognize a loss of €150,000 in Year 1 and a gain of €200,000 in Year 2. 66) A

Undistributed profits from a subsidiary do not require the creation of a deferred tax liability under U.S. GAAP if the subsidiary meets the indefinite reversal criterion. For IFRS, there are circumstances where a DTL is not created but the test for this treatment is not called or equivalent to the indefinite reversal criterion detailed in U.S. GAAP. 67) C

Assuming normal capacity levels, allocation of fixed production overhead is a product cost that is capitalized as part of inventory. Thus, this cost will not be recognized as an expense until the inventory is sold (it becomes part of COGS for that period). Administrative overhead and selling costs are period costs that must be expensed in the period incurred. 68) C

The $200,000 difference between the tax base and the carrying value of the equipment gives rise to a deductible temporary difference that leads to a deferred tax asset (DTA) of $80,000 ($200,000 × 40%). The tax loss carryforward of $300,000 also leads to a DTA but for $120,000 ($300,000 × 40%). The decrease in the tax rate from 40% to 35% will reduce the DTA of the equipment by $10,000 ($200,000 × 5%). It will reduce the DTA of the tax loss carryforward by $15,000 ($300,000 × 5%). In total, the DTA will decrease by $25,000. The decrease in the value of the DTA will increase income tax expense by $25,000 in the period when the DTA is decreased. 69) B

Under IFRS, a tax rate that has been enacted or substantively enacted is used to measure deferred tax items. Under U.S. GAAP, only a tax rate that has actually been enacted can be used. 70) B

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Based on a semiannual interest rate of 6.65% (13.30% / 2): Period

Coupon Payment

Interest Expense 0.00

1 2 3 4

53.20 55.08 57.08 59.21

25.00 25.00 25.00 25.00

Discount Amortization

28.20 30.08 32.08 34.21

Bond Carrying Value $ 800.00 828.20 858.28 890.36 $ 924.57

Interest expense for Year 2 is $57.08 + $59.21 = $116.29. 71) C

When exchanging one long-lived asset for another, a gain or loss is recorded as the difference between the old asset's carrying value and its fair value (or the fair value of the asset received in exchange, if that value is more evident). When selling an asset, the gain or loss is the difference between the carrying value and the cash received. When abandoning an asset, a firm records a loss equal to the carrying value of the asset. 72) C

Neither metric is directly relevant in evaluating the stability of a firm's inventory levels. Determining stability would presumably require other information such as purchase and sales levels, for example. The inventory turnover ratio and the number of days in inventory can be used to evaluate the relative age of a firm's inventory as well as the effectiveness of a firm's inventory management. 73) C

Deferred tax items are classified as noncurrent. 74) A

Estimated amortization expense for the next five years is required by U.S. GAAP but is not required by IFRS. 75) C

Permanent tax differences such as tax credits, non-deductible expenses, and tax differences between capital gains and operating income give rise to differences in the effective and statutory tax rates. 76) A

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As bond premium is amortized, interest expense will be successively lower each period, thus increasing earnings over the life of the bond. 77) B

Under U.S. GAAP, the full amount of a DTA is shown on the balance sheet, with a contra account (valuation allowance) if it is likely that the full amount of the DTA will not be realized in the future. Under IFRS, the reported value of a DTA is reduced if there is a positive probability that the full amount of the DTA will not be realized in the future. 78) C

Under U.S. GAAP, a LIFO firm values inventory at the lower of cost or market. Market is equal to the replacement cost subject to replacement cost being within a specific range. The upper bound is net realizable value (NRV), which is equal to selling price ($80) less selling costs ($2) for an NRV of $78. The lower bound is NRV ($78) less normal profit (5% of selling price = $4) for a net amount of $74. Since replacement cost ($73) is less than NRV minus normal profit ($74), then market equals NRV minus normal profit ($74). As well, we have to use the lower of cost ($90) or market ($74) principle so the recorders should be recorded at the lower amount of $74. 79) A

If the franchise cost had been amortized over six years beginning in 20X3, net income in 20X3 would have been $6 million instead of $1 million due to the cost of franchise expense of $6 million being eliminated and replaced by franchise amortization of $1 million. Net income in 20X4 would have been reduced by the franchise amortization to $7 million instead of $8 million. On the equity side, retained earnings at the end of 20X3 would have been $11 million ($5 million higher), and total equity for 20X3 would have been $8 + $11 = $19 million. Retained earnings for 20X4 would be the 20X3 retained earnings of $11 million increased by 20X4 net income of $7 million for a total of $18 million, and total equity for 20X4 would be $8 + $18 = $26 million. If the franchise cost were amortized, return on total equity for 20X4 would be $7 / ((19 + 26) / 2) = 31.1%. 80) C

U.S. GAAP requires the lessee to recognize a balance sheet liability for both finance leases and operating leases. 81) B

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The first step is to determine the direction of prices: Purchase Begin inventory 3/1/X6 Purchase 7/1/X6 9/1/X6

Total Cost $ 9,500 14,800 Total Cost 14,850 15,950

Units ÷ 250 ÷ 400 Units ÷ 450 ÷ 550

Per-unit Cost = $ 38 = $ 37 Per-unit Cost = $ 33 = $ 29

Notice that per-unit prices are falling. Under falling prices, LIFO inventory costing will result in higher net income because the recent units were cheaper than the older purchases (and beginning inventory), making the cost of goods sold lower and net income higher. Working capital will be higher because LIFO inventory is greater than FIFO inventory when prices are falling. 82) C

The required disclosures for long-lived assets under IFRS are more extensive than they are under U.S. GAAP. IFRS requires a reconciliation of beginning and ending carrying values for classes of PP&E, while U.S. GAAP does not. 83) B

When reclassifying a property from owner-occupied to investment property and using the fair value model for valuation of investment property, IFRS specifies that the firm should treat the event as a revaluation, recognizing a gain only if it reverses a previously recognized loss. 84) A

For tax purposes, bad debt expense cannot be deducted until the receivables are deemed worthless. Therefore, the tax base is $35,000 since no bad debt expense has been deducted on the tax return. Note that the carrying value would be $31,500 since bad debt expense is reflected on the income statement. 85) B

Using the effective interest method, the value of the liability is calculated using the bond’s yield at issuance. At the end of 20x1 the bond will have 8 semiannual periods remaining until maturity. N = 8; I/Y = 10 / 2 = 5; PMT = 8 / 2 × 1,000 = 40; FV = 1,000; CPT PV = −935.37. 86) C

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At the end of year 3, the oven has a tax base of zero (it has been fully depreciated for tax reporting) and a carrying value on the balance sheet of $12,675 − 3(0.2)($12,675) = $5,070. The deferred tax liability, valued at the 31% tax rate that will apply when the temporary difference reverses, is ($5,070 − $0)(0.31) = $1,571.70. 87) B

Writing down inventory to net realizable value decreases both net income and total assets in the period of the writedown. Because net income is most likely less than assets, the result in the period is a decrease in ROA. In later periods, lower-valued inventory will decrease COGS and increase net income. Combined with a lower value of total assets, this will increase ROA. 88) A

Return on total equity (net income / total equity) was $800,000 / ($2,200,000 + $1,800,000) = 20%. Under FIFO, net income increases by the increase in the LIFO reserve multiplied by (1 − tax rate). FIFO net income was $800,000 + ($600,000 − $400,000) (1 − 0.40) = $920,000. Total equity increases by the amount of accumulated FIFO profits that are added to retained earnings, which is calculated by multiplying the amount of the ending LIFO reserve by (1 − tax rate) for an increase of ($600,000) × (1 − 0.40) = $360,000. Total equity is $2,200,000 + $1,800,000 + $360,000 = $4,360,000. FIFO return on total equity is $920,000 / $4,360,000 = 21.1%. 89) B

With FIFO instead of LIFO: Inventory would be higher by $900,000, the amount of the ending LIFO reserve. Cumulative pretax income would also be higher by $900,000, so taxes paid would be higher by 0.40($900,000) = $360,000. Therefore cash would be lower by $360,000. Cumulative retained earnings would be higher by (1 − 0.40)($900,000) = $540,000. So assets under FIFO would be $11,800,000 + $900,000 − $360,000 = $12,340,000 and equity would be $1,000,000 + $1,500,000 + $540,000 = $3,040,000. The assets-to-equity ratio would be $12,340,000 / $3,040,000 = 4.06. 90) C

DTL = (tax depreciation − financial statement depreciation) × future tax rate = ($94,000 − $75,000) × 37% = $7,030. DTA = (estimated warranty expense − actual warranty expense) × future tax rate = ($250,000 − $100,000) × 37% = $55,500. 91) C

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Under U.S. GAAP, a PP&E asset is tested for impairment when events and circumstances indicate the firm may not recover its carrying value through future use, or if the asset is reclassified from held-for- use to held-for-sale. Under IFRS, firms are also required to assess at least annually whether events and circumstances indicate impairment may have occurred. 92) C

The ending LIFO reserve is $70 and the beginning LIFO reserve is $80. FIFO COGS = LIFO COGS − (ending LIFO reserve − beginning LIFO reserve) $800 − ($70 − $80) = $810 93) B

When inventory is written down to market, the replacement cost of the inventory is its market value, but the “market value” must fall between net realizable value (NRV) and NRV less normal profit margin. NRV is the market price of the inventory less selling costs. Therefore the minimum value is the market price minus selling costs minus normal profit margin. 94) B

Total taxes eventually due on 2004 activities were (($2,000,000 × 0.40) + ($4,000,000 × 0.20) =) $1,600,000. Permanent differences are adjusted in the effective tax rate, which is ($1,600,000 / $7,000,000 =) 22.86%. Of the $1,600,000 taxes due, (($2,000,000 × 0.50 × 0.40) + ($4,000,000 × 0.25 × 0.20) =) $600,000 were paid in 2004 and $1,000,000 ($1,600,000 − $600,000) is added to deferred tax liability. 95) C

Both U.S. GAAP and IFRS require companies to capitalize the interest that accrues during the construction of capital assets for their own use. 96) B

The LIFO conformity rule in the U.S. requires firms to use LIFO for their financial statements if they use LIFO for income tax purposes. 97) B

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DDB depreciation in each year is 2/5 of the carrying value at the beginning of the year, until the carrying value reaches the estimated salvage value. Year 1 DDB depreciation = $20,000 × 2/5 = $8,000 Carrying value = $20,000 − $8,000 = $12,000 Year 2 DDB depreciation = $12,000 × 2/5 = $4,800 Carrying value = $12,000 − $4,800 = $7,200 Year 3 DDB depreciation = $7,200 × 2/5 = $2,880 Because $7,200 − $2,880 = $4,320 would depreciate the equipment below its salvage value, depreciation in Year 3 is limited to $7,200 − $5,000 = $2,200. 98) B

Cash paid to redeem a bond is classified as a cash flow from financing activities. 99) C

Under U.S. GAAP accounting standards for lessors, a lease is classified as an operating lease if it cannot be classified as either a sales-type lease or a direct financing lease. If ownership risks are substantially transferred to the lessee and collection of the payments is reasonably assured, the lessor classifies the lease as a sales-type lease. If ownership risks are not substantially transferred, but a third party guarantees the residual value of the asset and the sum of the lease payments and the residual value is at least equal to the fair value of the asset, the lessor classifies the lease as a direct financing lease. 100)

B An increase in the tax rate increases the values of both DTAs and DTLs. Because the firm's DTAs are greater than its DTLs, the net effect of adjusting their values for an increase in the tax rate will be to decrease income tax expense. 101)

C For the purpose of analysis, the value of debt should be adjusted for a change in interest rates. This will change the debt-to-equity ratio. 102)

B The coupon payment is a cash outflow from operations. ($10,000,000 × 0.09) = $900,000. 103)

