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5/25/13
Opening Offer: $80.00
Posted by: jane
Date Posted: 5/25/13 11:37 AM
Due Date: 5/25/13
Posted by: jane
Date Posted: 5/25/13 11:37 AM
Due Date: 5/25/13
FIN 534 – Chapter 1-17
5/25/13
Opening Offer: $7.00
Posted by: jane
Date Posted: 5/25/13 11:34 AM
Due Date: 5/25/13
Posted by: jane
Date Posted: 5/25/13 11:34 AM
Due Date: 5/25/13
1. In Japan, 90-day securities have a 4% annualized return and 180-day securities have a 5% annualized return. In the United States, 90-day securities have a 4% annualized return and 180-day securities have an annualized return of 4.5%. All securities are of equal risk, and Japanese securities are denominated in terms of the Japanese yen. Assuming that interest rate parity holds in all markets, which of the following statements is most CORRECT?
a. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market.
b. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 180-day forward market.
c. The yen-dollar exchange rate in the 90-day forward market equals the yen-dollar exchange rate in the 180-day forward market.
d. The spot rate equals the 90-day forward rate.
e. The spot rate equals the 180-day forward rate.
2. If the spot rate of the Israeli shekel is 5.51 shekels per dollar and the 180-day forward rate is 5.97 shekels per dollar, then the forward rate for the Israeli shekel is selling at a ________________ to the spot rate.
a. premium of 8%
b. premium of 18%
c. discount of 18%
d. discount of 8%
e. premium of 16%
3. Stover Corporation, a U.S. based importer, makes a purchase of crystal glassware from a firm in Switzerland for 39,960 Swiss francs, or $24,000, at the spot rate of 1.665 francs per dollar. The terms of the purchase are net 90 days, and the U.S. firm wants to cover this trade payable with a forward market hedge to eliminate its exchange rate risk. Suppose the firm completes a forward hedge at the 90-day forward rate of 1.682 francs. If the spot rate in 90 days is actually 1.638 francs, how much will the U.S. firm have saved or lost in U.S. dollars by hedging its exchange rate exposure?
a. -$396
b. -$243
c. $0
d. $243
e. $638
4. A product sells for $750 in the United States. The exchange rate is $1 to 1.65 Swiss francs. If purchasing power parity (PPP) holds, what is the price of the product in Switzerland?
a. 123.75 Swiss francs
b. 454.55 Swiss francs
c. 750.00 Swiss francs
d. 1,237.50 Swiss francs
e. 1,650.00 Swiss francs
5. Chen Transport, a U.S. based company, is considering expanding its operations into a foreign country. The required investment at Time = 0 is $10 million. The firm forecasts total cash inflows of $4 million per year for 2 years, $6 million for the next 2 years, and then a possible terminal value of $8 million. In addition, due to political risk factors, Chen believes that there is a 50% chance that the gross terminal value will be only $2 million and a 50% chance that it will be $8 million. However, the government of the host country will block 20% of all cash flows. Thus, cash flows that can be repatriated are 80% of those projected. Chen's cost of capital is 15%, but it adds one percentage point to all foreign projects to account for exchange rate risk. Under these conditions, what is the project’s NPV?
a. $1.01 million
b. $2.77 million
c. $3.09 million
d. $5.96 million
e. $7.39 million
5/25/13
Opening Offer: $7.00
Posted by: jane
Date Posted: 5/25/13 11:31 AM
Due Date: 5/25/13
Posted by: jane
Date Posted: 5/25/13 11:31 AM
Due Date: 5/25/13
1. Swim Suits Unlimited is in a highly seasonal business, and the following summary balance sheet data show its assets and liabilities at peak and off-peak seasons (in thousands of dollars):
Peak Off-Peak
Cash $ 50 $ 30
Marketable securities 0 20
Accounts receivable 40 20
Inventories 100 50
Net fixed assets 500 500
Total assets $690 $620
Payables and accruals $ 30 $ 10
Short-term bank debt 50 0
Long-term debt 300 300
Common equity 310 310
Total claims $690 $620
From this data we may conclude that
a. Swim Suits' current asset financing policy calls for exactly matching asset and liability maturities.
b. Swim Suits' current asset financing policy is relatively aggressive; that is, the company finances some of its permanent assets with short-term discretionary debt.
c. Swim Suits follows a relatively conservative approach to current asset financing; that is, some of its short-term needs are met by permanent capital.
d. Without income statement data, we cannot determine the aggressiveness or conservatism of the company's current asset financing policy.
e. Without cash flow data, we cannot determine the aggressiveness or conservatism of the company's current asset financing policy.
2. Which of the following statements is CORRECT?
a. A firm that makes 90% of its sales on credit and 10% for cash is growing at a constant rate of 10% annually. Such a firm will be able to keep its accounts receivable at the current level, since the 10% cash sales can be used to finance the 10% growth rate.
b. In managing a firm's accounts receivable, it is possible to increase credit sales per day yet still keep accounts receivable fairly steady, provided the firm can shorten the length of its collection period (its DSO) sufficiently.
c. Because of the costs of granting credit, it is not possible for credit sales to be more profitable than cash sales.
d. Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must also have a high payables-to-sales ratio.
e. Other things held constant, if a firm can shorten its DSO, this will lead to a higher current ratio.
3. Halka Company is a no-growth firm. Its sales fluctuate seasonally, causing total assets to vary from $320,000 to $410,000, but fixed assets remain constant at $260,000. If the firm follows a maturity matching (or moderate) working capital financing policy, what is the most likely total of long-term debt plus equity capital?
a. $260,642
b. $274,360
c. $288,800
d. $304,000
e. $320,000
4. Your consulting firm was recently hired to improve the performance of Shin-Soenen Inc, which is highly profitable but has been experiencing cash shortages due to its high growth rate. As one part of your analysis, you want to determine the firm’s cash conversion cycle. Using the following information and a 365-day year, what is the firm’s present cash conversion cycle?
Average inventory = $75,000
Annual sales = $600,000
Annual cost of goods sold = $360,000
Average accounts receivable = $160,000
Average accounts payable = $25,000
a. 120.6 days
b. 126.9 days
c. 133.6 days
d. 140.6 days
e. 148.0 days
5. Affleck Inc.'s business is booming, and it needs to raise more capital. The company purchases supplies on terms of 1/10 net 20, and it currently takes the discount. One way of getting the needed funds would be to forgo the discount, and the firm's owner believes she could delay payment to 40 days without adverse effects. What would be the effective annual percentage cost of funds raised by this action? (Assume a 365-day year.)
a. 10.59%
b. 11.15%
c. 11.74%
d. 12.36%
e. 13.01%
5/25/13
Opening Offer: $7.00
Posted by: jane
Date Posted: 5/25/13 11:29 AM
Due Date: 5/25/13
Posted by: jane
Date Posted: 5/25/13 11:29 AM
Due Date: 5/25/13
1. Which of the following statements best describes the optimal capital structure? a. The optimal capital structure is the mix of debt, equity, and preferred stock that maximizes the company’s earnings per share (EPS). b. The optimal capital structure is the mix of debt, equity, and preferred stock that maximizes the company’s stock price. c. The optimal capital structure is the mix of debt, equity, and preferred stock that minimizes the company’s cost of equity. d. The optimal capital structure is the mix of debt, equity, and preferred stock that minimizes the company’s cost of debt. e. The optimal capital structure is the mix of debt, equity, and preferred stock that minimizes the company’s cost of preferred stock. 2. Which of the following statements is CORRECT? a. A firm can use retained earnings without paying a flotation cost. Therefore, while the cost of retained earnings is not zero, its cost is generally lower than the after-tax cost of debt. b. The capital structure that minimizes a firm’s weighted average cost of capital is also the capital structure that maximizes its stock price. c. The capital structure that minimizes the firm’s weighted average cost of capital is also the capital structure that maximizes its earnings per share. d. If a firm finds that the cost of debt is less than the cost of equity, increasing its debt ratio must reduce its WACC. e. Other things held constant, if corporate tax rates declined, then the Modigliani-Miller tax-adjusted tradeoff theory would suggest that firms should increase their use of debt. 3. Which of the following statements is CORRECT? a. In general, a firm with low operating leverage also has a small proportion of its total costs in the form of fixed costs. b. There is no reason to think that changes in the personal tax rate would affect firms’ capital structure decisions. c. A firm with high business risk is more likely to increase its use of financial leverage than a firm with low business risk, assuming all else equal. d. If a firm's after-tax cost of equity exceeds its after-tax cost of debt, it can always reduce its WACC by increasing its use of debt. e. Suppose a firm has less than its optimal amount of debt. Increasing its use of debt to the point where it is at its optimal capital structure will decrease the costs of both debt and equity financing. 4. Companies HD and LD have identical amounts of assets, operating income (EBIT), tax rates, and business risk. Company HD, however, has a much higher debt ratio than LD. Company HD’s basic earning power ratio (BEP) exceeds its cost of debt (rd). Which of the following statements is CORRECT? a. Company HD has a higher return on assets (ROA) than Company LD. b. Company HD has a higher times interest earned (TIE) ratio than Company LD. c. Company HD has a higher return on equity (ROE) than Company LD, and its risk, as measured by the standard deviation of ROE, is also higher than LD’s. d. The two companies have the same ROE. e. Company HD’s ROE would be higher if it had no debt. 5. Which of the following statements is CORRECT? a. Generally, debt-to-total-assets ratios do not vary much among different industries, although they do vary among firms within a given industry. b. Electric utilities generally have very high common equity ratios because their revenues are more volatile than those of firms in most other industries. c. Drug companies (prescription, not illegal!) generally have high debt-to-equity ratios because their earnings are very stable and, thus, they can cover the high interest costs associated with high debt levels. d. Wide variations in capital structures exist both between industries and among individual firms within given industries. These differences are caused by differing business risks and also managerial attitudes. e. Since most stocks sell at or very close to their book values, book value capital structures are almost always adequate for use in estimating firms' costs of capital.
5/25/13
Opening Offer: $7.00
Posted by: jane
Date Posted: 5/25/13 11:23 AM
Due Date: 5/25/13
Posted by: jane
Date Posted: 5/25/13 11:23 AM
Due Date: 5/25/13
1. Which of the following statements about dividend policies is CORRECT?
a. Modigliani and Miller argue that investors prefer dividends to capital gains because dividends are more certain than capital gains. They call this the ―bird-in-the hand‖ effect.
b. One reason that companies tend to avoid stock repurchases is that dividend payments are taxed at a lower rate than gains on stock repurchases.
c. One advantage of dividend reinvestment plans is that they allow shareholders to avoid paying taxes on the dividends that they choose to reinvest.
d. One key advantage of a residual dividend policy is that it enables a company to follow a stable dividend policy.
e. The clientele effect suggests that companies should follow a stable dividend policy.
2. Which of the following statements is CORRECT?
a. One disadvantage of dividend reinvestment plans is that they increase transactions costs for investors who want to increase their ownership in the company.
b. One advantage of dividend reinvestment plans is that they enable investors to postpone paying taxes on the dividends credited to their account.
c. Stock repurchases can be used by a firm that wants to increase its debt ratio.
d. Stock repurchases make sense if a company expects to have a lot of profitable new projects to fund over the next few years, provided investors are aware of these investment opportunities.
e. One advantage of an open market dividend reinvestment plan is that it provides new equity capital and increases the shares outstanding.
3. Which of the following statements is CORRECT?
a. When firms are deciding on the size of stock splits—say whether to declare a 2-for-1 split or a 3-for-1 split, it is best to declare the smaller one, in this case the 2-for-1 split, because then the after-split price will be higher than if the 3-for-1 split had been used.
b. Back before the SEC was created in the 1930s, companies would declare reverse splits in order to boost their stock prices. However, this was determined to be a deceptive practice, and it is illegal today.
c. Stock splits create more administrative problems for investors than stock dividends, especially determining the tax basis of their shares when they decide to sell them, so today stock dividends are used far more often than stock splits.
d. When a company declares a stock split, the price of the stock typically declines—by about 50% after a 2-for-1 split—and this necessarily reduces the total market value of the equity.
e. If a firm’s stock price is quite high relative to most stocks—say $500 per share—then it can declare a stock split of say 10-for-1 so as to bring the price down to something close to $50.
4. Which of the following statements is CORRECT?
a. If a firm follows the residual dividend policy, then a sudden increase in the number of profitable projects is likely to reduce the firm’s dividend payout.
b. The clientele effect can explain why so many firms change their dividend policies so often.
c. One advantage of adopting the residual dividend policy is that this policy makes it easier for corporations to develop a specific and well-identified dividend clientele.
d. New-stock dividend reinvestment plans are similar to stock dividends because they both increase the number of shares outstanding but don’t change the firm’s total amount of book equity.
e. Investors who receive stock dividends must pay taxes on the value of the new shares in the year the stock dividends are received.
5. DeAngelo Corp.'s projected net income is $150.0 million, its target capital structure is 25% debt and 75% equity, and its target payout ratio is 65%. DeAngelo has more positive NPV projects than it can finance without issuing new stock, but its board of directors had decreed that it cannot issue any new shares in the foreseeable future. The CFO now wants to determine how the maximum capital budget would be affected by changes in capital structure policy and/or the target dividend payout policy. Versus the current policy, how much larger could the capital budget be if (1) the target debt ratio were raised to 75%, other things held constant, (2) the target payout ratio were lowered to 20%, other things held constant, and (3) the debt ratio and payout were both changed by the indicated amounts.
Increase in Capital Budget
Increase Debt Lower Payout Do Both to 75% to 20%___________________
a. $114.0 $73.3 $333.9
b. $120.0 $77.2 $351.5
c. $126.4 $81.2 $370.0
d. $133.0 $85.5 $389.5
e. $140.0 $90.0 $410.0
5/25/13
Opening Offer: $7.00
Posted by: jane
Date Posted: 5/25/13 11:21 AM
Due Date: 5/25/13
Posted by: jane
Date Posted: 5/25/13 11:21 AM
Due Date: 5/25/13
1. Suppose Leonard, Nixon, & Shull Corporation’s projected free cash flow for next year is $100,000, and FCF is expected to grow at a constant rate of 6%. If the company’s weighted average cost of capital is 11%, what is the value of its operations?
a. $1,714,750
b. $1,805,000
c. $1,900,000
d. $2,000,000
e. $2,100,000
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2. Leak Inc. forecasts the free cash flows (in millions) shown below. If the weighted average cost of capital is 11% and FCF is expected to grow at a rate of 5% after Year 2, what is the Year 0 value of operations, in millions? Assume that the ROIC is expected to remain constant in Year 2 and beyond (and do not make any half-year adjustments).
Year: 1 2
Free cash flow: -$50 $100
a. $1,456
b. $1,529
c. $1,606
d. $1,686
e. $1,770
3. Based on the corporate valuation model, the value of a company’s operations is $1,200 million. The company’s balance sheet shows $80 million in accounts receivable, $60 million in inventory, and $100 million in short-term investments that are unrelated to operations. The balance sheet also shows $90 million in accounts payable, $120 million in notes payable, $300 million in long-term debt, $50 million in preferred stock, $180 million in retained earnings, and $800 million in total common equity. If the company has 30 million shares of stock outstanding, what is the best estimate of the stock’s price per share?
a. $24.90
b. $27.67
c. $30.43
d. $33.48
e. $36.82
4. Based on the corporate valuation model, the value of a company’s operations is $900 million. Its balance sheet shows $70 million in accounts receivable, $50 million in inventory, $30 million in short-term investments that are unrelated to operations, $20 million in accounts payable, $110 million in notes payable, $90 million in long-term debt, $20 million in preferred stock, $140 million in retained earnings, and $280 million in total common equity. If the company has 25 million shares of stock outstanding, what is the best estimate of the stock’s price per share?
a. $23.00
b. $25.56
c. $28.40
d. $31.24
e. $34.36
5. Vasudevan Inc. forecasts the free cash flows (in millions) shown below. If the weighted average cost of capital is 13% and the free cash flows are expected to continue growing at the same rate after Year 3 as from Year 2 to Year 3, what is the Year 0 value of operations, in millions?
Year: 1 2 3
Free cash flow: -$20 $42 $45
a. $586
b. $617
c. $648
d. $680
e. $714
5/25/13
Opening Offer: $7.00
Posted by: jane
Date Posted: 5/25/13 11:18 AM
Due Date: 5/25/13
Posted by: jane
Date Posted: 5/25/13 11:18 AM
Due Date: 5/25/13
1. Which of the following statements is CORRECT?
a. Perhaps the most important step when developing forecasted financial statements is to determine the breakdown of common equity between common stock and retained earnings.
b. The first, and perhaps the most critical, step in forecasting financial requirements is to forecast future sales.
c. Forecasted financial statements, as discussed in the text, are used primarily as a part of the managerial compensation program, where management’s historical performance is evaluated.
d. The capital intensity ratio gives us an idea of the physical condition of the firm’s fixed assets.
e. The AFN equation produces more accurate forecasts than the forecasted financial statement method, especially if fixed assets are lumpy, economies of scale exist, or if excess capacity exists.
2. Which of the following statements is CORRECT?
a. The sustainable growth rate is the maximum achievable growth rate without the firm having to raise external funds. In other words, it is the growth rate at which the firm's AFN equals zero.
b. If a firm’s assets are growing at a positive rate, but its retained earnings are not increasing, then it would be impossible for the firm’s AFN to be negative.
c. If a firm increases its dividend payout ratio in anticipation of higher earnings, but sales and earnings actually decrease, then the firm’s actual AFN must, mathematically, exceed the previously calculated AFN.
d. Higher sales usually require higher asset levels, and this leads to what we call AFN. However, the AFN will be zero if the firm chooses to retain all of its profits, i.e., to have a zero dividend payout ratio.
e. Dividend policy does not affect the requirement for external funds based on the AFN equation.
3. Which of the following statements is CORRECT?
a. When we use the AFN equation, we assume that the ratios of assets and liabilities to sales (A0*/S0 and L0*/S0) vary from year to year in a stable, predictable manner.
b. When fixed assets are added in large, discrete units as a company grows, the assumption of constant ratios is more appropriate than if assets are relatively small and can be added in small increments as sales grow.
c. Firms whose fixed assets are “lumpy” frequently have excess capacity, and this should be accounted for in the financial forecasting process.
d. For a firm that uses lumpy assets, it is impossible to have small increases in sales without expanding fixed assets.
e. There are economies of scale in the use of many kinds of assets. When economies occur the ratios are likely to remain constant over time as the size of the firm increases.
