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FIN 100 Principles of Finance

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 risk-free 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 one-year 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 long-term 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 one-year period.

Common-sized 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?

  1. Risk resulting from uncertainty regarding a possible strike against Ford.
    III. Risk resulting from an expensive recall of a Ford product.

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 14-year 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

  1. If the market price of a bond decreases, then:
    1. The yield to maturity increases
  2. If a corporation were to choose between issuing a debenture, a mortgage bond, or a subordinated debenture, which would have the highest yield to maturity, everything else equal?
    1. The subordinated debenture
  3. If market interest rates decline:
    1. Investor's current required rate of return is above the coupon rate of the bond.
  4. The yield to maturity on long-term bonds:
    1. is equal to the current yield if the bond is selling for face value.
  5. A bond will sell at a discount (below par value) if
    1. Investor's current required rate of return is above the coupon rate of the bond.
  6. Shafer Corporation issued callable bonds. The bonds are most likely to be called if:
    1. Interest rates decrease
  7. While checking the Wall Street Journal bond listings you notice that the price of an AT&T bond is the same as the price of a K-Mart bond. Based on this information you know that:
    1. The bond with the lower coupon rate will have the lower current yield.
  8. Zevo Corp. bonds have a coupon rate of 7%, a yield to maturity of 10%, a face value of $1,000, and mature in 10 years. Which of the following statements is most correct?
    1. An investor who purchases the bond today will earn a return of 10% per year if he holds the bond until it matures
  9. Two investors are considering the purchase of Corporation ABC bonds. The bonds are selling at their par value of $1,000 with a coupon rate of 9%. Investor A decides to buy the bonds and Investor B does not buy the bonds.
    1. Investor A must have a required return less than or equal to 9%.
  10. In 1998 Fischer Corp issued bonds with an 8 percent coupon rate, paid annually, and a $1,000 face value. The bonds mature on March 1, 2023. If an investor purchased one of these bonds on March 1, 2010, determine the yield to maturity if the investor paid $1,100 for the bond.
    1. 82%
  11. 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 payments.
    1. 0%
  12. Assume that Brady Corp. has an issue of 18-year $1,000 par value bonds that pay 7% interest, annually. Further assume that today's required rate of return on these bonds is 5%. How much would these bonds sell for today? Round off to the nearest $1.
    1. $1,233.79
  13. Homer's Trucking Company bonds have a 11% coupon rate. Interest is paid semi-annually. The bonds have a par value of $1,000 and will mature 8 years from now. Compute the value of Homer's Trucking Company bonds if investors' required rate of return is 9.5%.
    1. 75
  14. Podunk Communications bonds mature in 6 1/2 years with a par value of $1,000. They pay a coupon rate of 9% with semi-annual payments. If the required rate of return on these bonds is 11% what is the bond's value?
    1. 83
  15. Bartiromo, Inc. bonds have a 8% coupon rate with semi-annual coupon payments and $1,000 par value. The bonds have 6 years until maturity, and sell for $925. What is the current yield for Bartiromo's bonds?
    1. 65
    2. 32
  16. Other things being equal, investors will value which of the following bonds the highest?
    1. Convertible bonds
  17. 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:
    1. A discount to par varlue
  18. A bond will sell at a premium (above par value) if:
    1. Investor's current required rate of return is below the coupon rate of the bond.
  19. The yield to maturity on a bond is the rate of return that equates the present value of the bond's future cash flows with the bond's
    1. Market value
  20. Which of the following is NOT a definition of yield to maturity:
    1. discount rate that equates present value of future cash flows with a bond's face value.
  21. Which of the following statements is most correct?
    1. If a bond's yield to maturity exceeds its coupon rate, the bond's price must be less than its maturity value.
  22. Which of the following statements concerning junk bonds is most correct?
    1. Junk bonds have higher interest rates than AAA-rated bonds because of the higher risk.
  23. A corporate bond has a coupon rate of 9%, a face value of $1,000, and matures in 15 years. Which of the following statements is most correct?
    1. An investor who buys the bond for $900 will have a yield to maturity on the bond greater than 9%.
  24. A bond's yield to maturity depends upon all of the followingexcept:
    1. The individual investor’s required return
  25. Plasma TV Corporation bonds are currently priced at $1,088. They have a par value of $1,000 and 12 years to maturity. They pay an annual coupon rate of 6%. What is the yield to maturity on this bond?
    1. 0%
  26. What is the yield to maturity of a bond that pays an 5% coupon rate with annual coupon payments, has a par value of $1,000, matures in 15 years, and is currently selling for $769?
    1. 6%
  27. SWH Corporation issued bonds on January 1, 2004. The bonds had a coupon rate of 5.5%, with interest paid semiannually. The face value of the bonds is $1,000 and the bonds mature on January 1, 2019. What is the yield to maturity for an SWH Corporation bond on January 1, 2010 if the market price of the bond on that date is $950?
    1. 23%
  28. Swanson, Inc. bonds have a 10% coupon rate with semi-annual coupon payments. They have 12 and 1/2 years to maturity and a par value of $1,000. Compute the value of Swanson's bonds if investors' required rate of return is 8%.
    1. 22
  29. SWH Corporation issued bonds on January 1, 2004. The bonds had a coupon rate of 5.5%, with interest paid semiannually. The face value of the bonds is $1,000 and the bonds mature on January 1, 2019. What is the intrinsic value of an SWH Corporation bond on January 1, 2010 to an investor with a required return of 7%?
    1. 08
  30. Bartiromo, Inc. bonds have a 4% coupon rate with semi-annual coupon payments and a $1,000 par value. The bonds have 11 years until maturity, and sell for $1,025. What is the current yield for Bartiromo's bonds?
    1. 90
  31. A corporate bond has a coupon rate of 9%, a face value of $1,000, a market price of $850, and the bond matures in 15 years. Therefore, the bond's yield to maturity is:
    1. 1%.
  32. A $1,000 par value 14-year bond with a 10 percent coupon rate recently sold for $965. The yield to maturity is:
    1. 49%
  33. Peerless Securities has an issue of $1,000 par value bonds with 18 years remaining to maturity. The bonds pay 7.7% interest on a semi-annual basis. The current market price of the bonds is $1,175. What is the yield-to-maturity of the bonds?
    1. 09%
  34. What is the yield to maturity of a corporate bond with 13 years to maturity, a coupon rate of 8% per year, a $1,000 par value, and a current market price of $1,250? Assume semi-annual coupon payments.
    1. 31%
  35. Bartiromo, Inc. bonds have a 4% coupon rate with semi-annual coupon payments and a $1,000 par value. The bonds have 11 years until maturity, and sell for $925. What is the current yield for Bartiromo's bonds?
    1. 8%
  36. If market interest rates decline:
    1. Long-term bonds will rise in value more than short-term bonds.
  37. A bond will sell at a discount (below par value) if:
    1. Investor's current required rate of return is above the coupon rate of the bond.