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A write-down of inventory to net realizable value is typically recognized under U.S. GAAP as an increase in cost of goods sold in the period of the write-down. Consider the inventory equation: ending inventory = beginning inventory + purchases − cost of goods sold A write-down to NRV decreases ending inventory, with no effect on beginning inventory or purchases. For the inventory equation to hold, cost of goods sold must increase. 104)

B Face value of bonds = $67,831 Proceeds from bond sale: I/Y = 8; N = 4; PMT = $67,831 × 0.07 = $4,748.17; FV = $67,831; CPT PV = $65,582 Unamortized discount at issuance = $67,831 − $65,582 = $2,249. First year interest expense = $65,582 × 0.08 $5,247 Coupon payment = $67,831 × 0.07 = $4,748 Change in discount = $5,247 − $4,748 = $499 Unamortized discount at end of first year = $2,249 − $499 = $1,750. 105)

A Measurement of deferred tax items is based on the tax rate that will apply when the temporary difference reverses. In some cases this may depend on how a temporary difference is settled, which determines whether a capital gains tax rate or income tax rate will apply. 106)

C Net book value at the end of year 3 is $100,000 × 3/5 × 3/5 × 3/5 = $21,600. DDB amortization in year 4 of 2/5 × $21,600 = $8,640 would amortize the asset below its salvage value, so amortization expense is the remaining $1,600 that will amortize net book value to $20,000. 107)

A When analyzing disclosures related to financing liabilities, analysts would review the balance sheet and find the present value of the promised future liability payments. These payments would then be discounted at the rate in effect at issuance (i.e., the yield to maturity), not the coupon rate of the bonds. 108)

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Because the land is valued above its historical cost on the balance sheet, Dubois is using the revaluation model. The land’s revaluation up to €2.2 million would have been reflected in shareholders’ equity with a revaluation surplus of €200,000. The decrease in fair value to €1.8 million will reduce the revaluation surplus to zero, and the amount of the writedown below historical cost (€2 million − €1.8 million = €200,000) will be recognized as a loss on Dubois’s income statement. This loss, combined with the removal of the revaluation surplus, will decrease shareholders’ equity by €400,000. Note that the land was purchased for company use and therefore would not be classified as investment property. 109)

B Under IFRS, deferred tax assets and liabilities are classified as noncurrent. Under U.S. GAAP, deferred tax items may be current or noncurrent, depending on how the underlying asset or liability is classified. 110)

B Deferred taxes must be recognized for undistributed earnings from an investment in an associate firm under U.S. GAAP. Under IFRS, no deferred taxes are reported for undistributed earnings if the investor firm controls the sharing of profits and it is probable the temporary difference will not be reversed in the future. 111)

A The change in Fred’s rates causes its deferred tax liability to increase [(40 − 30) / 30] × $1,200,000 = $400,000. This is reported on the income statement as an increase in current income tax expense. 112)

C Under IFRS, bond liabilities are reported under the effective interest method and issuance costs are deducted from the proceeds to determine the initial liability. The yield at issuance is: PV = 97.5 million; FV = −100 million; PMT = −5 million; N = 10; CPT I/Y = 5.33. Change N to 8 and CPT PV after two years as 97.9 million. 113)

A A direct finance lease under U.S. GAAP is a lessor classification for leases that do not meet the transfer of ownership criteria. The other two conditions must be met. If a lease transfers substantially all the benefits and risks of ownership to the lessee, the lessor classifies it as a salestype lease. 114)

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Firms that have poor profitability are more likely to be non-dividend paying. Selecting only dividend paying stocks can serve as a check on poor profitability. Using positive ROE to control for poor performance can result in bogus results without additional filters. For example, if both the numerator (net income) and the denominator (average equity) are negative, ROE will be positive. The higher the assets-to-equity ratio, the higher the leverage. Selecting only stocks with an assets-to-equity ratio below a certain cut-off point will eliminate stocks with high leverage. Debt-to-equity above a certain point would include firms with higher, not lower, financial leverage. 115)

C Accounting standard-setting bodies issue financial reporting standards but do not enforce compliance with them. Securities regulators and counterparties to private contracts are among the mechanisms that discipline financial reporting quality. 116)

C A shift to premium, rather than commodity-like, products should result in higher gross margins, higher average revenue per unit (selling price per unit), and an increase in gross margins relative to operating margins (because of the increase in R&D and marketing expenditures). A successful shift to a premium product should increase operating margins rather than increase operating income through increased unit sales. Revenue would not necessarily increase as the company shifted to premium products. 117)

C A significant increase in days payables may indicate that payables have been "stretched" (not paid or paid more slowly), which increases operating cash flow in an unsustainable manner and calls the quality of the reported cash flow values into question. Stretching payables does not affect earnings because the related expenses were recognized in the period incurred. An increase in days payables will decrease net working capital, other things equal. 118)

B 2008 sales are expected to be $600 million ($500 million 2007 sales × 1.2) and 20X8 net income is expected to be $30 million ($600 million 20X8 sales × 5%). 2008 non-cash operating working capital is expected to be $120 million ($600 million 20X8 sales × 20%). The change in cash is expected to be −$5 million ($30 million 20X8 net income + $60 million 20X8 depreciation − $20 million increase in non- cash operating working capital − $75 million 20X8 capital expenditures). The 20X8 ending balance of cash is expected to be $30 million ($35 million beginning cash balance − $5 million decrease in cash). 119)

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A screen for firms with high dividend yields and high book-to-market ratios would likely result in an inordinate proportion of financial services companies and add a significant element of industry (sector) risk. Uncertainty about sustainability of dividend payments and recent market underperformance are typical characteristics of value stocks in general and not a drawback to using this screen to identify them. 120)

C Continental likely has the highest gross profit margin percentage since it is selling a customized product and does not compete primarily based on price. Because of the research and development costs of developing a new hybrid motorcycle, Continental likely has the higher operating expense stated as a percentage of total cost. 121)

A It is often the case a screening metric, such as low P/E, high dividend yield, or high ROE, will identify many stocks in the same industry. Undesirable characteristics can be avoided by including additional screening metrics. Financial statement measures provide a great amount of information about a firm’s characteristics.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 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. 1) ______ A) $37.63. B) $43.22. C) $19.22. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Fixed Income Valuation Source : Fixed Income > Fixed Income Question 1

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? 2) ______ A) $2,000. B) $2,025. C) $2,050. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Fixed-Income Securities: Defining Elements Source : Fixed Income > Fixed Income Question 2

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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? 3) ______ A) 5.42%. B) 5.33%. C) 5.26%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Fixed Income Valuation Source : Fixed Income > Fixed Income Question 3

4) A yield curve for coupon bonds is composed of yields on bonds with similar: 4) ______ A) coupon rates. B) issuers. C) maturities. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Fixed Income Valuation Source : Fixed Income > Fixed Income Question 4

5) In a commercial mortgage-backed security (CMBS), which of the following is an example of

CMBS- level call protection? 5) ______ A) Yield maintenance charges. B) Prepayment lockout. C) Residual tranche. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Asset-Backed Securities Source : Fixed Income > Fixed Income Question 5

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6) Which of the following statements about floating-rate notes is most accurate? 6) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Fixed-Income Securities: Defining Elements Source : Fixed Income > Fixed Income Question 6

7) The interest rate on excess reserves borrowed by one bank from another bank is most

accurately described as a(n): 7) ______ A) reserve swap rate. B) interbank lending rate. C) central bank funds rate. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Fixed-Income Markets: Issuance, Trading, and Funding Source : Fixed Income > Fixed Income Question 7

8) The reference rate for a floating-rate note should least likely match the note’s: 8) ______ A) reset frequency. B) maturity. C) currency. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Fixed-Income Markets: Issuance, Trading, and Funding Source : Fixed Income > Fixed Income Question 8

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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): 9) ______ A) negative covenant. B) affirmative covenant. C) inhibiting covenant. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Fixed-Income Securities: Defining Elements Source : Fixed Income > Fixed Income Question 9

10) Which of the following statements about U.S. Treasury Inflation Protection Securities (TIPS)

is most accurate? 10) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Fixed-Income Securities: Defining Elements Source : Fixed Income > Fixed Income Question 10

11) A bond’s indenture least likely specifies the: 11) ______ A) source of funds for repayment. B) covenants that apply to the issuer. C) identity of the lender. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Fixed-Income Securities: Defining Elements Source : Fixed Income > Fixed Income Question 11

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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? 12) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Fixed-Income Securities: Defining Elements Source : Fixed Income > Fixed Income Question 12

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: 13) ______ A) be more than 6%. B) be less than 6%. C) lie between 6% and 7%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Fixed Income Valuation Source : Fixed Income > Fixed Income Question 13

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: 14) ______ A) $935.12. B) $891.40. C) $847.69. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Fixed Income Valuation Source : Fixed Income > Fixed Income Question 14

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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? 15) ______ A) 7.75%. B) 7.65%. C) 7.53%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Fixed Income Valuation Source : Fixed Income > Fixed Income Question 15

16) A waterfall structure is least likely describe: 16) ______ A) credit card ABS. B) auto loan ABS. C) agency RMBS. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Asset-Backed Securities Source : Fixed Income > Fixed Income Question 16

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: 17) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Fixed Income Valuation Source : Fixed Income > Fixed Income Question 17

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18) A renegotiable mortgage has a fixed interest rate that: 18) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Asset-Backed Securities Source : Fixed Income > Fixed Income Question 18

19) Which of the following statements concerning the support tranche in a planned amortization

class (PAC) CMO backed by agency RMBS is least accurate? 19) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Asset-Backed Securities Source : Fixed Income > Fixed Income Question 19

20) A repurchase agreement is described as a “reverse repo” if: 20) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Fixed-Income Markets: Issuance, Trading, and Funding Source : Fixed Income > Fixed Income Question 20

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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: 21) ______ A) $1,052. B) $1,060. C) $984. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Fixed Income Valuation Source : Fixed Income > Fixed Income Question 21

22) One of the primary benefits of securitization is that it: 22) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Asset-Backed Securities Source : Fixed Income > Fixed Income Question 22

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: 23) ______ A) positive current yield and a capital gain. B) positive current yield, only. C) negative current yield and a capital gain. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Fixed Income Valuation Source : Fixed Income > Fixed Income Question 23

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24) Which of the following embedded bond options tends to benefit the borrower? 24) ______ A) Put option. B) Conversion option. C) Interest rate cap. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Fixed-Income Securities: Defining Elements Source : Fixed Income > Fixed Income Question 24

25) A 10-year spot rate is least likely the: 25) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Fixed Income Valuation Source : Fixed Income > Fixed Income Question 25

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? 26) ______ A) $1,081.00. B) $1,014.00. C) $1,047.50. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Fixed Income Valuation Source : Fixed Income > Fixed Income Question 26

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27) With respect to auto-loan backed ABS: 27) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Asset-Backed Securities Source : Fixed Income > Fixed Income Question 27

28) If a callable bond has an option-adjusted spread (OAS) of 75 basis points, this most likely

suggests: 28) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Fixed Income Valuation Source : Fixed Income > Fixed Income Question 28

29) An investor most concerned with reinvestment risk would be least likely to: 29) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Fixed-Income Securities: Defining Elements Topic : Understanding Fixed-Income Risk and Return Source : Fixed Income > Fixed Income Question 29

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30) If the yield curve is downward-sloping, the no-arbitrage value of a bond calculated using spot

rates will be: 30) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Fixed Income Valuation Source : Fixed Income > Fixed Income Question 30

31) Medium-term notes (MTNs) most likely: 31) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Fixed-Income Markets: Issuance, Trading, and Funding Source : Fixed Income > Fixed Income Question 31

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: 32) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Fixed Income Valuation Source : Fixed Income > Fixed Income Question 32

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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: 33) ______ A) greater than 5.2%. B) 5.2%. C) less than 5.2%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Fixed Income Valuation Source : Fixed Income > Fixed Income Question 33

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: 34) ______ A) unfavorable macroeconomic factors and favorable microeconomic factors. B) unfavorable macroeconomic and microeconomic factors. C) favorable macroeconomic factors and unfavorable microeconomic factors. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Introduction to Fixed Income Valuation Source : Fixed Income > Fixed Income Question 34

