The primary goal of a publicly owned corporation is to
maximize shareholder wealth
The five basic principles of finance include al of the following EXCEPT:
incremental profits determine value
All of the following measure liquidity EXCEPT
operating return on assets
Williams Inc. has a current ratio equal to 3, a quick ratio equal to 1.8, and total current assets of 6 million. Williams' inventory balance is:
2,400,000
Benkart Corporation has sales of 5,000,000, net income of 800,000, total assets of 2,000,000 and 100,000 shares of common stock outstanding. If Benkart's P/E ratio is 12, what is the company's current stock price?
$96 per share
A firm that wants to know if it has enough cash to meet its bills would be most likely to use which kind of ratio?
liquidity
The present value of a single future sum
depends upon the number of discount periods
the 3 basic type of issues addressed by the study of finance are
capital budgeting, capital structure decisions, and working capital management
The present value of 1,000 to be received in 5 years is _____ if the discount rate is 12.78%
$548
You charged 1,000 on your credit card for christmas presents. Your credit card company charges you 26% annual interest, compounded monthly. If you make the minimum payments of 25 per month, how long will it take to pay off your balance
94 months
Your company has received a 50,000 loan from an industrial finance company. The annual payments are 6,202.70. If the company is paying 9 percent interest per year, how many loan payments must the company make?
15
You have contracted to buy a house for 250,000 paying 30,000 down and taking out a fully amortizing loan for the balance, at a 5.7% annual rate for 30 years. What will your monthly payment be if they make equal monthly installments over the next 30 years?
1,277
Stock A's expected return is
8.2%
Stock W's standard deviation of returns is
17%
Changes in the general economy, like changes in interest rates or tax laws represent what type of risk?
market risk
Of the following different types of securities, which is typically considered most risky?
Common stocks of small companies
Which of the following would NOT normally be considered a flotation cost
dividends
The real rate of return is the return earned above the
inflation risk premium
If you were to use the standard deviation as a measure of investment risk, which of the following has historically been the least risky investment
US Treasury Bill
A typical measure for the riskfree rate of return is the
US Treasury Bill rate
The basic format of an income statement is
Sales  Expenses = Profits
Which of the following bond provisions will make a bond more desirable to investors, other things being equal?
The bond is convertible
Two consideration that cause corporation's cost of capital to be different than its investors' required returns are
corporate taxes and floatation costs
A firm's cost of capital is influenced by
capital structure
Shareholder wealth maximization means
maximizing the price of existing common stock.
All of the following statements about balance sheets are true EXCEPT
balance sheets show average asset balances over a oneyear period
Which of the following accounts belongs in the equity section of a balance sheet?
retained earnings
Siskiyou, Inc. has total current assets of 1,200,000; total current liabilities of 500,000; long term assets of 800,000 and longterm debt of 600,000. How much is the firm's total equity
900,000
What information does a firm's statement of cash flows provide to the viewing public?
a report documenting a firm's cash inflows and cash outflows from operating, financing, and investing activities for a defined period of time
Investors want a return that satisfies the following expectations:
Both A and B.
In order to reduce agency problems, managers may be provided compensation that includes:
an option to buy the company's stock
Investors generally don't like risk. Therefore, a typical investor
will only take on additional risk if he expects to be compensated in the form of additional return.
The true owners of the corporation are the
common stockholders.
ExxonMobil generates about $50 billion in cash annually from its operations and invests about half of that on new exploration. Therefore, ExxonMobil is an example of a(n):
savings surplus unit.
Three ways that savings can be transferred through the financial markets include all of the following except:
indirect transfer using the venture capital firm.
Money market transactions include which of the following?
securities that have a maturity of less than one year
The investment banker performs what three basic functions?
underwriting, distributing, and advising
Which of the following is not a valid theory that attempts to explain the shape of the term structure of interest rates
the Fisher Effect theory
A corporation's operating profit margin is equal to
EBIT divided by Sales.
PDQ Corp. has sales of $4,000,000; the firm's cost of goods sold is $2,500,000; and its total operating expenses are $600,000. What is PDQ's EBIT?
$900,000
The two principal sources of financing for corporations are
debt and equity.
All of the following statements about balance sheets are true except:
balance sheets show average asset balances over a oneyear period.
Commonsized balance sheets
show each balance sheet account as a percentage of total assets.
You have the choice of two equally risk annuities, each paying $5,000 per year for 8 years. One is an annuity due and the other is an ordinary annuity. If you are going to be receiving the annuity payments, which annuity would you choose to maximize your wealth?
the annuity due
Most stocks have betas between
0.60 and 1.60.
) You are considering investing in Ford Motor Company. Which of the following are examples of diversifiable risk?
Beta is a statistical measure of
the relationship between an investment's returns and the market return.
You have just purchased a share of preferred stock for $50.00. The preferred stock pays an annual dividend of $5.50 per share forever. What is the rate of return on your investment?
.110
Shafer Corporation issued callable bonds. The bonds are most likely to be called if
interest rates decrease.
Put the following in order of their claim on assets of a firm, starting with the LAST to have a claim: A. Subordinated debentures B. Debentures (unsubordinated)
C. Common Stock D. Preferred stock
Common stock, preffered stock, subordinated, unsubordianted
In an efficient securities market the market value of a security is equal to:
its intrinsic value.
What is the value of a bond that has a par value of $1,000, a coupon of $120 (annually), and matures in 10 years? Assume a required rate of return of 7.8%.
1,284.38
Finance theory suggests that the current market value of a bond is based upon which of the following?
The sum of the present value of the bond's interest payments and the present value of the principal.
A $1,000 par value 14year bond with a 10 percent coupon rate recently sold for $965. The yield to maturity is
10.49%.
What is the expected rate of return on a bond that matures in 5 years, has a par value of $1,000, a coupon rate of 11.5%, and is currently selling for $982? Assume annual coupon
12.0%
Cumulative preferred stock
requires dividends in arrears to be carried over into the next period.
Many preferred stocks have a provision that entitles a company to repurchase its preferred stock from their holders at stated prices over a given time period. What is the name of this provision?
Callable
Many preferred stocks have a feature that requires a firm to periodically set aside an amount of money for the retirement of its preferred stock. What is the name of this feature?
sinking fund
Keyes Corporation preferred stock pays an annual dividend of $7 per share. Which of the following statements is true for an investor with a required return of 9%?
The value of the preferred stock is $77.78 per share
Consider the following four types of payments that could be made by a normal operating firm: interest, common dividends, income taxes, and preferred dividends. Compared to the other payments mentioned, where would you rank common dividend payments in terms of the order of payment if the firm is liquidating?
fourth
An example of the growth factor in common stock is:
retaining profits in order to reinvest into the firm.
A company has preferred stock with a current market price of $18 per share. The preferred stock pays an annual dividend of 4% based on a par value of $100. Flotation costs associated with the sale of preferred stock equal $1.50 per share. The company's marginal tax rate is 40%. Therefore, the cost of preferred stock is
24.24%.
Due to changes in regulatory requirements, the transactions costs associated with selling corporate securities increased by $1 per share. This change will
cause the cost of capital to increase.
Chapter 7 Self Test
Chapter 8 SelfTest
Chapter 9 Self Test
Foundations of Finance, 7e (Keown/Martin/Petty)
Chapter 8 The Valuation and Characteristics of Stock
8.1 Learning Objective 1
1) Preferred stock is referred to as a hybrid security because it has many characteristics of both common stock and bonds.
Answer: TRUE
Keywords: Preferred Stock, Hybrid Security
AACSB: Reflective thinking skills
2) Because most preferred stocks are perpetuities, their value can be determined by dividing the annual dividend by an investor's required return.
Answer: TRUE
Keywords: Preferred Stock, Perpetuity, Intrinsic Value
AACSB: Reflective thinking skills
3) In terms of risk, preferred stock is safer than common stock because it has a prior claim on assets and income.
Answer: TRUE
Keywords: Preferred Stock, Common Stock, Risk
AACSB: Reflective thinking skills
4) Public perception and reputation do not affect stock prices, which are strictly a function of dividends and required returns.
Answer: FALSE
Keywords: Stock Valuation Reputation
AACSB: Reflective thinking skills
5) A call provision entitles a company to repurchase its preferred stock from holders at stated prices over a given time period.
Answer: TRUE
Keywords: Preferred Stock, Call Provision
AACSB: Reflective thinking skills
6) For a given constant required rate of return, the greatest portion of a preferred stockholder's return comes from increases in the price of preferred stock.
Answer: FALSE
Keywords: Preferred Stock, Capital Gain
AACSB: Reflective thinking skills
7) The amount of the preferred stock dividend is generally fixed either as a dollar amount or as a percentage of the par value.
Answer: TRUE
Keywords: Preferred Stock Dividend
AACSB: Reflective thinking skills
8) Preferred stock is riskier than longterm debt because its claim on assets and income come after those of bonds.
Answer: TRUE
Keywords: Claims on Income, Preferred Stock, Longterm Debt
AACSB: Reflective thinking skills
9) A call provision allows the issuing firm the opportunity to avoid rising interest rates by calling investors and asking for more cash.
Answer: FALSE
Keywords: Call Provision
AACSB: Reflective thinking skills
10) Although under normal operating conditions preferred shareholders do not have voting rights, protective provision generally allow for voting rights in the event of nonpayment of preferred dividends.
Answer: TRUE
Keywords: Preferred Stock, Protective Provisions
AACSB: Reflective thinking skills
11) If a firm does not have enough money to pay any common stock dividends, it is technically in default to the common shareholders.
Answer: FALSE
Keywords: Common Stock Dividends, Default
AACSB: Analytic skills
12) The use of a call provision in addition to a sinking fund can effectively create a maturity date for preferred stock.
Answer: TRUE
Keywords: Preferred Stock, Call Provision, Sinking Fund, Maturity Date
AACSB: Reflective thinking skills
13) The upper limit on common stock dividends, which is set by the SEC, is generally equal to the sum of dividends paid on the company's preferred stock.
Answer: FALSE
Keywords: Dividends, Common Stock
AACSB: Reflective thinking skills
14) A sinkingfund provision allows for the retirement of a portion of preferred stock each year.
Answer: TRUE
Keywords: Sinking Fund, Preferred Stock
AACSB: Reflective thinking skills
15) Two approaches that allow for the retirement of preferred stock are call provisions and sinking fund provisions.
Answer: TRUE
Keywords: Preferred Stock, Call Provision, Sinking Fund Provision
AACSB: Reflective thinking skills
16) A company's market capitalization is generally greater than its book value, in part due to its reputation for being able to deliver growth, attract top talent, and avoid ethical mistakes.
Answer: TRUE
Keywords: Reputation, Book Value, Market Capitalization
AACSB: Reflective thinking skills
17) Preferred stock valuation usually treats the preferred stock as a
Answer: B
Keywords: Preferred Stock, Perpetuity
AACSB: Reflective thinking skills
18) Preferred stock is similar to a bond in the following way
Answer: B
Keywords: Preferred Stock, Bonds
AACSB: Analytic skills
19) Cumulative preferred stock
Answer: A
Keywords: Cumulative Preferred Stock
AACSB: Analytic skills
20) How is preferred stock similar to bonds?
Answer: C
Keywords: Preferred Stock, Bonds
AACSB: Reflective thinking skills
21) Most preferred stocks have a feature that requires all past unpaid preferred dividend payments be paid before any common stock dividends can be paid. What is the name of this feature?
Answer: B
Keywords: Preferred Stock, Cumulative, Dividends
AACSB: Reflective thinking skills
22) Many preferred stocks have a provision that entitles a company to repurchase its preferred stock from their holders at stated prices over a given time period. What is the name of this provision?
Answer: C
Keywords: Callable Preferred Stock
AACSB: Reflective thinking skills
23) Many preferred stocks have a feature that requires a firm to periodically set aside an amount of money for the retirement of its preferred stock. What is the name of this feature?
Answer: D
Keywords: Preferred Stock, Sinking Fund
AACSB: Reflective thinking skills
8.2 Learning Objective 2
1) XYZ Corp 8% preferred stock with a par value of $100 and a market price of $150 will pay an annual dividend this year of $12 per share.
Answer: FALSE
Keywords: Preferred Stock, Dividends, Par Value
AACSB: Analytic skills
2) The YLD% shown in Wall Street Journal stock quotes stands for the stock's dividend yield and is calculated by dividing the amount of the dividend by the stock's opening price on the first day of the year.
Answer: FALSE
Keywords: Dividend Yield, Stock Quotes
AACSB: Reflective thinking skills
3) A preferred stock that pays an annual dividend of $10, has a par value of $100, and has a required return of 5% will be valued at $200.
Answer: TRUE
Keywords: Preferred Stock, Valuation
AACSB: Analytic skills
4) Keyes Corporation preferred stock pays an annual dividend of $7 per share. Which of the following statements is true for an investor with a required return of 9%?
Answer: C
Keywords: Preferred Stock Valuation
AACSB: Reflective thinking skills
5) Which of the following statements concerning preferred stock is most correct?
Answer: C
Keywords: Preferred Stock Valuation, Dividends, Perpetuity
AACSB: Reflective thinking skills
6) Nuray Corp. preferred stock pays a $.50 annual dividend. What is the value of the stock if your required rate of return is 10%?
Answer: C
Keywords: Preferred Stock
AACSB: Analytic skills
7) Bell Corp. has a preferred stock that pays a dividend of $2.40. If you are willing to purchase the stock at $11, what is your required rate of return (round your answer to the nearest .1% and assume that there are no transaction costs)?
Answer: A
Keywords: Preferred Stock, Required Return
AACSB: Analytic skills
8) What is the value of a preferred stock that pays a $4.50 dividend to an investor with a required rate of return of 10%?
Answer: C
Keywords: Preferred Stock Valuation
AACSB: Analytic skills
9) How is preferred stock affected by a decrease in the required rate of return?
Answer: A
Keywords: Preferred Stock Valuation, Required Return
AACSB: Reflective thinking skills
10) Casino Games Company preferred stock pays a perpetual annual dividend of 3.5% of its $100 par value. If investors' required rate of return on this stock is 11%, what is the value per share?
Answer: B
Keywords: Preferred Stock Valuation, Perpetual Dividend
AACSB: Analytic skills
11) CMT, Inc. has an issue of preferred stock whose par value is $500. The preferred stock pays a 4.5% dividend. If investors require a 5.5% rate of return for these shares, what price should the preferred stock sell for?