Chapter 8 Self-Test

  1. 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?
    1. Callable
  2. Which of the following features, or benefits, belong to a firm's common stockholders?
    1. Voting rights
    2. Limited liability
    3. Ownership of the firm
    4. All of these
  3. How is preferred stock affected by a decrease in the required rate of return?
    1. The value of a share of preferred stock increases
  4. Which of the following statements concerning the required rate of return on stocks is true?
    1. The higher the risk, the higher the required return, other things being equal.
  5. 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?
    1. Cumulative
  6. 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?
    1. Sinking fund
  7. Preferred stock valuation usually treats the preferred stock as a:
    1. Perpetuity
  8. Cumulative preferred stock:
    1. requires dividends in arrears to be carried over into the next period.
  9. Preferred stock is similar to a bond in the following way:
    1. both investments provide a stated income stream.
  10. 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%?
    1. The value of the preferred stock is $77.78 per share
  11. 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%?
    1. 45
  12. 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?
    1. 14%
  13. 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?
    1. Yes, because the present value of the expected future cash flows is greater than $40.
  14. 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.
    1. 24
  15. J. Corp.'s common stock paid $2.50 in dividends last year (D0). Dividends are expected to grow at a 12-percent 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?
    1. No the stock is overpriced
  16. 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
    1. growth rate in dividends, g.
  17. Which of the following statements concerning the constant growth dividend valuation model is true?
    1. The required rate of return must exceed the growth rate.
  18. Which of the following changes will make the value of a stock go up, other things being held constant?
    1. The required return decreases
  19. Which of the following is not true regarding common stock?
    1. Dividend payments, like interest payments, are fixed.
  20. 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.
    1. False, because the required return could be different
  21. All of the following affect the value of a share of common stock except:
    1. the stock and paid-in-capital amounts on the balance sheet.
  22. 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?
    1. $409.09
  23. 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?
    1. 33
  24. Nuray Corp. preferred stock pays a $.50 annual dividend. What is the value of the stock if your required rate of return is 10%?
    1. 00
  25. 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?
    1. 22
  26. 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%?
    1. 44
  27. 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:
    1. 50
  28. 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?
    1. 82
  29. 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)?
    1. 8
  30. 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?
    1. 10%
  31. 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 profit-retention rate was 60%. If these relationships continue, what will be United Financial Corp's internal growth rate?
    1. 6
  32. 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?
    1. 11
  33. 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:
    1. 83
  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?
    1. Yes, the market price is below the intrinsic value of the stock
  35. 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.
    1. 12
  36. 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.
    1. 38
  37. 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?
    1. 0