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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? 35) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Fixed-Income Risk and Return Source : Fixed Income > Fixed Income Question 35

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: 36) ______ A) less than 4.5%. B) greater than 4.5%. C) approximately 4.5%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Fixed-Income Risk and Return Source : Fixed Income > Fixed Income Question 36

37) The factors that must be considered when estimating the credit risk of a bond include: 37) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Fundamentals of Credit Analysis Source : Fixed Income > Fixed Income Question 37

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38) Which of the following will be the greatest for a putable bond at relatively high yields? 38) ______ A) Modified duration of the bond ignoring the option. B) Macaulay duration of the bond ignoring the option. C) Effective duration of the bond. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Fixed-Income Risk and Return Source : Fixed Income > Fixed Income Question 38

39) The factors that must be considered when estimating the credit risk of a bond include: 39) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Fundamentals of Credit Analysis Source : Fixed Income > Fixed Income Question 39

40) Which of the following will be the greatest for a putable bond at relatively high yields? 40) ______ A) Modified duration of the bond ignoring the option. B) Macaulay duration of the bond ignoring the option. C) Effective duration of the bond. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Fixed-Income Risk and Return Source : Fixed Income > Fixed Income Question 40

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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? 41) ______ A) $624. B) $574. C) $459. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Fixed-Income Risk and Return Source : Fixed Income > Fixed Income Question 41

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: 42) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Fixed-Income Risk and Return Source : Fixed Income > Fixed Income Question 42

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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: 43) ______ A) the same as Joseph. B) lower than Joseph. C) higher than Joseph. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Fundamentals of Credit Analysis Source : Fixed Income > Fixed Income Question 43

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? 44) ______ A) Shorter maturities and higher coupon levels. B) Longer maturities and higher coupon levels. C) Shorter maturities and lower coupon levels. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Fixed-Income Risk and Return Source : Fixed Income > Fixed Income Question 44

45) In comparing the price volatility of putable bonds to that of option-free bonds, a putable bond

will have: 45) ______ A) more price volatility at higher yields. B) less price volatility at higher yields. C) less price volatility at low yields. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Fixed-Income Risk and Return Source : Fixed Income > Fixed Income Question 45

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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: 46) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Fixed-Income Risk and Return Source : Fixed Income > Fixed Income Question 46

47) Structural subordination means that a parent company’s debt: 47) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Fundamentals of Credit Analysis Source : Fixed Income > Fixed Income Question 47

48) Duration and convexity are most likely to produce more accurate estimates of interest rate

risk when the term structure of yield volatility is: 48) ______ A) downward sloping. B) upward sloping. C) flat. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Fixed-Income Risk and Return Source : Fixed Income > Fixed Income Question 48

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49) Holding other factors constant, the interest rate risk of a coupon bond is higher when the

bond's: 49) ______ A) yield to maturity is lower. B) coupon rate is higher. C) current yield is higher. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Fixed-Income Risk and Return Source : Fixed Income > Fixed Income Question 49

50) If the term structure of yield volatility slopes upward: 50) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Fixed-Income Risk and Return Source : Fixed Income > Fixed Income Question 50

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: 51) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Fixed-Income Risk and Return Source : Fixed Income > Fixed Income Question 51

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52) All else equal, which of the following is least likely to increase the interest rate risk of a

bond? 52) ______ A) A longer maturity. B) A decrease in the YTM. C) Inclusion of a call feature. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Understanding Fixed-Income Risk and Return Source : Fixed Income > Fixed Income Question 52

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Answer Key Test name: Fixed Income 1) C

The no-arbitrage price of a bond is determined by discounting each of its cash flows at the appropriate spot rate. Any difference between the no-arbitrage price and the market price of a bond represents a potential arbitrage profit. = 19.80 + 19.51 + 19.13 + 18.48 + 879.86 = $956.78 976 − 956.78 = $19.22 2) B

This coupon payment is computed as follows:

3) C

First, find the annual yield to maturity of the bond as: FV = $1,000; PMT = $65; N = 10; PV = −1,089.25; CPT → I/Y = 5.33%. Then, find the semiannual-bond basis yield as:2 × [(1 + 0.0533)0.5 − 1] = 0.0526 = 5.26%. 4) B

Yield curves are typically constructed for bonds of the same or similar issuers, such as a government bond yield curve or AA rated corporate bond yield curve. 5) C

Call protection in the context of a CMBS refers to protection against prepayment risk. Structuring a CMBS with a residual (equity or first-loss) tranche provides investors in the senior tranches with CMBS- level call protection. Prepayment lockout periods and yield maintenance charges are examples of loan- level call protection because they apply to the individual loans. 6) C

The lowest possible reference rate is zero. If this occurs, the coupon on a floating-rate note cannot go lower than its quoted margin. Hence, the quoted margin is a floor coupon for a floating-rate note. The coupon on an inverse floater is determined by a formula such as “15% − 1.5 × reference rate.” If the reference rate goes to zero, the coupon on this inverse floater can go no higher than 15%. 7) C

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Required reserves are deposits with a country’s central bank. Banks that deposit more than the required amount with the central bank are said to have excess reserves and may lend these to other banks. This lending is said to take place in the central bank funds market and the interest rates on such loans are known as central bank funds rates. 8) B

An appropriate reference rate for a floating-rate note should match its currency and the frequency with which its coupon rate is reset, such as 90-day yen Libor for a yen-denominated note that resets quarterly. 9) B

Covenants are classified as negative or affirmative. Affirmative covenants specify administrative actions a bond issuer is required to take, such as maintaining insurance coverage on assets pledged as collateral. Negative covenants are restrictions on a bond issuer’s actions, such as preventing an issuer from selling any assets that have been pledged as collateral or pledging them again as collateral for additional debt. 10) C

The coupon rate is set at a fixed rate determined via auction. This is called the real rate. The principal that serves as the basis of the coupon payment and the maturity value is adjusted semiannually. Because of the possibility of deflation, the adjusted principal value may be less than par (however, at maturity the Treasury redeems the bonds at the greater of the inflation-adjusted principal and the initial par value). 11) C

The identity of the lender (i.e., the bondholder) is not specified in a bond’s indenture because a bond may be traded during its life. An indenture or trust deed is a legal contract that specifies a bond issuer’s obligations and restrictions. The indenture may include covenants that require the issuer to take or refrain from taking certain actions and may specify the source of funds for repayment, such as a project to be funded or the taxing power of a government. 12) C

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The coupon rate is set in the bond agreement (indenture) and cannot be changed unilaterally. Non- interest rate indexed floaters are indexed to a commodity price such as oil or aluminum. Business results could be impacted by numerous factors other than aluminum prices. Both of the other choices are true. By linking the coupon payments directly to the price of aluminum (meaning that when aluminum prices increase, the coupon rate increases and vice versa), the non- interest index floater allows Allcans to protect its credit rating during adverse circumstances. 13) B

The following relationship has to hold: (1 + spot rate0,0.5/2)1 × (1 + forward rate0.5,2/2)3 = (1 + spot rate0,2/2)4. For this relationship to hold the forward rate has to be less than 6%. 14) B

The flat price of the bond is the quoted price, 89.14% of par value, which is $891.40. 15) B

The current yield is computed as: (Annual Cash Coupon Payment) / (Current Bond Price). The annual coupon is: ($1,000)(0.0775) = $77.50. The current yield is then: ($77.50) / ($1,012.45) = 0.0765 = 7.65%. 16) C

A waterfall structure, where principal losses are allocated first to the lowest priority securities issued, would most likely describe auto loan ABS or credit card ABS, which often have a seniorsubordinated structure. Agency RMBS are pass-through securities and do not have a seniorsubordinated structure. 17) B

Bond Y will have the higher Z-spread due to the call option embedded in the bond. This option benefits the issuer, and investors will demand a higher yield to compensate for this feature. The option-adjusted spread removes the value of the option from the spread calculation, and would always be less than the Z-spread for a callable bond. Since Bond X is noncallable, the Z-spread and the OAS will be the same. 18) B

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A renegotiable or rollover mortgage has an initial fixed-rate period after which the interest rate changes to another fixed rate. A hybrid mortgage has an initial fixed-rate period after which the interest rate changes to a variable rate. A convertible mortgage may be changed from fixed-rate to variable-rate or from variable-rate to fixed-rate at the borrower’s option. 19) C

The support tranches are exposed to high levels of prepayment risk, not credit risk. 20) B

Bond dealers frequently use repurchase agreements as sources of funding. When a bond dealer enters a repo as the lender instead of the borrower, the agreement is referred to as a reverse repo. 21) B

Spot Rates: Year 1 = 7%. Year 2 = [(1.07)(1.0815)]1/2 − 1 = 7.57%. Year 3 = [(1.07)(1.0815)(1.103)]1/3 − 1 = 8.48%. Year 4 = [(1.07)(1.0815)(1.103)(1.120)]1/4 − 1 = 9.35%. Bond Value: N = 1; FV = 110; I/Y = 7; CPT → PV = 102.80 N = 2; FV = 110; I/Y = 7.57; CPT → PV = 95.06 N = 3; FV = 110; I/Y = 8.48; CPT → PV = 86.17 N = 4; FV = 1,110; I/Y = 9.35; CPT → PV = 776.33 102.80 + 95.06 + 86.17 + 776.33 = 1,060.36 22) C

Securitization reduces the cost of funding the assets. One way that is accomplished is through the transfer of the underlying financial assets to a special purpose entity so that securities holders have clear legal claim to them, something they may not have if they were to invest only in the securities of the securitizer, such as a bank. Securitization does not have improved collectability as a primary benefit. Problem loans are not good candidates for securitization because institutional investors require a minimum credit quality and even well performing loans can require internal or external credit enhancement for the securitized assets. 23) B

A coupon bond will have a positive current yield. It will not have a capital gain because its price will increase toward par along its constant-yield price trajectory as long as its YTM remains constant.

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24) C

The interest rate cap benefits the borrower who issues a floating rate bond. The cap places a restriction on how high the coupon rate can become during a rising interest rate environment. Therefore, the floating rate borrower is protected against ever-rising interest rates. 25) B

A 10-year spot rate is the yield-to-maturity on a 10-year zero-coupon security, and is the appropriate discount rate for the year 10 cash flow for a 20-year (or any maturity greater than or equal to 10 years) bond. Spot rates are used to value bonds and to ensure that bond prices eliminate any possibility for arbitrage resulting from buying a coupon security, stripping it of its coupons and principal payment, and reselling the strips as separate zero-coupon securities. The yield to maturity on a 10-year bond is the (complex) average of the spot rates for all its cash flows. 26) A

The full price is equal to the flat or clean price plus interest accrued from the last coupon date. Here, the flat price is 1,000 × 104.75%, or 1,000 × 1.0475 = 1,047.50. Thus, the full price = 1,047.50 + 33.50 = 1,081.00. 27) B

All automobile loan ABS have some sort of credit enhancement to make them attractive to institutional investors. 28) A

For a bond with an embedded call option, the OAS is less than its zero-volatility spread by the option cost. Therefore, the zero-volatility spread is greater than the OAS for callable bonds. If the embedded call option has any value to the issuer, a callable bond with an OAS of 75 basis points will have a Z- spread that is greater than 75 basis points. Because the OAS represents the bond’s spread to the spot yield curve excluding the effect of the embedded option, it does not include any compensation for the volatility risk related to the option. The implied cost of an embedded option is the difference between the bond’s zerovolatility spread (not the nominal spread) and its OAS. 29) B