Answer: C
Keywords: Preferred Stock Valuation
AACSB: Analytic skills
12) Department 65 has an issue of preferred stock that pays a dividend of $4.00. The preferred stockholders require a rate of return on this stock of 9%. At what price should the preferred stock sell for? Round off to the nearest $0.10.
Answer: B
Keywords: Preferred Stock Valuation
AACSB: Analytic skills
13) Positive Tronics Industries preferred stock has a par value of $100 and pays a dividend of $6.00 per share. It presently sells for $87 per share. What do investors require as a rate of return on this stock? Round off to the nearest .10%.
Answer: C
Keywords: Preferred Stock, Required Return
AACSB: Analytic skills
14) Yanti Corp. preferred stock has a 5% stated dividend percentage, and a $100 par value. What is the value of the stock if your required rate of return is 6% per year?
Answer: A
Keywords: Preferred Stock Valuation
AACSB: Analytic skills
15) If Neal O'Danny preferred stock pays an annual dividend of $2.80, and investors require a 9% return, what is the value of O'Danny's preferred stock today?
Answer: Vp = Div/R = $2.80/.09 = $31.11
Keywords: Preferred Stock Valuation
AACSB: Analytic skills
8.3 Learning Objective 3
1) The market price of a firm's common stock equals the sum of all equity accounts as reported in its balance sheet (common stock + paidin capital + retained earnings) divided by the number of shares outstanding.
Answer: FALSE
Keywords: Market Value of Equity
AACSB: Reflective thinking skills
2) Historically, price appreciation, or capital gains yield, has accounted for a greater portion of returns on common stocks than dividend payments.
Answer: TRUE
Keywords: Dividends, Returns on Common Stock, Price Appreciation
AACSB: Reflective thinking skills
3) Preferred stock is less risky than common stock, but more risky than debt.
Answer: TRUE
Keywords: Preferred Stock, Debt, Common Stock, Required Return
AACSB: Reflective thinking skills
4) Cumulative voting is advantageous to minority shareholders because it may allow them to elect a member of the board of directors.
Answer: TRUE
Keywords: Cumulative Voting, Minority Shareholders
AACSB: Reflective thinking skills
5) Shareholders, as owners of the corporation, face unlimited liability for the corporation's debts, while bondholders, as creditors, may only lose the value of their investment if the company goes bankrupt.
Answer: FALSE
Keywords: Shareholders, Creditors, Limited Liability
AACSB: Reflective thinking skills
6) Common stock cannot be worth less than its book value.
Answer: FALSE
Keywords: Common Stock, Book Value
AACSB: Reflective thinking skills
7) Convertibility is a common feature of common stock; it allows the common stockholders to convert their common shares into preferred shares or into bonds.
Answer: FALSE
Keywords: Convertibility
AACSB: Reflective thinking skills
8) Common stockholders demand a return on the price paid for their common stock, but since retained earnings on the balance sheet are merely "on paper" they do not require a return on earnings that have been retained.
Answer: FALSE
Keywords: Required Return, Retained Earnings
AACSB: Reflective thinking skills
9) The common stock of a constantgrowth firm is valued in the same manner as its preferred stock.
Answer: FALSE
Keywords: Constant Growth Common Stock Valuation Model, Preferred Stock
AACSB: Reflective thinking skills
10) Common stock does not mature.
Answer: TRUE
Keywords: Common Stock, Maturity Date
AACSB: Reflective thinking skills
11) Bondholders and preferred stockholders can be viewed as creditors, whereas the common stockholders are the true owners of the firm.
Answer: TRUE
Keywords: Common Stock, Preferred Stock, Bonds
AACSB: Reflective thinking skills
12) If a common stockholder cannot personally attend the meeting of shareholders then their votes are lost.
Answer: FALSE
Keywords: Voting Rights, Common Stock
AACSB: Reflective thinking skills
13) Under cumulative voting a 10% shareholder will likely be able to elect 10% of the board of directors.
Answer: TRUE
Keywords: Cumulative Voting, Board of Directors
AACSB: Reflective thinking skills
14) Under majority voting a majority (>50%) shareholder will just be able to elect a simple majority of the board of directors.
Answer: FALSE
Keywords: Majority Voting, Board of Directors
AACSB: Reflective thinking skills
15) Under majority voting a majority (>50%) shareholder will be able to elect the entire board of directors.
Answer: TRUE
Keywords: Majority Voting, Board of Directors
AACSB: Reflective thinking skills
16) Preferred stock and common stock issued by the same firm will have the same required return because the riskiness of the firm's cash flows is the same for both securities.
Answer: FALSE
Keywords: Preferred Stock, Common Stock, Required Return
AACSB: Reflective thinking skills
17) In theory, shareholders select the board of directors, but in reality, management effectively selects the directors.
Answer: TRUE
Keywords: Board of Directors, Agency Problems
AACSB: Reflective thinking skills
18) Limited liability for a corporation's common shareholders is a protective provision that aids the corporation in raising funds.
Answer: TRUE
Keywords: Limited Liability
AACSB: Reflective thinking skills
19) If a shareholder cannot attend the corporation's annual meeting, the shares may still be voted using
Answer: B
Keywords: Proxy
AACSB: Reflective thinking skills
20) Minority shareholders have a greater chance of electing a member to the board of directors if the company uses
Answer: A
Keywords: Cumulative Voting
AACSB: Analytic skills
21) Preferred stock differs from common stock in that
Answer: C
Keywords: Preferred Stock, Dividends
AACSB: Reflective thinking skills
22) How is preferred stock similar to common stock?
Answer: B
Keywords: Preferred Stock, Common Stock
AACSB: Reflective thinking skills
23) Which of the following is not true regarding common stock?
Answer: D
Keywords: Common Stock, Dividends
AACSB: Reflective thinking skills
24) Consider the following four types of payments that could be made by a normal operating firm: interest, common dividends, income taxes, and preferred dividends. Compared to the other payments mentioned, where would you rank common dividend payments in terms of the order of payment if the firm is liquidating?
Answer: D
Keywords: Common Stock Dividends
AACSB: Reflective thinking skills
25) Assume that a firm had such serious financial problems that it was about to be liquidated after a bankruptcy. All of the firm's assets are about to be sold in order to pay the following claims against the firm: bondholders, preferred stockholders, common stockholders, and federal income taxes. Of the claims mentioned, what priority would common stockholders have?
Answer: D
Keywords: Common Stock Claims, Liquidation
AACSB: Reflective thinking skills
26) What provision entitles the common shareholder to maintain a proportionate share of ownership in a firm?
Answer: D
Keywords: Preemptive Right, Common Stock
AACSB: Reflective thinking skills
27) Which of the following features, or benefits, belong to a firm's common stockholders?
Answer: D
Keywords: Common Stock, Limited Liability, Voting Rights
AACSB: Reflective thinking skills
28) Who bears the greatest risk of loss of value if a firm should fail?
Answer: C
Keywords: Claims on Assets, Bankruptcy, Risk
AACSB: Reflective thinking skills
8.4 Learning Objective 4
1) The most relevant form of growth for valuing a firm's common stock is internal growth.
Answer: TRUE
Keywords: Common Stock Valuation, Internal Growth
AACSB: Reflective thinking skills
2) Because common stock represents a residual interest in the corporation, the value of common stock is equal to the total firm value less the firm's outstanding debt.
Answer: TRUE
Keywords: Common Stock Valuation, Enterprise Value, Residual Interest
AACSB: Reflective thinking skills
3) An investor's required rate of return for a common stock can be estimated by summing the stock's dividend yield and annual growth rate, assuming the growth rate is constant over time.
Answer: TRUE
Keywords: Required Return, Dividend Yield, Growth Rate, Constant Growth Dividend Valuation Model
AACSB: Reflective thinking skills
4) Given the constant growth dividend valuation model, the expected percentage growth in value of a stock is equal to the capital gains yield for that stock.
Answer: TRUE
Keywords: Constant Growth Dividend Valuation Model, Capital Gains Yield
AACSB: Reflective thinking skills
5) If the expected growth rate for dividends is zero, then the value of common stock will be equal to the current dividend.
Answer: FALSE
Keywords: Constant Growth Dividend Valuation Model
AACSB: Analytic skills
6) A common stock with an expected dividend growth rate of zero would be valued in the same way as preferred stock, that is, the expected dividend divided by the required return.
Answer: TRUE
Keywords: Preferred Stock, Constant Growth Dividend Valuation Model
AACSB: Reflective thinking skills
7) In general, common stock and preferred stock are both valued by calculating the present value of all expected future cash flows, using the required return as the discount rate.
Answer: TRUE
Keywords: Common Stock, Preferred Stock, Valuation, Present Value, Required Return
AACSB: Reflective thinking skills
8) The stock valuation model D1/(rcs  g) requires the stock to grow at a rate greater than the required return; otherwise, the stock is worthless.
Answer: FALSE
Keywords: Constant Growth Common Stock Valuation Model
AACSB: Reflective thinking skills
9) The retention ratio is equal to 1 minus the dividend payout ratio.
Answer: TRUE
Keywords: Retention Ratio, Dividend Payout Ratio
AACSB: Reflective thinking skills
10) A firm can increase the growth rate of common stockholders' investment in the firm by retaining more earnings or increasing return on equity.
Answer: TRUE
Keywords: Growth Rate, Common Stock, Retained Earnings, Return on Equity
AACSB: Reflective thinking skills
11) Common stock valuation can be based on the present value of future dividends or alternatively on the present value of the firm's future quarterly net income.
Answer: FALSE
Keywords: Common Stock, Valuation, Dividends, Net Income
AACSB: Reflective thinking skills
12) The change in the value of a corporation's common stock as the result of growth is the same regardless of whether the growth is the result of internal growth or the infusion of new capital.
Answer: FALSE
Keywords: Dividend Valuation Model, Internal Growth
AACSB: Reflective thinking skills
13) United Financial Corp had a return on equity of 15%. The corporation's earnings per share was $6.00, its dividend payout ratio was 40% and its profitretention rate was 60%. If these relationships continue, what will be United Financial Corp's internal growth rate?
Answer: B
Keywords: Internal Growth Rate, ProfitRetention Rate
AACSB: Analytic skills
14) Baseheart, Inc. expects its current annual $2.50 per share common stock dividend to remain the same for the foreseeable future. Therefore, the value of the stock to an investor with a required return of 12% is:
Answer: C
Keywords: Constant Growth Dividend Valuation Model
AACSB: Analytic skills
15) Which of the following changes will make the value of a stock go up, other things being held constant?
Answer: A
Keywords: Risk/Return Tradeoff, Required Return, Stock Valuation
AACSB: Analytic skills
16) If two firms have the same current dividend and the same expected growth rate, their stocks must sell at the same current price or else the market will not be in equilibrium.
Answer: A
Keywords: Dividend, Growth Rate, Stock Valuation
AACSB: Analytic skills
17) You are considering the purchase of a common stock that paid a dividend of $2.00 yesterday. You expect this stock to have a growth rate of 15 percent for the next 3 years, resulting in dividends of D1=$2.30, D2=$2.645, and D3=$3.04. The longrun normal growth rate after year 3 is expected to be 10 percent (that is, a constant growth rate after year 3 of 10% per year forever). If you require a 14 percent rate of return, how much should you be willing to pay for this stock?
Answer: D
Keywords: Constant Growth, Stock Valuation
AACSB: Analytic skills
18) Which of the following statements concerning the required rate of return on stocks is true?
Answer: D
Keywords: Required Return, Risk, Stock Valuation
AACSB: Reflective thinking skills
19) Which of the following statements concerning the constant growth dividend valuation model is true?
Answer: A
Keywords: Required Return, Constant Growth Dividend Valuation Model
AACSB: Reflective thinking skills
20) A small biotechnology research corporation has been experiencing losses for the first three years of its existence, and thus has a negative balance in retained earnings. The corporation's stock price, however, is $1 per share. Which of the following statements is most correct?
Answer: B
Keywords: Required Return, Retained Earnings
AACSB: Reflective thinking skills
21) A small company struggling to reach profitability just announced a major new government contract that will validate its technology and generate revenue for the next several years. The announcement of the contract will
Answer: C
Keywords: Required Return, Growth Rate, Stock Valuation
AACSB: Analytic skills
22) Using the constant growth dividend valuation model and assuming dividends will growth a constant rate forever, the increase in the value of the stock each year should be equal to the
Answer: A
Keywords: Constant Growth Dividend Valuation Model
AACSB: Reflective thinking skills
23) Nogrowth Corporation expects their dividend to stay at $0.50 per share each year into the foreseeable future. Therefore,
Answer: B
Keywords: Constant Growth Dividend Valuation Model
AACSB: Analytic skills
24) A financial analyst expects KacieCo. to pay a dividend of $2 per share one year from today, a dividend of $3 per share in years two, and estimates the value of the stock at the end of year two to be $22. If your required return on KacieCo stock is 14 %, what is the most you would be willing to pay for the stock today if you plan to sell the stock in two years?
Answer: A
Keywords: Stock Valuation, Present Value
AACSB: Analytic skills
25) Kilsheimer Company just paid a dividend of $5 per share. Future dividends are expected to grow at a constant rate of 7% per year. What is the value of the stock if the required return is 16%?
Answer: C
Keywords: Constant Growth Dividend Valuation Model
AACSB: Analytic skills
26) Emery Company just paid a dividend yesterday of $2.25 per share. The company's stock is currently selling for $60 per share, and the required rate of return on Emery Company stock is 16%. What is the growth rate expected for Emery Company dividends assuming constant growth?
Answer: D
Keywords: Constant Growth Dividend Valuation Model, Growth Rate
AACSB: Analytic skills
27) J&S Corporation has preferred stock which paid an annual dividend in 2009 of $5 per share. J&S also has common stock which paid a dividend in 2009 of $5. Which of the following statements is most correct concerning J&S stock?
Answer: B
Keywords: Preferred Stock Valuation, Common Stock Valuation
AACSB: Reflective thinking skills
28) Using the dividend valuation method, an analyst determines the value of Company A's stock to be $10 and the value of Company B's stock to be $14. Based on this information, which of the following statements is most accurate?