4. Last year Jain Technologies had $250 million of sales and $100 million of fixed assets, so its FA/Sales ratio was 40%. However, its fixed assets were used at only 75% of capacity. Now the company is developing its financial forecast for the coming year. As part of that process, the company wants to set its target Fixed Assets/Sales ratio at the level it would have had had it been operating at full capacity. What target FA/Sales ratio should the company set?
a. 28.5%
b. 30.0%
c. 31.5%
d. 33.1%
e. 34.7%
5. Howton & Howton Worldwide (HHW) is planning its operations for the coming year, and the CEO wants you to forecast the firm's additional funds needed (AFN). The firm is operating at full capacity. Data for use in the forecast are shown below. However, the CEO is concerned about the impact of a change in the payout ratio from the 10% that was used in the past to 50%, which the firm's investment bankers have recommended. Based on the AFN equation, by how much would the AFN for the coming year change if HHW increased the payout from 10% to the new and higher level? All dollars are in millions.
Last year’s sales = S0 $300.0 Last year’s accounts payable $50.0
Sales growth rate = g 40% Last year’s notes payable $15.0
Last year’s total assets = A0* $500.0 Last year’s accruals $20.0
Last year’s profit margin = PM 20.0% Initial payout ratio 10.0%
a. $31.9
b. $33.6
c. $35.3
d. $37.0
e. $38.9
5/25/13
Opening Offer: $7.00
Posted by: jane
Date Posted: 5/25/13 11:16 AM
Due Date: 5/25/13
Posted by: jane
Date Posted: 5/25/13 11:16 AM
Due Date: 5/25/13
1. Which of the following statements is CORRECT?
a. An externality is a situation where a project would have an adverse effect on some other part of the firm’s overall operations. If the project would have a favorable effect on other operations, then this is not an externality.
b. An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank’s other offices to decline.
c. The NPV method automatically deals correctly with externalities, even if the externalities are not specifically identified, but the IRR method does not. This is another reason to favor the NPV.
d. Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified. However, the payback method does not.
e. Identifying an externality can never lead to an increase in the calculated NPV.
2. Taussig Technologies is considering two potential projects, X and Y. In assessing the projects’ risks, the company estimated the beta of each project versus both the company’s other assets and the stock market, and it also conducted thorough scenario and simulation analyses. This research produced the following data:
Project X Project Y
Expected NPV $350,000 $350,000
Standard deviation (σNPV) $100,000 $150,000
Project beta (vs. market) 1.4 0.8
Correlation of the project cash flows with cash flows from currently existing projects. Cash flows are not correlated with the cash flows from existing projects. Cash flows are highly correlated with the cash flows from existing projects.
Which of the following statements is CORRECT?
a. Project X has more stand-alone risk than Project Y.
b. Project X has more corporate (or within-firm) risk than Project Y.
c. Project X has more market risk than Project Y.
d. Project X has the same level of corporate risk as Project Y.
e. Project X has less market risk than Project Y.
3. Which of the following statements is CORRECT?
a. If an asset is sold for less than its book value at the end of a project’s life, it will generate a loss for the firm, hence its terminal cash flow will be negative.
b. Only incremental cash flows are relevant in project analysis, the proper incremental cash flows are the reported accounting profits, and thus reported accounting income should be used as the basis for investor and managerial decisions.
c. It is unrealistic to believe that any increases in net working capital required at the start of an expansion project can be recovered at the project’s completion. Working capital like inventory is almost always used up in operations. Thus, cash flows associated with working capital should be included only at the start of a project’s life.
d. If equipment is expected to be sold for more than its book value at the end of a project’s life, this will result in a profit. In this case, despite taxes on the profit, the end-of-project cash flow will be greater than if the asset had been sold at book value, other things held constant.
e. Changes in net working capital refer to changes in current assets and current liabilities, not to changes in long-term assets and liabilities. Therefore, changes in net working capital should not be considered in a capital budgeting analysis.
4. Temple Corp. is considering a new project whose data are shown below. The equipment that would be used has a 3-year tax life, would be depreciated by the straight-line method over its 3-year life, and would have a zero salvage value. No new working capital would be required. Revenues and other operating costs are expected to be constant over the project’s 3-year life. What is the project’s NPV?
Risk-adjusted WACC 10.0%
Net investment cost (depreciable basis) $65,000
Straight-line deprec. rate 33.3333%
Sales revenues, each year $65,500
Operating costs (excl. deprec.), each year $25,000
Tax rate 35.0%
a. $15,740
b. $16,569
c. $17,441
d. $18,359
e. $19,325
5. Florida Car Wash is considering a new project whose data are shown below. The equipment to be used has a 3-year tax life, would be depreciated on a straight-line basis over the project’s 3-year life, and would have a zero salvage value after Year 3. No new working capital would be required. Revenues and other operating costs will be constant over the project’s life, and this is just one of the firm’s many projects, so any losses on it can be used to offset profits in other units. If the number of cars washed declined by 40% from the expected level, by how much would the project’s NPV decline? (Hint: Note that cash flows are constant at the Year 1 level, whatever that level is.)
WACC 10.0%
Net investment cost (depreciable basis) $60,000
Number of cars washed 2,800
Average price per car $25.00
Fixed op. cost (excl. deprec.) $10,000
Variable op. cost/unit (i.e., VC per car washed) $5.375
Annual depreciation $20,000
Tax rate 35.0%
a. $28,939
b. $30,462
c. $32,066
d. $33,753
e. $35,530
5/24/13
Opening Offer: $7.00
Posted by: jane
Date Posted: 5/24/13 12:33 PM
Due Date: 5/24/13
Posted by: jane
Date Posted: 5/24/13 12:33 PM
Due Date: 5/24/13
1. Which of the following statements is CORRECT?
a. The internal rate of return method (IRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
b. The payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
c. The discounted payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
d. The net present value method (NPV) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
e. The modified internal rate of return method (MIRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
2. Projects A and B have identical expected lives and identical initial cash outflows (costs). However, most of one project’s cash flows come in the early years, while most of the other project’s cash flows occur in the later years. The two NPV profiles are given below:
Which of the following statements is CORRECT?
a. More of Project A’s cash flows occur in the later years.
b. More of Project B’s cash flows occur in the later years.
c. We must have information on the cost of capital in order to determine which project has the larger early cash flows.
d. The NPV profile graph is inconsistent with the statement made in the problem.
e. The crossover rate, i.e., the rate at which Projects A and B have the same NPV, is greater than either project’s IRR.
3. Suppose a firm relies exclusively on the payback method when making capital budgeting decisions, and it sets a 4-year payback regardless of economic conditions. Other things held constant, which of the following statements is most likely to be true?
a. It will accept too many short-term projects and reject too many long-term projects (as judged by the NPV).
b. It will accept too many long-term projects and reject too many short-term projects (as judged by the NPV).
c. The firm will accept too many projects in all economic states because a 4-year payback is too low.
d. The firm will accept too few projects in all economic states because a 4-year payback is too high.
e. If the 4-year payback results in accepting just the right set of projects under average economic conditions, then this payback will result in too few long-term projects when the economy is weak.
4. You are on the staff of Camden Inc. The CFO believes project acceptance should be based on the NPV, but Steve Camden, the president, insists that no project should be accepted unless its IRR exceeds the project’s risk-adjusted WACC. Now you must make a recommendation on a project that has a cost of $15,000 and two cash flows: $110,000 at the end of Year 1 and -$100,000 at the end of Year 2. The president and the CFO both agree that the appropriate WACC for this project is 10%. At 10%, the NPV is $2,355.37, but you find two IRRs, one at 6.33% and one at 527%, and a MIRR of 11.32%. Which of the following statements best describes your optimal recommendation, i.e., the analysis and recommendation that is best for the company and least likely to get you in trouble with either the CFO or the president?
a. You should recommend that the project be rejected because its NPV is negative and its IRR is less than the WACC.
b. You should recommend that the project be rejected because, although its NPV is positive, it has an IRR that is less than the WACC.
c. You should recommend that the project be accepted because (1) its NPV is positive and (2) although it has two IRRs, in this case it would be better to focus on the MIRR, which exceeds the WACC. You should explain this to the president and tell him that the firm’s value will increase if the project is accepted.
d. You should recommend that the project be rejected. Although its NPV is positive it has two IRRs, one of which is less than the WACC, which indicates that the firm’s value will decline if the project is accepted.
e. You should recommend that the project be rejected because, although its NPV is positive, its MIRR is less than the WACC, and that indicates that the firm’s value will decline if it is accepted.
5. A firm is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO wants to use the IRR criterion, while the CFO favors the NPV method. You were hired to advise the firm on the best procedure. If the wrong decision criterion is used, how much potential value would the firm lose?
WACC: 6.00%
Year 0 1 2 3 4
CFS -$1,025 $380 $380 $380 $380
CFL -$2,150 $765 $765 $765 $765
a. $188.68
b. $198.61
c. $209.07
d. $219.52
e. $230.49
5/24/13
Opening Offer: $7.00
Posted by: jane
Date Posted: 5/24/13 12:31 PM
Due Date: 5/24/13
Posted by: jane
Date Posted: 5/24/13 12:31 PM
Due Date: 5/24/13
1. Bankston Corporation forecasts that if all of its existing financial policies are followed, its proposed capital budget would be so large that it would have to issue new common stock. Since new stock has a higher cost than retained earnings, Bankston would like to avoid issuing new stock. Which of the following actions would REDUCE its need to issue new common stock?
a. Increase the dividend payout ratio for the upcoming year.
b. Increase the percentage of debt in the target capital structure.
c. Increase the proposed capital budget.
d. Reduce the amount of short-term bank debt in order to increase the current ratio.
e. Reduce the percentage of debt in the target capital structure.
2. LaPango Inc. estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and C) should the company accept?
a. Project B, which is of below-average risk and has a return of 8.5%.
b. Project C, which is of above-average risk and has a return of 11%.
c. Project A, which is of average risk and has a return of 9%.
d. None of the projects should be accepted.
e. All of the projects should be accepted.
3. Which of the following statements is CORRECT?
a. When calculating the cost of preferred stock, a company needs to adjust for taxes, because preferred stock dividends are deductible by the paying corporation.
b. All else equal, an increase in a company’s stock price will increase its marginal cost of retained earnings, rs.
c. All else equal, an increase in a company’s stock price will increase its marginal cost of new common equity, re.
d. Since the money is readily available, the after-tax cost of retained earnings is usually much lower than the after-tax cost of debt.
e. If a company’s tax rate increases but the YTM on its noncallable bonds remains the same, the after-tax cost of its debt will fall.
4. Which of the following statements is CORRECT?
a. Since debt capital can cause a company to go bankrupt but equity capital cannot, debt is riskier than equity, and thus the after-tax cost of debt is always greater than the cost of equity.
b. The tax-adjusted cost of debt is always greater than the interest rate on debt, provided the company does in fact pay taxes.
c. If a company assigns the same cost of capital to all of its projects regardless of each project’s risk, then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject.
d. Because no flotation costs are required to obtain capital as retained earnings, the cost of retained earnings is generally lower than the after-tax cost of debt.
e. Higher flotation costs tend to reduce the cost of equity capital.
5. Cranberry Corp. has two divisions of equal size: a computer manufacturing division and a data processing division. Its CFO believes that stand-alone data processor companies typically have a WACC of 8%, while stand-alone computer manufacturers typically have a 12% WACC. He also believes that the data processing and manufacturing divisions have the same risk as their typical peers. Consequently, he estimates that the composite, or corporate, WACC is 10%. A consultant has suggested using an 8% hurdle rate for the data processing division and a 12% hurdle rate for the manufacturing division. However, the CFO disagrees, and he has assigned a 10% WACC to all projects in both divisions. Which of the following statements is CORRECT?
a. While the decision to use just one WACC will result in its accepting more projects in the manufacturing division and fewer projects in its data processing division than if it followed the consultant’s recommendation, this should not affect the firm’s intrinsic value.
b. The decision not to adjust for risk means, in effect, that it is favoring the data processing division. Therefore, that division is likely to become a larger part of the consolidated company over time.
c. The decision not to adjust for risk means that the company will accept too many projects in the manufacturing division and too few in the data processing division. This will lead to a reduction in the firm’s intrinsic value over time.
d. The decision not to risk-adjust means that the company will accept too many projects in the data processing business and too few projects in the manufacturing business. This will lead to a reduction in its intrinsic value over time.
e. The decision not to risk adjust means that the company will accept too many projects in the manufacturing business and too few projects in the data processing business. This may affect the firm’s capital structure but it will not affect its intrinsic value
5/24/13
Opening Offer: $7.00
Posted by: jane
Date Posted: 5/24/13 12:29 PM
Due Date: 5/24/13
Posted by: jane
Date Posted: 5/24/13 12:29 PM
Due Date: 5/24/13
1. Which of the following statements is CORRECT?
a. Put options give investors the right to buy a stock at a certain strike price before a specified date.
b. Call options give investors the right to sell a stock at a certain strike price before a specified date.
c. Options typically sell for less than their exercise value.
d. LEAPS are very short-term options that were created relatively recently and now trade in the market.
e. An option holder is not entitled to receive dividends unless he or she exercises their option before the stock goes ex dividend.
2. Which of the following statements is CORRECT?
a. If the underlying stock does not pay a dividend, it makes good economic sense to exercise a call option as soon as the stock’s price exceeds the strike price by about 10%, because this permits the option holder to lock in an immediate profit.
b. Call options generally sell at a price less than their exercise value.
c. If a stock becomes riskier (more volatile), call options on the stock are likely to decline in value.
d. Call options generally sell at prices above their exercise value, but for an in-the-money option, the greater the exercise value in relation to the strike price, the lower the premium on the option is likely to be.
e. Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.
3. Which of the following statements is CORRECT?
a. An option's value is determined by its exercise value, which is the market price of the stock less its striking price. Thus, an option can't sell for more than its exercise value.
b. As the stock’s price rises, the time value portion of an option on a stock increases because the difference between the price of the stock and the fixed strike price increases.
c. Issuing options provides companies with a low cost method of raising capital.
d. The market value of an option depends in part on the option's time to maturity and also on the variability of the underlying stock's price.
e. The potential loss on an option decreases as the option sells at higher and higher prices because the profit margin gets bigger.
4. The current price of a stock is $22, and at the end of one year its price will be either $27 or $17. The annual risk-free rate is 6.0%, based on daily compounding. A 1-year call option on the stock, with an exercise price of $22, is available. Based on the binominal model, what is the option's value?
a. $2.43
b. $2.70
c. $2.99
d. $3.29
e. $3.62
5. An analyst wants to use the Black-Scholes model to value call options on the stock of Ledbetter Inc. based on the following data:
The price of the stock is $40.
The strike price of the option is $40.
The option matures in 3 months (t = 0.25).
The standard deviation of the stock’s returns is 0.40, and the variance is 0.16.
The risk-free rate is 6%.
Given this information, the analyst then calculated the following necessary components of the Black-Scholes model:
d1 = 0.175
d2 = -0.025
N(d1) = 0.56946
N(d2) = 0.49003
N(d1) and N(d2) represent areas under a standard normal distribution function. Using the Black- Scholes model, what is the value of the call option?
a. $2.81
b. $3.12
c. $3.47
d. $3.82
e. $4.20
5/24/13
Opening Offer: $7.00
Posted by: jane
Date Posted: 5/24/13 12:26 PM
Due Date: 5/24/13
Posted by: jane
Date Posted: 5/24/13 12:26 PM
Due Date: 5/24/13
1. Which of the following statements is CORRECT?
a. The constant growth model takes into consideration the capital gains investors expect to earn on a stock.
b. Two firms with the same expected dividend and growth rates must also have the same stock price.
c. It is appropriate to use the constant growth model to estimate a stock's value even if its growth rate is never expected to become constant.
d. If a stock has a required rate of return rs = 12%, and if its dividend is expected to grow at a constant rate of 5%, this implies that the stock’s dividend yield is also 5%.
e. The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.
2. Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
A B
Price $25 $25
Expected growth (constant) 10% 5%
Required return 15% 15%
a. Stock A's expected dividend at t = 1 is only half that of Stock B.
b. Stock A has a higher dividend yield than Stock B.
c. Currently the two stocks have the same price, but over time Stock B's price will pass that of A.
d. Since Stock A’s growth rate is twice that of Stock B, Stock A’s future dividends will always be twice as high as Stock B’s.
e. The two stocks should not sell at the same price. If their prices are equal, then a disequilibrium must exist.
3. Which of the following statements is CORRECT?
a. A major disadvantage of financing with preferred stock is that preferred stockholders typically have supernormal voting rights.
b. Preferred stock is normally expected to provide steadier, more reliable income to investors than the same firm’s common stock, and, as a result, the expected after-tax yield on the preferred is lower than the after-tax expected return on the common stock.
c. The preemptive right is a provision in all corporate charters that gives preferred stockholders the right to purchase (on a pro rata basis) new issues of preferred stock.
d. One of the disadvantages to a corporation of owning preferred stock is that 70% of the dividends received represent taxable income to the corporate recipient, whereas interest income earned on bonds would be tax free.
e. One of the advantages to financing with preferred stock is that 70% of the dividends paid out are tax deductible to the issuer.
4. Church Inc. is presently enjoying relatively high growth because of a surge in the demand for its new product. Management expects earnings and dividends to grow at a rate of 25% for the next 4 years, after which competition will probably reduce the growth rate in earnings and dividends to zero, i.e., g = 0. The company’s last dividend, D0, was $1.25, its beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is 3.00%. What is the current price of the common stock?
a. $26.77
b. $27.89
c. $29.05
d. $30.21
e. $31.42
5. Your boss, Sally Maloney, treasurer of Fred Clark Enterprises (FCE), asked you to help her estimate the intrinsic value of the company's stock. FCE just paid a dividend of $1.00, and the stock now sells for $15.00 per share. Sally asked a number of security analysts what they believe FCE's future dividends will be, based on their analysis of the company. The consensus is that the dividend will be increased by 10% during Years 1 to 3, and it will be increased at a rate of 5% per year in Year 4 and thereafter. Sally asked you to use that information to estimate the required rate of return on the stock, rs, and she provided you with the following template for use in the analysis.