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The key term here is coupon bond. While an investor in a fixed-coupon bond can usually eliminate interest rate risk by holding a bond until maturity, the same is not true for reinvestment risk. The receipt of periodic coupon payments exposes the investor to reinvestment risk. A noncallable bond reduces reinvestment risk by reducing the risk of repayment. Thus, an investor most concerned with reinvestment risk would prefer a noncallable bond to a callable bond. Since lower coupon bonds have lower reinvestment risk, this same investor would prefer a lower coupon bond to a higher coupon bond. (Study Session 14, Module 42.2, LOS 42.f, Study Session 15, Module 46.1, LOS 46.a) 30) B

The value of a bond calculated using appropriate spot rates is its no-arbitrage value. If no arbitrage opportunities are present, this value is equal to the market price of a bond. 31) C

As they are most often custom debt instruments, medium-term notes typically have less liquidity than a regular bond issue from the same issuer. Medium-term notes can have any maturity and are sold through agents. 32) B

The option cost is the difference between the zero volatility spread and the OAS, or 150 − 75 = 75 bp. With a flat yield curve, the G-spread and zero volatility spread will be the same. 33) A

This bond is priced at a discount to par value because its 4% coupon is less than its 5.2% yield to maturity. As the bond gets closer to maturity, the discount will amortize toward par value, which means its price will increase if its yield remains unchanged. For its price to remain unchanged, its yield would have to increase. Price with 10 years to maturity: N = 10; I/Y = 5.2; PMT = 40; FV = 1,000; CPT PV = −908.23 Yield with 8 years to maturity: N = 8; PMT = 40; FV = 1,000; PV = −908.23; CPT I/Y = 5.446% 34) A

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The benchmark yield increased, which suggests macroeconomic factors were unfavorable for bond prices overall. The corporate bond’s spread to its benchmark decreased from 250 basis points to 225 basis points, which suggests microeconomic factors were favorable for the bond’s price. 35) C

Compared to portfolio duration based on the cash flow yield of the portfolio, portfolio duration calculated as a weighted average of the durations of the individual bonds in the portfolio is easier to calculate and can be used for bonds with embedded options. Portfolio duration calculated using the cash flow yield for the entire portfolio is theoretically more correct. 36) C

With Macaulay duration equal to the investment horizon, market price risk and reinvestment risk approximately offset and the annualized horizon return should be close to the yield to maturity at purchase. 37) B

Credit risk is calculated with the probability of default (estimated from the bond rating) and the estimated recovery value should the bond default. Yield volatility is combined with duration to estimate the price risk of a bond. 38) B

Modified duration is less than Macaulay duration. The effective duration of a putable bond is less than its modified duration ignoring the put option. 39) B

Modified duration is less than Macaulay duration. The effective duration of a putable bond is less than its modified duration ignoring the put option. 41) B

935(1.035)30 = $2,624 Bond coupons: 30 × 35 = $1,050 Principal repayment: $1,000 2,624 − 1,000 − 1050 = $574 required reinvestment income

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42) C

If the investment horizon is shorter than the Macaulay duration, the price impact of a decrease in YTM dominates the loss of reinvestment income and the realized yield will be higher than the YTM at purchase. 43) A

Steven’s higher EBITDA/interest ratio is consistent with a higher credit rating than Joseph but its higher debt-to-capital ratio is consistent with a lower credit rating. Steven is most likely to have the same credit rating as Joseph. 44) C

Other things being equal, the amount of reinvestment risk embedded in a bond will decrease with lower coupons because there will be a lesser dollar amount to reinvest and with shorter maturities because the reinvestment period is shorter. 45) B

The only true statement is that putable bonds will have less price volatility at higher yields. At higher yields the put becomes more valuable and reduces the decline in price of the putable bond relative to the option-free bond. On the other hand, when yields are low, the put option has little or no value and the putable bond will behave much like an option-free bond. Therefore at low yields a putable bond will not have more price volatility nor will it have less price volatility than a similar option-free bond. 46) A

We can use duration and convexity to estimate the price effect of changes in spread in the same way we use them to estimate the price effect of changes in yield: Percent change in bond value = −duration (change in yield or spread) + (1/2) (convexity) (squared change in yield or spread) No adjustment for credit risk is needed and an analyst should use modified or effective duration. 47) C

Structural subordination means that cash flows from a subsidiary are used to pay the subsidiary’s debt before they may be paid to the parent company to service its debt. As a result, parent company debt is effectively subordinate to the subsidiary's debt. 48) C

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Duration and convexity assume the yield curve shifts in a parallel manner. A downward (upward) sloping term structure of yield volatility suggests shifts in the yield curve are likely to be non-parallel because short-term interest rates are more (less) volatile than long-term interest rates. 49) A

In this case the only determinant that will cause higher interest rate risk is having a low yield to maturity. A higher coupon rate and a higher current yield will result in lower interest rate risk. 50) B

If the term structure of yield volatility slopes upward, long-term interest rates are more variable than short-term interest rates. 51) A

The advisor’s description of the sources of return from investing in a bond is incomplete because it does not include the income from reinvesting the bond’s coupon payments. Although it is true that an investor who holds a bond to maturity will not realize a capital gain or loss, this is not why the advisor’s statement is incorrect. 52) C

Inclusion of a call feature will decrease the duration of a fixed income security. The other choices increase duration.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Portfolios that plot on the security market line in equilibrium: 1) ______ A) have only systematic (beta) risk. B) may be concentrated in only a few stocks. C) must be well diversified. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part II Source : Portfolio Management > Portfolio Management Question 1

2) Which of the following statements regarding the covariance of rates of return is least

accurate? 2) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part I Source : Portfolio Management > Portfolio Management Question 2

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3) All portfolios on the capital market line: 3) ______ A) contain different risky assets. B) are perfectly positively correlated. C) are unrelated except that they all contain the risk-free asset. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part II Source : Portfolio Management > Portfolio Management Question 3

4) Which of the following statements about active and passive asset management is most

accurate? 4) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Management: An Overview Source : Portfolio Management > Portfolio Management Question 4

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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: 5) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part II Source : Portfolio Management > Portfolio Management Question 5

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: 6) ______ A) money-weighted return. B) geometric mean return. C) arithmetic mean return. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part I Source : Portfolio Management > Portfolio Management Question 6

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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: 7) ______ A) Jones or Kelly, but not Lewis. B) Jones, but not Kelly or Lewis. C) any of these portfolios. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part I Source : Portfolio Management > Portfolio Management Question 7

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? 8) ______ A) 6.35%. B) 0.06%. C) 11.24%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part I Source : Portfolio Management > Portfolio Management Question 8

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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: 9) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part II Source : Portfolio Management > Portfolio Management Question 9

10) When the market is in equilibrium, all: 10) ______ A) assets plot on the CML. B) investors hold the market portfolio. C) assets plot on the SML. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part II Source : Portfolio Management > Portfolio Management Question 10

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11) In equilibrium, an inefficient portfolio will plot: 11) ______ A) on the CML and below the SML. B) below the CML and below the SML. C) below the CML and on the SML. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part II Source : Portfolio Management > Portfolio Management Question 11

12) According to the capital asset pricing model (CAPM): 12) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part II Source : Portfolio Management > Portfolio Management Question 12

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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: 13) ______ A) 5.5%. B) 7.0%. C) 10.4%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part I Source : Portfolio Management > Portfolio Management Question 13

14) Which of the following statements about the efficient frontier is least accurate? 14) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part I Source : Portfolio Management > Portfolio Management Question 14

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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: 15) ______ A) single-factor model. B) multifactor model. C) market model. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part II Source : Portfolio Management > Portfolio Management Question 15

16) A portfolio’s excess return per unit of systematic risk is known as its: 16) ______ A) Treynor measure. B) Jensen’s alpha. C) Sharpe ratio. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part II Source : Portfolio Management > Portfolio Management Question 16

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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: 17) ______ A) overvalued by approximately 1.8%. B) undervalued by approximately 2.1%. C) undervalued by approximately 1.8%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part II Source : Portfolio Management > Portfolio Management Question 17

18) Which of the following is the most accurate description of the market portfolio in Capital

Market Theory? The market portfolio consists of all: 18) ______ A) risky assets in existence. B) risky and risk-free assets in existence. C) equity securities in existence. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part II Source : Portfolio Management > Portfolio Management Question 18

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19) Which of the following is least likely considered a source of systematic risk for bonds? 19) ______ A) Market risk. B) Purchasing power risk. C) Default risk. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part II Source : Portfolio Management > Portfolio Management Question 19

20) A stock's abnormal rate of return is defined as the: 20) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part II Source : Portfolio Management > Portfolio Management Question 20

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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? 21) ______ A) 80% in Bridgeport, 20% in Rockaway. B) 50% in Bridgeport, 50% in Rockaway. C) 100% in Bridgeport. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part I Source : Portfolio Management > Portfolio Management Question 21

22) Which of the following statements best describes an investment that is not on the efficient

frontier? 22) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part I Source : Portfolio Management > Portfolio Management Question 22

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23) According to the CAPM, a rational investor would be least likely to choose as his optimal

portfolio: 23) ______ A) a 100% allocation to the risk-free asset. B) a 130% allocation to the market portfolio. C) the global minimum variance portfolio. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part I Source : Portfolio Management > Portfolio Management Question 23

24) James Franklin, CFA, has high risk tolerance and seeks high returns. Based on capital market

theory, Franklin would most appropriately hold: 24) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part II Source : Portfolio Management > Portfolio Management Question 24

25) All portfolios that lie on the capital market line: 25) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part II Source : Portfolio Management > Portfolio Management Question 25

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26) Which of the following pooled investment shares is least likely to trade at a price different

from its NAV? 26) ______ A) Exchange-traded fund shares. B) Closed-end mutual fund shares. C) Open-end mutual fund shares. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Management: An Overview Source : Portfolio Management > Portfolio Management Question 26

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: 27) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part I Source : Portfolio Management > Portfolio Management Question 27

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28) When a risk-free asset is combined with a portfolio of risky assets, which of the following is

least accurate? 28) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part II Source : Portfolio Management > Portfolio Management Question 28

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? 29) ______ A) Leveraged return. B) Real return. C) Nominal return. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Portfolio Risk and Return: Part I Source : Portfolio Management > Portfolio Management Question 29

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30) Which of the following is not necessarily included in an investment policy statement? 30) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Basics of Portfolio Planning and Construction Source : Portfolio Management > Portfolio Management Question 30

31) A head and shoulders pattern is most likely to precede a reversal in trend if: 31) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Technical Analysis Source : Portfolio Management > Portfolio Management Question 31

32) Which of the following uses of data is most accurately described as curation? 32) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Fintech in Investment Management Source : Portfolio Management > Portfolio Management Question 32

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33) The advantages of using technical analysis include: 33) ______ A) the incorporation of psychological reasons behind price changes. B) complete objectivity. C) ease in interpreting reasons behind stock price trends. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Technical Analysis Source : Portfolio Management > Portfolio Management Question 33

34) While assessing an investor’s risk tolerance, a financial adviser is least likely to ask which of

the following questions? 34) ______ A) “What rate of investment return do you expect?” B) “Is your home life stable?” C) “How much insurance coverage do you have?” Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Basics of Portfolio Planning and Construction Source : Portfolio Management > Portfolio Management Question 34

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: 35) ______ A) blockchain. B) tokenization. C) smart contracts. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Fintech in Investment Management Source : Portfolio Management > Portfolio Management Question 35

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36) The resistance level signifies the price at which a stock's supply would be expected to: 36) ______ A) cause the stock price to "break out". B) increase substantially. C) decrease substantially. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Technical Analysis Source : Portfolio Management > Portfolio Management Question 36

37) When performing strategic asset allocation, properly defined and specified asset classes

should: 37) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Basics of Portfolio Planning and Construction Source : Portfolio Management > Portfolio Management Question 37

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: 38) ______ A) unique circumstances. B) liquidity. C) legal and regulatory. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Basics of Portfolio Planning and Construction Source : Portfolio Management > Portfolio Management Question 38

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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? 39) ______ A) 33%, 33%, 33%. B) 50%, 25%, 25%. C) 90%, 6%, 4%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Basics of Portfolio Planning and Construction Source : Portfolio Management > Portfolio Management Question 39