Answer: C
Keywords: Free Cash Flow Valuation
AACSB: Reflective thinking skills
29) All of the following affect the value of a share of common stock except:
Answer: D
Keywords: Common Stock Valuation, Balance Sheet, Required Return, Dividends
AACSB: Reflective thinking skills
30) The PDQ Company's common stock is expected to pay a $2.00 dividend in the coming year. If investors require a 17% return and the growth rate in dividends is expected to be 8%, what will the market price of the stock be?
Answer: D
Keywords: Constant Growth Dividend Valuation Model, Common Stock
AACSB: Analytic skills
31) An example of the growth factor in common stock is:
Answer: B
Keywords: Growth Rate, Common Stock, Retained Profits
AACSB: Reflective thinking skills
32) You are considering the purchase of a share of Edie's common stock. You expect to sell it at the end of 1 year for $32.00. You will also receive a dividend of $2.50 at the end of the year. Edie just paid a dividend of $2.25. If your required return on this stock is 12%, what is the most you would be willing to pay for it now?
Answer: D
Keywords: Common Stock Valuation, Dividend, Required Return
AACSB: Analytic skills
33) Lily Co. paid a dividend of $5.25 on its common stock yesterday. The company's dividends are expected to grow at a constant rate of 8.5% indefinitely. If the required rate of return on this stock is 15.5%, compute the current value per share of Lily Co. stock.
Answer: A
Keywords: Constant Growth Dividend Valuation Model
AACSB: Analytic skills
34) Lily Co.paid a dividend of $5.25 on its common stock yesterday. The company's dividends are expected to grow at a constant rate of 8.5% indefinitely. The required rate of return on this stock is 15.5%. You observe a market price of $78.50 for the stock. Should you purchase this stock?
Answer: B
Keywords: Constant Growth Dividend Valuation Model
AACSB: Reflective thinking skills
35) Wallace Industries paid a dividend of $1.65 on its common stock yesterday. The dividends of Wallace Industries are expected to grow at 9% per year indefinitely. If the risk free rate is 3% and investors' risk premium on this stock is 8%, estimate the value of Wallace Industries stock 2 years from now.
Answer: A
Keywords: Constant Growth Dividend Valuation Model, Required Return, Risk Free Rate, Risk Premium
AACSB: Analytic skills
36) Greenland Airlines has net income of $2 million this year. The book value of Greenland Airlines common equity is $8 million dollars. The company's dividend payout ratio is 60% and is expected to remain this way. What is Greenland Airlines' internal growth rate?
Answer: C
Keywords: Sustainable Growth Rate
AACSB: Analytic skills
37) Berberich Corporation net income this year is $800,000. The company generally retains 35% of net income for reinvestment. The company's common equity currently has a book value of $5,000,000. They just paid a dividend of $1.37, and the required rate of return on this stock is 12%. Compute the value of this stock if dividends are expected to continue growing indefinitely at the company's internal growth rate.
Answer: A
Keywords: Internal Growth Rate, Constant Growth Dividend Valuation Model
AACSB: Analytic skills
38) Chambers Corporation's ROE is 20%. Their dividend payout ratio is 70%. The last dividend, just paid, was $2.00. If dividends are expected to grow by the company's internal growth rate indefinitely, what is the current value of Chambers common stock if its required return is 18%?
Answer: A
Keywords: Internal Growth Rate, Constant Growth Dividend Valuation Model
AACSB: Analytic skills
39) Johnstown Supply Corporation stock is currently selling for $58.00. It is expected to pay a dividend of $5.00 at the end of the year. Dividends are expected to grow at a constant rate of 7.5% indefinitely. Compute the required rate of return on Johnstown Supply Corporation stock.
Answer: D
Keywords: Constant Growth Dividend Valuation Model
AACSB: Analytic skills
40) Modem Development, Inc. paid a dividend of $5.00 per share on its common stock yesterday. Dividends are expected to grow at a constant rate of 4% for the next two years, at which point the stock is expected to sell for $56.00. If investors require a rate of return on Modem's common stock of 18%, what should the stock sell for today?
Answer: B
Keywords: Dividend Valuation Model
AACSB: Analytic skills
41) If you expect NoDiv Corporation to sell for $75 per share in three years while paying no dividends along the way, and if your required rate of return is 16% per year, how much is the stock worth today?
Answer: B
Keywords: Common Stock Valuation, Present Value
AACSB: Analytic skills
42) Creamy Custard common stock is currently selling for $79.00. It just paid a dividend of $4.60 and dividends are expected to grow at a rate of 5% indefinitely. What is the required rate of return on Creamy Custard's stock?
Answer: A
Keywords: Required Return, Constant Growth Dividend Valuation Model
AACSB: Analytic skills
43) Modem Development, Inc. paid a dividend of $5.00 per share on its common stock yesterday. Dividends are expected to grow at a constant rate of 10% for the next two years, at which point the dividends will begin to grow at a constant rate indefinitely. If the stock is selling for $50 today and the required return is 15%, what it the expected annual dividend growth rate after year two?
Answer: A
Keywords: Constant Growth Dividend Valuation Model
AACSB: Analytic skills
44) I Sage, whose common stock is currently selling for $12 per share, is expected to pay a $1.80 dividend, and sell for $14.40 one year from now. What are the dividend yield, growth rate, and total rate of return, respectively?
Answer: A
Keywords: Dividend Yield, Growth Rate, Total Rate of Return
AACSB: Analytic skills
45) Shara Miselle Co. just paid a dividend of $1.65 (D0) on its common stock. This company's dividends are expected to grow at a constant rate of 3% indefinitely. If the required rate of return on this stock is 11%, compute the current value per share of Shara Miselle stock.
Answer: B
Keywords: Constant Growth Dividend Valuation Model
AACSB: Analytic skills
46) You observe Golden Flashes Common Stock selling for $40.00 per share. The next dividend is expected to be $4.00, and is expected to grow at a 5% annual rate forever. If your required rate of return is 12%, should you purchase the stock?
Answer: A
Keywords: Common Stock Valuation, Required Return
AACSB: Reflective thinking skills
47) NewAge, Inc. paid a dividend yesterday of $2 per share. NewAge management expects the dividend to increase next year to $3 annually. If the dividend is expected to stay at $3 per year for the foreseeable future, what is the value of the stock to an investor with a required rate of return of 10%?
Answer: B
Keywords: Dividend Valuation Model, Zero Growth
AACSB: Analytic skills
48) H. J. Corp.'s common stock paid $2.50 in dividends last year (D0). Dividends are expected to grow at a 12percent annual rate forever. If H. J.'s current market price is $40.00, and your required rate of return is 23 percent, should you purchase the stock?
Answer: C
Keywords: Constant Growth Dividend Valuation Model, Required Rate of Return
AACSB: Reflective thinking skills
49) Diana Ltd. paid a $2.50 per share dividend yesterday. The dividend is expected to grow at 10 percent per year for the foreseeable future. Diana Ltd. has a beta of 1.6, a standard deviation of returns of 30 percent, and a required return of 18%. What is the value of a share of Diana Ltd. common stock?
Answer: D1 = $2.50 * (1.10) = $2.75; P0 = D1/(rcs — g) = $2.75/(.18  .10) = $34.38
Keywords: Constant Growth Dividend Valuation Model
AACSB: Analytic skills
50) You are considering the purchase of Zee Company stock. You anticipate that the company will pay dividends of $3.50 per share next year and $4.00 per share the following year. You believe that you can sell the stock for $20.00 per share two years from now. If your required rate of return is 10 percent, what is the maximum price that you would pay for a share of Zee Company stock?
Answer: VC = $3.50 (PVIF10%,1) + $24.00 (PVIF10%,2) = $23.02
Keywords: Common Stock Valuation
AACSB: Analytic skills
51) The price of DDS Corporation stock is expected to be $45 in 5 years. Dividends are anticipated to increase at an annual rate of 10 percent from the most recent dividend of $1.00. If your required rate of return is 15 percent, how much are you willing to pay for DDS stock?
Answer: The expected cash flows are the future dividends plus the future selling price,
Year 
D 
PV @ 15% 

1 
1.10 
.96 

2 
1.21 
.91 

3 
1.33 
.88 

4 
1.46 
.84 

5 
1.61 
.80 

$4.39 
=PV of dividends only 
P = $4.39 + ($68/(1.15^5 = 22.37) = $26.76
Keywords: Common Stock Valuation
AACSB: Analytic skills
8.5 Learning Objective 5
1) The expected rate of return implied by a given market price equals the required rate of return for investors at the margin.
Answer: TRUE
Keywords: Required Return, Expected Return
AACSB: Reflective thinking skills
2) Butler Corp paid a dividend today of $5 per share. The dividend is expected to grow at a constant rate of 6.5% per year. If Butler Corp stock is selling for $50.00 per share, the stockholders' expected rate of return is
Answer: D
Keywords: Expected Rate of Return, Constant Growth Dividend Valuation Model
AACSB: Analytic skills
3) The expected rate of return on a share of common stock whose dividends are growing at a constant rate (g) is which of the following, where D1 is the next dividend and Vc is the current value of the stock?
Answer: B
Keywords: Constant Growth Dividend Valuation Model, Expected Rate of Return
AACSB: Analytic skills
4) Bin Restaurant Corp preferred stock has a market price of $14.50. If it has a yearly dividend of $3.50, what is your expected rate of return if you purchase the stock at its market price?
Answer: D
Keywords: Preferred Stock, Expected Rate of Return
AACSB: Analytic skills
5) ADR Bank preferred stock pays an annual dividend of $2.75 per share. If the stock is currently selling for $27.50 per share, what is the expected rate of return on this stock?
Answer: B
Keywords: Preferred Stock, Expected Rate of Return
AACSB: Analytic skills
6) H. J. Corp. common stock paid $2.50 in dividends last year (D0). Dividends are expected to grow at a 12percent annual rate forever. If H. J.'s current market price is $40.00, what is the stock's expected rate of return (nearest .01 percent)?
Answer: D
Keywords: Constant Growth Dividend Valuation Model, Expected Rate of Return
AACSB: Analytic skills
7) U.S Technologies preferred stock sells for $80 and pays $9 each year in dividends. What is the expected rate of return?
Answer: rp = D/V = $9/805 = .1125 = 11.25%
Keywords: Preferred Stock Valuation, Expected Rate of Return
AACSB: Analytic skills
8) You purchased one share of Sophia Enterprises common stock for $30 today. If the stock pays a dividend of $6.50 in one year, and sells for $32.50 at that time, what will the dividend yield, growth rate, and total rate of return be for the year?
Answer: Dividend yield = Div/price = $6.50 / $30 = 21.67%
Growth rate = change in price = ($32.50  $30) / $30 = 8.33%
Total rate of return = Div. yield + growth rate = 30%
Keywords: Dividend Yield, Growth Rate, Total Rate of Return
AACSB: Analytic skills
9) Tannerly Worldwide's common stock is currently selling for $48 a share. If the expected dividend at the end of the year is $2.40 and last year's dividend was $2.00, what is the rate of return implicit in the current stock price?
Answer: rc = 2.40/48 + (2.40  2.00)/2.00 = .05 + .20 = 25%
Keywords: Expected Rate of Return, Dividend Yield, Growth Rate
AACSB: Analytic skills
10) Miller's preferred stock is selling at $54 on the market and pays an annual dividend of $4.20 per share.
Answer:
R = $4.20/54
R = 7.78%
V = $4.20/.09
V = $46.67
No, it is not a desirable investment because the current selling price exceeds the value to the investor.
Keywords: Preferred Stock Valuation, Expected Rate of Return, Required Rate of Return
AACSB: Analytic skills
11) The common stock of Cranberry Inc. is selling for $26.75 on the open market. Next year's dividend is expected to be $3.68, and the growth rate of this company is estimated to be 5.5%. If Richard Dean, an average investor, is considering purchasing this stock at the market price, what is his expected rate of return?
Answer:
R = (D/V) + g
R = ($3.68/$26.75) + .055
R = 19.26%
Keywords: Expected Rate of Return, Dividend Yield, Growth Rate
AACSB: Analytic skills
The par value of a bond:
generally is $1,000
The interest on corporate bonds is typically paid:
semiannually
On any given day, a bond can be issued at
a discount, a premium, par
Mortgage bonds
are secured by a lien on real property
Which type of value is shown on the firm's balance sheet?
Book Value
Which of the following is generally NOT a characteristic of a bond?
Voting Rights
Which of the following investors incurs the least risk?
bondholders
An ___ is used to outline the issuing company's contractual obligations to bondholders
indenture
The yield to maturity on a bond
is the required return on the bond
Bond ratings are usually not affected by
the company's fiscal year end
The discount rate used to value a bond is:
the market rate of interest
Which of the following statements is FALSE?
Interest rates and bond prices usually move in the same direction
Eurobonds are:
issued in a country different from the one in whose currency the bond is denominated
Which of the following statements about zero coupon bonds is FALSE?
When the bonds mature, the issuing firm is faced with small cash outflow relative to the cash inflow the firm receives when the bonds are initially issued
Which of the following bonds is sold by a corporation at a discount and pay no interest?
a zero coupon bond
Government bonds have lower yield to maturity than do corporate bonds of the same maturity because the __ premium is lower for government bonds
default
which of the following statements is true?
A bond will set at a premium if the prevailing required rate of return is less than the bond's coupon rate
Financial Management: Principles and Applications, 11e (Titman)
Chapter 9 Debt Valuation and Interest Rates
9.1 Overview of Corporate Debt
1) The par value of a bond:
Answer: C
Diff: 1
Topic: 9.1 Overview of Corporate Debt
Keywords: bonds
Principles: Principle 1: Money Has a Time Value
2) The interest on corporate bonds is typically paid:
Answer: A
Diff: 1
Topic: 9.1 Overview of Corporate Debt
Keywords: bonds
Principles: Principle 1: Money Has a Time Value
3) On any given day, a bond can be issued at:
Answer: D
Diff: 1
Topic: 9.1 Overview of Corporate Debt
Keywords: bonds
Principles: Principle 1: Money Has a Time Value
4) Mortgage bonds:
Answer: B
Diff: 1
Topic: 9.1 Overview of Corporate Debt
Keywords: bonds
Principles: Principle 2: There Is a RiskReturn Tradeoff
5) Bondholders have a priority claim on assets ahead of:
Answer: C
Diff: 1
Topic: 9.1 Overview of Corporate Debt
Keywords: bonds
Principles: Principle 2: There Is a RiskReturn Tradeoff
6) Which type of value is shown on the firm's balance sheet?