Sally told you that the growth rates in the template were just put in as a trial, and that you must replace them with the analysts' forecasted rates to get the correct forecasted dividends and then the estimated TV. She also notes that the estimated value for rs, at the top of the template, is also just a guess, and you must replace it with a value that will cause the Calculated Price shown at the bottom to equal the Actual Market Price. She suggests that, after you have put in the correct dividends, you can manually calculate the price, using a series of guesses as to the Estimated rs. The value of rs that causes the calculated price to equal the actual price is the correct one. She notes, though, that this trial-and-error process would be quite tedious, and that the correct rs could be found much faster with a simple Excel model, especially if you use Goal Seek. What is the value of rs?
a. 11.84%
b. 12.21%
c. 12.58%
d. 12.97%
e. 13.36%
5/24/13
Opening Offer: $7.00
Posted by: jane
Date Posted: 5/24/13 12:21 PM
Due Date: 5/24/13
Posted by: jane
Date Posted: 5/24/13 12:21 PM
Due Date: 5/24/13
1. Which of the following statements is CORRECT?
a. If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.
b. If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest an equal amount of money in each stock in the market. That is, if there were 10,000 traded stocks in the world, the least risky possible portfolio would include some shares of each one.
c. If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market.
d. Market risk can be eliminated by forming a large portfolio, and if some Treasury bonds are held in the portfolio, the portfolio can be made to be completely riskless.
e. A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate.
2. Jane has a portfolio of 20 average stocks, and Dick has a portfolio of 2 average stocks. Assuming the market is in equilibrium, which of the following statements is CORRECT?
a. Jane's portfolio will have less diversifiable risk and also less market risk than Dick's portfolio.
b. The required return on Jane's portfolio will be lower than that on Dick's portfolio because Jane's portfolio will have less total risk.
c. Dick's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Jane's portfolio, but the required (and expected) returns will be the same on both portfolios.
d. If the two portfolios have the same beta, their required returns will be the same, but Jane's portfolio will have less market risk than Dick's.
e. The expected return on Jane's portfolio must be lower than the expected return on Dick's portfolio because Jane is more diversified.
3. Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock's returns is 20%. The stocks' returns are independent of each other, i.e., the correlation coefficient, r, between them is zero. Portfolio P consists of 50% X and 50% Y. Given this information, which of the following statements is CORRECT?
a. Portfolio P has a standard deviation of 20%.
b. The required return on Portfolio P is equal to the market risk premium (rM − rRF).
c. Portfolio P has a beta of 0.7.
d. Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF.
e. Portfolio P has the same required return as the market (rM).
4. Which of the following statements is CORRECT?
a. When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market.
b. Portfolio diversification reduces the variability of returns on an individual stock.
c. Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihoods of unfavorable events.
d. The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs.
e. A stock with a beta of -1.0 has zero market risk if held in a 1-stock portfolio.
5. Which of the following statements is CORRECT?
a. If Mutual Fund A held equal amounts of 100 stocks, each of which had a beta of 1.0, and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0, then the two mutual funds would both have betas of 1.0. Thus, they would be equally risky from an investor's standpoint, assuming the investor's only asset is one or the other of the mutual funds.
b. If investors become more risk averse but rRF does not change, then the required rate of return on high-beta stocks will rise and the required return on low-beta stocks will decline, but the required return on an average-risk stock will not change.
c. An investor who holds just one stock will generally be exposed to more risk than an investor who holds a portfolio of stocks, assuming the stocks are all equally risky. Since the holder of the 1-stock portfolio is exposed to more risk, he or she can expect to earn a higher rate of return to compensate for the greater risk.
d. There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML.
e. Assume that the required rate of return on the market, rM, is given and fixed at 10%. If the yield curve were upward sloping, then the Security Market Line (SML) would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF.
5/23/13
Opening Offer: $7.00
Posted by: jane
Date Posted: 5/23/13 12:13 PM
Due Date: 5/23/13
Posted by: jane
Date Posted: 5/23/13 12:13 PM
Due Date: 5/23/13
1 . Three $1,000 face value bonds that mature in 10 years have the same level of risk, hence their YTMs are equal. Bond A has an 8% annual coupon, Bond B has a 10% annual coupon, and Bond C has a 12% annual coupon. Bond B sells at par. Assuming interest rates remain constant for the next 10 years, which of the following statements is CORRECT?
a. Bond A’s current yield will increase each year.
b. Since the bonds have the same YTM, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until maturity.
c. Bond C sells at a premium (its price is greater than par), and its price is expected to increase over the next year.
d. Bond A sells at a discount (its price is less than par), and its price is expected to increase over the next year.
e. Over the next year, Bond A’s price is expected to decrease, Bond B’s price is expected to stay the same, and Bond C’s price is expected to increase.
2. Which of the following statements is CORRECT?
a. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is below the coupon rate than if it is above the coupon rate.
b. A callable 10-year, 10% bond should sell at a higher price than an otherwise similar noncallable bond.
c. Corporate treasurers dislike issuing callable bonds because these bonds may require the company to raise additional funds earlier than would be true if noncallable bonds with the same maturity were used.
d. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is above the coupon rate than if it is below the coupon rate.
e. The actual life of a callable bond will always be equal to or less than the actual life of a noncallable bond with the same maturity. Therefore, if the yield curve is upward sloping, the required rate of return will be lower on the callable bond.
3. Which of the following statements is CORRECT?
a. Assume that two bonds have equal maturities and are of equal risk, but one bond sells at par while the other sells at a premium above par. The premium bond must have a lower current yield and a higher capital gains yield than the par bond.
b. A bond’s current yield must always be either equal to its yield to maturity or between its yield to maturity and its coupon rate.
c. If a bond sells at par, then its current yield will be less than its yield to maturity.
d. If a bond sells for less than par, then its yield to maturity is less than its coupon rate.
e. A discount bond’s price declines each year until it matures, when its value equals its par value.
4. Suppose a new company decides to raise a total of $200 million, with $100 million as common equity and $100 million as long-term debt. The debt can be mortgage bonds or debentures, but by an iron-clad provision in its charter, the company can never raise any additional debt beyond the original $100 million. Given these conditions, which of the following statements is CORRECT?
a. The higher the percentage of debt represented by mortgage bonds, the riskier both types of bonds will be and, consequently, the higher the firm’s total dollar interest charges will be.
b. If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds, we could be certain that the firm’s total interest expense would be lower than if the debt were raised by issuing $100 million of debentures.
c. In this situation, we cannot tell for sure how, or whether, the firm’s total interest expense on the $100 million of debt would be affected by the mix of debentures versus first mortgage bonds. The interest rate on each of the two types of bonds would increase as the percentage of mortgage bonds used was increased, but the result might well be such that the firm’s total interest charges would not be affected materially by the mix between the two.
d. The higher the percentage of debentures, the greater the risk borne by each debenture, and thus the higher the required rate of return on the debentures.
e. If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds, we could be certain that the firm’s total interest expense would be lower than if the debt were raised by issuing $100 million of first mortgage bonds.
5. Cosmic Communications Inc. is planning two new issues of 25-year bonds. Bond Par will be sold at its $1,000 par value, and it will have a 10% semiannual coupon. Bond OID will be an Original Issue Discount bond, and it will also have a 25-year maturity and a $1,000 par value, but its semiannual coupon will be only 6.25%. If both bonds are to provide investors with the same effective yield, how many of the OID bonds must Cosmic issue to raise $3,000,000? Disregard flotation costs, and round your final answer up to a whole number of bonds.
a. 4,228
b. 4,337
c. 4,448
d. 4,562
e. 4,676
5/23/13
Opening Offer: $7.00
Posted by: jane
Date Posted: 5/23/13 12:11 PM
Due Date: 5/23/13
Posted by: jane
Date Posted: 5/23/13 12:11 PM
Due Date: 5/23/13
1. A $50,000 loan is to be amortized over 7 years, with annual end-of-year payments.1. A $50,000 loan is to be amortized over 7 years, with annual end-of-year payments. Which of these statements is CORRECT?
a. The annual payments would be larger if the interest rate were lower.
b. If the loan were amortized over 10 years rather than 7 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 7-year amortization plan.
c. The proportion of each payment that represents interest as opposed to repayment of principal would be lower if the interest rate were lower.
d. The last payment would have a higher proportion of interest than the first payment.
e. The proportion of interest versus principal repayment would be the same for each of the 7 payments.
2. Which of the following statements is CORRECT?
a. If you have a series of cash flows, each of which is positive, you can solve for I, where the solution value of I causes the PV of the cash flows to equal the cash flow at Time 0.
b. If you have a series of cash flows, and CF0 is negative but each of the following CFs is positive, you can solve for I, but only if the sum of the undiscounted cash flows exceeds the cost.
c. To solve for I, one must identify the value of I that causes the PV of the positive CFs to equal the absolute value of the PV of the negative CFs. This is, essentially, a trial-and-error procedure that is easy with a computer or financial calculator but quite difficult otherwise.
d. If you solve for I and get a negative number, then you must have made a mistake.
e. If CF0 is positive and all the other CFs are negative, then you cannot solve for I.
3. Riverside Bank offers to lend you $50,000 at a nominal rate of 6.5%, compounded monthly. The loan (principal plus interest) must be repaid at the end of the year. Midwest Bank also offers to lend you the $50,000, but it will charge an annual rate of 7.0%, with no interest due until the end of the year. How much higher or lower is the effective annual rate charged by Midwest versus the rate charged by Riverside?
a. 0.52%
b. 0.44%
c. 0.36%
d. 0.30%
e. 0.24%
4. Steve and Ed are cousins who were both born on the same day, and both turned 25 today. Their grandfather began putting $2,500 per year into a trust fund for Steve on his 20th birthday, and he just made a 6th payment into the fund. The grandfather (or his estate's trustee) will make 40 more $2,500 payments until a 46th and final payment is made on Steve's 65th birthday. The grandfather set things up this way because he wants Steve to work, not be a "trust fund baby," but he also wants to ensure that Steve is provided for in his old age.
Until now, the grandfather has been disappointed with Ed, hence has not given him anything. However, they recently reconciled, and the grandfather decided to make an equivalent provision for Ed. He will make the first payment to a trust for Ed today, and he has instructed his trustee to make 40 additional equal annual payments until Ed turns 65, when the 41st and final payment will be made. If both trusts earn an annual return of 8%, how much must the grandfather put into Ed's trust today and each subsequent year to enable him to have the same retirement nest egg as Steve after the last payment is made on their 65th birthday?
a. $3,726
b. $3,912
c. $4,107
d. $4,313
e. $4,528
5. John and Daphne are saving for their daughter Ellen's college education. Ellen just turned 10 at (t = 0), and she will be entering college 8 years from now (at t = 8). College tuition and expenses at State U. are currently $14,500 a year, but they are expected to increase at a rate of 3.5% a year. Ellen should graduate in 4 years--if she takes longer or wants to go to graduate school, she will be on her own. Tuition and other costs will be due at the beginning of each school year (at t = 8, 9, 10, and 11).
So far, John and Daphne have accumulated $15,000 in their college savings account (at t = 0). Their long-run financial plan is to add an additional $5,000 in each of the next 4 years (at t = 1, 2, 3, and 4). Then they plan to make 3 equal annual contributions in each of the following years, t = 5, 6, and 7. They expect their investment account to earn 9%. How large must the annual payments at t = 5, 6, and 7 be to cover Ellen's anticipated college costs?
a. $1,965.21
b. $2,068.64
c. $2,177.51
d. $2,292.12
e. $2,412.76
5/23/13
Opening Offer: $7.00
Posted by: jane
Date Posted: 5/23/13 12:08 PM
Due Date: 5/23/13
Posted by: jane
Date Posted: 5/23/13 12:08 PM
Due Date: 5/23/13
1. Which of the following statements is CORRECT?
a. The ratio of long-term debt to total capital is more likely to experience seasonal fluctuations than is either the DSO or the inventory turnover ratio.
b. If two firms have the same ROA, the firm with the most debt can be expected to have the lower ROE.
c. An increase in the DSO, other things held constant, could be expected to increase the total assets turnover ratio.
d. An increase in the DSO, other things held constant, could be expected to increase the ROE.
e. An increase in a firm’s debt ratio, with no changes in its sales or operating costs, could be expected to lower the profit margin.
2. Companies HD and LD have the same tax rate, sales, total assets, and basic earning power. Both companies have positive net incomes. Company HD has a higher debt ratio and, therefore, a higher interest expense. Which of the following statements is CORRECT?
a. Company HD has a lower equity multiplier.
b. Company HD has more net income.
c. Company HD pays more in taxes.
d. Company HD has a lower ROE.
e. Company HD has a lower times interest earned (TIE) ratio.
3. Companies HD and LD have the same total assets, sales, operating costs, and tax rates, and they pay the same interest rate on their debt. However, company HD has a higher debt ratio. Which of the following statements is CORRECT?
a. Given this information, LD must have the higher ROE.
b. Company LD has a higher basic earning power ratio (BEP).
c. Company HD has a higher basic earning power ratio (BEP).
d. If the interest rate the companies pay on their debt is more than their basic earning power (BEP), then Company HD will have the higher ROE.
e. If the interest rate the companies pay on their debt is less than their basic earning power (BEP), then Company HD will have the higher ROE.
4. Muscarella Inc. has the following balance sheet and income statement data:
Cash $ 14,000 Accounts payable $ 42,000
Receivables 70,000 Other current liabilities 28,000
Inventories 210,000 Total CL $ 70,000
Total CA $294,000 Long-term debt 70,000
Net fixed assets 126,000 Common equity 280,000
Total assets $420,000 Total liab. and equity $420,000
Sales $280,000
Net income $ 21,000
The new CFO thinks that inventories are excessive and could be lowered sufficiently to cause the current ratio to equal the industry average, 2.70, without affecting either sales or net income. Assuming that inventories are sold off and not replaced to get the current ratio to the target level, and that the funds generated are used to buy back common stock at book value, by how much would the ROE change?
a. 4.28%
b. 4.50%
c. 4.73%
d. 4.96%
e. 5.21%
5. Quigley Inc. is considering two financial plans for the coming year. Management expects sales to be $301,770, operating costs to be $266,545, assets to be $200,000, and its tax rate to be 35%. Under Plan A it would use 25% debt and 75% common equity. The interest rate on the debt would be 8.8%, but the TIE ratio would have to be kept at 4.00 or more. Under Plan B the maximum debt that met the TIE constraint would be employed. Assuming that sales, operating costs, assets, the interest rate, and the tax rate would all remain constant, by how much would the ROE change in response to the change in the capital structure?
a. 3.83%
b. 4.02%
c. 4.22%
d. 4.43%
e. 4.65%
5/23/13
Opening Offer: $7.00
Posted by: jane
Date Posted: 5/23/13 12:06 PM
Due Date: 5/23/13
Posted by: jane
Date Posted: 5/23/13 12:06 PM
Due Date: 5/23/13
1. Which of the following statements is CORRECT?
a. Typically, a firm’s DPS should exceed its EPS.
b. Typically, a firm’s EBIT should exceed its EBITDA.
c. If a firm is more profitable than average (e.g., Google), we would normally expect to see its stock price exceed its book value per share.
d. If a firm is more profitable than most other firms, we would normally expect to see its book value per share exceed its stock price, especially after several years of high inflation.
e. The more depreciation a firm has in a given year, the higher its EPS, other things held constant.
2. Which of the following statements is CORRECT?
a. The statement of cash flows reflects cash flows from operations, but it does not reflect the effects of buying or selling fixed assets.
b. The statement of cash flows shows where the firm’s cash is located; indeed, it provides a listing of all banks and brokerage houses where cash is on deposit.
c. The statement of cash flows reflects cash flows from continuing operations, but it does not reflect the effects of changes in working capital.
d. The statement of cash flows reflects cash flows from operations and from borrowings, but it does not reflect cash obtained by selling new common stock.
e. The statement of cash flows shows how much the firm’s cash--the total of currency, bank deposits, and short-term liquid securities (or cash equivalents)--increased or decreased during a given year.
3. Which of the following statements is CORRECT?
a. Dividends paid reduce the net income that is reported on a company’s income statement.
b. If a company uses some of its bank deposits to buy short-term, highly liquid marketable securities, this will cause a decline in its current assets as shown on the balance sheet.
c. If a company issues new long-term bonds during the current year, this will increase its reported current liabilities at the end of the year.
d. Accounts receivable are reported as a current liability on the balance sheet.
e. If a company pays more in dividends than it generates in net income, its retained. earnings as reported on the balance sheet will decline from the previous year's balance.
4. Last year Roussakis Company’s operations provided a negative net cash flow, yet the cash shown on its balance sheet increased. Which of the following statements could explain the increase in cash, assuming the company’s financial statements were prepared under generally accepted accounting principles?
a. The company repurchased some of its common stock.
b. The company dramatically increased its capital expenditures.
c. The company retired a large amount of its long-term debt.
d. The company sold some of its fixed assets.
e. The company had high depreciation expenses.
5. Bartling Energy Systems recently reported $9,250 of sales, $5,750 of operating costs other than depreciation, and $700 of depreciation. The company had no amortization charges, it had $3,200 of outstanding bonds that carry a 5% interest rate, and its federal-plus-state income tax rate was 35%. In order to sustain its operations and thus generate sales and cash flows in the future, the firm was required to make $1,250 of capital expenditures on new fixed assets and to invest $300 in net operating working capital. By how much did the firm's net income exceed its free cash flow?
a. $673.27
b. $708.70
c. $746.00
d. $783.30
e. $822.47
5/23/13
Opening Offer: $7.00
Posted by: jane
Date Posted: 5/23/13 12:03 PM
Due Date: 5/23/13
Posted by: jane
Date Posted: 5/23/13 12:03 PM
Due Date: 5/23/13
1. Which of the following statements is CORRECT?
a. One of the disadvantages of a sole proprietorship is that the proprietor is exposed to unlimited liability.
b. It is generally easier to transfer one’s ownership interest in a partnership than in a corporation.
c. One of the advantages of the corporate form of organization is that it avoids double taxation.
d. One of the advantages of a corporation from a social standpoint is that every stockholder has equal voting rights, i.e., “one person, one vote.”
e. Corporations of all types are subject to the corporate income tax.
2. Which of the following would be most likely to lead to higher interest rates on all debt securities in the economy?
a. Households start saving a larger percentage of their income.
b. The economy moves from a boom to a recession.
c. The level of inflation begins to decline.
d. Corporations step up their expansion plans and thus increase their demand for capital.
e. The Federal Reserve uses monetary policy in an attempt to stimulate the economy.
3. Which of the following statements is CORRECT?
a. If General Electric were to issue new stock this year it would be considered a secondary market transaction since the company already has stock outstanding.
b. Capital market transactions only include preferred stock and common stock transactions.
c. The distinguishing feature between spot markets versus futures markets transactions is the maturity of the investments. That is, spot market transactions involve securities that have maturities of less than one year, whereas futures markets transactions involve securities with maturities greater than one year.
d. Both Nasdaq "dealers" and NYSE “specialists” hold inventories of stocks.
e. An electronic communications network (ECN) is a physical location exchange.