Chapter 9 Self Test

  1. The average cost associated with each additional dollar of financing for investment projects is:
    1. the marginal cost of capital.
  2. Using the weighted average cost of capital as the required rate of return for every project will:
    1. cause a firm to reject projects that should have been accepted and cause a firm to accept projects that were too risky.
  3. Joe's Discount Club currently has a weighted average cost of capital of 12%. Joe's has been growing rapidly over the past several years, selling common stock in each year to finance its growth. However, due to difficult economic times this year, Joe's decides to cut its dividend and increase its retained earnings so that the common equity portion of its capital structure will include only retained earnings and no new common stock will be sold. Joe's weighted average cost of capital this year should be
    1. Less than 12%
  4. In general, which of the following rankings, from highest to lowest cost, is most accurate?
    1. cost of new common stock, cost of retained earnings, cost of preferred stock, cost of debt
  5. Acme Conglomerate Corporation operates three divisions. One division involves significant research and development, and thus has a high-risk cost of capital of 15%. The second division operates in business segments related to Acme's core business, and this division has a cost of capital of 10% based upon its risk. Acme's core business is the least risky segment, with a cost of capital of 8%. The firm's overall weighted average cost of capital of 11% has been used to evaluate capital budgeting projects for all three divisions. This approach will
    1. favor projects in the research and development division because the higher risk projects look more favorable if a lower cost of capital is used to evaluate them.
  6. Interest rate parity exists because
    1. there are investors who stand ready to engage in arbitrage.
  7. Due to changes in regulatory requirements, the transactions costs associated with selling corporate securities increased by $1 per share. This change will
    1. cause the cost of capital to increase.
  8. Which of the following should not be considered when calculating a firm's WACC?
    1. Cost of carrying inventory
  9. Which of the following should NOT be considered when calculating a firm's WACC?
    1. After-tax cost of accounts payable
  10. A company has preferred stock that can be sold for $21 per share. The preferred stock pays an annual dividend of 3.5% based on a par value of $100. Flotation costs associated with the sale of preferred stock equal $1.25 per share. The company's marginal tax rate is 35%. Therefore, the cost of preferred stock is:
    1. 72
  11. KayCee Manufacturing Company paid a dividend yesterday of $3.50 per share. The dividend is expected to grow at a constant rate of 10% per year. The price of KayCee's common stock today is $40 per share. If KayCee decides to issue new common stock, flotation costs will equal $4.00 per share. Kaycee's marginal tax rate is 35%. Based on the above information, the cost of retained earnings is:
    1. 63
  12. Cost of new common stock is:
    1. 09
  13. Kelly Corporation will issue new common stock to finance an expansion. The existing common stock just paid a $1.50 dividend, and dividends are expected to grow at a constant rate 8% indefinitely. The stock sells for $45, and flotation expenses of 5% of the selling price will be incurred on new shares. What is the cost of new common stock be for Kelly Corp.?
    1. 79
  14. Five Rivers Casino is undergoing a major expansion. The expansion will be financed by issuing new 15-year, $1,000 par, 9% annual coupon bonds. The market price of the bonds is $1,070 each. Gamblers flotation expense on the new bonds will be $50 per bond. Gamblers marginal tax rate is 35%. What is the pre-tax cost of debt for the newly-issued bonds?
    1. 76
  15. Kendall, Inc. has $15 million of outstanding bonds with a coupon rate of 10 percent. The yield to maturity on these bonds is 12.5 percent. If the firm's tax rate is 30 percent, what is relevant cost of debt financing to Kendall, Inc.?
    1. 75 percent
  16. Clothier, Inc. has a target capital structure of 40% debt and 60% common equity, and has a 40% marginal tax rate. If Clothier's yield to maturity on bonds is 7.5% and investors require a 15% return on Clothier's common stock, what is the firm's weighted average cost of capital?
    1. 80%
  17. A U.S. company can borrow 12,000 pounds in Great Britain for 4% interest, paying back 12,480 pounds in one year. Alternatively, the U.S. company can borrow an equivalent amount of U.S dollars in the United States and pay 8% interest. Assuming capital markets are efficient, estimate the expected inflation rate in the United States if inflation in Great Britain is expected to be zero.
    1. 85
  18. Which of the following differentiates the cost of retained earnings from the cost of newly-issued common stock?
    1. The flotation costs incurred when issuing new securities.
  19. Why should firms that own and operate multiple businesses that have different risk characteristics use business-specific, or divisional costs of capital?
    1. Not all lines of business have equal risk and it is likely that the firm will accept projects whose returns are unacceptably low in relation to the risk involved.
  20. Which of the following causes a firm's cost of capital (WACC) to differ from an investor's required rate of return on the company's common stock?
    1. The incurrence of flotation costs when new securities are issued.
  21. All the following variables are used in computing the cost of debt except:
    1. risk-free rate.
  22. Higher flotation costs will result in all of the following except:
    1. higher cost of retained earnings
  23. A firm's weighted average cost of capital is a function of (1) the individual costs of capital, (2) the capital structure mix, and (3) the level of financing necessary to make the investment.
    1. True
  24. Jiffy Co. expects to pay a dividend of $3.00 per share in one year. The current price of Jiffy common stock is $60 per share. Flotation costs are $3.00 per share when Jiffy issues new stock. What is the cost of internal common equity (retained earnings) if the long-term growth in dividends is projected to be 8 percent indefinitely?
    1. 13 percent
  25. General Bill's will issue preferred stock to finance a new artillery line. The firm's existing preferred stock pays a dividend of $4.00 per share and is selling for $40 per share. Investment bankers have advised General Bill that flotation costs on the new preferred issue would be 5% of the selling price. The General's marginal tax rate is 30%. What is the relevant cost of new preferred stock?
    1. 53
  26. Triplin Corporation's marginal tax rate is 35%. It can issue 10-year bonds with an annual coupon rate of 7% and a par value of $1,000. After $12 per bond flotation costs, new bonds will net the company $966 in proceeds. Determine the appropriate after-tax cost of new debt for Triplin to use in a capital budgeting analysis.
    1. 87
  27. Porky Pine Co. is issuing a $1,000 par value bond that pays 8.5% interest annually. Investors are expected to pay $1,100 for the 12-year bond. Porky will pay $50 per bond in flotation costs. What is the after-tax cost of new debt if the firm is in the 35% tax bracket?
    1. 70
  28. 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: debt--8 percent; preferred stock--12 percent; common equity--16 percent. Assuming a 40 percent marginal tax rate, what after-tax rate of return must Higgins Office Corp. earn on its investments if the value of the firm is to remain unchanged?
    1. 00 percent
  29. Asian Trading Company paid a dividend yesterday of $5 per share (D0= $4). The dividend is expected to grow at a constant rate of 8% per year. The price of Asian Trading Company's stock today is $29 per share. If Asian Trading Company decides to issue new common stock, flotation costs will equal $2.50 per share. Asian Trading Company's marginal tax rate is 35%. Based on the above information, the cost of retained earnings is:
    1. 62%
  30. A corporate bond has a face value of $1,000 and a coupon rate of 9%. The bond matures in 14 years and has a current market price of $946. If the corporation sells more bonds it will incur flotation costs of $26 per bond. If the corporate tax rate is 35%, what is the after-tax cost of debt capital?
    1. 56
  31. Durocorp has a target capital structure of 30% debt and 70% equity. Durocorp is planning to invest in a project that will necessitate raising new capital. New debt will be issued at a before-tax yield of 14%, with a coupon rate of 10%. The equity will be provided by internally generated funds so no new outside equity will be issued. If the required rate of return on the firm's stock is 22% and its marginal tax rate is 35%, compute the firm's cost of capital.
    1. 13
  32. Given the following information on S & G Inc.'s capital structure, compute the company's weighted average cost of capital.



    The company's marginal tax rate is 40%.
    1. 6
  33. Milton Parker has a capital structure that consists of $7 million of debt, $2 million of preferred stock, and $11 million of common equity, based upon current market values. Parker's yield to maturity on its bonds is 7.4%, and investors require an 8% return on Parker's preferred and a 14% return on Parker's common stock. If the tax rate is 35%, what is Parker's WACC?
    1. 18

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 long-term debt because its claim on assets and income come after those of bonds.

Answer: TRUE

Keywords: Claims on Income, Preferred Stock, Long-term 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 sinking-fund 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

  1. A) capital asset.
  2. B) perpetuity.
  3. C) common stock.
  4. D) long-term bond.

Answer: B

Keywords: Preferred Stock, Perpetuity

AACSB: Reflective thinking skills

18) Preferred stock is similar to a bond in the following way

  1. A) preferred stock always contains a maturity date.
  2. B) both investments provide a stated income stream.
  3. C) both contain a growth factor similar to common stock.
  4. D) both provide interest payments.

Answer: B

Keywords: Preferred Stock, Bonds

AACSB: Analytic skills

19) Cumulative preferred stock

  1. A) requires dividends in arrears to be carried over into the next period.
  2. B) has a right to vote cumulatively.
  3. C) has a claim to dividends before bonds.
  4. D) has a higher required return than common stock.

Answer: A

Keywords: Cumulative Preferred Stock

AACSB: Analytic skills

20) How is preferred stock similar to bonds?

  1. A) Dividend payments to preferred shareholders (much like bond interest payments to bondholders) are tax deductible.
  2. B) Investors can sue the firm if preferred dividend payments are not paid (much like bondholders can sue for non-payment of interest payments).
  3. C) Preferred stockholders receive a dividend payment (much like interest payments to bondholders) that is usually fixed.
  4. D) Preferred stock is not like bonds in any way.

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?

  1. A) Participating
  2. B) Cumulative
  3. C) Provisional
  4. D) Convertible

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?

  1. A) Cumulative
  2. B) Putable
  3. C) Callable
  4. D) Convertible

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?

  1. A) Convertible
  2. B) Callable
  3. C) Cumulative
  4. D) Sinking fund

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%?

  1. A) The value of the preferred stock is $7 because the dividend is fixed at $7 each year .
  2. B) The value of the preferred stock is $63.00 per share.
  3. C) The value of the preferred stock is $77.78 per share.
  4. D) The value of the preferred stock is $6.30 per share because of the 9% required return.