Answer: A
Diff: 1
Topic: 9.1 Overview of Corporate Debt
Keywords: balance sheet
Principles: Principle 3: Cash Flows Are the Source of Value
7) Which of the following is generally NOT a characteristic of a bond?
Answer: A
Diff: 1
Topic: 9.1 Overview of Corporate Debt
Keywords: bonds
Principles: Principle 1: Money Has a Time Value
8) Common indenture provisions include:
Answer: D
Diff: 1
Topic: 9.1 Overview of Corporate Debt
Keywords: bonds
Principles: Principle 2: There Is a RiskReturn Tradeoff
9) The issuance of bonds to raise capital for a corporation:
Answer: D
Diff: 2
Topic: 9.1 Overview of Corporate Debt
Keywords: bonds
Principles: Principle 2: There Is a RiskReturn Tradeoff
10) A(n)________ is used to outline the issuing company's contractual obligations to bondholders.
Answer: D
Diff: 1
Topic: 9.1 Overview of Corporate Debt
Keywords: bonds
Principles: Principle 2: There Is a RiskReturn Tradeoff
11) Junk bonds:
Answer: D
Diff: 2
Topic: 9.1 Overview of Corporate Debt
Keywords: bonds
Principles: Principle 2: There Is a RiskReturn Tradeoff
12) Which of the following investors incurs the least risk?
Answer: A
Diff: 1
Topic: 9.1 Overview of Corporate Debt
Keywords: risk, return
Principles: Principle 2: There Is a RiskReturn Tradeoff
13) The par value of a corporate bond indicates the level of interest payments that will be paid to investors.
Answer: FALSE
Diff: 1
Topic: 9.1 Overview of Corporate Debt
Keywords: coupon rate
Principles: Principle 1: Money Has a Time Value
14) Any unsecured longterm debt instrument is a debenture.
Answer: TRUE
Diff: 1
Topic: 9.1 Overview of Corporate Debt
Keywords: bonds
Principles: Principle 2: There Is a RiskReturn Tradeoff
15) A mortgage bond is always secured by a lien on real property.
Answer: TRUE
Diff: 1
Topic: 9.1 Overview of Corporate Debt
Keywords: bonds
Principles: Principle 2: There Is a RiskReturn Tradeoff
16) The debenture is the legal agreement between the firm issuing a bond and the bond trustee who represents the bondholders.
Answer: FALSE
Diff: 1
Topic: 9.1 Overview of Corporate Debt
Keywords: bonds
Principles: Principle 2: There Is a RiskReturn Tradeoff
9.2 Valuing Corporate Debt
1) The yield to maturity on a bond:
Answer: C
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: yield to maturity
Principles: Principle 1: Money Has a Time Value
2) All of the following affect the value of a bond EXCEPT:
Answer: B
Diff: 1
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
3) A $1,000 par value 10year bond with a 10% coupon rate recently sold for $900. The yield to maturity:
Answer: B
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: yield to maturity
Principles: Principle 1: Money Has a Time Value
4) Sterling Corp. bonds pay 10% annual interest and are selling at 97. The market rate of interest:
Answer: B
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: market interest rate
Principles: Principle 1: Money Has a Time Value
5) The Blackburn Group has recently issued 20year, unsecured bonds rated BB by Moody's. These bonds are:
Answer: B
Diff: 1
Topic: 9.2 Valuing Corporate Debt
Keywords: bonds
Principles: Principle 1: Money Has a Time Value
6) Colby & Company bonds pay semiannual interest of $50. They mature in 15 years and have a par value of $1,000. The market rate of interest is 8%. The market value of Colby bonds is (round to the nearest dollar):
Answer: A
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
7) Caldwell, Inc. sold an issue of 30year, $1,000 par value bonds to the public. The bonds carry a 10.85% coupon rate and pay interest semiannually. It is now 12 years later. The current market rate of interest on the Caldwell bonds is 8.45%. What is the current market price (intrinsic value) of the bonds? Round off to the nearest $1.
Answer: C
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
8) MI has a $1,000 par value, 30year bond outstanding that was issued 20 years ago at an annual coupon rate of 10%, paid semiannually. Market interest rates on similar bonds are 7%. Calculate the bond's price.
Answer: D
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
9) Davis & Davis issued $1,000 par value bonds at 102. The bonds pay 12% interest annually and mature in 30 years. The market rate of interest is (round to the nearest hundredth of a percent):
Answer: B
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: market interest rate
Principles: Principle 1: Money Has a Time Value
10) What is the yield to maturity of a nineyear bond that pays a coupon rate of 20% per year, has a $1,000 par value, and is currently priced at $1,407? Round your answer to the nearest whole percent and assume annual coupon payments.
Answer: C
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: yield to maturity
Principles: Principle 1: Money Has a Time Value
11) What is the expected rate of return on a bond that matures in seven years, has a par value of $1,000, a coupon rate of 14%, and is currently selling for $911? Round your answer to the nearest whole percent and assume annual coupon payments.
Answer: D
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: yield to maturity
Principles: Principle 1: Money Has a Time Value
12) What is the expected rate of return on a bond that pays a coupon rate of 9%, has a par value of $1,000, matures in five years, and is currently selling for $714? Round your answer to the nearest whole percent and assume annual coupon payments.
Answer: A
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: yield to maturity
Principles: Principle 1: Money Has a Time Value
13) What is the value of a bond that has a par value of $1,000, a coupon rate of $80 (annually), and matures in 11 years? Assume a required rate of return of 11%, and round your answer to the nearest $10.
Answer: C
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
14) What is the value of a bond that matures in three years, has an annual coupon payment of $110, and a par value of $1,000? Assume a required rate of return of 11%, and round your answer to the nearest $10.
Answer: D
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
15) Bond ratings are usually not affected by:
Answer: A
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 2: There Is a RiskReturn Tradeoff
16) The discount rate used to value a bond is:
Answer: D
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
17) As interest rates, and consequently investors' required rates of return, change over time, the ________ of outstanding bonds will also change.
Answer: D
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
18) Zoro Sword Company bonds pay an annual coupon rate of 9 1/2%. They have eight years to maturity and face value, or par, of $1,000. Compute the value of Zoro bonds if investors' required rate of return is 10%.
Answer: B
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
19) Terminator Bug Company bonds have a 14% coupon rate. Interest is paid semiannually. The bonds have a par value of $1,000 and will mature 10 years from now. Compute the value of Terminator bonds if investors' required rate of return is 12%.
Answer: A
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
20) Brookline, Inc. just sold an issue of 30year bonds for $1,107.20. Investors require a rate of return on these bonds of 7.75%. The bonds pay interest semiannually. What is the coupon rate of the bonds?
Answer: D
Diff: 3
Topic: 9.2 Valuing Corporate Debt
Keywords: coupon rate
Principles: Principle 1: Money Has a Time Value
21) Applebee sold an issue of 30year, $1,000 par value bonds to the public. The coupon rate of 8.75% is payable annually. It is now five years later, and the current market rate of interest is 7.25%. What is the current market price (intrinsic value) of the bonds? Round off to the nearest $1.
Answer: B
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
22) Six years ago, Colt, Inc. sold an issue of 30year, $1,000 par value bonds. The coupon rate of 5.25% is payable annually. Investors presently require a rate of return of 8.375%. What is the current market price (intrinsic value) of the bonds? Round off to the nearest $1.
Answer: C
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
23) Frazier Fudge has a $1,000 par value bond that is currently selling for $1,300. It has an annual coupon rate of 7%, paid semiannually, and has nine years remaining until maturity. What is the annual yield to maturity on the bond? (Round to the nearest whole percentage.)
Answer: A
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: yield to maturity
Principles: Principle 1: Money Has a Time Value
24) You are considering the purchase of Hytec bonds that were issued 14 years ago. When the bonds were originally sold, they had a 30year maturity and a 14.375% coupon interest rate that is payable semiannually. The bond is currently selling for $1,508.72. What is the yield to maturity on the bonds?
Answer: A
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: yield to maturity
Principles: Principle 1: Money Has a Time Value
25) Aurand, Inc. has outstanding bonds with an 8% annual coupon rate paid semiannually. The bonds have a par value of $1,000, a current price of $904, and will mature in 14 years. What is the annual yield to maturity on the bond?
Answer: C
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: yield to maturity
Principles: Principle 1: Money Has a Time Value
26) Marshall Manufacturing has a bond outstanding that was issued 20 years ago at a coupon rate of 9%. The $1,000 par value bond pays interest semiannually and was originally issued with a term of 30 years. If today's interest rate is 14%, what is the value of the bond today?
Answer: B
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
27) A $1,000 par value bond is currently listed as selling at 92 1/8. This means:
Answer: B
Diff: 1
Topic: 9.2 Valuing Corporate Debt
Keywords: bond pricing
Principles: Principle 4: Market Prices Reflect Information
28) You paid $865.50 for a corporate bond that has a 6.75% coupon rate. What is the bond's current yield?
Answer: B
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: current yield
Principles: Principle 1: Money Has a Time Value
29) A $1,000 par value bond with a 12% coupon rate currently selling for $825 has a current yield of:
Answer: A
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: current yield
Principles: Principle 1: Money Has a Time Value
30) Bond ratings are favorably affected by:
Answer: D
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond rating
Principles: Principle 2: There Is a RiskReturn Tradeoff
31) Miller Motorworks has a $1,000 par value, 8% annual coupon bond with interest payable semiannually with a remaining term of 15 years. The annual market yield on similar bonds is 6%. What is the bond selling for today? (Round to the nearest whole dollar.)
Answer: A
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
32) Lambda Co. has bonds outstanding that mature in 10 years. The bonds have $1,000 par value, pay interest annually at a rate of 9%, and have a current selling price of $1,125. The yield to maturity on the bonds is:
Answer: A
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: yield to maturity
Principles: Principle 1: Money Has a Time Value
33) Generic, Inc. has bonds outstanding that mature in 20 years. The bonds have $1,000 par value, pay interest annually at a rate of 10%, and have a current selling price of $875.25. The yield to maturity on the bonds is:
Answer: C
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: yield to maturity
Principles: Principle 1: Money Has a Time Value
34) Beta, Inc. has bonds outstanding that mature in 10 years. The bonds have $1,000 par value and pay interest annually at a rate of 10%, which is also the current required rate of return on the bonds. The bonds' duration is:
Answer: B
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
35) Assume that you wish to purchase a 20year bond that has a maturity value of $1,000 and a coupon interest rate of 8%, paid semiannually. If you require a 10% rate of return on this investment, what is the maximum price that you would be willing to pay for this bond?
Answer: D
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
36) Assume that you wish to purchase a 30year bond that has a maturity value of $1,000 and a coupon interest rate of 9.5%, paid semiannually. If you require a 6.75% rate of return on this investment, what is the maximum price that you should be willing to pay for this bond?
Answer: C
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
37) Dry Seal plans to issue bonds to expand operations. The bonds will have a par value of $1,000, a 10year maturity, and a coupon interest rate of 9%, paid semiannually. Current market conditions are such that the bonds will be sold to net $937.79. What is the yieldtomaturity of these bonds?
Answer: B
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: yield to maturity
Principles: Principle 1: Money Has a Time Value
38) You purchased Photon, Inc. bonds exactly one year ago today for $875. During the latest year, you received $65 in interest on the bonds. What is your current yield on these bonds?
Answer: B
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: current yield
Principles: Principle 1: Money Has a Time Value
39) You purchased Gibraltar Corp. bonds exactly one year ago today for $1,075. During the latest year, you received $85 in interest on the bonds. What is your current yield on these bonds?
Answer: D
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: current yield
Principles: Principle 3: Cash Flows Are the Source of Value
40) The longer the time to maturity, the more sensitive a bond's price to changes in market interest rates.
Answer: TRUE
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
41) A bond's value equals the present value of interest and principal the owner will receive.
Answer: TRUE
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
42) The higher the bond rating, the more default risk associated with the bond.
Answer: FALSE
Diff: 1
Topic: 9.2 Valuing Corporate Debt
Keywords: risk, return
Principles: Principle 2: There Is a RiskReturn Tradeoff
43) Bond ratings measure the interest rate risk of a given bond issue.
Answer: FALSE
Diff: 1
Topic: 9.2 Valuing Corporate Debt
Keywords: risk, return
Principles: Principle 2: There Is a RiskReturn Tradeoff
44) When referring to bonds, expected rate of return and yield to maturity are often used interchangeably.
Answer: TRUE
Diff: 1
Topic: 9.2 Valuing Corporate Debt
Keywords: bonds
Principles: Principle 1: Money Has a Time Value
45) Junk bonds are rated BB or higher.
Answer: FALSE
Diff: 1
Topic: 9.2 Valuing Corporate Debt
Keywords: bonds
Principles: Principle 2: There Is a RiskReturn Tradeoff
46) The current yield of a bond will equal its coupon rate when the bond is selling at par value.
Answer: TRUE
Diff: 3
Topic: 9.2 Valuing Corporate Debt
Keywords: current yield
Principles: Principle 1: Money Has a Time Value
47) The better the bond rating, the lower the rate of return demanded in the capital markets.
Answer: TRUE
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: risk, return
Principles: Principle 2: There Is a RiskReturn Tradeoff
48) The sensitivity of a bond's value to changing interest rates depends on both the bond's time to maturity and its pattern of cash flows.
Answer: TRUE
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
49) Compare and contrast current yield and yield to maturity.
Answer: The current yield is a measure of the oneyear return on a bond if purchased today. The current yield is calculated by taking a bond's annual coupon payment and dividing by its market price. Yield to maturity measures the return on a bond if it is held to maturity. The yield to maturity is that discount rate that would make the present value of the expected future cash flows exactly equal to the market price at time of calculation. In an efficient market, the yield to maturity will reflect the market rate of interest and required return of bondholders.
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: yield to maturity
Principles: Principle 1: Money Has a Time Value
50) BCD's $1,000 par value bonds currently sell for $798.50. The coupon rate is 10%, paid semiannually. If the bonds have five years before maturity, what is the yield to maturity or expected rate of return?
Answer: $1,000(PVIF)
By trial and error try 8%.
$798.50 = $50 × 6.710 + $1,000 × .463
$798.50 = $798.50
Yield to maturity = (.08)(2) = .16
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: yield to maturity
Principles: Principle 1: Money Has a Time Value
51) If you are willing to pay $1,392.05 for a 15year, $1,000 par value bond that pays 10% interest semiannually, what is your expected rate of return?