4. Which of the following statements is CORRECT?
a. A good goal for a firm’s management is maximization of expected EPS.
b. Most business in the U.S. is conducted by corporations, and corporations’ popularity results primarily from their favorable tax treatment.
c. Because most stock ownership is concentrated in the hands of a relatively small segment of society, firms' actions to maximize their stock prices have little benefit to society.
d. Corporations and partnerships have an advantage over proprietorships because a sole proprietor is exposed to unlimited liability, but the liability of all investors in the other types of businesses is more limited.
e. The potential exists for agency conflicts between stockholders and managers.
5. Which of the following statements is NOT CORRECT?
a. When a corporation’s shares are owned by a few individuals and are not traded on public markets, we say that the firm is “closely, or privately, held."
b. “Going public” establishes a firm's true intrinsic value, and it also insures that a highly liquid market will always exist for the firm’s shares.
c. When stock in a closely held corporation is offered to the public for the first time, the transaction is called “going public,” and the market for such stock is called the new issue market.
d. Publicly owned companies have shares owned by investors who are not associated with management, and public companies must register with and report to a regulatory agency such as the SEC.
e. It is possible for a firm to go public and yet not raise any additional new capital at the time.
5/22/13
Opening Offer: $15.00
Posted by: jane
Date Posted: 5/22/13 3:51 PM
Due Date: 5/22/13
Posted by: jane
Date Posted: 5/22/13 3:51 PM
Due Date: 5/22/13
Question 1 2 out of 2 points
Suppose 6 months ago a Swiss investor bought a 6-month U.S. Treasury bill at a price of $9,708.74, with a maturity value of $10,000. The exchange rate at that time was 1.420 Swiss francs per dollar. Today, at maturity, the exchange rate is 1.324 Swiss francs per dollar. What is the annualized rate of return to the Swiss investor?
Question 2 2 out of 2 points
Suppose hockey skates sell in Canada for 105 Canadian dollars, and 1 Canadian dollar equals 0.71 U.S. dollars. If purchasing power parity (PPP) holds, what is the price of hockey skates in the United States?
Question 3 2 out of 2 points
A box of candy costs 28.80 Swiss francs in Switzerland and $20 in the United States. Assuming that purchasing power parity (PPP) holds, what is the current exchange rate?
Question 4 2 out of 2 points
Which of the following statements is NOT CORRECT?
Question 5 2 out of 2 points
Suppose a foreign investor who holds tax-exempt Eurobonds paying 9% is considering investing in an equivalent-risk domestic bond in a country with a 28% withholding tax on interest paid to foreigners. If 9% after-tax is the investor's required return, what before-tax rate would the domestic bond need to pay to provide the required after-tax return?
Question 6 2 out of 2 points
If the inflation rate in the United States is greater than the inflation rate in Britain, other things held constant, the British pound will
Question 7 2 out of 2 points
If one Swiss franc can purchase $0.71 U.S. dollars, how many Swiss francs can one U.S. dollar buy?
Question 8 2 out of 2 points
Suppose 90-day investments in Britain have a 6% annualized return and a 1.5% quarterly (90-day) return. In the U.S., 90-day investments of similar risk have a 4% annualized return and a 1% quarterly (90-day) return. In the 90day forward market, 1 British pound equals $1.65. If interest rate holds, what parity is the spot exchange rate?
Question 9 2 out of 2 points
If one U.S. dollar buys 1.64 Canadian dollars, how many U.S. dollars can you purchase for one Canadian dollar?
Question 10 2 out of 2 points
Suppose one year ago, Hein Company had inventory in Britain valued at 240,000 pounds. The exchange rate for dollars to pounds was 1 = 2 U.S. dollars. This year the exchange rate is 1 = 1.82 U.S. dollars. The inventory in Britain is still valued at 240,000 pounds. What is the gain or loss in inventory value in U.S. dollars as a result of the change in exchange rates?
Question 11 2 out of 2 points
Suppose 144 yen could be purchased in the foreign exchange market for one U.S. dollar today. If the yen depreciates by 8.0% tomorrow, how many yen could one U.S. dollar buy tomorrow?
Question 12 2 out of 2 points
Suppose the exchange rate between U.S. dollars and Swiss francs is SF 1.41 = $1.00, and the exchange rate between the U.S. dollar and the euro is $1.00 = 1.64 euros. What is the cross-rate of Swiss francs to euros?
Question 13 2 out of 2 points
Suppose in the spot market 1 U.S. dollar equals 1.60 Canadian dollars. 6-month Canadian securities have an annualized return of 6% (and thus a 6-month periodic return of 3%). 6month U.S. securities have an annualized return of 6.5% and a periodic return of 3.25%. If interest rate parity holds, what is the U.S. dollar-Canadian dollar exchange rate in the 180-day forward market?
Question 14 2 out of 2 points
Suppose one British pound can purchase 1.82 U.S. dollars today in the foreign exchange market, and currency forecasters predict that the U.S. dollar will depreciate by 12.0% against the pound over the next 30 days. How many dollars will a pound buy in 30 days?
Question 15 2 out of 2 points
Suppose that currently, 1 British pound equals 1.62 U.S. dollars and 1 U.S. dollar equals 1.62 Swiss francs. What is the cross exchange rate between the pound and the franc?
5/22/13
Opening Offer: $15.00
Posted by: jane
Date Posted: 5/22/13 3:47 PM
Due Date: 5/22/13
Posted by: jane
Date Posted: 5/22/13 3:47 PM
Due Date: 5/22/13
1. Which of the following statement completions is CORRECT? If the yield curve is upward sloping, then the marketable securities held in a firm's portfolio, assumed to be held for emergencies, should
Answer
consist mainly of long-term securities because they pay higher rates.
consist mainly of short-term securities because they pay higher rates.
consist mainly of U.S. Treasury securities to minimize interest rate risk.
consist mainly of short-term securities to minimize interest rate risk.
be balanced between long- and short-term securities to minimize the adverse effects of either an upward or a downward trend in interest rates.
2 points
Question 2
A lockbox plan is most beneficial to firms that
have suppliers who operate in many different parts of the country.
have widely dispersed manufacturing facilities.
have a large marketable securities portfolio and cash to protect.
receive payments in the form of currency, such as fast food restaurants, rather than in the form of checks.
have customers who operate in many different parts of the country.
2 points
Question 3
Which of the following actions would be likely to shorten the cash conversion cycle?
Adopt a new manufacturing process that speeds up the conversion of raw materials to finished goods from 20 days to 10 days.
Change the credit terms offered to customers from 3/10 net 30 to 1/10 net 50.
Begin to take discounts on inventory purchases; we buy on terms of 2/10 net 30.
Adopt a new manufacturing process that saves some labor costs but slows down the conversion of raw materials to finished goods from 10 days to 20 days.
Change the credit terms offered to customers from 2/10 net 30 to 1/10 net 60.
2 points
Question 4
Which of the following statements is CORRECT?
Other things held constant, the higher a firm's days sales outstanding (DSO), the better its credit department.
If a firm that sells on terms of net 30 changes its policy to 2/10 net 30, and if no change in sales volume occurs, then the firm's DSO will probably increase.
If a firm sells on terms of 2/10 net 30, and its DSO is 30 days, then the firm probably has some past-due accounts.
If a firm sells on terms of net 60, and if its sales are highly seasonal, with a sharp peak in December, then its DSO as it is typically calculated (with sales per day = Sales for past 12 months/365) would probably be lower in January than in July.
If a firm changed the credit terms offered to its customers from 2/10 net 30 to 2/10 net 60, then its sales should increase, and this should lead to an increase in sales per day, and that should lead to a decrease in the DSO.
2 points
Question 5
Which of the following statements is NOT CORRECT?
A company may hold a relatively large amount of cash and marketable securities if it is uncertain about its volume of sales, profits, and cash flows during the coming year.
Credit policy has an impact on working capital because it influences both sales and the time before receivables are collected.
The cash budget is useful to help estimate future financing needs, especially the need for short-term working capital loans.
If a firm wants to generate more cash flow from operations in the next month or two, it could change its credit policy from 2/10 net 30 to net 60.
Managing working capital is important because it influences financing decisions and the firm's profitability.
2 points
Question 6
Which of the following statements is CORRECT?
Net working capital is defined as current assets minus the sum of payables and accruals, and any increase in the current ratio automatically indicates that net working capital has increased.
Although short-term interest rates have historically averaged less than long-term rates, the heavy use of short-term debt is considered to be an aggressive strategy because of the inherent risks associated with using short-term financing.
If a company follows a policy of "matching maturities," this means that it matches its use of common stock with its use of long-term debt as opposed to short-term debt.
Net working capital is defined as current assets minus the sum of payables and accruals, and any decrease in the current ratio automatically indicates that net working capital has decreased.
If a company follows a policy of "matching maturities," this means that it matches its use of short-term debt with its use of long-term debt.
2 points
Question 7
Other things held constant, which of the following will cause an increase in net working capital?
Cash is used to buy marketable securities.
A cash dividend is declared and paid.
Merchandise is sold at a profit, but the sale is on credit.
Long-term bonds are retired with the proceeds of a preferred stock issue.
Missing inventory is written off against retained earnings.
2 points
Question 8
Which of the following statements is CORRECT?
Accruals are an expensive but commonly used way to finance working capital.
A conservative financing policy is one where the firm finances part of its fixed assets with short-term capital and all of its net working capital with short-term funds.
If a company receives trade credit under terms of 2/10 net 30, this implies that the company has 10 days of free trade credit.
One cannot tell if a firm has a conservative, aggressive, or moderate current asset financing policy without an examination of its cash budget.
If a firm has a relatively aggressive current asset financing policy vis-à-vis other firms in its industry, then its current ratio will probably be relatively high.
2 points
Question 9
Which of the following statements is CORRECT?
Under normal conditions, a firm's expected ROE would probably be higher if it financed with short-term rather than with long-term debt, but using short-term debt would probably increase the firm's risk.
Conservative firms generally use no short-term debt and thus have zero current liabilities.
A short-term loan can usually be obtained more quickly than a long-term loan, but the cost of short-term debt is normally higher than that of long-term debt.
If a firm that can borrow from its bank at a 6% interest rate buys materials on terms of 2/10 net 30, and if it must pay by Day 30 or else be cut off, then we would expect to see zero accounts payable on its balance sheet.
If one of your firm's customers is "stretching" its accounts payable, this may be a nuisance but it will not have an adverse financial impact on your firm if the customer periodically pays off its entire balance.
2 points
Question 10
Which of the following statements is NOT CORRECT?
Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate.
Accruals are "free" in the sense that no explicit interest is paid on these funds.
A conservative approach to working capital management will result in most if not all permanent current operating assets being financed with long-term capital.
The risk to a firm that borrows with short-term credit is usually greater than if it borrowed using long-term debt. This added risk stems from the greater variability of interest costs on short-term debt and possible difficulties with rolling over short-term debt.
Bank loans generally carry a higher interest rate than commercial paper.
2 points
Question 11
Firms generally choose to finance temporary current operating assets with short-term debt because
Answer
matching the maturities of assets and liabilities reduces risk under some circumstances, and also because short-term debt is often less expensive than long-term capital.
short-term interest rates have traditionally been more stable than long-term interest rates.
a firm that borrows heavily on a long-term basis is more apt to be unable to repay the debt than a firm that borrows short term.
the yield curve is normally downward sloping.
short-term debt has a higher cost than equity capital.
2 points
Question 12
Which of the following statements is CORRECT?
Depreciation is included in the estimate of cash flows (Cash flow = Net income + Depreciation), hence depreciation is set forth on a separate line in the cash budget.
If cash inflows from collections occur in equal daily amounts but most payments must be made on the 10th of each month, then a regular monthly cash budget will be misleading. The problem can be corrected by using a daily cash budget.
Sound working capital policy is designed to maximize the time between cash expenditures on materials and the collection of cash on sales.
If a firm wants to generate more cash flow from operations in the next month or two, it could change its credit policy from 2/10 net 30 to net 60.
If a firm sells on terms of net 90, and if its sales are highly seasonal, with 80% of its sales in September, then its DSO as it is typically calculated (with sales per day = Sales for past 12 months/365) would probably be lower in October than in August.
2 points
Question 13
A lockbox plan is
used to protect cash, i.e., to keep it from being stolen.
used to identify inventory safety stocks.
used to slow down the collection of checks our firm writes.
used to speed up the collection of checks received.
used primarily by firms where currency is used frequently in transactions, such as fast food restaurants, and less frequently by firms that receive payments as checks.
2 points
Question 14
Which of the following statements is most consistent with efficient inventory management? The firm has a
below average inventory turnover ratio.
low incidence of production schedule disruptions.
below average total assets turnover ratio.
relatively high current ratio.
relatively low DSO.
2 points
Question 15
Other things held constant, which of the following would tend to reduce the cash conversion cycle?
Carry a constant amount of receivables as sales decline.
Place larger orders for raw materials to take advantage of price breaks.
Take all discounts that are offered.
Continue to take all discounts that are offered and pay on the net date.
Offer longer payment terms to customers.
5/22/13
Opening Offer: $22.99
Posted by: jane
Date Posted: 5/22/13 3:43 PM
Due Date: 5/22/13
Posted by: jane
Date Posted: 5/22/13 3:43 PM
Due Date: 5/22/13
.Question 1
Which of the following statements is correct?
Answer
One advantage of dividend reinvestment plans is that they enable investors to avoid paying taxes on the dividends they receive.
If a company has an established clientele of investors who prefer a high dividend payout, and if management wants to keep stockholders happy, it should not
follow the strict residual dividend policy.
If a firm follows a strict residual dividend policy, then, holding all else constant, its dividend payout ratio will tend to rise whenever the firm's investment opportunities improve.
If Congress eliminates taxes on capital gains but leaves the personal tax rate on dividends unchanged, this would motivate companies to increase their dividend payout ratios.
Despite its drawbacks, following the residual dividend policy will tend to stabilize actual cash dividends, and this will make it easier for firms to attract a clientele that prefers high dividends, such as retirees.
2 points
Question 2
In the real world, dividends
Answer
are usually more stable than earnings.
fluctuate more widely than earnings.
tend to be a lower percentage of earnings for mature firms.
are usually changed every year to reflect earnings changes, and these changes are randomly higher or lower, depending on whether earnings increased or decreased.
are usually set as a fixed percentage of earnings, e.g., at 40% of earnings, so if EPS = $2.00, then DPS will equal $0.80. Once the percentage is set, then dividend policy is on "automatic pilot" and the actual dividend depends strictly on earnings.
2 points
Question 3
Which of the following statements is correct?
Answer
Firms with a lot of good investment opportunities and a relatively small amount of cash tend to have above average payout ratios.
One advantage of the residual dividend policy is that it leads to a stable dividend payout, which investors like.
An increase in the stock price when a company decreases its dividend is consistent with signaling theory as postulated by MM.
If the "clientele effect" is correct, then for a company whose earnings fluctuate, a policy of paying a constant percentage of net income will probably maximize the stock price.
Stock repurchases make the most sense at times when a company believes its stock is undervalued.
2 points
Question 4
If a firm adheres strictly to the residual dividend policy, the issuance of new common stock would suggest that
Answer
the dividend payout ratio has remained constant.
the dividend payout ratio is increasing.
no dividends were paid during the year.
the dividend payout ratio is decreasing.
the dollar amount of investments has decreased.
2 points
Question 5
You own 100 shares of Troll Brothers' stock, which currently sells for $120 a share. The company is contemplating a 2-for-1 stock split. Which of the following best describes what your position will be after such a split takes place?
Answer
You will have 200 shares of stock, and the stock will trade at or near $120 a share.
You will have 200 shares of stock, and the stock will trade at or near $60 a share.
You will have 100 shares of stock, and the stock will trade at or near $60 a share.
You will have 50 shares of stock, and the stock will trade at or near $120 a share.
You will have 50 shares of stock, and the stock will trade at or near $60 a share.
2 points
Question 6
If a firm adheres strictly to the residual dividend policy, then if its optimal capital budget requires the use of all earnings for a given year (along with new debt according to the optimal debt/total assets ratio), then the firm should pay
Answer
no dividends except out of past retained earnings.
no dividends to common stockholders.
dividends only out of funds raised by the sale of new common stock.
dividends only out of funds raised by borrowing money (i.e., issue debt).
dividends only out of funds raised by selling off fixed assets.
2 points
Question 7
Which of the following statements is correct?
Answer
Under the tax laws as they existed in 2008, a dollar received for repurchased stock must be taxed at the same rate as a dollar received as dividends.
One nice feature of dividend reinvestment plans (DRIPs) is that they reduce the taxes investors would have to pay if they received cash dividends.
Empirical research indicates that, in general, companies send a negative signal to the marketplace when they announce an increase in the dividend, and as a result share prices fall when dividend increases are announced. The reason is that investors interpret the increase as a signal that the firm has relatively few good investment opportunities.
If a company wants to raise new equity capital rather steadily over time, a new stock dividend reinvestment plan would make sense. However, if the firm does not want or need new equity, then an open market purchase dividend reinvestment plan would probably make more sense.
Dividend reinvestment plans have not caught on in most industries, and today about 99% of all companies with DRIPs are utilities.
2 points
Question 8
Which of the following would be most likely to lead to a decrease in a firm's dividend payout ratio?
Answer
Its earnings become more stable.
Its access to the capital markets increases.
Its R&D efforts pay off, and it now has more high-return investment opportunities.
Its accounts receivable decrease due to a change in its credit policy.
Its stock price has increased over the last year by a greater percentage than the increase in the broad stock market averages.
2 points
Question 9
Firm M is a mature firm in a mature industry. Its annual net income and net cash flows are both consistently high and stable. However, M's growth prospects are quite limited, so its capital budget is small relative to its net income. Firm N is a relatively new firm in a new and growing industry. Its markets and products have not stabilized, so its annual operating income fluctuates considerably. However, N has substantial growth opportunities, and its capital budget is expected to be large relative to its net income for the foreseeable future. Which of the following statements is correct?
Answer
Firm M probably has a lower debt ratio than Firm N.
Firm M probably has a higher dividend payout ratio than Firm N.
If the corporate tax rate increases, the debt ratio of both firms is likely to decline.
The two firms are equally likely to pay high dividends.
Firm N is likely to have a clientele of shareholders who want to receive consistent, stable dividend income.
2 points
Question 10
Which of the following statements is correct?
Answer
One disadvantage of dividend reinvestment plans is that they increase transactions costs for investors who want to increase their ownership in the company.
One advantage of dividend reinvestment plans is that they enable investors to postpone paying taxes on the dividends credited to their account.
Stock repurchases can be used by a firm that wants to increase its debt ratio.
Stock repurchases make sense if a company expects to have a lot of profitable new projects to fund over the next few years, provided investors are aware of these investment opportunities.