Answer: C

Keywords: Preferred Stock Valuation

AACSB: Reflective thinking skills

5) Which of the following statements concerning preferred stock is most correct?

  1. A) Preferred stock is valued the same as zero coupon bonds because the cash flow patterns are similar.
  2. B) If a corporation issues 4% preferred stock with a par value of $100, the dividend will increase by 4% per year.
  3. C) Preferred stock dividends are typically the same each year, allowing a preferred stock to be valued as a perpetuity.
  4. D) Preferred stock dividends are calculated as a percentage of common stock dividends, although the preferred stock dividends must be paid first.

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%?

  1. A) $.05
  2. B) $.50
  3. C) $5.00
  4. D) $50.00

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)?

  1. A) 21.8%
  2. B) 11.0%
  3. C) 9.1%
  4. D) 20.1%

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%?

  1. A) $22.22
  2. B) $27.83
  3. C) $45
  4. D) $55.50

Answer: C

Keywords: Preferred Stock Valuation

AACSB: Analytic skills

9) How is preferred stock affected by a decrease in the required rate of return?

  1. A) The value of a share of preferred stock increases.
  2. B) The dividend increases.
  3. C) The dividend decreases.
  4. D) The dividend yield increases.

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?

  1. A) $35.00
  2. B) $31.82
  3. C) $7.97
  4. D) $3.18

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?

  1. A) $611.11
  2. B) $508.33
  3. C) $409.09
  4. D) $81.82

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.

  1. A) $36.00
  2. B) $44.40
  3. C) $62.50
  4. D) $88.80

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%.

  1. A) 14.5%
  2. B) 9.3%
  3. C) 6.9%
  4. D) 6.0%

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?

  1. A) $83.33
  2. B) $94.05
  3. C) $100.00
  4. D) $30.00

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 + paid-in 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 constant-growth 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

  1. A) the preemptive right.
  2. B) a proxy.
  3. C) majority voting rules.
  4. D) the cumulative voting right.

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

  1. A) cumulative voting.
  2. B) majority voting.
  3. C) minority voting.
  4. D) proxy voting.

Answer: A

Keywords: Cumulative Voting

AACSB: Analytic skills

21) Preferred stock differs from common stock in that

  1. A) preferred stock usually has a maturity date.
  2. B) preferred stock investors have a higher required return than common stock investors.
  3. C) preferred stock dividends are fixed.
  4. D) common stock investors have a required return and preferred stock investors do not.

Answer: C

Keywords: Preferred Stock, Dividends

AACSB: Reflective thinking skills

22) How is preferred stock similar to common stock?

  1. A) Preferred dividend payments usually have unlimited growth potential.
  2. B) Investors cannot sue a corporation for the non-payment of dividends.
  3. C) Both preferred and common stockholders have voting control of a firm.
  4. D) Preferred stock dividends and common stock dividends are fixed.

Answer: B

Keywords: Preferred Stock, Common Stock

AACSB: Reflective thinking skills

23) Which of the following is not true regarding common stock?

  1. A) Dividends, unlike interest payments, are not tax deductible.
  2. B) Common stock, unlike bond principal, does not mature.
  3. C) Common stockholders are owners of the firm, whereas bondholders are creditors.
  4. D) Dividend payments, like interest payments, are fixed.

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?

  1. A) First
  2. B) Second
  3. C) Third
  4. D) Fourth

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?

  1. A) First
  2. B) Second
  3. C) Third
  4. D) Fourth

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?

  1. A) the cumulative feature
  2. B) the convertible feature
  3. C) the proportionality clause
  4. D) the preemptive right

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?

  1. A) limited liability
  2. B) ownership of the firm
  3. C) voting rights
  4. D) all of the above

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?

  1. A) bondholders
  2. B) preferred stockholders
  3. C) common stockholders
  4. D) All of the above bear equal risk of loss.

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 profit-retention rate was 60%. If these relationships continue, what will be United Financial Corp's internal growth rate?

  1. A) 6.0%
  2. B) 8.6%
  3. C) 9.0%
  4. D) 15.6%

Answer: B

Keywords: Internal Growth Rate, Profit-Retention 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:

  1. A) $3.00
  2. B) $18.33
  3. C) $20.83
  4. D) $30.00

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?

  1. A) The required return decreases.
  2. B) The required return increases.
  3. C) In general, investors become more risk averse.
  4. D) The growth rate of dividends decreases.

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.

  1. A) False, because the required return could be different
  2. B) True, because we are using a dividend valuation model
  3. C) True if markets are semi-strong form efficient
  4. D) True if investors are risk-averse

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 long-run 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?

  1. A) $89.75
  2. B) $83.65
  3. C) $56.46
  4. D) $62.57

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?

  1. A) The higher an investor's required rate of return, the higher the value of the stock.
  2. B) If risk is reduced, the required return will decrease because more investors are risk-averse.
  3. C) The required return on preferred stock is generally higher than the required return on common stock.
  4. D) The higher the risk, the higher the required return, other things being equal.

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?

  1. A) The required rate of return must exceed the growth rate.
  2. B) The dividend growth rate must be bigger than 8%.
  3. C) The growth rate must increase every year.
  4. D) The required rate of return must be equal to the growth rate for dividends.

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?

  1. A) Investors are irrational to pay $1 per share when earnings per share have been negative for three years.
  2. B) Investors believe the stock is worth $1 per share because future earnings (and cash flows) are expected to be positive.
  3. C) The corporation's accountants must have made a mistake because retained earnings may not be negative.
  4. D) The required return on the stock will be small because the company has very few assets.

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

  1. A) cause the stock price to increase because rcs (the required return) is likely to increase.
  2. B) cause the stock price to decrease because the government usually pays below market price for the goods and services it purchases.
  3. C) cause the stock price to increase because rcs(the required return) is likely to decrease and g (the growth rate in future dividends) is likely to increase.
  4. D) have no effect on the stock price because the company has not yet paid any dividends.

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

  1. A) growth rate in dividends, g.
  2. B) required return on the stock, rcs.
  3. C) dividend yield plus the capital gains yield.
  4. D) dividend yield.

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,

  1. A) the stock will be valued at $0.50 times the number of years an investor plans to keep it.
  2. B) the value of the stock can be estimated as $0.50 divided by an investor's required rate of return.
  3. C) the value of the stock can not be determined using the dividend valuation model because the growth rate is zero.
  4. D) the value of the stock is positive only if the required return is negative

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?

  1. A) $20.99
  2. B) $26.75
  3. C) $26.90
  4. D) $27.00

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%?