Answer: Try 3%.
$1,392.05 = $50 × 19.601 + $1,000 × 0.412
Required rate of return = (.03)(2) = .06
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: yield to maturity
Principles: Principle 1: Money Has a Time Value
52) DAH, Inc. has issued a 12% bond that is to mature in nine years. The bond had a $1,000 par value, and interest is due to be paid semiannually. If your required rate of return is 10%, what price would you be willing to pay for the bond?
Answer: V = 60(11.69) + 1000(.416)
V = 701.40 + 416.00
V = 1,117.40
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
53) Calculate the value of a bond that is expected to mature in 13 years with a $1,000 face value. The interest coupon rate is 8%, and the required rate of return is 10%. Interest is paid annually.
Answer:
V = PV of interest payments as an annuity + PV of maturity value.
V = 568.27 + 289.66
V = $857.93
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
54) The market price of a 20year, $1,000 bond that pays 9% interest semiannually is $774.31. What is the bond's yield to maturity?
Answer: By trial and error, select 6% semiannually (12% annually).
$774.31 = ($45 × 15.046) + ($1,000 × 0.097)
$774.31 = $774.07
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: yield to maturity
Principles: Principle 1: Money Has a Time Value
55) Garvin, Inc.'s bonds have a par value of $1,000. The bonds pay semiannual interest of $40 and mature in five years.
Answer:
po = 922.88
po = 1,000
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
56) Given the following information, determine the market value of EAO Company bonds.
Par value $1,000
Coupon rate 10%
Years to maturity 6
Market rate 8%
Interest paid semiannually
Answer:
po = (50 × 9.375) + (1,000 × 0.625)
po = 1,093.75
Diff: 2
Topic: 9.2 Valuing Corporate Debt
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
9.3 Bond Valuation: Four Key Relationships
1) If the market price of a bond increases, then:
Answer: A
Diff: 2
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: yield to maturity
Principles: Principle 1: Money Has a Time Value
2) If current market interest rates rise, what will happen to the value of outstanding bonds?
Answer: B
Diff: 2
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: interest rate risk
Principles: Principle 1: Money Has a Time Value
3) If current market interest rates fall, what will happen to the value of outstanding bonds?
Answer: A
Diff: 2
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: interest rate risk
Principles: Principle 1: Money Has a Time Value
4) Cassel Corp. bonds pay an annual coupon rate of 10%. If investors' required rate of return is now 8% on these bonds, they will be priced at:
Answer: B
Diff: 2
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
5) Which of the following statements is true?
Answer: B
Diff: 2
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
6) Quirk Drugs sold an issue of 30year, $1,000 par value bonds to the public that carry a 10.85% coupon rate, payable semiannually. It is now 10 years later, and the current market rate of interest is 9.00%. If interest rates remain at 9.00% until Quirk's bonds mature, what will happen to the value of the bonds over time?
Answer: A
Diff: 2
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
7) Which of the following statements is true?
Answer: C
Diff: 2
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
8) A bond with a face value of $1,000 has annual coupon payments of $100 and was issued seven years ago. The bond currently sells for a premium and has eight years left to maturity. This bond's ________ must be less than 10%.
Answer: E
Diff: 3
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: yield to maturity
Principles: Principle 1: Money Has a Time Value
9) A bond has a coupon rate of 10% and yield to maturity of 12%. Which of the following must be true?
Answer: A
Diff: 3
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
10) Which of the following statements about bonds is true?
Answer: B
Diff: 2
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: interest rate risk
Principles: Principle 1: Money Has a Time Value
11) Which of the following statements about bonds is true?
Answer: D
Diff: 2
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
12) Which of the following statements about bonds is true?
Answer: A
Diff: 2
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
13) Which of the following statements is FALSE?
Answer: D
Diff: 2
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
14) Which of the following statements about bonds is true?
Answer: A
Diff: 2
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
15) Bonds cannot be worth less than their book value.
Answer: FALSE
Diff: 1
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: bond valuation
Principles: Principle 2: There Is a RiskReturn Tradeoff
16) So long as a bond sells for an amount above its par value, the coupon interest rate and yield to maturity remain equal.
Answer: FALSE
Diff: 2
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
17) As market interest rates increase, bond prices decrease.
Answer: TRUE
Diff: 1
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: bond valuation
Principles: Principle 2: There Is a RiskReturn Tradeoff
18) Bonds that sell at a discount have a coupon rate lower than the market interest rate.
Answer: TRUE
Diff: 2
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: market interest rate
Principles: Principle 1: Money Has a Time Value
19) Bonds with a longer time to maturity have less interest rate risk.
Answer: FALSE
Diff: 1
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: interest rate risk
Principles: Principle 1: Money Has a Time Value
20) As investors' required rate of return on a bond increases, the value of the bond increases also.
Answer: FALSE
Diff: 2
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
21) As the maturity date of a bond approaches, the bond's market value approaches its par value.
Answer: TRUE
Diff: 2
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: time to maturity
Principles: Principle 1: Money Has a Time Value
22) Shorterterm bonds have greater interest rate risk than do longerterm bonds.
Answer: FALSE
Diff: 2
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: interest rate risk
Principles: Principle 2: There Is a RiskReturn Tradeoff
23) Why are longerterm bonds more sensitive to changes in interest rates than shorterterm bonds?
Answer: Longerterm bonds are more pricesensitive to changes in interest rates because there are more cash flows remaining whose values are affected by the change. Since shorterterm bonds have fewer cash flows remaining, price sensitivity to change in interest rates will be lower. In addition, as the bond gets closer to maturity, the present value of the maturity payment gets less and less volatile. Duration is a measure of how responsive a bond's price is to changing interest rates. Duration is higher for longterm bonds than for shortterm bonds.
Diff: 2
Topic: 9.3 Bond Valuation: Four Key Relationships
Keywords: bond pricing relationships
Principles: Principle 1: Money Has a Time Value
9.4 Types of Bonds
1) Eurobonds are:
Answer: A
Diff: 1
Topic: 9.4 Types of Bonds
Keywords: bonds
Principles: Principle 1: Money Has a Time Value
2) Which of the following statements about zero coupon bonds is FALSE?
Answer: A
Diff: 2
Topic: 9.4 Types of Bonds
Keywords: zero coupon bond
Principles: Principle 1: Money Has a Time Value
3) Eurobonds:
Answer: D
Diff: 1
Topic: 9.4 Types of Bonds
Keywords: bonds
Principles: Principle 1: Money Has a Time Value
4) Which of the following bonds is sold by a corporation at a discount and pays no interest?
Answer: B
Diff: 1
Topic: 9.4 Types of Bonds
Keywords: zero coupon bond
Principles: Principle 1: Money Has a Time Value
5) Which of the following is an advantage of zero coupon bonds?
Answer: D
Diff: 2
Topic: 9.4 Types of Bonds
Keywords: zero coupon bond
Principles: Principle 1: Money Has a Time Value
6) Debentures are unsecured longterm debt.
Answer: TRUE
Diff: 1
Topic: 9.4 Types of Bonds
Keywords: debenture
Principles: Principle 1: Money Has a Time Value
7) Zero coupon bonds are disadvantageous to the issuing firm if interest rates fall.
Answer: TRUE
Diff: 2
Topic: 9.4 Types of Bonds
Keywords: bond valuation
Principles: Principle 1: Money Has a Time Value
8) Eurobonds are bonds issued in a country different from the one in whose currency the bond is denominated.
Answer: TRUE
Diff: 1
Topic: 9.4 Types of Bonds
Keywords: bonds
Principles: Principle 1: Money Has a Time Value
9) The duration of a zero coupon bond is the same as the bond's maturity.
Answer: TRUE
Diff: 2
Topic: 9.4 Types of Bonds
Keywords: zero coupon bond
Principles: Principle 1: Money Has a Time Value
9.5 Determinants of Interest
1) Which of the following statements about debentures is FALSE?
Answer: B
Diff: 2
Topic: 9.5 Determinants of Interest Rates
Keywords: debenture
Principles: Principle 2: There Is a RiskReturn Tradeoff
2) Government bonds have lower yield to maturity than do corporate bonds of the same maturity because the ________ premium is lower for government bonds.
Answer: C
Diff: 1
Topic: 9.5 Determinants of Interest Rates
Keywords: risk
Principles: Principle 2: There Is a RiskReturn Tradeoff
3) Pursuant to the Fisher Effect, the real interest rate is exactly equal to the nominal interest rate less the rate of inflation
Answer: FALSE
Diff: 1
Topic: 9.5 Determinants of Interest Rates
Keywords: inflation
Principles: Principle 2: There Is a RiskReturn Tradeoff
4) When inflation rates go up, bond prices go up as well.
Answer: FALSE
Diff: 1
Topic: 9.5 Determinants of Interest Rates
Keywords: bond valuation
Principles: Principle 2: There Is a RiskReturn Tradeoff
5) As the time to maturity increases, the maturity premium increases.
Answer: TRUE
Diff: 1
Topic: 9.5 Determinants of Interest Rates
Keywords: interest rate risk
Principles: Principle 2: There Is a RiskReturn Tradeoff
6) Explain why an increase in the inflation rate will cause the yield to maturity on a bond to increase.
Answer: When the inflation rate increases, it means that the risk free rate of return will increase. This happens because investors need to make some real return, even on a risk free investment. This means that in order to keep the real rate of return constant, when the inflation rate goes up, the nominal interest rate goes up as well. Consequently, to maintain the same real rate of return, the nominal rate must go up, which in turn raises the required return, or yield to maturity.
Diff: 2
Topic: 9.5 Determinants of Interest Rates
Keywords: bond valuation
Principles: Principle 2: There Is a RiskReturn Tradeoff
7) What elements determine what the yield to maturity will be for a bond?
Answer: The starting point is the risk free rate, a rate for a bond with no risks. A short term treasury bill reflects the risk free rate. The risk free rate comprises the real rate of return plus an inflation premium, so that the investor can earn the real return. If one knows the nominal risk free rate and the inflation rate, one can determine the real rate through the Fisher effect. When there is a possibility of default, the investor must receive a default premium to reflect that risk. Finally, there is the risk that the yield to maturity of the bond may change over the life of the bond, possibly lowering its value. This risk is reflected by the investor adding a maturity premium to the required return. In summary, the yield to maturity will be the real return, plus premiums for inflation, default, and maturity.
Diff: 2
Topic: 9.5 Determinants of Interest Rates
Keywords: yield to maturity
Principles: Principle 2: There Is a RiskReturn Tradeoff
8) Given the anticipated rate of inflation (i) of 6.3% and the real rate of interest (R) of 4.7%, find the nominal rate of interest (r).
Answer:
r = R + i + iR
r = .047 + 0.63 + (.063)(.047)
r = 11.3%
Diff: 2
Topic: 9.5 Determinants of Interest Rates
Keywords: inflation
Principles: Principle 2: There Is a RiskReturn Tradeoff
9) If provided the nominal rate of interest (r) of 14.2% and the anticipated rate of inflation (i) of 5.5%, what is the real rate of interest (R)?
Answer: r = R + i + iR
.142 = R + .055 + (.055)(R)
.142  .055 = 1.055R + .055  .055
.087 = 1.055R
R = 8.2%
Diff: 2
Topic: 9.5 Determinants of Interest Rates
Keywords: inflation
Principles: Principle 2: There Is a RiskReturn Tradeoff
10) Given the anticipated rate of inflation (i) of 6.13% and the real rate of interest (R) of 7.56%, what is the true inflation premium?
Answer: We know the inflation premium to equal i + iR or = 0.0613 + (.0613)(.0756) = 6.59%
Diff: 2
Topic: 9.5 Determinants of Interest Rates
Keywords: fisher effect
Principles: Principle 2: There Is a RiskReturn Tradeoff
1) The expected rate of return on a share of common stock whose dividends are growing at a constant rate (g) is which of the following, where D1 is the next dividend and Vc is the current value of the stock?
(D1+g)/Vc
D1/Vc
D1/g
None of the above
2) Convertibility is a common feature of common stock; it allows the common stockholders to convert their common shares into preferred shares or into bonds.
TRUE/FALSE
3) The sum of the present values of an investment's expected future cash flows is known as the investment's intrinsic value.
TRUE/FALSE
4) Common stock does not mature.
TRUE/FALSE
5) Like common stock, preferred stock pays a dividend that varies with earnings
TRUE/FALSE
6) The security market line reflects an individual investor's attitude toward risk
TRUE/FALSE
7) A bond rating of A is lower than a bond rating of AA.
TRUE/FALSE
8) An efficient market may be defined as one in which the values of all securities at any instant in time fully reflect all available information
TRUE/FALSE
9) The total amount of interest earned on a lump sum investment will exactly double if the amount of time is exactly doubled, everything else equal.
TRUE/FALSE
10) Unlike market value, the intrinsic value of an asset is estimated independently of risk
TRUE/FALSE
11) Beginning with an investment in one company's securities, as we add securities of other companies in other industries to our portfolio, which type of risk declines:
Systematic Risk
Market Risk
Nondiversifiable Risk
Unsystematic
12) Which of the following statements is true:
The value of a bond is inversely related to changes in investors' present required rate of return
If interest rates decrease, the value of a bond will decrease
If interest rates increase, the value of a bond will increase
None of the above
13) One characteristic of an annuity is that the payment amount is the same during each period
TRUE/FALSE
14) A security with a beta of one has a required rate of return equal to the overall market rate of return
TRUE/FALSE
1) The expected yield on junk bonds is lower than the yield on AAArated bonds because of the higher default risk associated with junk bonds.
A)True
B)False
2) Incremental cash flows refer to:
A)The difference between aftertax cash flows and beforetax accounting profits.
B)The new cash flows that will be generated if a project is undertaken.
C)The cash flows of a project, minus financing costs.
D)The cash flows that are foregone if a firm does not undertake a project.
3) The yield to maturity on a bond:
A)is fixed in the indenture.
B)is lower for higher risk bonds.
C)is the required rate of return on the bond.
D)is generally below the coupon interest rate.
4) Current assets would usually not include
A)plant and equipment
B)marketable securities
C)accounts receivables
D)inventories
5) AJAX Company paid a dividend today of $4 per share.
The dividend is expected to grow at a constant rate of 5% per year. If AJAX Company stock is selling for $56 per share, the stockholders’ expected rate of return is:
A)12.1%
B)12.5%
C)7.5%
D)5.0%
6) The internal rate of return is:
7) Changes in the general economy, like changes in interest rates or tax laws represent what type of risk?