One advantage of an open market dividend reinvestment plan is that it provides new equity capital and increases the shares outstanding.
2 points
Question 11
Which of the following should not influence a firm's dividend policy decision?
Answer
The firm's ability to accelerate or delay investment projects.
A strong preference by most shareholders for current cash income versus capital gains.
Constraints imposed by the firm's bond indenture.
The fact that much of the firm's equipment has been leased rather than bought and owned.
The fact that Congress is considering changes in the tax law regarding the taxation of dividends versus capital gains.
2 points
Question 12
Which of the following statements is correct?
Answer
If a firm repurchases some of its stock in the open market, then shareholders who sell their stock for more than they paid for it will be subject to capital gains taxes.
An open-market dividend reinvestment plan will be most attractive to companies that need new equity and would otherwise have to issue additional shares of common stock through investment bankers.
Stock repurchases tend to reduce financial leverage.
If a company declares a 2-for-1 stock split, its stock price should roughly double.
One advantage of adopting the residual dividend policy is that this makes it easier for corporations to meet the requirements of Modigliani and Miller's dividend clientele theory.
2 points
Question 13
Which of the following statements is NOT correct?
Answer
Stock repurchases can be used by a firm as part of a plan to change its capital structure.
After a 3-for-1 stock split, a company's price per share should fall, but the number of shares outstanding will rise.
Investors can interpret a stock repurchase program as a signal that the firm's managers believe the stock is undervalued.
Companies can repurchase shares to distribute large inflows of cash, say from the sale of a division, to stockholders without paying cash dividends.
Stockholders pay no income tax on dividends if the dividends are used to purchase stock through a dividend reinvestment plan.
2 points
Question 14
Which of the following actions will best enable a company to raise additional equity capital?
Answer
Refund long-term debt with lower cost short-term debt.
Declare a stock split.
Begin an open-market purchase dividend reinvestment plan.
Initiate a stock repurchase program.
Begin a new-stock dividend reinvestment plan.
2 points
Question 15
Which of the following statements is correct?
Answer
The tax code encourages companies to pay dividends rather than retain earnings.
If a company uses the residual dividend model to determine its dividend payments, dividends payout will tend to increase whenever its profitable investment opportunities increase.
The stronger management thinks the clientele effect is, the more likely the firm is to adopt a strict version of the residual dividend model.
Large stock repurchases financed by debt tend to increase earnings per share, but they also increase the firm's financial risk.
A dollar paid out to repurchase stock is taxed at the same rate as a dollar paid out in dividends. Thus, both companies and investors are indifferent between distributing cash through dividends and stock repurchase programs.
2 points
Question 16
Based on the information below, what is Ezzel Enterprises' optimal capital structure?
Answer
Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $26.50.
Debt = 50%; Equity = 50%; EPS = $3.05; Stock price = $28.90.
Debt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20.
Debt = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.40.
Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.00.
2 points
Question 17
Which of the following events is likely to encourage a company to raise its target debt ratio, other things held constant?
Answer
An increase in the corporate tax rate.
An increase in the personal tax rate.
An increase in the company's operating leverage.
The Federal Reserve tightens interest rates in an effort to fight inflation.
The company's stock price hits a new high.
2 points
Question 18
If debt financing is used, which of the following is CORRECT?
Answer
The percentage change in net operating income will be greater than a given percentage change in net income.
The percentage change in net operating income will be equal to a given percentage change in net income.
The percentage change in net income relative to the percentage change in net operating income will depend on the interest rate charged on debt.
The percentage change in net income will be greater than the percentage change in net operating income.
The percentage change in sales will be greater than the percentage change in EBIT, which in turn will be greater than the percentage change in net income.
2 points
Question 19
Which of the following statements is CORRECT? As a firm increases the operating leverage used to produce a given quantity of output, this will
Answer
normally lead to an increase in its fixed assets turnover ratio.
normally lead to a decrease in its business risk.
normally lead to a decrease in the standard deviation of its expected EBIT.
normally lead to a decrease in the variability of its expected EPS.
normally lead to a reduction in its fixed assets turnover ratio.
2 points
Question 20
Business risk is affected by a firm's operations. Which of the following is NOT associated with (or does not contribute to) business risk?
Answer
Demand variability.
Sales price variability.
The extent to which operating costs are fixed.
The extent to which interest rates on the firm's debt fluctuate.
Input price variability.
2 points
Question 21
Firms U and L each have the same amount of assets, and both have a basic earning power ratio of 20%. Firm U is unleveraged, i.e., it is 100% equity financed, while Firm L is financed with 50% debt and 50% equity. Firm L's debt has a before-tax cost of 8%. Both firms have positive net income. Which of the following statements is CORRECT?
Answer
The two companies have the same times interest earned (TIE) ratio.
Firm L has a lower ROA than Firm U.
Firm L has a lower ROE than Firm U.
Firm L has the higher times interest earned (TIE) ratio.
Firm L has a higher EBIT than Firm U.
2 points
Question 22
Which of the following statements is CORRECT, holding other things constant?
Answer
Firms whose assets are relatively liquid tend to have relatively low bankruptcy costs, hence they tend to use relatively little debt.
An increase in the personal tax rate is likely to increase the debt ratio of the average corporation.
If changes in the bankruptcy code make bankruptcy less costly to corporations, then this would likely reduce the debt ratio of the average corporation.
An increase in the company's degree of operating leverage is likely to encourage a company to use more debt in its capital structure.
An increase in the corporate tax rate is likely to encourage a company to use more debt in its capital structure.
2 points
Question 23
Which of the following statements is CORRECT?
Answer
Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its WACC.
Since debt financing is cheaper than equity financing, raising a company's debt ratio will always reduce its WACC.
Increasing a company's debt ratio will typically reduce the marginal cost of both debt and equity financing. However, this action still may raise the company's WACC.
Increasing a company's debt ratio will typically increase the marginal cost of both debt and equity financing. However, this action still may lower the company's WACC.
Since a firm's beta coefficient it not affected by its use of financial leverage, leverage does not affect the cost of equity.
2 points
Question 24
Volga Publishing is considering a proposed increase in its debt ratio, which would also increase the company's interest expense. The plan would involve issuing new bonds and using the proceeds to buy back shares of its common stock. The company's CFO thinks the plan will not change total assets or operating income, but that it will increase earnings per share (EPS). Assuming the CFO's estimates are correct, which of the following statements is CORRECT?
Answer
Since the proposed plan increases Volga's financial risk, the company's stock price still might fall even if EPS increases.
If the plan reduces the WACC, the stock price is also likely to decline.
Since the plan is expected to increase EPS, this implies that net income is also expected to increase.
If the plan does increase the EPS, the stock price will automatically increase at the same rate.
Under the plan there will be more bonds outstanding, and that will increase their liquidity and thus lower the interest rate on the currently outstanding bonds.
2 points
Question 25
The firm's target capital structure should be consistent with which of the following statements?
Answer
Maximize the earnings per share (EPS).
Minimize the cost of debt (rd).
Obtain the highest possible bond rating.
Minimize the cost of equity (rs).
Minimize the weighted average cost of capital (WACC).
2 points
Question 26
Which of the following statements is CORRECT?
Answer
If corporate tax rates were decreased while other things were held constant, and if the Modigliani-Miller tax-adjusted tradeoff theory of capital structure were correct, this would tend to cause corporations to decrease their use of debt.
A change in the personal tax rate should not affect firms' capital structure decisions.
"Business risk" is differentiated from "financial risk" by the fact that financial risk reflects only the use of debt, while business risk reflects both the use of debt and such factors as sales variability, cost variability, and operating leverage.
The optimal capital structure is the one that simultaneously (1) maximizes the price of the firm's stock, (2) minimizes its WACC, and (3) maximizes its EPS.
If changes in the bankruptcy code make bankruptcy less costly to corporations, then this would likely reduce the debt ratio of the average corporation.
2 points
Question 27
Companies HD and LD have identical tax rates, total assets, and basic earning power ratios, and their basic earning power exceeds their before-tax cost of debt, rd. However, Company HD has a higher debt ratio and thus more interest expense than Company LD. Which of the following statements is CORRECT?
Answer
Company HD has a higher net income than Company LD.
Company HD has a lower ROA than Company LD.
Company HD has a lower ROE than Company LD.
The two companies have the same ROA.
The two companies have the same ROE.
2 points
Question 28
Which of the following statements is CORRECT?
Answer
As a rule, the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS.
The optimal capital structure simultaneously maximizes EPS and minimizes the WACC.
The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price.
The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, and the WACC.
The optimal capital structure simultaneously maximizes stock price and minimizes the WACC.
2 points
Question 29
Which of the following would increase the likelihood that a company would increase its debt ratio, other things held constant?
Answer
An increase in costs incurred when filing for bankruptcy.
An increase in the corporate tax rate.
An increase in the personal tax rate.
The Federal Reserve tightens interest rates in an effort to fight inflation.
The company's stock price hits a new low.
2 points
Question 30
Which of the following statements is CORRECT?
Answer
The capital structure that maximizes expected EPS also maximizes the price per share of common stock.
The capital structure that minimizes the interest rate on debt also maximizes the expected EPS.
The capital structure that minimizes the required return on equity also maximizes the stock price.
The capital structure that minimizes the WACC also maximizes the price per share of common stock.
The capital structure that gives the firm the best credit rating also maximizes the stock price.
5/22/13
Opening Offer: $22.99
Posted by: jane
Date Posted: 5/22/13 3:39 PM
Due Date: 5/22/13
Posted by: jane
Date Posted: 5/22/13 3:39 PM
Due Date: 5/22/13
A company expects sales to increase during the coming year, and it is using the AFN equation to forecast the additional capital that it must raise. Which of the following conditions would cause the AFN to increase?
Answer
The company previously thought its fixed assets were being operated at full capacity, but now it learns that it actually has excess capacity.
The company increases its dividend payout ratio.
The company begins to pay employees monthly rather than weekly.
The company's profit margin increases.
The company decides to stop taking discounts on purchased materials.
Which of the following statements is CORRECT?
Answer
Once a firm has defined its purpose, scope, and objectives, it must develop a strategy or strategies for achieving its goals. The statement of corporate strategies sets forth detailed plans rather than broad approaches for achieving a firm's goals.
A firm's corporate purpose states the general philosophy of the business and provides managers with specific operational objectives.
Operating plans provide management with detailed implementation guidance, consistent with the corporate strategy, to help meet the corporate objectives. These operating plans can be developed for any time horizon, but many companies use a 5-year horizon.
A firm's mission statement defines its lines of business and geographic area of operations.
The corporate scope is a condensed version of the entire set of strategic plans.
Last year Wei Guan Inc. had $350 million of sales, and it had $270 million of fixed assets that were used at 65% of capacity. In millions, by how much could Wei Guan's sales increase before it is required to increase its fixed assets?
Answer
$170.09
$179.04
$188.46
$197.88
$207.78
Last year Godinho Corp. had $250 million of sales, and it had $75 million of fixed assets that were being operated at 80% of capacity. In millions, how large could sales have been if the company had operated at full capacity?
Answer
$312.5
$328.1
$344.5
$361.8
$379.8
The term "additional funds needed (AFN)" is generally defined as follows:
Answer
Funds that are obtained automatically from routine business transactions.
Funds that a firm must raise externally from non-spontaneous sources, i.e., by borrowing or by selling new stock to support operations.
The amount of assets required per dollar of sales.
The amount of internally generated cash in a given year minus the amount of cash needed to acquire the new assets needed to support growth.
A forecasting approach in which the forecasted percentage of sales for each balance sheet account is held constant.
Spontaneous funds are generally defined as follows:
Answer
Assets required per dollar of sales.
A forecasting approach in which the forecasted percentage of sales for each item is held constant.
Funds that a firm must raise externally through short-term or long-term borrowing and/or by selling new common or preferred stock.
Funds that arise out of normal business operations from its suppliers, employees, and the government, and they include immediate increases in accounts payable, accrued wages, and accrued taxes.
The amount of cash raised in a given year minus the amount of cash needed to finance the additional capital expenditures and working capital needed to support the firm's growth.
Which of the following statements is CORRECT?
Answer
Any forecast of financial requirements involves determining how much money the firm will need, and this need is determined by adding together increases in assets and spontaneous liabilities and then subtracting operating income.
The AFN equation for forecasting funds requirements requires only a forecast of the firm's balance sheet. Although a forecasted income statement may help clarify the results, income statement data are not essential because funds needed relate only to the balance sheet.
Dividends are paid with cash taken from the accumulated retained earnings account, hence dividend policy does not affect the AFN forecast.
A negative AFN indicates that retained earnings and spontaneous liabilities are far more than sufficient to finance the additional assets needed.
If the ratios of assets to sales and spontaneous liabilities to sales do not remain constant, then the AFN equation will provide more accurate forecasts than the forecasted financial statements method.
Jefferson City Computers has developed a forecasting model to estimate its AFN for the upcoming year. All else being equal, which of the following factors is most likely to lead to an increase of the additional funds needed (AFN)?
Answer
A sharp increase in its forecasted sales.
A switch to a just-in-time inventory system and outsourcing production.
The company reduces its dividend payout ratio.
The company switches its materials purchases to a supplier that sells on terms of 1/5, net 90, from a supplier whose terms are 3/15, net 35.
The company discovers that it has excess capacity in its fixed assets.
Which of the following is NOT a key element in strategic planning as it is described in the text?
Answer
The mission statement.
The statement of the corporation's scope.
The statement of cash flows.
The statement of corporate objectives.
The corporation's strategies.
Which of the following statements is CORRECT?
Answer
Since accounts payable and accrued liabilities must eventually be paid off, as these accounts increase, AFN as calculated by the AFN equation must also increase.
Suppose a firm is operating its fixed assets at below 100% of capacity, but it has no excess current assets. Based on the AFN equation, its AFN will be larger than if it had been operating with excess capacity in both fixed and current assets.
If a firm retains all of its earnings, then it cannot require any additional funds to support sales growth.
Additional funds needed (AFN) are typically raised using a combination of notes payable, long-term debt, and common stock. Such funds are non-spontaneous in the sense that they require explicit financing decisions to obtain them.
If a firm has a positive free cash flow, then it must have either a zero or a negative AFN.
Which of the following statements is CORRECT?
Answer
When we use the AFN equation, we assume that the ratios of assets and liabilities to sales (A0*/S0 and L0*/S0) vary from year to year in a stable, predictable manner.
When fixed assets are added in large, discrete units as a company grows, the assumption of constant ratios is more appropriate than if assets are relatively small and can be added in small increments as sales grow.
Firms whose fixed assets are "lumpy" frequently have excess capacity, and this should be accounted for in the financial forecasting process.
For a firm that uses lumpy assets, it is impossible to have small increases in sales without expanding fixed assets.
There are economies of scale in the use of many kinds of assets. When economies occur the ratios are likely to remain constant over time as the size of the firm increases. The Economic Ordering Quantity model for establishing inventory levels demonstrates this relationship.
Which of the following is NOT one of the steps taken in the financial planning process?
Answer
Forecast the funds that will be generated internally. If internal funds are insufficient to cover the required new investment, then identify sources from which the required external capital can be raised.
Monitor operations after implementing the plan to spot any deviations and then take corrective actions.
Determine the amount of capital that will be needed to support the plan.
Develop a set of forecasted financial statements under alternative versions of the operating plan in order to analyze the effects of different operating procedures on projected profits and financial ratios.
Consult with key competitors about the optimal set of prices to charge, i.e., the prices that will maximize profits for our firm and its competitors.
Last year Handorf-Zhu Inc. had $850 million of sales, and it had $425 million of fixed assets that were used at only 60% of capacity. What is the maximum sales growth rate the company could achieve before it had to increase its fixed assets?
Answer
54.30%
57.16%
60.17%
63.33%
66.67%
Which of the following assumptions is embodied in the AFN equation?
Answer
None of the firm's ratios will change.
Accounts payable and accruals are tied directly to sales.
Common stock and long-term debt are tied directly to sales.
Fixed assets, but not current assets, are tied directly to sales.
Last year's total assets were not optimal for last year's sales.
Which of the following statements is CORRECT?
Answer
The sustainable growth rate is the maximum achievable growth rate without the firm having to raise external funds. In other words, it is the growth rate at which the firm's AFN equals zero.
If a firm's assets are growing at a positive rate, but its retained earnings are not increasing, then it would be impossible for the firm's AFN to be negative.
If a firm increases its dividend payout ratio in anticipation of higher earnings, but sales and earnings actually decrease, then the firm's actual AFN must, mathematically, exceed the previously calculated AFN.
Higher sales usually require higher asset levels, and this leads to what we call AFN. However, the AFN will be zero if the firm chooses to retain all of its profits, i.e., to have a zero dividend payout ratio.
Dividend policy does not affect the requirement for external funds based on the AFN equation.
Which of the following statements is NOT CORRECT?
Answer
The corporate valuation model can be used both for companies that pay dividends and those that do not pay dividends.
The corporate valuation model discounts free cash flows by the required return on equity.
The corporate valuation model can be used to find the value of a division.
An important step in applying the corporate valuation model is forecasting the firm's pro forma financial statements.
Free cash flows are assumed to grow at a constant rate beyond a specified date in order to find the horizon, or terminal, value.
Leak Inc. forecasts the free cash flows (in millions) shown below. If the weighted average cost of capital is 11% and FCF is expected to grow at a rate of 5% after Year 2, what is the Year 0 value of operations, in millions? Assume that the ROIC is expected to remain constant in Year 2 and beyond (and do not make any half-year adjustments).
Year: 1 2
Free cash flow: -$50 $100
Answer
$1,456
$1,529
$1,606
$1,686
$1,770
Akyol Corporation is undergoing a restructuring, and its free cash flows are expected to be unstable during the next few years. However, FCF is expected to be $50 million in Year 5, i.e., FCF at t = 5 equals $50 million, and the FCF growth rate is expected to be constant at 6% beyond that point. If the weighted average cost of capital is 12%, what is the horizon value (in millions) at t = 5?
Answer
$719
$757
$797
$839
$883
Based on the corporate valuation model, the value of a company's operations is $900 million. Its balance sheet shows $70 million in accounts receivable, $50 million in inventory, $30 million in short-term investments that are unrelated to operations, $20 million in accounts payable, $110 million in notes payable, $90 million in long-term debt, $20 million in preferred stock, $140 million in retained earnings, and $280 million in total common equity. If the company has 25 million shares of stock outstanding, what is the best estimate of the stock's price per share?
Answer
$23.00
$25.56
$28.40
$31.24
$34.36
Suppose Leonard, Nixon, & Shull Corporation's projected free cash flow for next year is $100,000, and FCF is expected to grow at a constant rate of 6%. If the company's weighted average cost of capital is 11%, what is the value of its operations?