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: 40) ______ A) educate the client about investment risk and re-administer the questionnaire. B) emphasize bonds over stocks. C) emphasize stocks over bonds. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Basics of Portfolio Planning and Construction Source : Portfolio Management > Portfolio Management Question 40

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Answer Key Test name: Portfolio Management 1) B

All portfolios plot on the SML in equilibrium according to the capital asset pricing model. 2) C

Negative covariance means rates of return for one security will tend to be above its mean return in periods when the other is below its mean return, and vice versa. Positive covariance means that returns on both securities will tend to be above (or below) their mean returns in the same time periods. For the returns to always move in opposite directions, they would have to be perfectly negatively correlated. Negative covariance by itself does not imply anything about the strength of the negative correlation, it must be standardized by dividing by the product of the securities’ standard deviations of return. 3) B

The introduction of a risk-free asset changes the Markowitz efficient frontier into a straight line. This straight efficient frontier line is called the capital market line (CML). Since the line is straight, the math implies that the returns on any two portfolios on this line will be perfectly, positively correlated with each other. Note: Whenra,b = 1, then the equation for risk changes tosport = WAsA + WBsB, which is a straight line. The risky assets for each portfolio on the CML are the same, the tangency (or market) portfolio of risky assets. 4) C

Because fees for passive management are lower than fees for active management, passive management represents a smaller share of industry revenues than assets under management. Passive management has been gaining market share over time versus active management. Smart beta is a passive management strategy that focuses on a specific market risk factor. 5) B

Although the risk measure on the capital market line diagram is total risk, all portfolios that lie on the CML are well diversified and have only systematic risk. This is because portfolios on the CML are all constructed from the risk-free asset and the (well-diversified) market portfolio. Any portfolio, including single securities, will plot along the SML in equilibrium. Their unsystematic risk can be significant, but it is not measured on the SML diagram because unsystematic risk is not related to expected return. Both the CML and the SML reflect relations that hold when prices are in equilibrium.

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6) B

Geometric mean return (time-weighted return) is the most appropriate method for performance measurement as it does not consider additions to or withdrawals from the account. 7) C

Risk aversion means that to accept greater risk, an investor must be compensated with a higher expected return. For the three portfolios given, higher risk is associated with higher expected return. Therefore a risk-averse investor may select any of these portfolios. A risk-averse investor will not select a portfolio if another portfolio offers a higher expected return with the same risk, or lower risk with the same expected return. 8) B

The holding period return in year one is ($89.00 − $100.00 + $1.00) / $100.00 = −10.00%. The holding period return in year two is ($98.00 − $89.00 + $1.00) / $89 = 11.24%. The time-weighted return is [{1 + (−0.1000)}{1 + 0.1124}]1/2 − 1 = 0.06%. 9) B

Portfolio X’s required return is 0.05 + 0.9 × (0.12 − 0.05) = 11.3%. It is expected to return 13%. The portfolio has an expected excess return of 1.7% Portfolio Y’s required return is 0.05 + 1.1 × (0.12 − 0.05) = 12.7%. It is expected to return 14%. The portfolio has an expected excess return of 1.3%. Since both portfolios are undervalued, the investor should sell the portfolio that offers less excess return. Sell Portfolio Y because its excess return is less than that of Portfolio X. 10) C

When the market is in equilibrium, expected returns equal required returns. Since this means that all assets are correctly priced, all assets plot on the SML. By definition, all stocks and portfolios other than the market portfolio fall below the CML. (Only the market portfolio is efficient). 11) C

An inefficient portfolio will plot below the CML. In equilibrium, all portfolios will plot on the SML. 12) C

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One of the assumptions of the CAPM is that all investors who hold risky assets will hold the same portfolio of risky assets (the market portfolio). Risk aversion means an investor will accept more risk only if compensated with a higher expected return. In capital market theory, all investors exhibit risk aversion, even an investor who is short the risk-free asset. In the CAPM, a stock’s risk is measured as its beta, not its standard deviation of returns. 13) C

January − March return = 51,000 / 50,000 − 1 = 2.00% April − June return = 60,000 / (51,000 + 10,000) − 1 = −1.64% July − December return = 33,000 / (60,000 − 30,000) − 1 = 10.00% Time-weighted return = [(1 + 0.02)(1 − 0.0164)(1 + 0.10)] − 1 = 0.1036 or 10.36% 14) C

The optimal portfolio for each investor is the highest indifference curve that is tangent to the efficient frontier. 15) A

A model that estimates a stock’s expected excess return based only on the book-to-market ratio is a single-factor model. The market model is a single-factor model that estimates expected excess return based on a security’s sensitivity to the expected excess return of the market portfolio. A multifactor model would estimate expected excess return based on more than one factor. 16) A

The Treynor measure is excess return relative to beta. The Sharpe ratio measures excess return relative to standard deviation. Jensen’s alpha measures a portfolio’s excess return relative to return of a portfolio on the SML that has the same beta. 17) A

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To determine whether a stock is overvalued or undervalued, we need to compare the expected return (or holding period return) and the required return (from Capital Asset Pricing Model, or CAPM). Step 1: Calculate Expected Return (Holding period return) The formula for the (one-year) holding period return is: HPR = (D1 + S1 − S0) / S0, where D = dividend and S = stock price. Here, HPR = (1.50 + 39 − 35) / 35 = 15.71% Step 2: Calculate Required Return The formula for the required return is from the CAPM:RR = Rf + (ERM − Rf) × Beta Here, we are given the information we need except for Beta. Remember that Beta can be calculated with:Betastock = [covS,M] / [σ2M]. Here we are given the numerator and the denominator, so the calculation is: 0.85 / 0.702 = 1.73. RR = 4.50% + (12.0 − 4.50%) × 1.73 = 17.48%. Step 3: Determine over/under valuation The required return is greater than the expected return, so the security is overvalued. The amount = 17.48% − 15.71% = 1.77%. 18) A

The market portfolio, in theory, contains all risky assets in existence. It does not contain any risk-free assets. 19) C

Default risk is based on company-specific or unsystematic risk. 20) B

Abnormal return = Actual return − expected risk-adjusted return 21) C

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First, calculate the correlation coefficient to check whether diversification will provide any benefit. rBridgeport, Rockaway = covBridgeport, Rockaway / [( σBridgeport) × (σRockaway)] = 0.0325 / (0.13 × 0.25) = 1.00 Since the stocks are perfectly positively correlated, there are no diversification benefits and we select the stock with the lowest risk (as measured by variance or standard deviation), which is Bridgeport. 22) C

The efficient frontier outlines the set of portfolios that gives investors the highest return for a given level of risk or the lowest risk for a given level of return. Therefore, if a portfolio is not on the efficient frontier, there must be a portfolio that has lower risk for the same return. Equivalently, there must be a portfolio that produces a higher return for the same risk. 23) C

According to the CAPM, rational, risk-averse investors will optimally choose to hold a portfolio along the capital market line. This can range from a 100% allocation to the risk-free asset to a leveraged position in the market portfolio constructed by borrowing at the risk-free rate to invest more than 100% of the portfolio equity value in the market portfolio. The global minimum variance portfolio lies below the CML and is not an efficient portfolio under the assumptions of the CAPM. 24) A

According to capital market theory, all investors will choose a combination of the market portfolio and borrowing or lending at the risk-free rate; that is, a portfolio on the CML. (Study Session 18, Module 53.1, LOS 53.a) 25) B

All portfolios on the CML include the same tangency portfolio of risky assets, except the intercept (all invested in risk-free asset). The tangency portfolio contains none of the risk-free asset and “borrowing portfolios” can be constructed with a negative allocation to the risk-free asset. Portfolios on the CML are efficient (well-diversified) and have no unsystematic risk. (Study Session 18, Module 53.1, LOS 53.b, 53.c) 26) C

Shares of open-end mutual funds trade at NAV. The others may deviate from NAV. 27) C

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Steeply sloped risk-return indifference curves indicate that a greater increase in expected return is required as compensation for assuming an additional unit of risk, compared to less-steep indifference curves. The more risk-averse Smith will choose an optimal portfolio with lower risk and a lower expected return than the less risk-averse Jones's optimal portfolio. 28) B

This statement is not correct; the standard deviation of returns for the resulting portfolio is a weighted average of the returns standard deviation of the risk-free asset (zero) and the returns standard deviation of the risky-asset portfolio. 29) B

No calculations are needed. The real return is greater than the nominal return because the inflation rate is negative. The leveraged return is more negative than the nominal return because the investment lost value and leverage magnifies the loss. 30) C

At a minimum an IPS should contain a clear statement of client circumstances and constraints, an investment strategy based on these, and some benchmark against which to evaluate the account performance. The investment must periodically update the IPS as circumstances change, but explicit procedures for these updates are not necessarily included in the IPS itself. 31) C

Decreasing volume on each of the high prices in a head and shoulders pattern (or each of the low prices in an inverse head and shoulders) suggests weakening in the supply and demand forces that were driving the price trend. 32) A

Curation is ensuring the quality of data—for example, by adjusting for bad or missing data. Word clouds are a visualization technique. Moving data from a storage medium to where they are needed is referred to as transfer. 33) A

Technical analysis avoids having to use fundamental data and adjusting for accounting problems, incorporates psychological as well as economic reasons behind price changes, and tells WHEN to buy; not WHY investors are buying. Drawbacks include subjective interpretation of charts and graphs. 34) A

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While the degree of risk tolerance will have an affect on expected returns, assessing the risk tolerance comes first, and the resulting set of feasible returns follows. The other questions address risk tolerance. 35) B

Tokenization refers to maintaining ownership records for physical assets on a distributed ledger. This might, but would not necessarily, use a blockchain, which is a subcategory of distributed ledgers. Smart contracts are computerized agreements designed to automatically carry out certain actions if defined conditions are met. 36) B

Support and resistance levels. Most stock prices remain relatively stable and fluctuate up and down from their true value. The lower limit to these fluctuations is called a support level – the price range where a stock appears cheap and attracts buyers. The upper limit is called a resistance level – the price range where a stock appears expensive and initiates selling. Generally, a resistance level tends to develop after a stock has experienced a steady decline from a higher price level. Technicians believe that the decline in price will cause some investors who acquired the stock at a higher price to look for an opportunity to sell it near their break-even points. Therefore, the supply of stock owned by investors is overhanging the market. When the price rebounds to the target price set by these investors, this overhanging supply of stock comes to the market and dramatically reverses the price increase on heavy volume. 37) C

When taken together, the asset classes should approximate the investor's total investible universe. Properly defined and specified asset classes should each have a low return correlation to the other asset classes, and within each asset class should be assets that have similar expected risk and return. 38) C

Legal and regulatory constraints are those that apply to an investor by law. 39) C

Several studies support the idea that approximately 90% of the variation in a single portfolio’s returns can be explained by its target asset allocations, with security selection and tactical variations from the target (market timing) playing a much less significant role. In fact, for actively managed funds, actual portfolio returns are slightly less than those that would have been achieved if the manager strictly maintained the target allocation, thus illustrating the difficultly of improving returns through security selection or market timing.

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40) B

When determining an investor's risk tolerance, an advisor must consider both the investor's ability and willingness to bear risk. Even though the investor has a high willingness to bear risk, his ability to take risk (based on his financial situation) is low, and this should take precedence. A portfolio that emphasizes bonds over stocks has less investment risk and is the most appropriate choice.