8) In order to maximize firm value, management should invest in new assets
9) The debt ratio is a measure of a firm's
10) Increased depreciation expenses affect taxrelated cash flows by
11) Flotation costs cause a corporation's cost of capital to be lower than its investors' required returns.
12) Which of the following is NOT considered in the calculation of incremental cash flows?
13) A firm that wants to know if it has enough cash to meet its bills would be most likely to use which kind of ratio?
14) The discount rate used to value a bond is
15) In general, the least expensive source of capital is:
16) Which of the following best describes why cash flows are utilized rather than accounting profits when evaluating capital projects?
17) A cash flow statement can be used to answer a variety of questions. Which of the following would this statement not be likely to answer?
18)The present value of $1,000 to be received in 10 years is ________ if the discount rate is 7.3%.
19) Activities of the investment banker include
20) Market risk refers to the tendency of a stock to move with the general stock market. A stock with aboveaverage market risk will tend to be more viola tile than an average stock and it will also have a beta which is greater than 1.0.
21) Which of the following is false?
22) The lessrisky investment is always the more desirable choice.
23) Which of the following statements best represents the "Agency Problem"?
24) You are considering investing in a project with the following yearend after tax cash flows
Year l: $5,000
Year 2: $3,200
Year 3: $7,800
If the initial outlay for the project is $12,113, compute the project's internal rate of return.
25) Emery Inc. has a beta equal to 1.5 and a required return of 14% based on the CAPM. If the risk free rate of return is 2%, the expected return on the market portfolio is:
26) Company A and Company B have the same profit margin and the same total asset turnover, but company A has a higher return on equity. This may result from
27) As business goals go, maximization of profits is worthy but it does not adequately consider which of the following?
28) All of the following would result in an increase in stockholders equity except
29) The calculation of incremental free cash flows over a project's life should include
30) All of the following are equity accounts on a balance sheet except:
31)
Preferred dividends are tax deductible whereas common dividends are not.
32) Choose the most correct answer for the following:
(1) Which is the measure of risk for choosing an asset which is to be held in isolation?
(2) Which is the measure of risk for choosing an asset to be held as part of a welldiversified portfolio?
33) Higgins Office Corp. plans to maintain its optimal capital structure of 40 percent debt, 10 percent preferred stock, and 50 percent common equity indefinitely. The required return on each component source of capital is as follows: debt8 percent; preferred stock12 percent; common equity16 percent. Assuming a 40 percent marginal tax rate, what aftertax rate of return must Higgins Office Corp. earn on its investments if the value of the firm is to remain unchanged?
34) Bill borrowed $100,000 today that he must repay in 10 annual endofyear installments of $14,902. What annual interest rate is Bill paying on his loan?
35) The appropriate measure for risk according to the capital asset pricing model is:
36) Bobby's grandmother deposited $100 in a savings account for him when he was born. The money has been earning an annual rate of 12% interest, compounded quarterly for the last 25 years. He is getting married and would like to take his new bride on a fabulous honeymoon. How much does he have in this account to use?
37) The riskreturn relationship for each financial asset is shown on
38) An IPO (Initial Public Offering) is an example of secondary market transaction.
39) Savings are generally transferred to the business firms by
40) Which of the following represents an attempt to measure the earnings of the firm's operations over a gIven time period?
41) Kingsbury Associate's current assets are as follows:
Cash $3,000
Accounts Receivable $4,500
Inventories $8,000
If Kingsbury has a current ratio of 3.2, what is its quick ratio?
42)Which of the following statements about the net present value is true?
43) Emery Inc. had $5 million of gross income, operating expenses of $1 million, paid $1 million of interest on borrowing of $10 million, and paid a dividend of $0.50 million. Emery Inc.'s taxable income is
44) Cabell Corp. bonds pay an annual coupon rate of 10%. If investors' required rate of return is now 12% on these bonds, they will be priced at:
45) Your company is considering an investment in a project which would require an initial outlay of $300,000 and produce expected cash flows in years 15 of $87,385 per year. You have determined that the current aftertax cost of the firm's capital (required rate of return) for each source of financing is as follows
Cost of Debt 8%
Cost of Preferred Stock 12%
Cost of Common Stock 16%
Long term debt currently makes up 20% of the capital structure, preferred stock 10%, and common stock 70%. What is the net present value of this project?
46) Which of the following factors tend to encourage management to pursue stock price maximization as a goal?
47) Capital market instruments include
48) You just purchased a parcel of land for $10,000. If you expect a 14% annual rate of return on your investment, how much will you sell the land for in 10 years?
49) All of the following are criticisms of the payback period criterion except:
50)
Casino Games Company preferred stock pays a perpetual annual dividend of 3.5% of its $100 par value. If investors' required rate of return on this stock is 11%, what is the value per share?
Selected practice questions from Chapters 6 – 8, FIN 335, with Dr. Graham
From Chapter 6 – Bonds and Bond Value
Answer: A
Answer: B
Answer: D
Answer: E
Answer: B
Answer: C
Answer: A
Answer: E
Answer: D
Answer: B
Answer: D
III. coupon rate
Answer: D
Answer: E
Answer: A
Answer: B
Answer: B
Answer: C
Answer: C
Answer: A
III. Coupon rate.
Answer: B
Answer: C
Response: $940 = 1000 FV, 60 PMT, 6 N, 940 PV, CPT I/Y = 7.27%;
YTM = 7.27% x 2 = 14.54%
Answer: E
Response:
1000 FV, 45 PMT, 16 N, 3.5 I/Y, CPT PV = $1,120.94; Annual coupon is 45 x 2 = 90.
Current Yield (CY) = $90 / 1,120.94 = 8.03%
Answer: D
Response: coupon rate = ($30 x 4) / 1,000 = 12%
Answer: C
1000 FV, 25 N, 180 PV, CPT I/Y = YTM = 7.1%; Year 1 interest = $180 x .071 = $12.78
Answer: A
1000 FV, 25 N, 180 PV, CPT I/Y = 7.1%; 180 PV, 5 N, 7.1 I/Y, CPT FV = $253.64
Answer: D
1000 FV, 18 N, 300 PV, CPT I/Y = YTM = 6.92%
Answer: C
Response: price = $1,000 / 1.0720 = $258.42; proceeds = $258.42 x 60 = $15,505
There is the algebra, but what are the entries using your TVOM keys on your TI BA II Plus?
And what of the algebra and keystrokes for numbers 2940 below? Recognizing the algebra is important, and extending that recognition to the keystrokes is “key.”
Answer: B
Response: price = $1,000 / 1.0720 = $258.42; # of bonds = $5,000,000 / 258.42 = 19,349
Answer: D
50 N, 80 PMT, 1000 FV, 12/2 = I/Y, CPT PV = 1,315
Answer: C
1000 FV, 80 PMT, 20 N, 7.5 I/Y, CPT PV = 1,051
Answer: C
Response:
Using the TVOM keystrokes above, you get the price of around $1,051.
Now, in this problem, you must calculate the value of the annuity stream (the interest payments or coupons) and divide that into the bond price. Recall that the total bond value is comprised of the PV of the coupons plus the PV of the maturity payoff of $1000.
Keystrokes for the PV of the coupons? 80 PMT, 7.5 I/Y, 20 N, CPT PV = 815.56. Divide that into 1051 and you get $815.56 / 1,050.97 = 77.6%.
Answer: A, Response: PV of par = $1,000 / 1.07520 = $235.41
(1000 FV, 20 N, 7.5 I/Y, CPT PV = 235.41)
Answer: C
Response: PV of coupons = $80 [(1 1/1.07520)/ .075] = $815.56
Using the TVOM keys instead of algebra?
Coupon payments are 8% of $1000 or $80. So, 80 PMT, 20 N, 7.5I/Y, CPT PV = 815.56
Answer: E
Response:
$1,236.94 = $50 {[1  1/(1 + R)28] / R} + 1,000 / (1 + R)28; R = 3.637%; YTM = 3.64% x 2 = 7.27%
The algebra is a bit annoying, so do the TVOM stuff, thusly: 1,236.94PV, 1000 FV, 28 N, 50 PMT, CPT I/Y = 3.637. I/Y x 2 = 3.637 x 2 = 7.274 or 7.27%
Answer: A
Response: price = $45 [(1  1/1.111) / .1] + 1,000 / 1.111 = $642.77
TVOM stuff? 1000 FV, 45 PMT, 11 N, 10 I/Y, CPT PV = 642.77
Answer: A
1000 FV, 90/4 = 22.5 PMT, 10 x 4 = 40 N, 10/4=2.5 I/Y, CPT PV = 937.24
Answer: D
Response: $874.68 = $40 {[1  1/(1 + R)12] / R} + 1,000 / (1 + R)12; R = 5.45%; YTM = 5.45% x 2 = 10.9%
TVOM keystrokes? 40 PMT, 12 N, 1000 FV, 874.68 PV, CPT I/Y = 5.45 x 2 = YTM = 10.9%
Answer: D
Response: price = $120 [(1  1/1.095) / .09] + 1,000 / 1.095 = $1,116.69
1000 FV, 120 PMT, 5 N, 9 I/Y, CPT PV = 1,116.69
Answer: A
Response:
Bond A: $1,150 = $50 {[1  1/(1 + R)50 ]/ R} + 1,000 / (1 + R)50; R = 4.27%;
Bond B: price = $40 [(1  1/1.042750) / .0427] + 1,000 / 1.042750 = $944.58
First, compute the YTM for bond A, thusly:
1000 FV, 25x2=N, 50 PMT, 1,150 PV, CPT I/Y = YTM = 4.27. Then compute PV of bond B:
1000 FV, 40 PMT, 25x2= N, 4.27 I/Y, CPT PV = 944.58
Answer: B
Response: 8.4(1  .34) = 5.54%
CHAPTER 7 QUESTIONS BEGIN HERE
Answer: B
Answer: C
Answer: D
Answer: C
Answer: E
Answer: D
III. Par value of the common stock.
Answer: B
Answer: E
Answer: B
III. the appropriate discount rate ten years from now
Answer: B
Answer: C
III. The total return on a share of stock = dividend yield + capital gains yield.
Answer: D
Answer: D
Answer: B
Response: P0 = $3 / 1.15 + 90 / 1.15 = $80.87
Answer: C
Response: P0 = $3.00 / 1.12 + 4.25 / 1.122 + 106 / 1.123 = $81.52
Answer: D
Response: $10.71 = $1.50 / R; R = 14%
Answer: C
Response: $30 = D / .08; D = $2.40
Answer: A
Response: P0 = $2 / (.12  .05) = $28.57
Answer: C
Response: P_{1} = P_{0}(1 + g) = $90 (1.06) = $95.40
Answer: A
Response: g = .13  ($2 / 40) = 8%
Answer: B
Response: R = ($2.89 / 80) + .05 = 8.7%
Answer: B
Response: ($2.89  2.75) / 2.75 = .051; R = .036 + .051 = 8.7%
Answer: E
Response: DY = ($0.75 x 4) / 36 = 8.3%
Answer: C
Response: P0 = $3.25 / .10 = $32.50
Answer: E
Response: P0 = [$1.80(1.08)] / (.14  .08) = $32.40
Answer: D
Response: R = [$2(1.07)] / 40 +  .07 = 12.35%
Answer: E
Response: current: $50 = $4 / R; R = 8%; future: $32 = $4 / R; R = 12.5
Answer: B
Response: D1 = $50 (.05) = $2.50
Answer: B
Use the following to answer questions 3036:
Answer: B
Response: 30.76  0.56 = 30.20
Answer: B
Doing the algebra? Expected DPS = Yld x Close = .033 x 30.20 = 1
Answer: D
Response: R = [($1.00 x 1.10) / 30.20] + .10 = 13.6%
Answer: C
Response: EPS = $30.20 / 18 = $1.68
Answer: E
The algebra? How about 20,925 x 100 = 2,092,500
Answer: D : Response: g = ($1.00 / 0.92)  1 = 8.7%
Answer: A
Response: P0 = [$1.00 (1.12) ] / (.16  .12) = $28.00; overvalued at $30.20 in the market
CHAPTER 8 QUESTIONS BEGIN HERE
Answer: A
Answer: C
Answer: C
Answer: A
Answer: B
Answer: D
Answer: C
Answer: D
Answer: C
Answer: C
Answer: D
Answer: A
Answer: B
III. Average accounting return
Answer: B
Answer: A
Answer: A
Yr 0 = –$800; Yr 1 = –$80; Yr 2 = $100; Yr 3 = $300; Yr 4 = $500; Yr 5 = $500
Answer: B
Response: NPV = $800  80 / 1.1 + 100 / 1.12 + 300 / 1.13 + 500 / 1.14 + 500 / 1.15 = $87.28
Using your cashflow keys? CF0= 800, CO1 = 80, FO1=1, CO2 = 100, FO2=1, CO3 = 300, FO3=1, CO4 = 500, FO4=2. Then hit the NPV key, type in 10 for “I,” hit the down arrow to get you back to the NPV display, and hit CPT and you get 87.28.
Answer: B
CFO = 600, CO1=224, CO2=250.88, CO3=280.99. All the FO’s are equal to one, with each cash flow occurring once. After entering all the Cashflows (the CO1’s, 2’s and 3’s), hit the NPV key, set I equal to 12, hit the down arrow to get back to NPV, hit CPT and you get about zero, or B.
Answer: C
Response: recover $275 in 4 years, need $25 / 50 = 4.50 years
Answer: C
Response: $2,500 = $400 {[1  1/(1 + IRR)8] / IRR}; IRR = 5.84%
2,500 PV, 400 PMT, 8 N, CPT I/Y = 5.84%
Or you could use your CF keys … but with equally sized cashflows, the TVOM keys are easier.
Answer: C
Response: NPV = $25,000 + 6,500 [(1  1/1.125) / .12] = $1,568.95
6,500 PMT, 5 N, 12 I/Y, CPT PV = 23,431 the present value of your inflows.
Your NPV = PV(Inflows) – PV (outflows) = 23,431 – 25,000 or a negative 1,569.
Answer: B
CF0 = 10000
CO1 = 1000
FO1 = 1
CO2 = 10000
FO2 = 2
CO3 = 5000
I = 15
NPV = 408.27
Answer: A
Response: NPV = + 2,500[(1  1/1.086) / .08] = $1,557.20
2,500 PMT, 6 N, 8 I/Y, CPT PV = 11,557, which is greater than the $10,000 cost by $1,557, so you DO THIS DEAL!! You accept.