Answer
$1,714,750
$1,805,000
$1,900,000
$2,000,000
$2,100,000
Based on the corporate valuation model, Bernile Inc.'s value of operations is $750 million. Its balance sheet shows $50 million of short-term investments that are unrelated to operations, $100 million of accounts payable, $100 million of notes payable, $200 million of long-term debt, $40 million of common stock (par plus paid-in-capital), and $160 million of retained earnings. What is the best estimate for the firm's value of equity, in millions?
Answer
$429
$451
$475
$500
$525
Zhdanov Inc. forecasts that its free cash flow in the coming year, i.e., at t = 1, will be -$10 million, but its FCF at t = 2 will be $20 million. After Year 2, FCF is expected to grow at a constant rate of 4% forever. If the weighted average cost of capital is 14%, what is the firm's value of operations, in millions?
Answer
$158
$167
$175
$184
$193
Which of the following does NOT always increase a company's market value?
Answer
Increasing the expected growth rate of sales.
Increasing the expected operating profitability (NOPAT/Sales).
Decreasing the capital requirements (Capital/Sales).
Decreasing the weighted average cost of capital.
Increasing the expected rate of return on invested capital.
Based on the corporate valuation model, the value of a company's operations is $1,200 million. The company's balance sheet shows $80 million in accounts receivable, $60 million in inventory, and $100 million in short-term investments that are unrelated to operations. The balance sheet also shows $90 million in accounts payable, $120 million in notes payable, $300 million in long-term debt, $50 million in preferred stock, $180 million in retained earnings, and $800 million in total common equity. If the company has 30 million shares of stock outstanding, what is the best estimate of the stock's price per share?
Answer
$24.90
$27.67
$30.43
$33.48
$36.82
Simonyan Inc. forecasts a free cash flow of $40 million in Year 3, i.e., at t = 3, and it expects FCF to grow at a constant rate of 5% thereafter. If the weighted average cost of capital is 10% and the cost of equity is 15%, what is the horizon value, in millions at t = 3?
Answer
$840
$882
$926
$972
$1,021
Based on the corporate valuation model, Hunsader's value of operations is $300 million. The balance sheet shows $20 million of short-term investments that are unrelated to operations, $50 million of accounts payable, $90 million of notes payable, $30 million of long-term debt, $40 million of preferred stock, and $100 million of common equity. The company has 10 million shares of stock outstanding. What is the best estimate of the stock's price per share?
Answer
$13.72
$14.44
$15.20
$16.00
$16.80
A company forecasts the free cash flows (in millions) shown below. The weighted average cost of capital is 13%, and the FCFs are expected to continue growing at a 5% rate after Year 3. Assuming that the ROIC is expected to remain constant in Year 3 and beyond, what is the Year 0 value of operations, in millions?
Year: 1 2 3
Free cash flow: -$15 $10 $40
Answer
$315
$331
$348
$367
$386
Suppose Yon Sun Corporation's free cash flow during the just-ended year (t = 0) was $100 million, and FCF is expected to grow at a constant rate of 5% in the future. If the weighted average cost of capital is 15%, what is the firm's value of operations, in millions?
Answer
$948
$998
$1,050
$1,103
$1,158
Which of the following is NOT normally regarded as being a good reason to establish an ESOP?
Answer
To increase worker productivity.
To enable the firm to borrow at a below-market interest rate.
To make it easier to grant stock options to employees.
To help prevent a hostile takeover.
To help retain valued employees.
Which of the following is NOT normally regarded as being a barrier to hostile takeovers?
Answer
Abnormally high executive compensation.
Targeted share repurchases.
Shareholder rights provisions.
Restricted voting rights.
Poison pills.
5/22/13
Opening Offer: $22.99
Posted by: jane
Date Posted: 5/22/13 3:36 PM
Due Date: 5/22/13
Posted by: jane
Date Posted: 5/22/13 3:36 PM
Due Date: 5/22/13
Question 1
Which of the following statements is CORRECT?
Answer
One advantage of the NPV over the IRR is that NPV takes account of cash flows over a project's full life whereas IRR does not.
One advantage of the NPV over the IRR is that NPV assumes that cash flows will be reinvested at the WACC, whereas IRR assumes that cash flows are reinvested at the IRR. The NPV assumption is generally more appropriate.
One advantage of the NPV over the MIRR method is that NPV takes account of cash flows over a project's full life whereas MIRR does not.
One advantage of the NPV over the MIRR method is that NPV discounts cash flows whereas the MIRR is based on undiscounted cash flows.
Since cash flows under the IRR and MIRR are both discounted at the same rate (the WACC), these two methods always rank mutually exclusive projects in the same order.
2 points
Question 2
Westchester Corp. is considering two equally risky, mutually exclusive projects, both of which have normal cash flows. Project A has an IRR of 11%, while Project B's IRR is 14%. When the WACC is 8%, the projects have the same NPV. Given this information, which of the following statements is CORRECT?
Answer
If the WACC is 13%, Project A's NPV will be higher than Project B's.
f the WACC is 9%, Project A's NPV will be higher than Project B's.
If the WACC is 6%, Project B's NPV will be higher than Project A's.
If the WACC is greater than 14%, Project A's IRR will exceed Project B's.
If the WACC is 9%, Project B's NPV will be higher than Project A's.
Question 3
Four of the following statements are truly disadvantages of the regular payback method, but one is not a disadvantage of this method. Which one is NOT
a disadvantage of the payback method?
Answer
Lacks an objective, market-determined benchmark for making decisions.
Ignores cash flows beyond the payback period.
Does not directly account for the time value of money.
Does not provide any indication regarding a project's liquidity or risk.
Does not take account of differences in size among projects.
2 points
Question 4
Projects S and L are equally risky, mutually exclusive, and have normal cash flows. Project S has an IRR of 15%, while Project L's IRR is 12%. The two projects have the same NPV when the WACC is 7%. Which of the following statements is CORRECT?
Answer
If the WACC is 10%, both projects will have positive NPVs.
If the WACC is 6%, Project S will have the higher NPV.
If the WACC is 13%, Project S will have the lower NPV.
If the WACC is 10%, both projects will have a negative NPV.
Project S's NPV is more sensitive to changes in WACC than Project L's.
Question 5
Assume that the economy is enjoying a strong boom, and as a result interest rates and money costs generally are relatively high. The WACC for two mutually exclusive projects that are being considered is 12%. Project S has an IRR of 20% while Project L's IRR is 15%. The projects have the same NPV at the 12% current WACC. However, you believe that the economy will soon fall into a mild recession, and money costs and thus your WACC will soon decline. You also think that the projects will not be funded until the WACC has decreased, and their cash flows will not be affected by the change in economic conditions. Under these conditions, which of the following statements is CORRECT?
Answer
You should reject both projects because they will both have negative NPVs under the new conditions.
You should delay a decision until you have more information on the projects, even if this means that a competitor might come in and capture this market.
You should recommend Project L, because at the new WACC it will have the higher NPV.
You should recommend Project S, because at the new WACC it will have the higher NPV.
You should recommend Project L because it will have both a higher IRR and a higher NPV under the new conditions.
2 points
Question 6
Which of the following statements is CORRECT?
Answer
The MIRR and NPV decision criteria can never conflict.
The IRR method can never be subject to the multiple IRR problem, while the MIRR method can be.
One reason some people prefer the MIRR to the regular IRR is that the MIRR is based on a generally more reasonable reinvestment rate assumption.
The higher the WACC, the shorter the discounted payback period.
The MIRR method assumes that cash flows are reinvested at the crossover rate.
Question 7
Which of the following statements is CORRECT?
Answer
The NPV, IRR, MIRR, and discounted payback (using a payback requirement of 3 years or less) methods always lead to the same accept/reject decisions for independent projects.
For mutually exclusive projects with normal cash flows, the NPV and MIRR methods can never conflict, but their results could conflict with the discounted payback and the regular IRR methods.
Multiple IRRs can exist, but not multiple MIRRs. This is one reason some people favor the MIRR over the regular IRR.
If a firm uses the discounted payback method with a required payback of 4 years, then it will accept more projects than if it used a regular payback of 4 years.
The percentage difference between the MIRR and the IRR is equal to the project's WACC.
2 points
Question 8
Which of the following statements is CORRECT?
Answer
The shorter a project's payback period, the less desirable the project is normally considered to be by this criterion.
One drawback of the regular payback is that this method does not take account of cash flows beyond the payback period.
If a project's payback is positive, then the project should be accepted because it must have a positive NPV.
The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem.
One drawback of the discounted payback is that this method does not consider the time value of money, while the regular payback overcomes this drawback.
Question 9
Which of the following statements is CORRECT?
Answer
The IRR method appeals to some managers because it gives an estimate of the rate of return on projects rather than a dollar amount, which the NPV method provides.
The discounted payback method eliminates all of the problems associated with the payback method.
When evaluating independent projects, the NPV and IRR methods often yield conflicting results regarding a project's acceptability.
To find the MIRR, we discount the TV at the IRR.
A project's NPV profile must intersect the X-axis at the project's WACC.
2 points
Question 10
Which of the following statements is CORRECT?
Answer
The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the IRR.
The NPV method assumes that cash flows will be reinvested at the risk-free rate, while the IRR method assumes reinvestment at the IRR.
The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the risk-free rate.
The NPV method does not consider all relevant cash flows, particularly cash flows beyond the payback period.
The IRR method does not consider all relevant cash flows, particularly cash flows beyond the payback period.
Question 11
Assume that the economy is in a mild recession, and as a result interest rates and money costs generally are relatively low. The WACC for two mutually exclusive projects that are being considered is 8%. Project S has an IRR of 20% while Project L's IRR is 15%. The projects have the same NPV at the 8% current WACC. However, you believe that the economy is about to recover, and money costs and thus your WACC will also increase. You also think that the projects will not be funded until the WACC has increased, and their cash flows will not be affected by the change in economic conditions. Under these conditions, which of the following statements is CORRECT?
Answer
You should reject both projects because they will both have negative NPVs under the new conditions.
You should delay a decision until you have more information on the projects, even if this means that a competitor might come in and capture this market.
You should recommend Project L, because at the new WACC it will have the higher NPV.
You should recommend Project S, because at the new WACC it will have the higher NPV.
You should recommend Project S because it has the higher IRR and will continue to have the higher IRR even at the new WACC.
2 points
Question 12
Which of the following statements is CORRECT?
Answer
One defect of the IRR method is that it does not take account of cash flows over a project's full life.
One defect of the IRR method is that it does not take account of the time value of money.
One defect of the IRR method is that it does not take account of the cost of capital.
One defect of the IRR method is that it values a dollar received today the same as a dollar that will not be received until sometime in the future.
One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid.
Question 13
Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.
Answer
A project's NPV is generally found by compounding the cash inflows at the WACC to find the terminal value (TV), then discounting the TV at the IRR to find its PV.
The higher the WACC used to calculate the NPV, the lower the calculated NPV will be.
If a project's NPV is greater than zero, then its IRR must be less than the WACC.
If a project's NPV is greater than zero, then its IRR must be less than zero.
The NPVs of relatively risky projects should be found using relatively low WACCs.
2 points
Question 14
Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.
Answer
The longer a project's payback period, the more desirable the project is normally considered to be by this criterion.
One drawback of the regular payback for evaluating projects is that this method does not properly account for the time value of money.
If a project's payback is positive, then the project should be rejected because it must have a negative NPV.
The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem.
If a company uses the same payback requirement to evaluate all projects, say it requires a payback of 4 years or less, then the company will tend to reject projects with relatively short lives and accept long-lived projects, and this will cause its risk to increase over time.
Question 15
Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.
Answer
A project's regular IRR is found by compounding the cash inflows at the WACC to find the terminal value (TV), then discounting this TV at the WACC.
A project's regular IRR is found by discounting the cash inflows at the WACC to find the present value (PV), then compounding this PV to find the IRR.
If a project's IRR is greater than the WACC, then its NPV must be negative.
To find a project's IRR, we must solve for the discount rate that causes the PV of the inflows to equal the PV of the project's costs.
To find a project's IRR, we must find a discount rate that is equal to the WACC.
2 points
Question 16
Which of the following statements is CORRECT?
Answer
An externality is a situation where a project would have an adverse effect on some other part of the firm's overall operations. If the project would have a favorable effect on other operations, then this is not an externality.
An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank's other offices to increase.
The NPV method automatically deals correctly with externalities, even if the externalities are not specifically identified, but the IRR method does not. This is another reason to favor the NPV.
Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified. However, the payback method does not.
Identifying an externality can never lead to an increase in the calculated NPV.
Question 17
Which of the following statements is CORRECT?
Answer
A sunk cost is any cost that must be expended in order to complete a project and bring it into operation.
A sunk cost is any cost that was expended in the past but can be recovered if the firm decides not to go forward with the project.
A sunk cost is a cost that was incurred and expensed in the past and cannot be recovered if the firm decides not to go forward with the project.
Sunk costs were formerly hard to deal with but now that the NPV method is widely used, it is possible to simply include sunk costs in the cash flows and then calculate the PV of the project.
A good example of a sunk cost is a situation where Home Depot opens a new store, and that leads to a decline in sales of one of the firm's existing stores.
2 points
Question 18
Which of the following statements is CORRECT?
Answer
An example of a sunk cost is the cost associated with restoring the site of a strip mine once the ore has been depleted.
Sunk costs must be considered if the IRR method is used but not if the firm relies on the NPV method.
A good example of a sunk cost is a situation where a bank opens a new office, and that new office leads to a decline in deposits of the bank's other offices.
A good example of a sunk cost is money that a banking corporation spent last year to investigate the site for a new office, then expensed that cost for tax purposes, and now is deciding whether to go forward with the project.
If sunk costs are considered and reflected in a project's cash flows, then the project's calculated NPV will be higher than it otherwise would be.
Question 19
Which of the following statements is CORRECT?
Answer
In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project's cash flows will lead to an upward
bias in the NPV.
In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project's cash flows will lead to a downward
bias in the NPV.
The existence of any type of "externality" will reduce the calculated NPV versus the NPV that would exist without the externality.
If one of the assets to be used by a potential project is already owned by the firm, and if that asset could be sold or leased to another firm if the new project were not undertaken, then the net after-tax proceeds that could be obtained should be charged as a cost to the project under consideration.
If one of the assets to be used by a potential project is already owned by the firm but is not being used, then any costs associated with that asset is a sunk cost and should be ignored.
2 points
Question 20
Which of the following statements is CORRECT?
Answer
Sensitivity analysis is a good way to measure market risk because it explicitly takes into account diversification effects.
One advantage of sensitivity analysis relative to scenario analysis is that it explicitly takes into account the probability of specific effects occurring, whereas scenario analysis cannot account for probabilities.
Well-diversified stockholders do not need to consider market risk when determining required rates of return.
Market risk is important, but it does not have a direct effect on stock prices because it only affects beta.
Simulation analysis is a computerized version of scenario analysis where input variables are selected randomly on the basis of their probability distributions.
Question 21
Which of the following factors should be included in the cash flows used to estimate a project's NPV?
Answer
All costs associated with the project that have been incurred prior to the time the analysis is being conducted.
Interest on funds borrowed to help finance the project.
The end-of-project recovery of any working capital required to operate the project.
Cannibalization effects, but only if those effects increase the project's projected cash flows.
Expenditures to date on research and development related to the project, provided those costs have already been expensed for tax purposes.
2 points
Question 22
Which of the following should be considered when a company estimates the cash flows used to analyze a proposed project?
Answer
The new project is expected to reduce sales of one of the company's existing products by 5%.
Since the firm's director of capital budgeting spent some of her time last year to evaluate the new project, a portion of her salary for that year should be charged to the project's initial cost.
The company has spent and expensed $1 million on R&D associated with the new project.
The company spent and expensed $10 million on a marketing study before its current analysis regarding whether to accept or reject the project.
The firm would borrow all the money used to finance the new project, and the interest on this debt would be $1.5 million per year.
Question 23
The relative risk of a proposed project is best accounted for by which of the following procedures?
Answer
Adjusting the discount rate upward if the project is judged to have above-average risk.
Adjusting the discount rate downward if the project is judged to have above-average risk.
Reducing the NPV by 10% for risky projects.
Picking a risk factor equal to the average discount rate.
Ignoring risk because project risk cannot be measured accurately.
2 points
Question 24
Rowell Company spent $3 million two years ago to build a plant for a new product. It then decided not to go forward with the project, so the building is available for sale or for a new product. Rowell owns the building free and clear--there is no mortgage on it. Which of the following statements is CORRECT?
Answer
Since the building has been paid for, it can be used by another project with no additional cost. Therefore, it should not be reflected in the cash flows for any new project.
If the building could be sold, then the after-tax proceeds that would be generated by any such sale should be charged as a cost to any new project that would use it.
This is an example of an externality, because the very existence of the building affects the cash flows for any new project that Rowell might consider.
Since the building was built in the past, its cost is a sunk cost and thus need not be considered when new projects are being evaluated, even if it would be used by those new projects.
If there is a mortgage loan on the building, then the interest on that loan would have to be charged to any new project that used the building.
Question 25
Suppose Tapley Inc. uses a WACC of 8% for below-average risk projects, 10% for average-risk projects, and 12% for above-average risk projects. Which of the following independent projects should Tapley accept, assuming that the company uses the NPV method when choosing projects?
Answer
Project A, which has average risk and an IRR = 9%.
Project B, which has below-average risk and an IRR = 8.5%.
Project C, which has above-average risk and an IRR = 11%.
Without information about the projects' NPVs we cannot determine which project(s) should be accepted.
All of these projects should be accepted.
2 points
Question 26
Which one of the following would NOT result in incremental cash flows and thus should NOT be included in the capital budgeting analysis for a new product?
Answer
Using some of the firm's high-quality factory floor space that is currently unused to produce the proposed new product. This space could be used for other products if it is not used for the project under consideration.
Revenues from an existing product would be lost as a result of customers switching to the new product.
Shipping and installation costs associated with a machine that would be used to produce the new product.
The cost of a study relating to the market for the new product that was completed last year. The results of this research were positive, and they led to the tentative decision to go ahead with the new product. The cost of the research was incurred and expensed for tax purposes last year.
It is learned that land the company owns and would use for the new project, if it is accepted, could be sold to another firm.
Question 27
Which one of the following would NOT result in incremental cash flows and thus should NOT be included in the capital budgeting analysis for a new product?
Answer
A firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for agricultural purposes.
A new product will generate new sales, but some of those new sales will be from customers who switch from one of the firm's current products.
A firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery.
A firm has spent $2 million on R&D associated with a new product. These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected.
A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm's other products.
2 points
Question 28
A company is considering a new project. The CFO plans to calculate the project's NPV by estimating the relevant cash flows for each year of the project's life (i.e., the initial investment cost, the annual operating cash flows, and the terminal cash flow), then discounting those cash flows at the company's overall WACC. Which one of the following factors should the CFO be sure to INCLUDE in the cash flows when estimating the relevant cash flows?
Answer
All sunk costs that have been incurred relating to the project.
All interest expenses on debt used to help finance the project.
The investment in working capital required to operate the project, even if that investment will be recovered at the end of the project's life.
Sunk costs that have been incurred relating to the project, but only if those costs were incurred prior to the current year.
Effects of the project on other divisions of the firm, but only if those effects lower the project's own direct cash flows.
Question 29
When evaluating a new project, firms should include in the projected cash flows all of the following EXCEPT:
Answer
Changes in net working capital attributable to the project.
Previous expenditures associated with a market test to determine the feasibility of the project, provided those costs have been expensed for tax purposes.
The value of a building owned by the firm that will be used for this project.
A decline in the sales of an existing product, provided that decline is directly attributable to this project.
The salvage value of assets used for the project that will be recovered at the end of the project's life.
2 points
Question 30
Which of the following statements is CORRECT?
Answer
Using accelerated depreciation rather than straight line would normally have no effect on a project's total projected cash flows but it would affect the timing of the cash flows and thus the NPV.
Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer.
Corporations must use the same depreciation method (e.g., straight line or accelerated) for stockholder reporting and tax purposes.
Since depreciation is not a cash expense, it has no effect on cash flows and thus no effect on capital budgeting decisions.
Under accelerated depreciation, higher depreciation charges occur in the early years, and this reduces the early cash flows and thus lowers a project's projected NPV.
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Under accelerated depreciation, higher depreciation charges occur in the early years, and this reduces the early cash flows and thus lowers a project's projected NPV.
5/22/13
Opening Offer: $22.99
Posted by: jane
Date Posted: 5/22/13 3:14 PM
Due Date: 5/22/13
Posted by: jane
Date Posted: 5/22/13 3:14 PM
Due Date: 5/22/13
1.Which of the following statements is CORRECT?
Answer
If the underlying stock does not pay a dividend, it does not make good economic sense to exercise a call option prior to its expiration date, even if this would yield an immediate profit.
If the underlying stock does not pay a dividend, it does not make good economic sense to exercise a call option prior to its expiration date, even if this would yield an immediate profit.
Call options generally sell at a price greater than their exercise value, and the greater the exercise value, the higher the premium on the option is likely to be.
Call options generally sell at a price below their exercise value, and the greater the exercise value, the lower the premium on the option is likely to be.
Call options generally sell at a price below their exercise value, and the lower the exercise value, the lower the premium on the option is likely to be.
Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.
2 points
Question 2
Call options on XYZ Corporation's common stock trade in the market. Which of the following statements is most correct, holding other things constant?
Answer
The price of these call options is likely to rise if XYZ's stock price rises.
The higher the strike price on XYZ's options, the higher the option's price will be.
Assuming the same strike price, an XYZ call option that expires in one month will sell at a higher price than one that expires in three months.
If XYZ's stock price stabilizes (becomes less volatile), then the price of its options will increase.
If XYZ pays a dividend, then its option holders will not receive a cash payment, but the strike price of the option will be reduced by the amount of the dividend.
Question 2
Call options on XYZ Corporation's common stock trade in the market. Which of the following statements is most correct, holding other things constant?
Answer
The price of these call options is likely to rise if XYZ's stock price rises.
The higher the strike price on XYZ's options, the higher the option's price will be.
Assuming the same strike price, an XYZ call option that expires in one month will sell at a higher price than one that expires in three months.
If XYZ's stock price stabilizes (becomes less volatile), then the price of its options will increase.
If XYZ pays a dividend, then its option holders will not receive a cash payment, but the strike price of the option will be reduced by the amount of the dividend.
2 points
Question 3
Which of the following statements is CORRECT?
Answer
If the underlying stock does not pay a dividend, it does not make good economic sense to exercise a call option prior to its expiration date, even if this would yield an immediate profit.
Call options generally sell at a price greater than their exercise value, and the greater the exercise value, the higher the premium on the option is likely to be.
Call options generally sell at a price below their exercise value, and the greater the exercise value, the lower the premium on the option is likely to be.
Call options generally sell at a price below their exercise value, and the lower the exercise value, the lower the premium on the option is likely to be.
Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.
Question 3
Which of the following statements is CORRECT?
Answer
If the underlying stock does not pay a dividend, it does not make good economic sense to exercise a call option prior to its expiration date, even if this would yield an immediate profit.
Call options generally sell at a price greater than their exercise value, and the greater the exercise value, the higher the premium on the option is likely to be.
Call options generally sell at a price below their exercise value, and the greater the exercise value, the lower the premium on the option is likely to be.
Call options generally sell at a price below their exercise value, and the lower the exercise value, the lower the premium on the option is likely to be.
Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.
2 points
Question 4
Which of the following statements is CORRECT?
Answer
An option's value is determined by its exercise value, which is the market price of the stock less its striking price. Thus, an option can't sell for more than its exercise value.
As the stock's price rises, the time value portion of an option on a stock increases because the difference between the price of the stock and the fixed strike price increases.
Issuing options provides companies with a low cost method of raising capital.
The market value of an option depends in part on the option's time to maturity and also on the variability of the underlying stock's price.
The potential loss on an option decreases as the option sells at higher and higher prices because the profit margin gets bigger.
Question 4
Which of the following statements is CORRECT?
Answer
An option's value is determined by its exercise value, which is the market price of the stock less its striking price. Thus, an option can't sell for more than its exercise value.
As the stock's price rises, the time value portion of an option on a stock increases because the difference between the price of the stock and the fixed strike price increases.
Issuing options provides companies with a low cost method of raising capital.
The market value of an option depends in part on the option's time to maturity and also on the variability of the underlying stock's price.
The potential loss on an option decreases as the option sells at higher and higher prices because the profit margin gets bigger.
2 points
Question 5
An option that gives the holder the right to sell a stock at a specified price at some future time is
Answer
a call option.
a put option.
an out-of-the-money option.
a naked option.
a covered option.
An option that gives the holder the right to sell a stock at a specified price at some future time is
Answer
a call option.
a put option.
an out-of-the-money option.
a naked option.
a covered option.
2 points
Question 6
Other things held constant, the value of an option depends on the stock's price, the risk-free rate, and the
Answer
Strike price.
Variability of the stock price.
Option's time to maturity.
All of the above.
None of the above.
Question 6
Other things held constant, the value of an option depends on the stock's price, the risk-free rate, and the
Answer
Strike price.
Variability of the stock price.
Option's time to maturity.
All of the above.
None of the above.
2 points
Question 7
Suppose you believe that Delva Corporation's stock price is going to decline from its current level of $82.50 sometime during the next 5 months. For $510.25 you could buy a 5-month put option giving you the right to sell 100 shares at a price of $85 per share. If you bought this option for $510.25 and Delva's stock price actually dropped to $60, what would your pre-tax net profit be?
Question 7
Suppose you believe that Delva Corporation's stock price is going to decline from its current level of $82.50 sometime during the next 5 months. For $510.25 you could buy a 5-month put option giving you the right to sell 100 shares at a price of $85 per share. If you bought this option for $510.25 and Delva's stock price actually dropped to $60, what would your pre-tax net profit be?
Answer
-$510.25
$1,989.75
$2,089.24
$2,193.70
$2,303.38
-$510.25
$1,989.75
$2,089.24
$2,193.70
$2,303.38
2 points
Question 8
Which of the following statements is CORRECT?
Answer
Put options give investors the right to buy a stock at a certain strike price before a specified date.
Call options give investors the right to sell a stock at a certain strike price before a specified date.
Options typically sell for less than their exercise value.
LEAPS are very short-term options that were created relatively recently and now trade in the market.
An option holder is not entitled to receive dividends unless he or she exercises their option before the stock goes ex dividend.
Question 8
Which of the following statements is CORRECT?
Answer
Put options give investors the right to buy a stock at a certain strike price before a specified date.
Call options give investors the right to sell a stock at a certain strike price before a specified date.
Options typically sell for less than their exercise value.
LEAPS are very short-term options that were created relatively recently and now trade in the market.
An option holder is not entitled to receive dividends unless he or she exercises their option before the stock goes ex dividend.
2 points
Question 9
Deeble Construction Co.'s stock is trading at $30 a share. Call options on the company's stock are also available, some with a strike price of $25 and some with a strike price of $35. Both options expire in three months. Which of the following best describes the value of these options?
Answer
The options with the $25 strike price will sell for $5.
The options with the $25 strike price will sell for less than the options with the $35 strike price.
The options with the $25 strike price have an exercise value greater than $5.
The options with the $35 strike price have an exercise value greater than $0.
If Deeble's stock price rose by $5, the exercise value of the options with the $25 strike price would also increase by $5.
Question 9
Deeble Construction Co.'s stock is trading at $30 a share. Call options on the company's stock are also available, some with a strike price of $25 and some with a strike price of $35. Both options expire in three months. Which of the following best describes the value of these options?
Answer
The options with the $25 strike price will sell for $5.
The options with the $25 strike price will sell for less than the options with the $35 strike price.
The options with the $25 strike price have an exercise value greater than $5.
The options with the $35 strike price have an exercise value greater than $0.
If Deeble's stock price rose by $5, the exercise value of the options with the $25 strike price would also increase by $5.
2 points
Question 10
Warner Motors' stock is trading at $20 a share. Call options that expire in three months with a strike price of $20 sell for $1.50. Which of the following will occur if the stock price increases 10%, to $22 a share?
Answer
The price of the call option will increase by $2.
The price of the call option will increase by more than $2.
The price of the call option will increase by less than $2, and the percentage increase in price will be less than 10%.
The price of the call option will increase by less than $2, but the percentage increase in price will be more than 10%.
The price of the call option will increase by more than $2, but the percentage increase in price will be less than 10%.
Question 10
Warner Motors' stock is trading at $20 a share. Call options that expire in three months with a strike price of $20 sell for $1.50. Which of the following will occur if the stock price increases 10%, to $22 a share?
Answer
The price of the call option will increase by $2.
The price of the call option will increase by more than $2.
The price of the call option will increase by less than $2, and the percentage increase in price will be less than 10%.
The price of the call option will increase by less than $2, but the percentage increase in price will be more than 10%.
The price of the call option will increase by more than $2, but the percentage increase in price will be less than 10%.
2 points
Question 11
Which of the following statements is CORRECT?
Answer
If the underlying stock does not pay a dividend, it makes good economic sense to exercise a call option as soon as the stock's price exceeds the strike price by about 10%, because this permits the option holder to lock in an immediate profit.
Call options generally sell at a price less than their exercise value.
If a stock becomes riskier (more volatile), call options on the stock are likely to decline in value.
Call options generally sell at prices above their exercise value, but for an in-the-money option, the greater the exercise value in relation to the strike price, the lower the premium on the option is likely to be.
Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.
2 points
Question 12
The current price of a stock is $22, and at the end of one year its price will be either $27 or $17. The annual risk-free rate is 6.0%, based on daily compounding. A 1-year call option on the stock, with an exercise price of $22, is available. Based on the binominal model, what is the option's value?
Answer
$2.43
$2.70
$2.99
$3.29
$3.62
2 points
Question 13
Suppose you believe that Johnson Company's stock price is going to increase from its current level of $22.50 sometime during the next 5 months. For $310.25 you can buy a 5-month call option giving you the right to buy 100 shares at a price of $25 per share. If you buy this option for $310.25 and Johnson's stock price actually rises to $45, what would your pre-tax net profit be?
Answer
-$310.25
$1,689.75
$1,774.24
$1,862.95
$1,956.10
2 points
Question 14
GCC Corporation is planning to issue options to its key employees, and it is now discussing the terms to be set on those options. Which of the following actions would decrease the value of the options, other things held constant?
Answer
GCC's stock price suddenly increases.
The exercise price of the option is increased.
The life of the option is increased, i.e., the time until it expires is lengthened.
The Federal Reserve takes actions that increase the risk-free rate.
GCC's stock price becomes more risky (higher variance).
2 points
Question 15
An investor who writes standard call options against stock held in his or her portfolio is said to be selling what type of options?
Answer
In-the-money
Put
Naked
Covered
Out-of-the-money
2 points
Question 16
Which of the following statements is CORRECT?
Answer
The bond-yield-plus-risk-premium approach to estimating the cost of common equity involves adding a risk premium to the interest rate on the company's own long-term bonds. The size of the risk premium for bonds with different ratings is published daily in The Wall Street Journal.
The WACC is calculated using a before-tax cost for debt that is equal to the interest rate that must be paid on new debt, along with the after-tax costs for common stock and for preferred stock if it is used.
An increase in the risk-free rate is likely
to reduce the marginal costs of both debt and equity.
to reduce the marginal costs of both debt and equity.
The relevant WACC can change depending on the amount of funds a firm raises during a given year. Moreover, the WACC at each level of funds raised is a weighted average of the marginal costs of each capital component, with the weights based on the firm's target capital structure.
Beta measures market risk, which is generally
the most relevant risk measure for a publicly-owned firm that seeks to maximize its intrinsic value. However, this is not true unless all of the firm's stockholders are well diversified.
the most relevant risk measure for a publicly-owned firm that seeks to maximize its intrinsic value. However, this is not true unless all of the firm's stockholders are well diversified.
2 points
Question 17
Which of the following statements is CORRECT?
Answer
The WACC is calculated using before-tax
costs for all components.
costs for all components.
The after-tax cost of debt usually exceeds
the after-tax cost of equity.
the after-tax cost of equity.
For a given firm, the after-tax cost of debt is always more expensive than the after-tax cost of non-convertible preferred stock.
Retained earnings that were generated in the past and are reported on the firm's balance sheet are available to finance the firm's capital budget during the coming year.
The WACC that should be used in capital budgeting is the firm's marginal, after-tax cost of capital.
2 points
Question 18
For a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and assume that the firm operates
at its target capital structure.
at its target capital structure.
Answer
rs> re > rd > WACC.
re> rs > WACC > rd.
WACC > re > rs> rd.
rd> re > rs > WACC.
WACC > rd > rs > re.
2 points
Question 19
Which of the following statements is CORRECT?
Answer
The WACC as used in capital budgeting is an estimate of a company's before-tax cost of capital.
The percentage flotation cost associated with issuing new common equity is typically smaller than the flotation cost for new debt.
The WACC as used in capital budgeting is an estimate of the cost of all the capital a company has raised to acquire its assets.
There is an "opportunity cost" associated with using retained earnings, hence they are not "free."
The WACC as used in capital budgeting would
be simply the after-tax cost of debt if the firm plans to use only debt to finance its capital budget during the coming year.
be simply the after-tax cost of debt if the firm plans to use only debt to finance its capital budget during the coming year.
2 points
Question 20
The MacMillen Company has equal amounts of low-risk, average-risk, and high-risk projects. The firm's overall WACC is 12%. The CFO believes that this is the correct WACC for the company's average-risk projects, but that a lower rate should be used for lower-risk projects and a higher rate for higher-risk projects. The CEO disagrees, on the grounds that even though projects have different risks, the WACC used to evaluate each project should be the same because the company obtains capital for all projects from the same sources. If the CEO's position is accepted, what is likely to happen over time?
Answer
The company will take on too many high-risk projects and reject too many low-risk projects.
The company will take on too many low-risk projects and reject too many high-risk projects.
Things will generally even out over time, and, therefore, the firm's risk should remain constant over time.
The company's overall WACC should decrease
over time because its stock price should be increasing.
over time because its stock price should be increasing.
The CEO's recommendation would maximize the
firm's intrinsic value.
firm's intrinsic value.
2 points
Question 21
Which of the following statements is CORRECT?
Answer
Since the costs of internal and external
equity are related, an increase in the flotation cost required to sell a new issue of stock will increase the cost of retained earnings.
equity are related, an increase in the flotation cost required to sell a new issue of stock will increase the cost of retained earnings.
Since its stockholders are not directly
responsible for paying a corporation's income taxes, corporations should focus on before-tax cash flows when calculating the WACC.
responsible for paying a corporation's income taxes, corporations should focus on before-tax cash flows when calculating the WACC.
An increase in a firm's tax rate will increase the component cost of debt, provided the YTM on the firm's bonds is not affected by the change in the tax rate.
When the WACC is calculated, it should reflect the costs of new common stock, retained earnings, preferred stock, long-term debt, short-term bank loans if the firm normally finances with bank debt, and accounts payable if the firm normally has accounts payable on its balance sheet.
If a firm has been suffering accounting losses that are expected to continue into the foreseeable future, and therefore its tax rate is zero, then it is possible for the after-tax cost of preferred stock to be less than the after-tax cost of debt.
2 points
Question 22
Which of the following statements is CORRECT? Assume that the firm is a publicly-owned corporation and is seeking to maximize shareholder wealth.
Answer
If a firm has a beta that is less than 1.0, say 0.9, this would suggest that the expected returns on its assets are negatively
correlated with the returns on most other firms' assets.
correlated with the returns on most other firms' assets.
If a firm's managers want to maximize the value of their firm's stock, they should, in theory, concentrate on project risk as measured by the standard deviation of the project's expected future cash flows.
If a firm evaluates all projects using the same cost
of capital, and the CAPM is used to help determine that cost, then its risk as measured by beta will probably decline over time.
of capital, and the CAPM is used to help determine that cost, then its risk as measured by beta will probably decline over time.
Projects with above-average risk typically have higher
than average expected returns. Therefore, to maximize a firm's intrinsic value, its managers should favor high-beta projects over those with lower betas.
than average expected returns. Therefore, to maximize a firm's intrinsic value, its managers should favor high-beta projects over those with lower betas.
Project A has a standard deviation of expected returns
of 20%, while Project B's standard deviation is only 10%. A's returns are negatively correlated with both the firm's other assets and the returns on most stocks in the economy, while B's returns are positively correlated. Therefore, Project A is less risky to a firm and should be evaluated with a lower cost of capital.
of 20%, while Project B's standard deviation is only 10%. A's returns are negatively correlated with both the firm's other assets and the returns on most stocks in the economy, while B's returns are positively correlated. Therefore, Project A is less risky to a firm and should be evaluated with a lower cost of capital.
2 points
Question 23
Which of the following statements is CORRECT?
Answer
A change in a company's target capital
structure cannot affect its WACC.
structure cannot affect its WACC.