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 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? 1) ______ A) $528,150. B) $549,487. C) $574,253. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Time Value of Money Source : Quantitative Methods > Quantitative Methods Question 1

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? 2) ______ A) 60. B) 10. C) 125. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Probability Concepts Source : Quantitative Methods > Quantitative Methods Question 2

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3) A company says that whether it increases its dividends depends on whether its earnings

increase. From this we know: 3) ______ 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). Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Probability Concepts Source : Quantitative Methods > Quantitative Methods Question 3

4) Determining the number of ways five tasks can be done in order, requires: 4) ______ A) only the factorial function. B) the permutation formula. C) the labeling formula. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Probability Concepts Source : Quantitative Methods > Quantitative Methods Question 4

5) Which of the following is an a priori probability? 5) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Probability Concepts Source : Quantitative Methods > Quantitative Methods Question 5

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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: 6) ______ A) 58%. B) 37%. C) 91%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Probability Concepts Source : Quantitative Methods > Quantitative Methods Question 6

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? 7) ______ A) 34,650. B) 495. C) 1,320. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Probability Concepts Source : Quantitative Methods > Quantitative Methods Question 7

8) The "likelihood" of an event occurring is defined as: 8) ______ A) an unconditional probability. B) a conditional probability. C) a joint probability. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Probability Concepts Source : Quantitative Methods > Quantitative Methods Question 8

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9) Compute the present value of a perpetuity with $100 payments beginning four years from

now. Assume the appropriate annual interest rate is 10%. 9) ______ A) $1,000. B) $751. C) $683. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Time Value of Money Source : Quantitative Methods > Quantitative Methods Question 9

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: 10) ______ A) $1,650; $1,702. B) $1,650; $1,468. C) $1,468; $1,702. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Time Value of Money Source : Quantitative Methods > Quantitative Methods Question 10

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: 11) ______ A) $6038.40. B) $1116.90. C) $1244.90. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Time Value of Money Source : Quantitative Methods > Quantitative Methods Question 11

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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: 12) ______ A) $3,505.00 B) $3,330.00 C) $3,356.00 Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Time Value of Money Source : Quantitative Methods > Quantitative Methods Question 12

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? 13) ______ A) 47%. B) 28%. C) 37%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Probability Concepts Source : Quantitative Methods > Quantitative Methods Question 13

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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? 14) ______ A) $42,212. B) $38,375. C) $25,937. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Time Value of Money Source : Quantitative Methods > Quantitative Methods Question 14

15) The real risk-free rate can be thought of as: 15) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Time Value of Money Source : Quantitative Methods > Quantitative Methods Question 15

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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. 16) ______ A) 25%; 300%. B) 1,300%; 10,947,544%. C) 25%; 1,300%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Time Value of Money Source : Quantitative Methods > Quantitative Methods Question 16

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? 17) ______ A) 0.50. B) 2.10. C) 1.99. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Probability Concepts Source : Quantitative Methods > Quantitative Methods Question 17

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18) Consider the following set of stock returns: 12%, 23%, 27%, 10%, 7%, 20%,15%. The third

quartile is: 18) ______ A) 23%. B) 20.0%. C) 21.5%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Statistical Concepts and Market Returns Source : Quantitative Methods > Quantitative Methods Question 18

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? 19) ______ A) $186,109. B) $192,444. C) $189,229. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Time Value of Money Source : Quantitative Methods > Quantitative Methods Question 19

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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% 20) ______

A) 8.9%. B) 3.8%. C) 10.5%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Probability Concepts Source : Quantitative Methods > Quantitative Methods Question 20

21) Which of the following statements about probability is most accurate? 21) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Probability Concepts Source : Quantitative Methods > Quantitative Methods Question 21

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22) As the number of compounding periods increases, what is the effect on the EAR? EAR: 22) ______ A) increases at an increasing rate. B) does not increase. C) increases at a decreasing rate. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Time Value of Money Source : Quantitative Methods > Quantitative Methods Question 22

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: 23) ______ A) $2,070. B) $2,080. C) $2,065. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Time Value of Money Source : Quantitative Methods > Quantitative Methods Question 23

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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 24) ______

A) Option A B) Option B C) Option C Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Statistical Concepts and Market Returns Source : Quantitative Methods > Quantitative Methods Question 24

25) Which of the following statements is least accurate regarding covariance? 25) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Probability Concepts Source : Quantitative Methods > Quantitative Methods Question 25

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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? 26) ______ A) $42,165. B) $39,204. C) $35,967. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Time Value of Money Source : Quantitative Methods > Quantitative Methods Question 26

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: 27) ______ A) geometric mean return. B) arithmetic mean return. C) time-weighted return. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Statistical Concepts and Market Returns Source : Quantitative Methods > Quantitative Methods Question 27

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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: 28) ______ A) required rate of return. B) discount rate. C) opportunity cost. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Time Value of Money Source : Quantitative Methods > Quantitative Methods Question 28

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:

Smoker Nonsmoker Total

Suffer from Allergies 35 55 90

Don't Suffer from Allergies 25 185 210

Total 60 240 300 29) ______

A) 1.00. B) 0.00. C) 0.50. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Probability Concepts Source : Quantitative Methods > Quantitative Methods Question 29

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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? 30) ______ A) 17.5%; 5.75%. B) 15.0%; 7.58%. C) 15.0%; 5.75%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Statistical Concepts and Market Returns Source : Quantitative Methods > Quantitative Methods Question 30

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? 31) ______ A) $23,185.00 B) $15,000.00 C) $13,453.00 Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Time Value of Money Source : Quantitative Methods > Quantitative Methods Question 31

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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? 32) ______ A) 0.07%. B) 2.64%. C) 1.39%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Probability Concepts Source : Quantitative Methods > Quantitative Methods Question 32

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%? 33) ______ A) $272,977. B) $234,422. C) $274,422. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : The Time Value of Money Source : Quantitative Methods > Quantitative Methods Question 33

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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: 34) ______ A) positive. B) zero. C) negative. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Statistical Concepts and Market Returns Source : Quantitative Methods > Quantitative Methods Question 34

35) Which of the following rules is used to calculate an unconditional probability? 35) ______ A) Addition rule. B) Total probability rule. C) Multiplication rule. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Probability Concepts Source : Quantitative Methods > Quantitative Methods Question 35

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)? 36) ______ A) 0.125. B) 0.625. C) 0.375. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Probability Concepts Source : Quantitative Methods > Quantitative Methods Question 36

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37) Which of the following is a joint probability? The probability that a: 37) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Probability Concepts Source : Quantitative Methods > Quantitative Methods Question 37

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? 38) ______ A) 6.83%. B) 0.38%. C) 6.20%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Probability Concepts Source : Quantitative Methods > Quantitative Methods Question 38

39) If X and Y are independent events, which of the following is most accurate? 39) ______ A) P(X or Y) = P(X) + P(Y). B) P(X or Y) = (P(X)) × (P(Y)). C) P(X | Y) = P(X). Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Probability Concepts Source : Quantitative Methods > Quantitative Methods Question 39

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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: 40) ______ A) unbiased and consistent. B) efficient and consistent. C) unbiased and efficient. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Sampling and Estimation Source : Quantitative Methods > Quantitative Methods Question 40

41) Which of the following could be the set of all possible outcomes for a random variable that

follows a binomial distribution? 41) ______ A) (1,2). B) (0, 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11). C) (-1, 0,1). Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Common Probability Distributions Source : Quantitative Methods > Quantitative Methods Question 41

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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: 42) ______ A) larger of the two sample means. B) average difference between pairs of returns. C) difference between the sample means for each population. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Hypothesis Testing Source : Quantitative Methods > Quantitative Methods Question 42

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? 43) ______ A) 0.600. B) 0.167. C) 0.333. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Common Probability Distributions Source : Quantitative Methods > Quantitative Methods Question 43

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44) Which of the following statements about a confidence interval for a population mean is most

accurate? 44) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Sampling and Estimation Source : Quantitative Methods > Quantitative Methods Question 44

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? 45) ______ A) The mean of the continuously compounded returns. B) The mean of the holding period returns. C) Neither, because both will equal zero. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Common Probability Distributions Source : Quantitative Methods > Quantitative Methods Question 45

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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: 46) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Sampling and Estimation Source : Quantitative Methods > Quantitative Methods Question 46

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? 47) ______ A) 0.4096. B) 0.7373. C) 0.0819. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Common Probability Distributions Source : Quantitative Methods > Quantitative Methods Question 47

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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: 48) ______ 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%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Hypothesis Testing Source : Quantitative Methods > Quantitative Methods Question 48

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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? 49) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Hypothesis Testing Source : Quantitative Methods > Quantitative Methods Question 49

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50) A stock increased in value last year. Which will be greater, its continuously compounded or

its holding period return? 50) ______ A) Neither, they will be equal. B) Its continuously compounded return. C) Its holding period return. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Common Probability Distributions Source : Quantitative Methods > Quantitative Methods Question 50

51) Consider a random variable X that follows a continuous uniform distribution: 7 ≤ X ≤ 20.

Which of the following statements is least accurate? 51) ______ A) F(10) = 0.23 B) F(12 ≤ X ≤ 16) = 0.307. C) F(21) = 0.00. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Common Probability Distributions Source : Quantitative Methods > Quantitative Methods Question 51

52) A multivariate distribution is best defined as describing the behavior of: 52) ______ A) two or more independent random variables. B) two or more dependent random variables. C) a random variable with more than two possible outcomes. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Common Probability Distributions Source : Quantitative Methods > Quantitative Methods Question 52

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53) A p-value of 0.02% means that a researcher: 53) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Hypothesis Testing Source : Quantitative Methods > Quantitative Methods Question 53

54) Which of the following statements regarding the central limit theorem (CLT) is least

accurate? The CLT: 54) ______ A) holds for any population distribution, assuming a large sample size. B) gives the variance of the distribution of sample means as σ2/n, where σ2 is the

population variance and n is the sample size. C) states that for a population with mean µ and variance σ2, the sampling distribution of the sample means for any sample of size n will be approximately normally distributed. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Sampling and Estimation Source : Quantitative Methods > Quantitative Methods Question 54

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55) Which of the following statements about probability distributions is most accurate? 55) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Common Probability Distributions Source : Quantitative Methods > Quantitative Methods Question 55

56) When sampling from a population, the most appropriate sample size: 56) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Sampling and Estimation Source : Quantitative Methods > Quantitative Methods Question 56

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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? 57) ______ A) 0.250. B) 0.750. C) 0.500. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Common Probability Distributions Source : Quantitative Methods > Quantitative Methods Question 57

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: 58) ______ A) 10 correlations. B) 45 correlations. C) overall correlation. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Common Probability Distributions Source : Quantitative Methods > Quantitative Methods Question 58

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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: 59) ______ A) 2.048 B) 2.045 C) 2.042 Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Hypothesis Testing Source : Quantitative Methods > Quantitative Methods Question 59

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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 60) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Hypothesis Testing Source : Quantitative Methods > Quantitative Methods Question 60

61) Which of the following would least likely be categorized as a multivariate distribution? 61) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Common Probability Distributions Source : Quantitative Methods > Quantitative Methods Question 61

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62) The sample mean is an unbiased estimator of the population mean because the: 62) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Sampling and Estimation Source : Quantitative Methods > Quantitative Methods Question 62

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? 63) ______ A) Chi-square test. B) Paired comparisons test. C) Difference in means test. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Hypothesis Testing Source : Quantitative Methods > Quantitative Methods Question 63

64) Which of the following is least likely a step in stratified random sampling? 64) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Sampling and Estimation Source : Quantitative Methods > Quantitative Methods Question 64

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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): 65) ______ A) α percent point estimate. B) (1 − α) percent confidence interval. C) α percent confidence interval. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Sampling and Estimation Source : Quantitative Methods > Quantitative Methods Question 65

66) The probability density function of a continuous uniform distribution is best described by a: 66) ______ A) line segment with a 45-degree slope. B) line segment with a curvilinear slope. C) horizontal line segment. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Common Probability Distributions Source : Quantitative Methods > Quantitative Methods Question 66

67) The standard normal distribution is most completely described as a: 67) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Common Probability Distributions Source : Quantitative Methods > Quantitative Methods Question 67

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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? 68) ______ A) Yes, Tekei will receive $68,058. B) No, Tekei will only receive $61,878. C) Yes, Tekei will receive $67,028. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Common Probability Distributions Source : Quantitative Methods > Quantitative Methods Question 68