Answer: B
Response: recover $12,000 in 3 years, need $3,000 / 6,000 = 3.50 years
Answer: C
Response: recover $27,500 in 4 years, need $2,500 / 10,000 = 4.25 years
Answer: D
Response: $25 = $10 / (1 + IRR) + 10 / (1 + IRR)2 + 25 / (1 + IRR)3; IRR = 30%
CF0=25, CO1=10, FO1=2, CO2=25, FO2=1, IRR, CPT, IRR = 29.97% or about 30%
Answer: E
Response:
A: NPV = + 25,000 [(1  1/1.123) / .12] = $10,046
B: NPV = + 20,000 [(1  1/1.124) / .12] = $10,747
Project 
Initial Investment 
NPV 
1 
$50,000 
$10,000 
2 
75,000 
25,000 
3 
60,000 
15,000 
4 
40,000 
17,000 
5 
90,000 
40,000 
Answer: E
Response:
Project 1: PI = $60,000 / 50,000 = 1.200; Project 2: PI = $100,000 / 75,000 = 1.333
Project 3: PI = $75,000 / 60,000 = 1.250; Project 4: PI = $57,000 / 40,000 = 1.425
Project 5: PI = $130,000 / 90,000 = 1.444
Answer: B
Response:
A: NPV = + 20,000 / 1.15 + 40,000 / 1.152 + 80,000 / 1.153 = $238
B: NPV = + 75,000 / 1.15 + 45,000 / 1.152 + 40,000 / 1.153 = $545
Answer: C
Response: NPV = $8,000 + 2,000 [(1  1/1.136) / .13] = $0 (actual $4.90)
Use your TVOM keys with equallysized cash flows.
Thusly: 2000 PMT, 6 N, 13 I/Y, CPT PV = 7,995, which is less than 8,000, so your NPV would be about a negative five bucks, as with the algebra above.
Answer: A
Response: $18,500 = $5,250 {[1  1/(1 + IRR)5] / IRR}; IRR = 12.92%
Just use your TVOM keys with equal cash flows to calculate IRR. Thusly:
18,500 PV, 5,250 PMT, 5 N, CPT I/Y = IRR with equallysized cashflows or 12.92%
Answer: B
Response: PV = $50 / 1.1 + 75 / 1.12 + 75 / 1.13 = $163.79; PI = $163.79 / 150 = 1.09
Answer: E
Response: recover $10,000 + 8,000 + 4,000 + 2,000 = $24,000; never pays back
Use the following to answer questions 3538:
Bill plans to open a doityourself dog bathing center in a storefront. The bathing equipment will cost $50,000. Bill expects the aftertax cash inflows to be $15,000 annually for 8 years, after which he plans to scrap the equipment and retire to the beaches of Jamaica.
Answer: B
Response: payback = $50,000 / 15,000 = 3.33 years
Answer: D
Response: NPV = + 15,000 [(1  1/1.108) / .10] = $30,023.89
Use the CF keys for practice: CF0=50,000, CO1=15,000, FO1=8, NPV, I=10, NPV = 30,024
Practice these questions using our BA II Plus review sheet problems 1822.
Answer: C
Response: $50,000 = $15,000 {[1  1/(1 + IRR)8] / IRR}; IRR = 24.95% > 20%; accept
50,000 PV, 15,000 PMT, 8 N, CPT I/Y = IRR = 24.95%
Answer: D
Response:
PV of inflows = $15,000 [(1  1/1.28) / .2] = $57,557; PI = $57,557 / 50,000 = 1.15; accept
At a discount rate of 20%, the PV of the inflows equals the NPV of 7,557 plus the cost of 50,000 or 57,557. (Recall the PV(Inflows) = NPV + PV(Outflows))
Financial management deals with the maintenance and creation of economic value
True
Shareholder wealth maximization means maximizing the price of the existing common stock
True
It is important to evaluate a corporate manager's financial decision by measuring the effect the decision should have on the corporations stock price if everything else were held constant
True
The goal of the firm's financial managers should be the maximization of the total value of the firms stock
True
The goal of profit maximization ignores the risk of financial decisions
True
Shareholders react to poor investment or dividend decisions by causing the total value of the firms stock to fall, and they react to good decisions by causing the total value of the firm's stock to fall, and they react to good decisions by bidding the price of the stock up
True
When making financial decisions, managers should always look at marginal or incremental cash flows
True
The root cause of agency problems is conflicts of interests
True
Giving the company's CEO stock options as a part of his or her compensation package is an example of an agency cost.
True
The sole proprietorship has no legal business structure separate from its owner
True
An efficient market is one where the prices of the assets traded in that market fully reflect all available information at any instant in time
True
A corporate treasurer is typically responsible for cash management, credit management, and raising capital
True
Determining how a firm should raise money to fund its longterm investments is referred to as capital structure decisions
True
The chief financial officer(CFO) is responsible for overseeing financial planning, corporate strategic planning, and controlling the firms cash flow.
True
The sole proprietorship for all practical purposes the absence of any formal legal business structure
True
Stype corporations and limited liability companies are taxed like partnerships, but have the advantage of limited liability for their owners
True
A limited liability company is taxed like a partnership but provides limited liability for its owners similar to a corporation
True
Its ability to raise capital by selling stock makes the corporation the best form of organization in term
True
The owners of a corporation enjoy limited liability
true
In a sole proprietorship the owner is personally responsible without limitations for the liabilities incurred
True
In a limited partnership at least one general partner must exist; that general unlimited liability
True
Individuals, corporations, and governments can be either savings deficit unit or savings surplus units
True
Part of the US Government huge deficit is financed by foreign countries, such as china, which is a savings surplus unit
True
Capital markets are all the financial institutions that help a business raise long term capital
True
Organized stock exchanges provide the benefits of a continuous market, fair security principles and helping business raise new capital
True
On the basis of the number of shares traded, more stocks are traded over the counter than on the organized exchanges
True
Three ways that savings can be transferred through the financial markets to those in need of funds include direct transfers, indirect transfers using the investment banker, and indirect transfers using the financial intermediary
True
The money market includes transactions in shortterm financial instuments
True
Over the counter markets include all security markets, with the exception of organized exchanges
True
For a firm to have its securities listed on exchange, it must meet certain requirements. These usually include measures of profitability, size, market value, and public ownership
True
The vast majority of corporate bond business takes place over the counter
True
Financial markets exist in order to allocate savings in the economy to the demanders of those savings
True
A seasoned equity offering is the sale of additional by a company whose shares are already publicly traded
True
Financial intermediaries issue their own indirect securities and use the proceeds to purchase the direct securities of other economic units
True
Cash markets are often referred to as spot markets
True
The investment banker performs three basic functions (1)underwriting (2) distributing (3) advising
True
The negotiated purchase is the most prevalent method of securities distribution in the private sector
True
The syndicate can be thought of as a wholesaler of securities and the dealer organization as a retailer of securities
True
A group of investment bankers organized to distribute large securities issues is known as a syndicate
True
The competitive bid purchase is largely confined to railroad, public utility, and municipal bond issues
True
The bid price is the price that a dealer will pay for a security; the asked price is the price at which she will sell a security
True
In a private placement, the securities are offered and sold to a limited number of investors
True
The process of shelf registration is beneficial to the issuing firm because it will reduce the time needed for the firm to take an issue to market
True
Over time there has been a high correlation between actual rates of return on securities and the securities standard deviations of returns
True
The rate of return available on the next best investment alternative for the saver refers to the opportunity cost of funds
true
The term structure of interest rates usually indicates that longer terms to maturity have higher expected returns
true
If two companies have the same revenues and operating expenses, their net incomes will still be different if one company finances its assets with more debt and the other company with more equity
True
Common sized income statements restate the numbers in the income statement as a percentage of sales to assist in the comparison of a firm' s financial performance across time and with competitors
True
Earnings before taxes, or taxable income is equal to operating income minus financing costs
true
Profit to sales relationships are defined as profit margins
True
The accounting book value of an asset represents the historical cost of the asset rather than its current market value or replacement cost
True
A firms income statement reports the results from operating the business for a period of time, while the firms balance sheet provides a snapshot of the firms financial position at a specific point in time
True
An income statement reports the firms revenues and expenses for a specific period of time
True
A balance sheet is a statement of the financial position of the firm on a given date, including its asset holdings, liabilities and equity
True
Under current accounting rules, the plant and equipment account shows the historical cost of plus any subsequent improvements to the plant and equipment
True
The balance sheet reflects the accounting equation: Assets= Liabilites + Owners equity
True
According to accrual accounting, revenues are recognized when earned and expenses are recognized when incurred
True
The statement of cash flow explains the changes that took place in the firms cash balance over the period of interest
True
Ratio analysis enhances our understanding of three basic attributes of performance: liquidity, profitability, and the ability to create shareholder value
True
Financial ratios are used by managers inside the company and by lenders, creditrating agents and investors outside of the company
True
Common stockholders may use financial rations to monitor manger actions to help lessen agency problems
True
Financial ratios that are higher than industry averages may indicate problems that are as detrimental to the firms as ratios that are too low
True
Ratios are used to standardize financial information, thereby making it easier to interpret
True
How managers choose to finance the business affects the company's risk, and as a result the rate of return stockholders receive on their investments
True
Return on equity is driven by (1) the spread between the operating return on assets and the interest rate, and (2) changes in the debt ration
True
Operating return on assets is equal to the operating profit margin times total asset turnoner
True
If company A has a lower average collection period than company B, then company A will have a higher accounts receivable turnover
True
Operating profits or EBIT is used to measure a firm's profits on assets because it does not include the firms cost of debt financing
True
Operating return on assets is equal to operation profit margin times total asset turnover
true
a high debt ratio can be favorable because higher leverage may result in a higher return on equity
true
A common method of evaluation a firm's financial ratios is to compare the current values the firm's ratios to its own ratios from prior periods. This is referred to as trend analysis
true
Ratios that examine profit relative to investment are useful in evaluation the overall effectiveness of the firms mangament
true
One weakness of the times interest earned ratio is that it includes only the annual interest expense as a finance expense and ignores other financing items such as lease payments that must be paid
true
DuPont analysis indicates that the return on equity may be boosted above the return on assets by using leverage
true
economic value added attempts to measure a firm;s economic profit rather than its accounting profit
true
Economic value added includes a charge for the cost of equity that is not included on financial statemtents prepared according to GAAP
true
Financial ratios are used by personnel in marketing, human resources, and other groups within a firm, not just by the finance and accounting personnel
true
Seasonality causes comparability problems into ratio analysis. A common solution is to use an average account balance as opposed to an ending account balance
true
Ratio analysis enhances our understanding of three basic attributes of performance: liquidty, profitability, and the ability to create shareholder value
True
Theoretically, market values of assets are better for evaluating the creation of the shareholders wealth than accounting numbers, but accounting numbers are used because they are more avaliable
true
Financial ratios are often reported by industry or line of business because differences in the type of business can make ratio comparisons uninformative or evenmisleading
true
Financial ratios are used by managers inside the company and by lenders, creditrating agencies, and investors outside of the company
true
Financial ratios that are higher than industry averages may indicate problems that are as detrimental to the firm as ratios that are too low
true
ratios are used to standardized financial information, thereby making it easier to interpret
true
How managers choose to finance the business affects the companys risk and as a result the rate of return stockholders recieve on their investments
true
Operating return on assets is equal to the operating profit margin times total asset turnover
true
Operating profits or EBIT is used to measure a firms profits on assets because it does include the firms cost of debt financing
true
Operating return on assets is equal to operating profit margin times total assets turnover
true
A common method of evaluating a firms financial ratio is to compare the current value of the firms ratio to its own ratios from prior period, this referred as to trend analysis
true
Ratios that examine profit relative to investment are useful in evaluation the overall effectivness of the firms management
true
Economic value added attempts to measure a firm's profit rather than its accounting profit
true
Financial ratios are used by personnel in marketing, human resources and other groups within a firm , not just by the finance and accounting personnel
true
Seasonality causes comparability problems in ratio analysis
true
The time value of money is the opportunity cost of passing up the earning potential of a dollar today
true
A rational investor would prefer to recieve $1200 today rather than $100 per month for 12 months
true
A timeline identifies the timing and amount of a stream of cash flows, along with the interest rate it earns
true
If only you earned interest on your initial investment, and not on previously earned interest it would be called simple interest
true
when using a financial calculation cash outflows generally have to be entered as negative numbers, because a financial calculator sees money leaving your hands
true
When solving a problem involving an annuity due, you must select the beinning mode on your financial calculator
true
At an annual interest rate of 9% an initital sum of money will double approximately every 8 years
true
The present value of a single future of money is inversely related to both the number of years until payment is received and the discount rate
true
The same underlying formula is used for computing both the future value and present value
true
The future value of annuity will increase if the interest rate goes up, but the present value of the same annuity will decrease as the interest rate goes up
True
The interest rate is positive, then the future value of an annuity due will be greater than the future value of an ordinary annuity
true
To evaluate or compare investment proposals, we must adjust the value of all cash flows to a common date
true
an example of an annuity is the interest received from bonds
true
The value of a bond investment, which provides fixed interest payments will increase when discounted at 8% rate rather than a 11% rate
true
The future value of an annuity is greater than the future value of an otherwise identical ordinary annuity
true
If we invest money for 10 years at 8 percent interest, compounded semiannually, we are really investing money for 20 six month periods, and receiving 4 percent interest each period
true
For a given stated interest rate, an investor would recieve a greater future value with daily compounding as opposed to monthly compounding
true
A certificate of deposit that pays 9.8% compounded montly is better than a similar certificate of deposit that pays 10% compounded only once per year
true
a.3.5 b. b.4.5 c. c.4.66 d. d.5
Financial Management: Principles and Applications,
Chapter 7 An Introduction to Risk and ReturnHistory of Financial Market Returns
7.1 Realized and Expected Rates of Return and Risk
1) You purchased the stock of Sargent Motors at a price of $75.75 one year ago today. If you sell the stock today for $89.00, what is your holding period return?
Answer: C
Diff: 2
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
Principles: Principle 2: There Is a RiskReturn Tradeoff
2) You have invested in a project that has the following payoff schedule:
Probability of
Payoff Occurrence
$40 .15
$50 .20
$60 .30
$70 .30
$80 .05
What is the expected value of the investment's payoff? (Round to the nearest $1.)