WACC calculations should be based on the before-tax costs of all the individual capital components.
Flotation costs associated with issuing new common stock normally reduce the WACC.
If a company's tax rate increases, then, all else equal, its weighted average cost of capital will decline.
An increase in the risk-free rate will normally lower the marginal costs of both debt and equity financing.
2 points
Question 24
Which of the following statements is CORRECT?
Answer
In the WACC calculation, we must adjust the cost of preferred stock (the market yield) to reflect the fact that 70% of the dividends received by corporate investors are excluded from their taxable income.
We should use historical measures of the component costs from prior financings that are still outstanding when estimating a company's WACC for capital budgeting purposes.
The cost of new equity (re) could possibly be lower than the cost of retained earnings (rs) if the market risk premium, risk-free rate, and the company's beta all decline by a sufficiently large amount.
A firm's cost of retained earnings is the rate of return stockholders require on a firm's common stock.
The component cost of preferred stock is expressed as rp(1 - T), because preferred stock dividends are treated as
fixed charges, similar to the treatment of interest on debt.
fixed charges, similar to the treatment of interest on debt.
2 points
Question 25
Firm M's earnings and stock price tend to move up and down with other firms in the S&P 500, while Firm W's earnings and stock price move counter cyclically with M and other S&P companies. Both M and W estimate their costs of equity using the CAPM, they have identical market values, their standard deviations of returns are identical, and they both finance only with common equity. Which of the following statements is CORRECT?
Answer
M should have the lower WACC because it is like most other companies, and investors like that fact.
M and W should have identical WACCs because their risks as measured by the standard deviation of returns are identical.
If M and W merge, then the merged firm MW should have a WACC that is a simple average of M's and W's WACCs.
Without additional information, it is impossible to predict what the merged firm's WACC would be if M and W merged.
Since M and W move counter cyclically to one another, if they merged, the merged firm's WACC would be less than the simple average of the two firms' WACCs.
2 points
Question 26
Duval Inc. uses only equity capital, and it has two equally-sized divisions. Division A's cost of capital is 10.0%, Division B's cost is 14.0%, and the corporate (composite) WACC is 12.0%. All of Division A's projects are equally risky, as are all of Division B's projects. However, the projects of Division A are less risky than those of Division B. Which of the following projects should the firm accept?
Answer
A Division B project with a 13% return.
A Division B project with a 12% return.
A Division A project with an 11% return.
A Division A project with a 9% return.
A Division B project with an 11% return.
2 points
Question 27
Schalheim Sisters Inc. has always paid out all of its earnings as dividends; hence, the firm has no retained earnings. This same situation is expected to persist in the future. The company uses the CAPM to calculate its cost of equity, and its target capital structure consists of common stock, preferred stock, and debt. Which of the following events would REDUCE its WACC?
Answer
The market risk premium declines.
The flotation costs associated with issuing new common stock increase.
The company's beta increases.
Expected inflation increases.
The flotation costs associated with issuing preferred stock increase.
2 points
Question 28
Norris Enterprises, an all-equity firm, has a beta of 2.0. The chief financial officer is evaluating a project with an expected
return of 14%, before any risk adjustment. The risk-free rate is 5%, and the market risk premium is 4%. The project being evaluated is riskier than an average project, in terms of both its beta risk and its total risk. Which of the following statements is CORRECT?
return of 14%, before any risk adjustment. The risk-free rate is 5%, and the market risk premium is 4%. The project being evaluated is riskier than an average project, in terms of both its beta risk and its total risk. Which of the following statements is CORRECT?
Answer
The project should definitely be accepted because its expected return (before any risk adjustments) is greater than its required return.
The project should definitely be rejected because its expected return (before risk adjustment) is less than its required return.
Riskier-than-average projects should have their expected returns increased to reflect their higher risk. Clearly, this would make the project acceptable regardless of the amount of the adjustment.
The accept/reject decision depends on the firm's risk-adjustment policy. If Norris' policy is to increase the required return on a riskier-than-average project to 3% over rS, then it should reject the project.
Capital budgeting projects should be evaluated solely on the basis of their total risk. Thus, insufficient information has been provided to make the accept/reject decision.
2 points
Question 29
For a company whose target capital structure calls for 50% debt and 50% common equity, which of the following statements is CORRECT?
Answer
The interest rate used to calculate the WACC is the average after-tax cost of all the company's outstanding debt as shown on its balance sheet.
The WACC is calculated on a before-tax basis.
The WACC exceeds the cost of equity.
The cost of equity is always equal to or greater than the cost of debt.
The cost of retained earnings typically exceeds the cost of new common stock.
2 points
Question 30
Which of the following statements is CORRECT?
Answer
The discounted cash flow method of estimating the cost
of equity cannot be used unless the growth rate, g, is expected to be constant forever.
of equity cannot be used unless the growth rate, g, is expected to be constant forever.
If the calculated beta underestimates the firm's true investment risk--i.e., if the forward-looking beta that investors think exists exceeds the historical beta--then the CAPM method based on the historical beta will produce an estimate of rs and thus WACC that is too high.
Beta measures market risk, which is, theoretically, the most relevant risk measure for a publicly-owned firm that seeks to maximize its intrinsic value. This is true even if not all of the firm's stockholders are well diversified.
An advantage shared by both the DCF and CAPM methods when they are used to estimate the cost of equity is that they
are both "objective" as opposed to "subjective," hence little or no judgment is required.
are both "objective" as opposed to "subjective," hence little or no judgment is required.
The specific risk premium used in the CAPM is the same as the risk premium used in the bond-yield-plus-risk-premium approach.
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Posted by: jane
Date Posted: 5/22/13 3:06 PM
Due Date: 5/22/13
1) Which of the following statements is CORRECT?
Answer
a)A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio.
b)A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations.
c)A two-stock portfolio will always have a lower beta than a one-stock portfolio.
d)If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio.
e)A stock with an above-average standard deviation must also have an above-average beta.
2 points
Question 2
Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15%, betas of 1.6, and standard deviations of 30%. The returns of the two stocks are independent, so the correlation coefficient between them, rXY, is zero. Which of the following statements best describes the characteristics of your 2-stock portfolio?
Answer
a)Your portfolio has a standard deviation of 30%, and its expected return is 15%.
b)Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6.
c)Your portfolio has a beta equal to 1.6, andits expected return is 15%.
d)Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%.
e)Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6.
Question 3
Assume that in recent years both expected inflation and the market risk premium (rM− rRF) have declined. Assume also that all stocks have positive betas. Which of the following would be most likely to have occurred as a result of these changes?
Answer
The required returns on all stocks have fallen, but the decline has been greater for stocks with lower betas.
The required returns on all stocks have fallen, but the fall has been greater for stocks with higher betas.
The average required return on the market, rM, has remained constant, but the required returns have fallen for stocks that have betas greater than 1.0.
Required returns have increased for stocks with betas greater than 1.0 but have declined for stocks with betas less than 1.0.
The required returns on all stocks have fallen by the same amount
Question 4
1. Which of the following statements is CORRECT?
Answer
The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks.
If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio.
The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future.
The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks.
It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in theory, its required rate of return would be equal to the risk-free (default-free) rate of return, rRF.
2 points
Question 5
1. Which is the best measure of risk for a single asset held in isolation, and which is the best measure for an asset held in a diversified portfolio?
Answer
Variance; correlation coefficient.
Standard deviation; correlation coefficient.
Beta; variance.
Coefficient of variation; beta.
Beta; beta.
2 points
Question 6
1. Bob has a $50,000 stock portfolio with a beta of 1.2, an expected return of 10.8%, and a standard deviation of 25%. Becky also has a $50,000 portfolio, but it has a beta of 0.8, an expected return of 9.2%, and a standard deviation that is also 25%. The correlation coefficient, r, between Bob's and Becky's portfolios is zero. If Bob and Becky marry and combine their portfolios, which of the following best describes their combined $100,000 portfolio?
Answer
The combined portfolio's expected return will be less than the simple weighted average of the expected returns of the two individual portfolios, 10.0%.
The combined portfolio's beta will be equal to a simple weighted average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios' standard deviations, 25%.
The combined portfolio's expected return will be greater than the simple weighted average of the expected returns of the two individual portfolios, 10.0%.
The combined portfolio's standard deviation will be greater than the simple average of the two portfolios' standard deviations, 25%.
The combined portfolio's standard deviation will be equal to a simple average of the two portfolios' standard deviations, 25%.
2 points
Question 7
1. Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements must be true, according to the CAPM?
Answer
If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio would have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated.
Stock Y's realized return during the coming year will be higher than Stock X's return.
If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.
Stock Y's return has a higher standard deviation than Stock X.
If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y.
Question 8
1. Which of the following statements is CORRECT?
Answer
A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are selected.
Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk.
A large portfolio of randomly selected stocks will have a standard deviation of returns that is greater than the standard deviation of a 1-stock portfolio if that one stock has a beta less than 1.0.
A large portfolio of stocks whose betas are greater than 1.0 will have less market risk than a single stock with a beta = 0.8.
If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.
2 points
Question 9
1. Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true about these securities? (Assume market equilibrium.)
Answer
When held in isolation, Stock A has more risk than Stock B.
Stock B must be a more desirable addition to a portfolio than A.
Stock A must be a more desirable addition to a portfolio than B.
The expected return on Stock A should be greater than that on B.
The expected return on Stock B should be greater than that on A.
2 points
Question 10
1. Which of the following statements is CORRECT?
Answer
A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock.
If an investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable risk inherent in owning stocks. Therefore, if a portfolio contained all publicly traded stocks, it would be essentially riskless.
The required return on a firm's common stock is, in theory, determined solely by its market risk. If the market risk is known, and if that risk is expected to remain constant, then no other information is required to specify the firm's required return.
Portfolio diversification reduces the variability of returns (as measured by the standard deviation) of each individual stock held in a portfolio.
A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock.
2 points
Question 11
1. During the coming year, the market risk premium (rM − rRF), is expected to fall, while the risk-free rate, rRF, is expected to remain the same. Given this forecast, which of the following statements is CORRECT?
Answer
The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0.
The required return on all stocks will remain unchanged.
The required return will fall for all stocks, but it will fall more for stocks with higher betas.
The required return for all stocks will fall by the same amount.
The required return will fall for all stocks, but it will fall less for stocks with higher betas.
2 points
Question 12
1. Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has equal amounts invested in each of the three stocks. Each of the stocks has a standard deviation of 25%. The returns on the three stocks are independent of one another (i.e., the correlation coefficients all equal zero). Assume that there is an increase in the market risk premium, but the risk-free rate remains unchanged. Which of the following statements is CORRECT?
Answer
The required return of all stocks will remain unchanged since there was no change in their betas.
The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium.
The required return on the average stock will remain unchanged, but the returns of riskier stocks (such as Stock C) will increase while the returns of safer stocks (such as Stock A) will decrease.
The required returns on all three stocks will increase by the amount of the increase in the market risk premium.
The required return on the average stock will remain unchanged, but the returns on riskier stocks (such as Stock C) will decrease while the returns on safer stocks (such as Stock A) will increase.
Question 13
1. Inflation, recession, and high interest rates are economic events that are best characterized as being
Answer
systematic risk factors that can be diversified away.
company-specific risk factors that can be diversified away.
among the factors that are responsible for market risk.
risks that are beyond the control of investors and thus should not be considered by security analysts or portfolio managers.
irrelevant except to governmental authorities like the Federal Reserve.
2 points
Question 14
1. Which of the following statements is CORRECT?
Answer
If a company with a high beta merges with a low-beta company, the best estimate of the new merged company's beta is 1.0.
Logically, it is easier to estimate the betas associated with capital budgeting projects than the betas associated with stocks, especially if the projects are closely associated with research and development activities.
The beta of an "average stock," which is also "the market beta," can change over time, sometimes drastically.
If a newly issued stock does not have a past history that can be used for calculating beta, then we should always estimate that its beta will turn out to be 1.0. This is especially true if the company finances with more debt than the average firm.
During a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different from the beta that will exist in the future.
2 points
Question 15
1. Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE?
Answer
The fact that a security or project may not have a past history that can be used as the basis for calculating beta.
Sometimes, during a period when the company is undergoing a change such as toward more leverage or riskier assets, the calculated beta will be drastically different from the "true" or "expected future" beta.
The beta of an "average stock," or "the market," can change over time, sometimes drastically.
Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed.
All of the statements above are true.
2 points
Question 16
1. If a stock's dividend is expected
to grow at a constant rate of 5% a year, which of the following statements is CORRECT? The stock is in equilibrium.
Answer
The expected return on the stock is 5% a year.
The stock's dividend yield is 5%.
The price of the stock is expected to decline in the future.
The stock's required return must be equal to or less than 5%.
The stock's price one year from now is expected to be 5% above the current price.
2 points
Question 17
1. Which of the following statements is CORRECT, assuming stocks are in equilibrium?
Answer
The dividend yield on a constant growth stock must equal its expected total return minus its expected capital gains yield.
Assume that the required return on a given stock is 13%. If the stock's dividend is growing at a constant rate of 5%, its expected dividend yield is 5% as well.
A stock's dividend yield can never exceed its expected growth rate.
A required condition for one to use the constant growth model is that the stock's expected growth rate exceeds its required rate of return.
Other things held constant, the higher a company's beta coefficient, the lower its required rate of return.
Question 18
1. Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of
the following statements is CORRECT?
X Y
Price $30 $30
Expected growth (constant) 6% 4%
Required return 12% 10%
Answer
Stock X has a higher dividend yield than Stock Y.
Stock Y has a higher dividend yield than Stock X.
One year from now, Stock X's price is expected to be higher than Stock Y's price.
Stock X has the higher expected year-end dividend.
Stock Y has a higher capital gains yield.
2 points
Question 19
1. Companies can issue different classes of common stock. Which of the following statements concerning stock classes is CORRECT?
Answer
All common stocks fall into one of three classes: A, B, and C.
All common stocks, regardless of class, must have the same voting rights.
All firms have several classes of common stock.
All common stock, regardless of class, must pay the same dividend.
Some class or classes of common stock are entitled to more votes per share than other classes.
2 points
Question 20
1. The required returns of Stocks X and Y are rX = 10% and rY = 12%. Which of the following statements is CORRECT?
Answer
If the market is in equilibrium, and if Stock Y has the lower expected dividend yield, then it must have the higher expected growth rate.
If Stock Y and Stock X have the same dividend yield, then Stock Y must have a lower expected capital gains yield than Stock X.
If Stock X and Stock Y have the same current dividend and the same expected dividend growth rate, then Stock Y must sell for a higher price.
The stocks must sell for the same price.
Stock Y must have a higher dividend yield than Stock X.
2 points
Question 21
1. Which of the following statements is CORRECT?
Answer
The constant growth model is often appropriate for evaluating start-up companies that do not have a stable history of growth but are expected to reach stable growth within the next few years.
If a stock has a required rate of return rs = 12% and its dividend is expected to grow at a constant rate of 5%, this implies that the stock's dividend yield is also 5%.
The stock valuation model, P0 = D1/(rs - g), can be used to value firms whose dividends are expected to decline at a constant rate, i.e., to grow at a negative rate.
The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.
The constant growth model cannot be used for a zero growth stock, where the dividend is expected to remain constant over time.
2 points
Question 22
1. Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
A B
Required return 10% 12%
Market price $25 $40
Expected growth 7% 9%
Answer
These two stocks should have the same price.
These two stocks must have the same dividend yield.
These two stocks should have the same expected return.
These two stocks must have the same expected capital gains yield.
These two stocks must have the same expected year-end dividend.
Question 23
1. The preemptive right is important to shareholders because it
Answer
allows managers to buy additional shares below the current market price.
will result in higher dividends per share.
is included in every corporate charter.
protects the current shareholders against a dilution of their ownership interests.
protects bondholders, and thus enables the firm to issue debt with a relatively low interest rate.
2 points
Question 24
1. Two constant growth stocks are in equilibrium, have the same price, and have the same required rate of return. Which of the following statements is CORRECT?
Answer
The two stocks must have the same dividend per share.
If one stock has a higher dividend yield, it must also have a lower dividend growth rate.
If one stock has a higher dividend yield, it must also have a higher dividend growth rate.
The two stocks must have the same dividend growth rate.
The two stocks must have the same dividend yield.
2 points
Question 25
1. The expected return on Natter Corporation's stock is 14%. The stock's dividend is expected to grow at a constant rate of 8%, and it currently sells for $50 a share. Which of the following statements is CORRECT?
Answer
The stock's dividend yield is 7%.
The stock's dividend yield is 8%.
The current dividend per share is $4.00.
The stock price is expected to be $54 a share one year from now.
The stock price is expected to be $57 a share one year from now.
2 points
Question 26
1. If in the opinion of a given investor a stock's expected return exceeds its required return, this suggests that the investor thinks
Answer
the stock is experiencing supernormal growth.
the stock should be sold.
the stock is a good buy.
management is probably not trying to maximize the price per share.
dividends are not likely to be declared.
2 points
Question 27
1. Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
A B
Price $ 25 $40
Expected growth 7% 9%
Expected return 10% 12%
Answer
The two stocks should have the same expected dividend.
The two stocks could not be in equilibrium with the numbers given in the question.
A's expected dividend is $0.50.
B's expected dividend is $0.75.
A's expected dividend is $0.75 and B's expected dividend is $1.20.
2 points
Question 28
1. Which of the following statements is CORRECT?
Answer
If a company has two classes of common stock, Class A and Class B, the stocks may pay different dividends, but under all state charters the two classes must have the same voting rights.
The preemptive right gives stockholders the right to approve or disapprove of a merger between their company and some other company.
The preemptive right is a provision in the corporate charter that gives common stockholders the right to purchase (on a pro rata basis) new issues of the firm's common stock.
The stock valuation model, P0= D1/(rs - g), cannot be used for firms that have negative growth rates.
The stock valuation model, P0= D1/(rs - g), can be used only for firms whose growth rates exceed their required returns.
Question 29
1. For a stock to be in equilibrium, that is, for there to be no long-term pressure for its price to depart from its current level, then
Answer
the expected future return must be less than the most recent past realized return.
The past realized return must be equal to the expected return during the same period.
the required return must equal the realized return in all periods.
the expected return must be equal to both the required future return and the past realized return.
the expected future returns must be equal to the required return.
2 points
Question 30
1. If markets are in equilibrium, which of the following conditions will exist?
Answer
Each stock's expected return should equal its realized return as seen by the marginal investor.
Each stock's expected return should equal its required return as seen by the marginal investor.
All stocks should have the same expected return as seen by the marginal investor.
The expected and required returns on stocks and bonds should be equal.
All stocks should have the same realized return during the coming year.
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