  1. A) $33.44
  2. B) $55.56
  3. C) $59.44
  4. D) $65.87

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?

  1. A) 9.47%
  2. B) 9.89%
  3. C) 10.87%
  4. D) 11.81%

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?

  1. A) The price of the preferred stock should equal the price of the common stock since the dividends are the same.
  2. B) The price of the common stock could be higher than the price of the preferred stock if the common stock dividends are expected to grow in the future.
  3. C) The price of the preferred stock is expected to be higher than the price of the common stock because the required return on preferred stock is higher than the required return on common stock.
  4. D) If the required return on the preferred stock is the same as the required return on the common stock, then the price of preferred stock should equal the price of the common stock if markets are efficient.

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?

  1. A) Company B must be riskier than Company A, and risk requires a reward.
  2. B) Other things being equal, if Company A and Company B have the same firm value, Company B must have more debt, thus leveraging its returns for the benefit of shareholders.
  3. C) Other things being equal, if Company A and Company B have the same firm value, Company A may have more shares of stock outstanding than Company B.
  4. D) Company B's required rate of return is higher than Company A's required return.

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:

  1. A) the dollar amount of the dividends.
  2. B) investors' required rate of return.
  3. C) the future growth rate for dividends.
  4. D) the stock and paid-in-capital amounts on the balance sheet.

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?

  1. A) $11.76
  2. B) $24.00
  3. C) $23.11
  4. D) $22.22

Answer: D

Keywords: Constant Growth Dividend Valuation Model, Common Stock

AACSB: Analytic skills

31) An example of the growth factor in common stock is:

  1. A) acquiring a loan to fund an investment in Asia.
  2. B) retaining profits in order to reinvest into the firm.
  3. C) issuing new stock to provide capital for future growth.
  4. D) two strong companies merging together to increase their economy of scale.

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?

  1. A) $28.57
  2. B) $33.05
  3. C) $20.83
  4. D) $30.80

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.

  1. A) $81.38
  2. B) $76.43
  3. C) $56.23
  4. D) $43.90

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?

  1. A) No, the market price is above the intrinsic value of the stock.
  2. B) Yes, the market price is below the intrinsic value of the stock.
  3. C) No, the growth rate in dividends is too far below the required return.
  4. D) Yes, but only if you can keep the stock for at least 5 years.

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.

  1. A) $106.84
  2. B) $100.43
  3. C) $91.81
  4. D) $54.71

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?

  1. A) 6%
  2. B) 9%
  3. C) 10%
  4. D) 15%

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.

  1. A) $22.61
  2. B) $11.42
  3. C) $15.63
  4. D) $4.35

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%?

  1. A) $17.67
  2. B) $16.89
  3. C) $14.92
  4. D) $11.52

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.

  1. A) 12.48%
  2. B) 15.65%
  3. C) 13.64%
  4. D) 16.12%

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?

  1. A) $50.22
  2. B) $48.51
  3. C) $44.76
  4. D) $40.22

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?

  1. A) $42.68
  2. B) $48.05
  3. C) $51.10
  4. D) $74.64

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?

  1. A) 11.11%
  2. B) 11.76%
  3. C) 12.2%
  4. D) 14.21%

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?

  1. A) 3.365%
  2. B) 3.878%
  3. C) 4.556%
  4. D) 5.000%

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?

  1. A) 15% 20% 35%
  2. B) 10% 5% 15%
  3. C) 15% 12% 27%
  4. D) 20% 15% 35%

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.

  1. A) $20.63
  2. B) $21.24
  3. C) $15.00
  4. D) $55.00

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?

  1. A) Yes, because the present value of the expected future cash flows is greater than $40.
  2. B) No, because the present value of the expected future cash flows is less than $40.
  3. C) Yes, because the present value of the expected future cash flows is less than $40.
  4. D) No, because the present value of the expected future cash flows is greater than $40.

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%?

  1. A) $7.50
  2. B) $30.00
  3. C) $32.00
  4. D) $50.00

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 12-percent 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?

  1. A) No, the percentage return on the stock is too high, thus it is too risky.
  2. B) Yes, the stock is expected to return more than you require.
  3. C) No, the stock is overpriced.
  4. D) Not enough information is given.

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

  1. A) 11.50%.
  2. B) 13.56%.
  3. C) 15.49%.
  4. D) 16.50%.

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?

  1. A) (D1+ g)/Vc
  2. B) D1/Vc + g
  3. C) D1/g
  4. D) D1/g + Vc

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?

  1. A) 41.43%
  2. B) 19.45%
  3. C) 22.36%
  4. D) 24.14%

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?

  1. A) 2.75%
  2. B) 10.0%
  3. C) 17.5%
  4. D) 27.5%

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 12-percent 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)?

  1. A) 5.50%
  2. B) 11.00%
  3. C) 18.25%
  4. D) 19.00%

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.

  1. What is the expected rate of return on the stock?
  2. If an investor's required rate of return is 9%, what is the value of the stock to that investor?
  3. Considering the investor's required rate of return, does this stock seem to be a desirable investment?

Answer:

  1. R = D/V

R = $4.20/54

R = 7.78%

  1. V = D/R

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

  1. Which one of the following has a maturity value? a. Assets b. Bonds c. Common stock d. Preferred stock
  2. a bond indenture: a. Contains the legal agreement between the firm and the trustee. b. States the bond’s current rating. c. States the yield to maturity of the bond d. Allows the sale of accounts receivable
  3. A bond has a 1-% coupon rate, a par value of $1000, and a market price of $800. What is the current yield of this bond? a. 10% b. 11.4% c. 12.2% d. 12.5%
  4. Which type of value is shown on the firm’s balance sheet? a. Liquidation value b. Book value c. Market value d. Intrinsic value
  5. the present value of the expected future cash flows of an asset represents the asset’s: a. Liquidation value. b. Book value c. Intrinsic value d. Par value
  6. in an efficient securities market, the market value of a security is equal to its: a. liquidation value, b. book value c. intrinsic value d. par value
  7. What is the value of a bond that has a par value of $1000, a coupon of $80(annually), and matures in 11 years? Assume a required rate of return of 11%, and round your answer to the nearest $10.
  8. $320 b. $500 c. $810 d. $790
  9. the interest on corporate bonds is typically paid: a. semi-annually b. annually c. quarterly d. monthly
  10. Terminator bug company bonds have a 14% coupon rate. Interest is paid semi-annually. The bonds have a par value of $1000 and will mature 10 years from now. Compute the value of terminator bonds if investors’ required rate of return is 12%, rounded to the nearest dollar. a. $1115 b. $1149 c. $1000 d. $894
  11. Cassel corporation bonds pay an annual coupon rate of 10%. If investors’ required rate of return is now *% on these bonds, they will be priced at: a. par value b. a premium to par value c. a discount to par value d. asset value
  12. How is preferred stock similar to a bond? a. Preferred stock always contains a maturity date b. Dividends are limited in amount c. Both contain a growth factor similar to common stock d. Dividends are deductible for tax purposes
  13. cumulative preferred stock: a. provides for the right to vote b. provides for the right to vote cumulatively c. provides for a claim to dividends after common stock d. requires dividends in arrears to be carried over into the next period
  14. valuation methods treat preferred stock as a: a. perpetuity b. capital asset c. common stock d. long-term bond
  15. Style corporation preferred stock pays a dividend of $3.15 a year. What is the value of the stock if the required rate of return is 8.5%? (round your answer to the nearest$1)
  16. 23 b. 27 c. 33 d. 37
  17. What is the value of a preferred stock that pays a $2.10 dividend annually to an investor with a required rate of return of 11%? (round your answer to the nearest $1) a. $17 b. $19 c. $21 d. $23
  18. Common stock involves ____________the Corporation. a. Ownership in b. Personally managing c. Being a creditor of d. The maturity of
  19. Common stock dividends must be ________ before issued. a. Approved by common stockholders b. Registered with the SEC c. Approved by preferred stockholders d. Declared by the firm’s board of directors
  20. Which of the following is an example of the internal growth factor of common stock? a. Acquiring a loan to fund an investment in Germany b. Two strong companies merging together to increase their economy of scale c. Issuing new stock to provide capital for future growth d. Retaining profits in order to reinvest into the firm.
  21. Little feet Shoe Company just paid a dividend of $1.65 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 this stock. a. $15 b. $20.63 c. $21.25 d. $55
  22. What is the expected rate of return for a stock with a current market price of $35, if the expected dividend at the conclusion of this year is $1.75, and earnings are growing at a 10% annual rate? (Assume that the dividends are anticipated to grow at the same rate.) a. 25% b. 15% c. 10% d. 5%
  1. What is the payback period for a $20000 project that is expected to return $6000 per year for the first two years and $3000 per year for years three through five? a.3.5 b. b.4.5 c. c.4.66 d. d.5
  2. Rymer, inc. is considering a new assembler, which costs $180,000 installed, and has a depreciable life of 5 years. The expected annual after-tax cash flows for the assembler are $60,000 in each of the 5 years and nothing thereafter. Calculate the net present value (NPV) of the assembler if the required rate of return is 14%. Round to the nearest ten dollars. a. $25,200 b. $25,980 c. $51,960 d. $120,000
  3. Which of the following is considered in the calculation of incremental cash flow? a. Re-engineering and installation costs b. Repayment of principal if new debt is issued c. Increased dividend payments if additional common stock issued d. Interest charges associated with raising funds.
  4. An old machine was purchased for $20,000, at a book value of $5,000, and sold for $9,000. The firm’s marginal tax rate is 25%. What is the amount of taxes due? a. $9000 b. $5000 c. $2250 d. $1000
  5. A firm purchased an asset with a 5-year life for $90,000, and it cost $10,000 for shipping and installation. Using the simplified straight-line method, what is the annual depreciation? a. $20000 b. $18000 c. $10000 d. $5000
  6. The Acu Punct Corporation is considering the purchase of a new machine with an initial outlay of $4500 and expected cash flows in years 1-4 of $2200 per year. The risk-adjusted discount rate for the firm is 12%, and the risk-free rate is 5%. Compute the net present value of this project. a. 4300 b. 2181 c. 1899 d. 1535
  7. J&B, Inc. has $5 million of debt outstanding with a coupon rate of 12%. Currently the yield to maturity on these bonds is 12%. If the firm’s tax rate is 40%, what is the cost of debt to J&B? a. 14% b. 12% c. 8.4% d. 5.6%
  8. Vipsu Corporation plans to issue 10-year bonds with a par value of $1000 that will pay $55 every six months. The net amount of capital to the firm from the sale of each bond is $840.68. If Vipsu is in the 25% tax bracket and its before-tax cost of capital is 14%, what is the after-tax cost of debt? a. 7 b. 10.5 c. 11.5 d. 14
  9. XYZ Corporation is trying to determine the appropriate cost of preferred stock to use in determining the firm’s cost of capital. This firm’s preferred stock is currently selling for $36, and pays a perpetual annual dividend of $2.60 per share. Underwriters of a new issue of preferred stock would charge $6 per share in flotation costs. The firm’s tax rate is 30%. Compute the cost of new preferred stock for XYZ. a. 6.2% b. 7.2% c. 8.7% d. 16.7%
  10. Shawhan supply plans to maintain is optimal capital structure of 30% debt, 20% preferred stock, and 50% common stock far into the future. The required return on each component is: debt 10%, preferred stock 11%, and common stock 18%. Assuming a 40% marginal tax rate, what is the firm’s weighted average cost of capital? a. 10% b. 12% c. 13% d. 14.2%
  1. Use the percent of sales method to forecast next year’s accounts payable. Current year slaes are $24,500,000 and sales are expected to rise by 25%. The firm’s accounts payable balance is $1,701,600. what is the projection for next year’s accounts payable? a. $1,000,600 b. $2,127,000 c. $3,981,250 d. $6,125,000
  2. A firm has a return on equity (ROE)of 15%. Dividend payout is 25% of net income. Leverage is 1.20. What is the sustainable rate of growth? a. 3.75% b. 4.28% c. 11.25% d. 13.50%
  3. A company collects 60% of its sales during the month of sale, 30% one month after the sale, and 10% two months after the sale. Expected sales are: $10,000 in August, $20,000 in September, $30,000 in October, and $40,000 in November. How much cash is expected to be collected in October? a. $15000 b. $25000 c. $35000 d. $60000
  4. A 6-month loan of $5000 at 6% interest would require an interest payment of : a. $900 b. $600 c. $300 d. $150
  5. Atlas Tire Irons, Inc. is considering borrowing $5000 for a 90-day period. The firm will repay the $5000 principle amount plus $150 in interest. What is the effective annual rate of interest? Use a 360-day year. a. 7% b. 12% c. 15% d. 25%
  6. The effective annual cost of not taking advantage of the 3/10, net 30 terms offered by a supplier is (Use a 360 day year.) a. 55.7% b. 45.4% c. 40.5% d. 32.3%
  1. Assume that liquid funds can be invested to yield 12%. If annual remittance checks total $2 billion, what is it worth for the firm to reduce float by 1 day? a. $54,833 b. $657,534 c. $1,000,000 d. $24,000,000
  2. If you compare the yield of a municipal bond with that of a treasury bond, what is the equivalent before-tax yield of a municipal bond yielding 6% per year for an investor in the 25% tax bracket? a. 4.0% b. 7.5% c. 8.0% d. 9.5%
  3. Determine the effective annualized cost of foregoing the trade discount on terms 2/10 net 45, rounded to the nearest tenth of a percent. a. 16.0% b. 16.3% c. 21.0% d. 25.9%
  4. Stern Corporation uses semi-hex joints in its manufacturing process. If stern’s total demand for the joints for next year is estimated to be 15,000 units, and if the cost per order is $80, what is stern’s economic order quantity of semi-hex joints? Assume that carrying costs for semi-hex joints are $.51 per unit and round to the nearest 100 units. a. 1500 b. 1700 c. 2000 d. 2200
  5. Crisp international purchased 30,000 cases of French wine at a cost of 3,136,000 euros. If the current exchange rate is .7445 euros to the US dollar, what is the purchase price in US dollars? a. $2,106,111 b. $2,334,752 c. $3,333,333 d. $4,212,223
  6. Assume the british pound is worth $1.9459. if a new jaguar costs $49,500, what is the cost in british pounds? a. 12,719 b. 25,438 c. 48,161 d. 96,322