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: 69) ______ A) variances are not equal. B) variances are equal. C) variance of Stock B is significantly greater than the variance of Stock A. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Hypothesis Testing Source : Quantitative Methods > Quantitative Methods Question 69

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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? 70) ______ A) Time-period bias. B) Look-ahead bias. C) Survivorship bias. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Sampling and Estimation Source : Quantitative Methods > Quantitative Methods Question 70

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? 71) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Hypothesis Testing Source : Quantitative Methods > Quantitative Methods Question 71

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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: 72) ______ A) −16.2% to 51.6%. B) −48.7% to 84.1%. C) 16.8% to 18.6%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Sampling and Estimation Source : Quantitative Methods > Quantitative Methods Question 72

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? 73) ______ 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. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Sampling and Estimation Source : Quantitative Methods > Quantitative Methods Question 73

74) A test of a hypothesis that the means of two normally distributed populations are equal based

on two independent random samples: 74) ______ A) is done with a t-statistic. B) is a paired-comparisons test. C) is based on a chi-square statistic. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Hypothesis Testing Source : Quantitative Methods > Quantitative Methods Question 74

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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: 75) ______ A) 25%. B) 39%. C) 14%. Question Details Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Gradable : automatic Topic : Common Probability Distributions Source : Quantitative Methods > Quantitative Methods Question 75

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Answer Key Test name: Quantitative Methods 1) B

The investor has to ensure that the amount deposited now will grow into the amount needed to fund the perpetuity. With semiannual compounding, the effective annual rate (EAR) earned on funds in the account is: The present value of the perpetuity = $25,000/0.0404 = $618,811.88. Note that since the first scholarship award is paid out in four years, the present value of the perpetuity represents the amount that must be in the account at time t = 3. We can find the required deposit from: FV = −618,811.88; N = 3; I = 4.04; CPT → PV = $549,487.24 or 618, 811.88/1.04043 = $549,487.24 2) A

We can view this problem as the number of ways to choose three analysts from five analysts when the order they are chosen matters. The formula for the number of permutations is

On the TI financial calculator: 5 2nd nPr 3 = 60. Alternatively, there are 5 2nd nCr 3 = 10 ways to select three of the five analysts, and for each group of selected analysts, there are 3! = 3 × 2 × 1 = 6 ways to assign them the three industries. Therefore, there are 10 × 6 = 60 ways to assign the industries to the analysts. 3) B

If two events A and B are dependent, then the conditional probabilities of P(A | B) and P(B | A) will not equal their respective unconditional probabilities (of P(A) and P(B), respectively). Both remaining choices may or may not occur, e.g., P(A | B) = P(B) is possible but not necessary. 4) A

The factorial function, denoted n!, tells how many different ways n items can be arranged where all the items are included. 5) C

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A priori probability is based on formal reasoning and inspection. Given the number of stocks in the airline industry in the S&P500 for example, the a priori probability of selecting an airline stock would be that number divided by 500. 6) C

P(A|B) = P(AB) / P(B). The probability of a new coffee shop given a new office building is 58% / 64% = 90.63%. 7) A

This problem is a labeling problem where the 12 employees will be assigned one of three labels. It requires the labeling formula. There are [(12!) / (4! × 4! × 4!)] = 34,650 ways to group the employees. 8) B

“Likelihood” is defined in the Level I curriculum as a conditional probability, the probability of an observation, given a particular set of conditions (although, in general, it is often used as a synonym for probability). An unconditional probability refers to the probability of an event occurring regardless of past of future events. A joint probability is the probability that two events will both occur. 9) B

Compute the present value of the perpetuity at (t = 3). Recall, the present value of a perpetuity or annuity is valued one period before the first payment. So, the present value at t = 3 is 100 / 0.10 = 1,000. Now it is necessary to discount this lump sum to t = 0. Therefore, present value att = 0 is 1,000 / (1.10)3 = 751. 10) A

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Step 1: Calculate the annual payment. Using a financial calculator (remember to clear your registers): PV = 15,000; FV = 0; I/Y = 11; N = 7; PMT = $3,183 Step 2: Calculate the portion of the first payment that is interest. Interest1 = Principal × Interest rate = (15,000 × 0.11) = 1,650 Step 3: Calculate the portion of the second payment that is principal. Principal1 = Payment − Interest1 = 3,183 − 1,650 = 1,533 (interest calculation is from Step 2) Interest2 = Principal remaining × Interest rate = [(15,000 − 1.533) × 0.11] = 1,481 Principal2 = Payment − Interest1 = 3,183 − 1,481 = 1,702 11) C

With PV = 20,000, N = 4, I/Y = 8, computed Pmt = 6,038.42. Interest (Yr1) = 20,000(0.08) = 1600. Interest (Yr2) = (20,000 − (6038.42 − 1600))(0.08) = 1244.93 12) C

This is a two-step problem. First, we need to calculate the present value of the amount she needs over her sabbatical. (This amount will be in the form of an annuity due since she requires the payment at the beginning of the month.) Then, we will use future value formulas to determine how much she needs to save each month (ordinary annuity). Step 1: Calculate present value of amount required during the sabbatical Using a financial calculator: Set to BEGIN Mode, then N = 12 × 1.5 = 18; I/Y = 10 / 12 = 0.8333; PMT = 2,500; FV = 0; CPT → PV = 41,974 Step 2: Calculate amount to save each month Make sure the calculator is set to END mode, then N = 12; I/Y = 9 / 12 = 0.75; PV = 0; FV = 41,974; CPT → PMT = -3,356 13) C

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Given a set of prior probabilities for an event of interest, Bayes’ formula is used to update the probability of the event, in this case that the car we already know has a radio is red. Bayes’ formula says to divide the Probability of New Information given Event by the Unconditional Probability of New Information and multiply that result by the Prior Probability of the Event. In this case, P(red car has a radio) = 0.70 is divided by 0.76 (which is the Unconditional Probability of a car having a radio (40% are red of which 70% have radios) plus (60% are blue of which 80% have radios) or ((0.40) × (0.70)) + ((0.60) × (0.80)) = 0.76.) This result is then multiplied by the Prior Probability of a car being red, 0.40. The result is (0.70 / 0.76) × (0.40) = 0.37 or 37%. 14) B 0

$ 100,000

At the end of the 10-year deferral period, the value will be: $100,000 × (1 + 0.10)10 = $259,374.25. Using a financial calculator: N = 10, I = 10, PV = $100,000, PMT = 0, Compute FV = $259,374.25. Using a financial calculator and solving for a 10-year annuity due because the payments are made at the beginning of each period (you need to put your calculator in the “begin” mode), with a present value of $259,374.25, a number of payments equal to 10, an interest rate equal to ten percent, and a future value of $0.00, the resultant payment amount is $38,374.51. Alternately, the same payment amount can be determined by taking the future value after nine years of deferral ($235,794.77), and then solving for the amount of an ordinary (payments at the end of each period) annuity payment over 10 years. 15) C

The approximate relationship between nominal rates, real rates and expected inflation rates can be written as: Nominal risk-free rate = real risk-free rate + expected inflation rate. Therefore we can rewrite this equation in terms of the real risk-free rate as: Real risk-free rate = Nominal risk-free rate − expected inflation rate The exact relation is: (1 + real)(1 + expected inflation) = (1 + nominal) 16) B

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Stated Weekly Rate = 5/4 − 1 = 25% Stated Annual Rate = 1,300% Annual Effective Interest Rate = (1 + 0.25)52 − 1 = 109,476.44 − 1 = 10,947,544% 17) C

If you purchase one ticket, the probability of your ticket being drawn is 1/343 or 0.00292. If you purchase two tickets, your probability becomes 2/344 or 0.00581, so you are 0.00581 / 0.00292 = 1.99 times more likely to win. 18) A

The third quartile is calculated as:Ly = (7 + 1) (75/100) = 6. When we order the observations in ascending order: 7%, 10%, 12%, 15%, 20%, 23%, 27%, “23%” is the sixth observation from the left. 19) C

With monthly payments, we need a monthly rate: 6% / 12 = 0.5%. Next, solve for the monthly payment. The calculator keystrokes are: PV = 200,000; FV = 0; N = 360; I/Y = 0.5; CPT → PMT = −$1,199.10. The balance at any time on an amortizing loan is the present value of the remaining payments. There are 312 payments remaining after the 48th payment is made. The loan balance at this point is: PMT = −1,199.10; FV = 0; N = 312; I/Y = 0.5; CPT → PV = $189,228.90. Note that only N has to be changed to calculate this new present value; the other inputs are unchanged. 20) A

Using the multiplication rule: (0.25)(0.42) − (0.25)(0.15)(0.42) = 0.08925 or 8.9% 21) C

Conditional probability is the probability of one event happening given that another event has happened. An outcome is the numerical result associated with a random variable. 22) C

There is an upper limit to the EAR as the frequency of compounding increases. In the limit, with continuous compounding the EAR = eAPR –1. Hence, the EAR increases at a decreasing rate. 23) B

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This is a two-step problem. First, we need to calculate the present value of the amount she needs over her sabbatical. (This amount will be in the form of an annuity due since she requires the payment at the beginning of the month.) Then, we will use future value formulas to determine how much she needs to save each month. Step 1: Calculate present value of amount required during the sabbatical Using a financial calculator: Set to BEGIN Mode, then N = 4; I/Y = 9.5 / 12 = 0.79167; PMT = 6,000; FV = 0; CPT → PV = -23,719. Step 2: Calculate amount to save each month Using a financial calculator: Make sure it is set to END mode, then N = 11; I/Y = 8.5 / 12.0 = 0.70833; PV = 0; FV = 23,719; CPT → PMT= -2,081, or approximately $2,080. 24) C

If the observations in Distribution Y are three times the observations in Distribution X, the mean and standard deviation of Distribution Y are three times the mean and standard deviation of Distribution X. The standard deviation of a data set measured in feet, for example, will be 3 times the standard deviation of the data set measured in yards (since 1 yard = 3 feet). 25) A

The covariance of a variable with itself is its variance. Both remaining statements are true. Covariance represents the linear relationship between two variables and is not limited in value (i.e., it can range from negative infinity to positive infinity). 26) B

Switch to BGN mode. PMT = –1,000; N = 10, I/Y = 9, PV = 0; CPT → FV = 16,560.29. Remember the answer will be one year after the last payment in annuity due FV problems. Now PV10 = 16,560.29; N = 10; I/Y = 9; PMT = 0; CPT → FV = 39,204.23. Switch back to END mode. 27) B

The arithmetic mean will overstate the average annual compound return of the mutual fund. The average annual compound rate of return is calculated as the geometric mean return over the period. The annual time-weighted return is a geometric mean return. 28) B

He needs to figure out how much the trip will cost in one year, and use the 5% as a discount rate to convert the future cost to a present value. Thus, in this context the rate is best viewed as a discount rate. 29) B

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These are mutually exclusive, so the joint probability is zero. 30) B

Mean = (0.4)(10) + (0.4)(12.5) + (0.2)(30) = 15% Var = (0.4)(10 − 15)2 + (0.4)(12.5 − 15)2 + (0.2)(30 − 15)2 = 57.5 Standard deviation = √57.5 = 7.58 31) B

With PMT = 5,000; N = 7; I/Y = 11.5; value (at t = 4) = 23,185.175. Therefore, PV (at t = 0) = 23,185.175 / (1.115)4 = $15,000.68. 32) B

The standard deviation of the portfolio is found by: [w12σ12 + w22σ22 + 2w1w2σ1σ2ρ1,2]0.5 = [(0.40)2(0.0015) + (0.60)2(0.0021) + (2)(0.40)(0.60)(0.0387)(0.0458)(−0.35)]0.5 = 0.0264, or 2.64%. 33) C

This is an annuity due so set your calculator to the BGN mode. N = 15; I/Y = 14.5; PMT = – 40,000; FV = 0; CPT → PV = 274,422.50. Switch back to END mode. 34) C