Answer: C
Diff: 2
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
Principles: Principle 2: There Is a RiskReturn Tradeoff
3) If there is a 20% chance we will get a 16% return, a 30% chance of getting a 14% return, a 40% chance of getting a 12% return, and a 10% chance of getting an 8% return, what is the expected rate of return?
Answer: B
Diff: 2
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
Principles: Principle 2: There Is a RiskReturn Tradeoff
4) You are considering investing in a project with the following possible outcomes:
Probability of Investment
States Occurrence Returns
State 1: Economic boom 15% 16%
State 2: Economic growth 45% 12%
State 3: Economic decline 25% 5%
State 4: Depression 15% 5%
Calculate the expected rate of return for this investment.
Answer: C
Diff: 2
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
Principles: Principle 2: There Is a RiskReturn Tradeoff
5) Spartan Sofas, Inc. is selling for $50.00 per share today. In one year, Spartan will be selling for $48.00 per share, and the dividend for the year will be $3.00. What is the cash return on Spartan stock?
Answer: B
Diff: 2
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
Principles: Principle 2: There Is a RiskReturn Tradeoff
6) What is the standard deviation of an investment that has the following expected scenario? 18% probability of a recession, 2.0% return; 65% probability of a moderate economy, 9.5% return; 17% probability of a strong economy, 14.2% return.
Answer: A
Diff: 2
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: standard deviation
Principles: Principle 2: There Is a RiskReturn Tradeoff
7) You are considering investing in a firm that has the following possible outcomes:
Economic boom: probability of 25%; return of 25%
Economic growth: probability of 60%; return of 15%
Economic decline: probability of 15%; return of 5%
What is the expected rate of return on the investment?
Answer: C
Diff: 2
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
Principles: Principle 2: There Is a RiskReturn Tradeoff
8) Which of the following best measures the risk of holding an asset in isolation (i.e., standalone risk)?
Answer: B
Diff: 2
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: standard deviation
Principles: Principle 2: There Is a RiskReturn Tradeoff
9) The holding period return is always positive.
Answer: FALSE
Diff: 1
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
Principles: Principle 2: There Is a RiskReturn Tradeoff
10) Because returns are more certain for the least risky investments, the required return on these investments should be higher than the required returns on more risky investments.
Answer: FALSE
Diff: 1
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
Principles: Principle 2: There Is a RiskReturn Tradeoff
11) Even though an investor expects a positive rate of return, it is possible that the actual return will be negative.
Answer: TRUE
Diff: 1
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
Principles: Principle 2: There Is a RiskReturn Tradeoff
12) The expected rate of return is the weighted average of the possible returns for an investment.
Answer: TRUE
Diff: 1
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
Principles: Principle 2: There Is a RiskReturn Tradeoff
13) The expected rate of return is the sum of each possible return times it likelihood of occurrence.
Answer: TRUE
Diff: 1
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: holding period return
Principles: Principle 2: There Is a RiskReturn Tradeoff
14) The higher the standard deviation, the less risk the investment has.
Answer: FALSE
Diff: 1
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: standard deviation
Principles: Principle 2: There Is a RiskReturn Tradeoff
15) Using the following information for McDonovan, Inc.'s stock, calculate their expected return and standard deviation.
State Probability Return
Boom 20% 40%
Normal 60% 15%
Recession 20% (20%)
Answer: Ki = Σ(Ki)(Pi) = (.20)(40%) + (.60)(15%) + (.20)(20%)
= 8% + 9%  4% = 13%
σi = (Σ(Ki – K)2Pi).5
σi = ((40%13%)2(.2) + (15%13%)2 (.6) + (20%13%)2 (.2)).5 = 19.13%
Diff: 2
Topic: 7.1 Realized and Expected Rates of Return and Risk
Keywords: standard deviation
Principles: Principle 2: There Is a RiskReturn Tradeoff
7.2 A Brief History of Financial Market Returns
1) The riskreturn tradeoff tells us that expected returns should be higher on investments that have higher risk.
Answer: TRUE
Diff: 1
Topic: 7.2 A Brief History of Financial Market Returns
Keywords: risk
Principles: Principle 2: There Is a RiskReturn Tradeoff
2) Riskier investments have traditionally had lower returns than less risky investments have had.
Answer: FALSE
Diff: 1
Topic: 7.2 A Brief History of Financial Market Returns
Keywords: risk
Principles: Principle 2: There Is a RiskReturn Tradeoff
3) Less risky investments have lower standard deviations than do more risky investments.
Answer: TRUE
Diff: 1
Topic: 7.2 A Brief History of Financial Market Returns
Keywords: risk, return
Principles: Principle 2: There Is a RiskReturn Tradeoff
4) Investments in emerging markets have higher volatility than do U.S. Stocks.
Answer: TRUE
Diff: 1
Topic: 7.2 A Brief History of Financial Market Returns
Keywords: standard deviation
Principles: Principle 2: There Is a RiskReturn Tradeoff
5) Expected return and realized return are the same thing.
Answer: FALSE
Diff: 1
Topic: 7.2 A Brief History of Financial Market Returns
Keywords: holding period return
Principles: Principle 2: There Is a RiskReturn Tradeoff
6) Historically, in the United States stocks have had higher returns and greater volatility than have government bonds.
Answer: TRUE
Diff: 1
Topic: 7.2 A Brief History of Financial Market Returns
Keywords: risk, return
Principles: Principle 2: There Is a RiskReturn Tradeoff
7) Treasury Bills have less default risk than do Government Bonds.
Answer: TRUE
Diff: 1
Topic: 7.2 A Brief History of Financial Market Returns
Keywords: risk, return
Principles: Principle 2: There Is a RiskReturn Tradeoff
8) Investors are always rewarded for taking higher risk with higher realized returns.
Answer: FALSE
Diff: 1
Topic: 7.2 A Brief History of Financial Market Returns
Keywords: risk, return
Principles: Principle 2: There Is a RiskReturn Tradeoff
9) Investors make different investment choices partially because individuals do not all have the same tolerance for risk.
Answer: TRUE
Diff: 1
Topic: 7.2 A Brief History of Financial Market Returns
Keywords: investor tolerance
Principles: Principle 2: There Is a RiskReturn Tradeoff
7.3 Geometric vs. Arithmetic Average Rates of Return
1) Marcus Berger invested $9842.33 in Hawkeyehats, Inc. four years ago. He sold the stock today for $11,396.22. What is his geometric average return?
Answer: C
Diff: 1
Topic: 7.3 Geometric vs. Arithmetic Average Rates of Return
Keywords: holding period return
Principles: Principle 1: Money Has a Time Value
2) Marcus Berger invested $9842.33 in Hawkeyehats, Inc. four years ago. He sold the stock today for $11,396.22. What is his arithmetic average return?
Answer: A
Diff: 1
Topic: 7.3 Geometric vs. Arithmetic Average Rates of Return
Keywords: arithmetic average return
Principles: Principle 1: Money Has a Time Value
Use the following to answer the following question(s).
Roddy Richards invested $12014.88 in Wolverine Meat Distributors (W.M.D.) five years ago. The investment had yearly arithmetic returns of 9.7%, 8.1%, 15%, 7.2%, and 15.4%.
3) What is the arithmetic average return of Roddy Richard's investment?
Answer: B
Diff: 2
Topic: 7.3 Geometric vs. Arithmetic Average Rates of Return
Keywords: arithmetic average return
Principles: Principle 1: Money Has a Time Value
4) What is the geometric average return of Roddy's Richard's investment?
Answer: A
Diff: 2
Topic: 7.3 Geometric vs. Arithmetic Average Rates of Return
Keywords: compound interest
Principles: Principle 1: Money Has a Time Value
5) How much money did Roddy Richards receive when he sold his shares of W.M.D.?
Answer: D
Diff: 2
Topic: 7.3 Geometric vs. Arithmetic Average Rates of Return
Keywords: compound interest
Principles: Principle 1: Money Has a Time Value
Use the following information to answer the following question(s).
Susan Bright will get returns of 18%, 20.3%, 14%, 17.6%, and 8.3% in the next five years on her investment in CoffeeTown, Inc. stock, which she purchases for $73,419.66 today.
6) What is the arithmetic average return on her stock if she sells it five years from today?
Answer: A
Diff: 2
Topic: 7.3 Geometric vs. Arithmetic Average Rates of Return
Keywords: arithmetic average return
Principles: Principle 1: Money Has a Time Value
7) What is the geometric average return on her stock if she sells it five years from today?
Answer: B
Diff: 2
Topic: 7.3 Geometric vs. Arithmetic Average Rates of Return
Keywords: geometric average return
Principles: Principle 1: Money Has a Time Value
8) How much will Susan's stock be worth if she sells it five years from today?
Answer: C
Diff: 2
Topic: 7.3 Geometric vs. Arithmetic Average Rates of Return
Keywords: holding period return
Principles: Principle 1: Money Has a Time Value
9) Arithmetic average rate of return takes compounding into effect.
Answer: FALSE
Diff: 1
Topic: 7.3 Geometric vs. Arithmetic Average Rates of Return
Keywords: compound interest
Principles: Principle 1: Money Has a Time Value
10) An investor who wishes to hold a stock for five years will be most interested in geometric average rather than in the arithmetic average return.
Answer: TRUE
Diff: 1
Topic: 7.3 Geometric vs. Arithmetic Average Rates of Return
Keywords: compound interest
Principles: Principle 1: Money Has a Time Value
11) If an investor holds a stock for six years, the value at the end of six years will be the initial cost times (1 + geometric average return)to the sixth power.
Answer: TRUE
Diff: 1
Topic: 7.3 Geometric vs. Arithmetic Average Rates of Return
Keywords: compound interest
Principles: Principle 1: Money Has a Time Value
12) If an investor holds a stock for three years, the value at the end of three years will always be the initial cost of the stock times (1 + arithmetic average return) to the third power.
Answer: FALSE
Diff: 1
Topic: 7.3 Geometric vs. Arithmetic Average Rates of Return
Keywords: compound interest
Principles: Principle 1: Money Has a Time Value
13) Why do the arithmetic average return and the geometric return differ?
Answer: The arithmetic average return does not take what the value of the investment was at the start of each period. Hence, even though a company may have the same arithmetic return for two consecutive years, the dollar amount of those returns will be different in later years than in the first year. For instance, if the investor started with $1,000, and earned 20% the first year, lost 20% the second year, and earned 15% the third year, the average arithmetic return would be 5%, and the 20% gain the first year would be $200, but the 20% loss the second year would be $240. The investment would be worth $1104 after three years, giving an average geometric return of 3.35%, different from the average arithmetic return.
Diff: 2
Topic: 7.3 Geometric vs. Arithmetic Average Rates of Return
Keywords: compound interest
Principles: Principle 1: Money Has a Time Value
7.4 What Determines Stock Prices?
1) Each of the following would tend to weaken the Efficient Market Hypothesis EXCEPT:
Answer: A
Diff: 1
Topic: 7.4 What Determines Stock Prices?
Keywords: efficient markets
Principles: Principle 4: Market Prices Reflect Information
2) Stock prices go up when there is positive information about a company, and go down when there is negative information about the company.
Answer: TRUE
Diff: 1
Topic: 7.4 What Determines Stock Prices?
Keywords: efficient markets
Principles: Principle 4: Market Prices Reflect Information
3) An investor with access to all publicly available information will be able to make higher than expected profit if the market has semistrong efficiency.
Answer: FALSE
Diff: 1
Topic: 7.4 What Determines Stock Prices?
Keywords: efficient markets
Principles: Principle 4: Market Prices Reflect Information
4) If a market has weak form efficiency, an investor can make higher than expected profits by studying the past price patterns of a stock.
Answer: FALSE
Diff: 1
Topic: 7.4 What Determines Stock Prices?
Keywords: efficient markets
Principles: Principle 4: Market Prices Reflect Information
5) If an individual with inside information can make higher than expected profits, the market is no more than semistrong form efficient.
Answer: TRUE
Diff: 1
Topic: 7.4 What Determines Stock Prices?
Keywords: efficient markets
Principles: Principle 4: Market Prices Reflect Information
6) Under the efficient market hypothesis, would securities be properly priced.
Answer: If markets were perfectly efficient, then investors would price a stock based on the company's expected future cash flows, so at any time the security would be properly priced. If good news becomes available, that would tend to increase the expected cash flows to a company, the stock price will go up, meaning that the new price is then the proper price for the stock.
Diff: 2
Topic: 7.4 What Determines Stock Prices?
Keywords: efficient markets
Principles: Principle 4: Market Prices Reflect Information
7) Are markets moving toward being more efficient or toward being less efficient?
Answer: Empirical evidence shows that since about the year 2000 pricing anomalies have diminished considerably. Hedge funds have been trying to exploit pricing inefficiencies, and by doing so, eliminate the inefficiencies. Hence, the market appears to be becoming more efficient over time.
Diff: 2
Topic: 7.4 What Determines Stock Prices?
Keywords: efficient markets
Principles: Principle 4: Market Prices Reflect Information
Financial Management: Principles and Applications, 11e (Titman)
Chapter 8 Risk and ReturnCapital Market Theory
8.1 Portfolio Returns and Portfolio Risk
1) Which of the following investments is clearly preferred to the others?
Return Risk
A 14% 12%
B 22% 20%
C 18% 16%
Answer: D
Diff: 2
Topic: 8.1 Portfolio Returns and Portfolio Risk
Keywords: risk, return
Principles: Principle 2: There Is a RiskReturn Tradeoff
2) You are considering investing in U.S. Steel. Which of the following is an example of nondiversifiable risk?
Answer: D
Diff: 2
Topic: 8.1 Portfolio Returns and Portfolio Risk
Keywords: diversifying risk
Principles: Principle 2: There Is a RiskReturn Tradeoff
3) You are considering buying some stock in Continental Grain. Which of the following is an example of nondiversifiable risk?
Answer: A
Diff: 2
Topic: 8.1 Portfolio Returns and Portfolio Risk
Keywords: diversifying risk
Principles: Principle 2: There Is a RiskReturn Tradeoff
4) If there is a 20% chance we will get a 16% return, a 30% chance of getting a 14% return, a 40% chance of getting a 12% return, and a 10% chance of getting an 8% return, what is the expected rate of return?
Answer: B
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