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:

  1. A) never equals its market value.
  2. B) is determined by the investor.
  3. C) generally is $1,000.
  4. D) is never returned to the bondholder.

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:

  1. A) semiannually.
  2. B) annually.
  3. C) quarterly.
  4. D) monthly.

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:

  1. A) a discount.
  2. B) a premium.
  3. C) par.
  4. D) all of the above.

Answer: D

Diff: 1

Topic: 9.1 Overview of Corporate Debt

Keywords: bonds

Principles: Principle 1: Money Has a Time Value

4) Mortgage bonds:

  1. A) are a type of debenture.
  2. B) are secured by a lien on real property.
  3. C) usually pay little or no interest.
  4. D) can only be issued by financial institutions.

Answer: B

Diff: 1

Topic: 9.1 Overview of Corporate Debt

Keywords: bonds

Principles: Principle 2: There Is a Risk-Return Tradeoff

5) Bondholders have a priority claim on assets ahead of:

  1. A) common stockholders.
  2. B) preferred stockholders.
  3. C) both A and B.
  4. D) none of the above.

Answer: C

Diff: 1

Topic: 9.1 Overview of Corporate Debt

Keywords: bonds

Principles: Principle 2: There Is a Risk-Return Tradeoff

6) Which type of value is shown on the firm's balance sheet?

  1. A) Book value
  2. B) Liquidation value
  3. C) Market value
  4. D) Intrinsic value

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?

  1. A) Voting rights
  2. B) Par value
  3. C) Claims on assets and income
  4. D) Indenture

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:

  1. A) restrictions on the issuance of common stock dividends.
  2. B) restrictions on the sale or purchase of fixed assets.
  3. C) constraints on additional borrowing.
  4. D) all of the above.

Answer: D

Diff: 1

Topic: 9.1 Overview of Corporate Debt

Keywords: bonds

Principles: Principle 2: There Is a Risk-Return Tradeoff

9) The issuance of bonds to raise capital for a corporation:

  1. A) magnifies the returns to the stockholders.
  2. B) increases risk to the stockholders.
  3. C) is a cheaper form of capital than the issuance of common stock.
  4. D) all of the above.
  5. E) none of the above.

Answer: D

Diff: 2

Topic: 9.1 Overview of Corporate Debt

Keywords: bonds

Principles: Principle 2: There Is a Risk-Return Tradeoff

10) A(n)________ is used to outline the issuing company's contractual obligations to bondholders.

  1. A) mortgage
  2. B) debenture
  3. C) bond rating
  4. D) indenture

Answer: D

Diff: 1

Topic: 9.1 Overview of Corporate Debt

Keywords: bonds

Principles: Principle 2: There Is a Risk-Return Tradeoff

11) Junk bonds:

  1. A) are high yield bonds.
  2. B) have higher default risk.
  3. C) were used to finance "fallen angels."
  4. D) all of the above.

Answer: D

Diff: 2

Topic: 9.1 Overview of Corporate Debt

Keywords: bonds

Principles: Principle 2: There Is a Risk-Return Tradeoff

12) Which of the following investors incurs the least risk?

  1. A) Bondholders
  2. B) Preferred stockholders
  3. C) Common stockholders
  4. D) All of the above bear equal risk

Answer: A

Diff: 1

Topic: 9.1 Overview of Corporate Debt

Keywords: risk, return

Principles: Principle 2: There Is a Risk-Return 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 long-term debt instrument is a debenture.

Answer: TRUE

Diff: 1

Topic: 9.1 Overview of Corporate Debt

Keywords: bonds

Principles: Principle 2: There Is a Risk-Return 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 Risk-Return 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 Risk-Return Tradeoff

9.2 Valuing Corporate Debt

1) The yield to maturity on a bond:

  1. A) is fixed in the indenture.
  2. B) is lower for higher-risk bonds.
  3. C) is the required return on the bond.
  4. D) is generally equal to the coupon interest rate.

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:

  1. A) investors' required rate of return.
  2. B) the recorded value of the firm's assets.
  3. C) the coupon rate of interest.
  4. D) the maturity date of the bond.

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 10-year bond with a 10% coupon rate recently sold for $900. The yield to maturity:

  1. A) is 10%.
  2. B) is greater than 10%.
  3. C) is less than 10%.
  4. D) cannot be determined.

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:

  1. A) is less than 10%.
  2. B) is greater than 10%.
  3. C) equals 10%.
  4. D) cannot be determined.

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 20-year, unsecured bonds rated BB by Moody's. These bonds are:

  1. A) low-risk bonds.
  2. B) debentures.
  3. C) premium bonds.
  4. D) mortgage bonds.

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):

  1. A) $1,173.
  2. B) $743.
  3. C) $1,000.
  4. D) $827.

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 30-year, $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.

  1. A) $751
  2. B) $1,177
  3. C) $1,220
  4. D) $976

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, 30-year 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.

  1. A) $956.42
  2. B) $1,000.00
  3. C) $1,168.31
  4. D) $1,213.19

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):

  1. A) 12.00%.
  2. B) 11.76%.
  3. C) 10.12%.
  4. D) 11.29%.

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 nine-year 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.

  1. A) 5%
  2. B) 14%
  3. C) 12%
  4. D) 11%

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.