Unless the returns were equal for all ten years (unlikely), the geometric mean return over the period will be less than the arithmetic mean return. 35) B

Given a mutually exclusive and exhaustive set of outcomes for random variable R, the total probability rule for expected value states that the unconditional expected value of R is the sum of the conditional expected values of R for each outcome multiplied by their probabilities: E(R) = E(R | S1) × P(S1) + E(R | S2) × P(S2) + ... + E(R | Sn) × P(Sn) 36) B

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Using the total probability rule, we can compute the P(B): P(B) = [P(B | A) × P(A)] + [P(B | AC) × P(AC)] P(B) = [0.5 × 0.4] + [0.2 × 0.6] = 0.32 Using Bayes’ formula, we can solve for P(A | B): P(A | B) = [ P(B | A) ÷ P(B) ] × P(A) = [0.5 ÷ 0.32] × 0.4 = 0.625 37) B

A joint probability applies to two events that both must occur. 38) C

The standard deviation of the portfolio is found by:

[W12σ12 + W22σ22 + 2W1W2σ1σ2r1,2]0.5,

or [(0.30)2(0.046)2 + (0.70)2(0.078)2 + (2)(0.30)(0.70)(0.046)(0.078)(0.45)]0.5 = 0.0620, or 6.20%. 39) C

Note that events being independent means that they have no influence on each other. It does not necessarily mean that they are mutually exclusive. Accordingly, P(X or Y) = P(X) + P(Y) − P(X and Y). By the definition of independent events, P(X|Y) = P(X). 40) C

The estimator is unbiased because the expected value of the sample mean is equal to the population mean. The estimator is efficient because the variance of the sampling distribution is smaller than that for other estimators of the parameter. The estimator is not consistent. To be consistent, as the sample size increases, the standard error of the sample mean must decrease. 41) B

This reflects a basic property of binomial outcomes. They take on whole number values that must start at zero up to the upper limit n. The upper limit in this case is 11. 42) B

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A hypothesis test of the equality of the means of two normally distributed non-independent populations (hypothesized mean difference = 0) is a t-test and the numerator is the average difference between the sample returns over the sample period. 43) B

If the possible outcomes are X: (0,1,2,3,4,5), then the probability of each of the six outcomes is 1 / 6 = 0.167. 44) C

Although the t-distribution begins to approach the shape of a normal distribution for large sample sizes, at a sample size of 30 a t-statistic produces a wider confidence interval than a z-statistic. A confidence interval for the population mean is the sample mean plus-or-minus the appropriate critical value times the standard error, which is the standard deviation divided by the square root of the sample size. If a population is normally distributed, we can use a t-statistic to construct a confidence interval for the population mean from a small sample, even if the population variance is unknown. 45) B

The holding period returns will have a positive arithmetic mean. For example, a fall from 100 to 90 is a decrease of 10%, but a rise from 90 to 100 is an increase of 11.1%. The continuously compounded returns will have an arithmetic mean of zero. Using the same example values, ln (90/100) = −10.54% and ln (100/90) = 10.54%. 46) A

The central limit theorem tells us that for a population with a mean µ and a finite variance σ2, the sampling distribution of the sample means of all possible samples of size n will be approximately normally distributed with a mean equal to µ and a variance equal to σ2/n, no matter the distribution of the population, assuming a large sample size. 47) B

The outcome follows a binomial distribution where n = 5 and p = 0.2. In this case p(0) = 0.85 = 0.3277 and p(1) = 5 × 0.84 × 0.2 = 0.4096, so P(X=0 or X=1) = 0.3277 + 0.4096. 48) C

This test has a significance level of 5%. The relationship between confidence and significance is: significance level = 1 – confidence level. We know that the significance level is 5% because the sample size is large and the critical value of the test statistic is 1.96 (2.5% of probability is in both the upper and lower tails).

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49) C

Using the process of Hypothesis testing: Step 1: State the Hypothesis. For 25% bonus level -Ho: m ≥ 30% Ha: m < 30%; For 50% bonus level - Ho: m ≥ 25% Ha: m < 25%. Step 2: Select Appropriate Test Statistic. Here, we have a normally distributed population with a known variance (standard deviation is the square root of the variance) and a large sample size (greater than 30.) Thus, we will use thez-statistic. Step 3: Specify the Level of Significance. α = 0.10. Step 4: State the Decision Rule. This is a one-tailed test. The critical value for this question will be thez-statistic that corresponds to an α of 0.10, or an area to the left of the mean of 40% (with 50% to the right of the mean). Using thez-table (normal table), we determine that the appropriate critical value = -1.28(Remember that we highly recommend that you have the “common” zstatistics memorized!) Thus, we will reject the null hypothesis if the calculated test statistic is less than -1.28. Step 5: Calculate sample (test) statistics. Z (for 50% bonus) = (24.2 − 25) / (1.5 / √ 100) = −5.333. Z (for 25% bonus) = (24.2 − 30) / (1.5 / √ 100) = −38.67. Step 6: Make a decision. Reject the null hypothesis for both the 25% and 50% bonus level because the test statistic is less than the critical value. Thus, Huffman should give So berg a 50% bonus.The other statements are false. The critical value of −1.28 is based on the significance level, and is thus the same for both the 50% and 25% bonus levels. 50) C

When a stock increases in value, the holding period return is always greater than the continuously compounded return that would be required to generate that holding period return. For example, if a stock increases from $1 to $1.10 in a year, the holding period return is 10%. The continuously compounded rate needed to increase a stock's value by 10% is Ln(1.10) = 9.53%. 51) C

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F(21) = 1.00. For a cumulative distribution function, the expression F(x) refers to the probability of an outcome less than or equal to x. In this distribution all the possible outcomes are between 7 and 20. Therefore the probability of an outcome less than or equal to 21 is 100%.

The other choices are true. A. F(10) = (10 − 7) / (20 − 7) = 3 / 13 = 0.23 B. F(12 ≤ X ≤ 16) = F(16) − F(12) = [(16 − 7) / (20 − 7)] − [(12 − 7) / (20 − 7)] = 0.692 − 0.385 = 0.307 52) B

A multivariate distribution describes the relationships between two or more random variables, when the behavior of each random variable is dependent on the others in some way. 53) B

A p-value of 0.02% means that the smallest significance level at which the hypothesis can be rejected is 0.0002, which is smaller than 0.05 or 0.01. Therefore the null hypothesis can be rejected at both the 5% and 1% significance levels. 54) C

This question is asking you to select the inaccurate statement. The CLT states that for a population with mean µ and a finite varianceσ2, the sampling distribution of the sample means becomes approximately normally distributed as the sample size becomes large. The other statements are accurate. 55) A

Binomial probability distributions give the result of a single outcome and are used to study discrete random variables where you want to know the probability that an exact event will happen. A continuous uniform distribution has both an upper and a lower limit. A discrete uniform random variable has equal probabilities for each outcome. 56) C

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A larger sample reduces the sampling error and the standard deviation of the sample statistic around its population value. However, this does not imply that the sample should be as large as possible, or that the sampling error must be as small as can be achieved. Larger samples might contain observations that come from a different population, in which case they would not necessarily improve the estimates of the population parameters. Cost also increases with the sample size. When the cost of increasing the sample size is greater than the value of the extra precision gained, increasing the sample size is not appropriate. 57) B

The limits of the uniform distribution are three and 15. Since the problem concerns time, it is continuous. Noon is six minutes after 11:54 A.M. The probability the order is executed after noon is (15 − 6) / (15 − 3) = 0.75. 58) B

The number of correlations in a multivariate normal distribution of n variables is computed by the formula ((n) × (n-1)) / 2, in this case (10 × 9) / 2 = 45. 59) A

The test statistic for a hypothesis test concerning population correlation follows a t-distribution with n − 2 degrees of freedom. For a sample size of 30 and a significance level of 5%, the sample statistic must be greater than 2.048 or less than −2.048 to reject the hypothesis that the population correlation equals zero. 60) B

The way the alternative hypothesis is written you are only looking at the right side of the distribution. You are only interested in showing that B is greater than 0. You don't care if it is less than zero. For a one-tailed test at the 5% level of significance, the critical z value is 1.645. Since the test statistic of 1.68 is greater than the critical value we would reject the null hypothesis. 61) C

The number of days a stock traded and did not trade describes only one random variable. Both of the other cases involve two or more random variables. 62) B

An unbiased estimator is one for which the expected value of the estimator is equal to the parameter you are trying to estimate. 63) B

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Portfolio theory teaches us that returns on two stocks over the same time period are unlikely to be independent since both have some systematic risk. Because the samples are not independent, a paired comparisons test is appropriate to test whether the means of the two stocks’ returns distributions are equal. A difference in means test is not appropriate because it requires that the samples be independent. A chi-square test compares the variances of two samples, rather than their means. 64) B

In stratified random sampling we first divide the population into subgroups, called strata, based on some classification scheme. Then we randomly select a sample from each stratum and pool the results. The size of the samples from each strata is based on the relative size of the strata relative to the population and are not necessarily the same across strata. 65) B

A 95% confidence interval for the population mean (α = 5%), for example, is a range of estimates within which the actual value of the population mean will lie with a probability of 95%. Point estimates, on the other hand, are single (sample) values used to estimate population parameters. There is no such thing as a α percent point estimate or a (1 − α) percent crosssectional point estimate. 66) C

By definition, for a continuous uniform distribution, the probability density function is a horizontal line segment over a range of values such that the area under the segment (total probability of an outcome in the range) equals one. 67) B

The standard normal distribution is defined as a normal distribution that has a mean of zero and a standard deviation of one. The other choices apply to any normal distribution. 68) C

Because the rate is 8% compounded continuously, the effective annual rate ise0.08 - 1 = 8.33%. To find the present value of the inheritance, enter N=5, I/Y=8.33, PMT=0, FV=100,000 CPT PV = 67,028. Alternatively,100,000e-0.08(5) = 67,032. 69) B

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A test of the equality of variances requires an F-statistic. The calculated F-statistic is 0.0083/0.0078 = 1.064. Since the calculated F value of 1.064 is less than the critical F value of 1.61, we cannot reject the null hypothesis that the variances of the 2 stocks are equal. 70) C

Survivorship bias is not likely to significantly influence the results of this study because the authors looked at the stocks in the S&P 500 at the beginning of the year and measured performance over the following three months. Look-ahead bias could be a problem because earnings-price ratios are calculated and the trading strategy implemented at a time before earnings are actually reported. Finally, the study is conducted over a relatively short time period during the long bull market of the 1990s. This suggests the results may be time-specific and the result of time-period bias. 71) C

The null hypothesis is that earnings estimates are equal to reported earnings. To reject the null hypothesis, the calculated test statistic must fall outside the two critical values. IF the analyst tests the null hypothesis with a z-statistic, the critical values at a 5% confidence level are ±1.96. Because the calculated test statistic, 1.25, lies between the two critical values, the analyst should fail to reject the null hypothesis and conclude that earnings estimates are not significantly different from reported earnings. If the analyst uses a t-statistic, the upper critical value will be even greater than 1.96, never less, so even without the exact degrees of freedom the analyst knows any t-test would fail to reject the null. 72) B

A 95% confidence interval is ± 1.96 standard deviations from the mean, so 0.177 ± 1.96(0.339) = (− 48.7%, 84.1%). 73) B

The mean of the sample is ∑X / n = 20 / 5 = 4. The sampling error of the sample is the difference between a sample statistic and its corresponding population parameter. 74) A

We have two formulas for test statistics for the hypothesis of equal sample means. Which one we use depends on whether or not we assume the samples have equal variances. Either formula generates a test statistic that follows a T-distribution. 75) A

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A cumulative distribution function (cdf) gives the probability of an outcome for a random variable less than or equal to a specific value. For the random variable X, the cdf for the outcome 10 is 0.25, which means there is a 25% probability that X will take a value less than or equal to 10.

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