  1. A) 13%
  2. B) 14%
  3. C) 15%
  4. D) 16%

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.

  1. A) 18%
  2. B) 13%
  3. C) 16%
  4. D) 17%

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.

  1. A) $320
  2. B) $500
  3. C) $810
  4. D) $790

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.

  1. A) $970
  2. B) $1,330
  3. C) $330
  4. D) $1,000

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:

  1. A) the company's fiscal year end.
  2. B) profitable operations.
  3. C) variability in earnings.
  4. D) firm size.

Answer: A

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 2: There Is a Risk-Return Tradeoff

16) The discount rate used to value a bond is:

  1. A) the coupon interest rate.
  2. B) determined by the issuing company.
  3. C) fixed for the life of the bond.
  4. D) the market rate of interest.

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.

  1. A) maturity date
  2. B) coupon interest payment
  3. C) par value
  4. D) price

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%.

  1. A) $1,516.18
  2. B) $973.33
  3. C) $1,027.17
  4. D) $950.00

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%.

  1. A) $1,114.70
  2. B) $1,149.39
  3. C) $894.06
  4. D) $1,000.00

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 30-year 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?

  1. A) 7.750%
  2. B) 11.072%
  3. C) 9.375%
  4. D) 8.675%

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 30-year, $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.

  1. A) $715
  2. B) $1,171
  3. C) $1,225
  4. D) $697

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 30-year, $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.

  1. A) $1,050
  2. B) $932
  3. C) $681
  4. D) $1,111

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.)

  1. A) 3%
  2. B) 5%
  3. C) 7%
  4. D) 9%

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 30-year 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?

  1. A) 8.50%
  2. B) 14.38%
  3. C) 11.11%
  4. D) 7.67%

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?

  1. A) 15.80%
  2. B) 10.47%
  3. C) 9.24%
  4. D) 7.90%
  5. E) 4.62%

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?

  1. A) $654.98
  2. B) $735.15
  3. C) $814.42
  4. D) $941.87

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:

  1. A) that you can buy the bond for $92.125.
  2. B) that you can buy the bond for $921.25.
  3. C) that if you purchase the bond today, you will receive $921.25 when the bond matures.
  4. D) none of the above.

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?

  1. A) 8.375%
  2. B) 7.800%
  3. C) 15.001%
  4. D) 6.667%

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:

  1. A) 14.55%.
  2. B) 12.44%.
  3. C) 7.27%.
  4. D) 5.61%.

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:

  1. A) a greater reliance on equity in financing the firm.
  2. B) high variability in past earnings.
  3. C) large firm size.
  4. D) both A and C.

Answer: D

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond rating

Principles: Principle 2: There Is a Risk-Return 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.)

  1. A) $1,196
  2. B) $1,042
  3. C) $1,000
  4. D) $946

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:

  1. A) 7.20%.
  2. B) 9%.
  3. C) 10.12%.
  4. D) 14.40%.

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:

  1. A) 10%.
  2. B) 8.75%.
  3. C) 11.63%.
  4. D) 7.24%.

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:

  1. A) 10.00.
  2. B) 6.76.
  3. C) 5.
  4. D) unable to be determined based on the information given.

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 20-year 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?

  1. A) $619
  2. B) $674
  3. C) $761
  4. D) $828
  5. E) $902

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 30-year 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?

  1. A) $1,111
  2. B) $1,450
  3. C) $1,352
  4. D) $675
  5. E) $1,000

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 10-year 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 yield-to-maturity of these bonds?

  1. A) 11%
  2. B) 10%
  3. C) 9%
  4. D) 8%
  5. E) 7%

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?

  1. A) 11.3%
  2. B) 7.4%
  3. C) 6.5%
  4. D) 10.5%
  5. E) 9.1%

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?

  1. A) 11.3%
  2. B) 8.5%
  3. C) 6.5%
  4. D) 7.9%
  5. E) 9.1%

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 Risk-Return 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 Risk-Return 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 Risk-Return 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 Risk-Return 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 one-year 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 15-year, $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 20-year, $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% semi-annually (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.

  1. How much would you pay for Garvin bonds if your required rate of return is 10%?
  2. How much would you pay if your required rate of return is 8%?

Answer:

  1. po= (40 × 7.722) + (1,000 × 0.614)

po = 922.88

  1. po= (40 × 8.111) + (1,000 × 0.676)

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:

  1. A) the yield to maturity decreases.
  2. B) the coupon rate increases.
  3. C) the yield to maturity increases.
  4. D) none of the above.

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?

  1. A) It will rise.
  2. B) It will fall.
  3. C) It will remain unchanged.
  4. D) There is no connection between current market interest rates and 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?

  1. A) It will rise.
  2. B) It will fall.
  3. C) It will remain unchanged.
  4. D) There is no connection between current market interest rates and 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:

  1. A) par value.
  2. B) a premium to par value.
  3. C) a discount to par value.
  4. D) cannot be determined from information given.

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?

  1. A) A bond that has a rating of AA is considered to be a junk bond.
  2. B) A bond will sell at a premium if the prevailing required rate of return is less than the bond's coupon rate.
  3. C) A zero coupon is a bond that is secured by a lien on real property.
  4. D) The legal document that describes all of the terms and conditions of a bond issue is called a debenture agreement.

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 30-year, $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?

  1. A) The bonds will sell at a premium and decline in value until maturity.
  2. B) The bonds will sell at a discount and rise in value until maturity.
  3. C) The bonds will sell at a premium and rise in value until maturity.
  4. D) The bonds will sell at a discount and fall in value until maturity.

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?

  1. A) When investors' required rate of return equals the bond's coupon rate, then the market value of the bond may be selling at par value.
  2. B) When investors' required rate of return exceeds the bond's coupon rate, then the market value of the bond will be greater than par value.
  3. C) When investors' required rate of return is less than the bond's coupon rate, then market value of the bond will be greater than par value.
  4. D) When investors' required rate of return is less than the bond's coupon rate, then the market value of the bond will be less than par value.

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%.

  1. A) yield to maturity
  2. B) current yield
  3. C) coupon rate
  4. D) current yield and coupon rate
  5. E) yield to maturity and current yield

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?

  1. A) The bond is selling at a discount.
  2. B) The bond is selling at a premium.
  3. C) The bond's current yield is less than the coupon rate.
  4. D) Both A and C.
  5. E) Both B and C.

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?

  1. A) Bond prices move in the same direction as market interest rates.
  2. B) If market interest rates change, long-term bonds will fluctuate more in value than short-term bonds.
  3. C) Long-term bonds are less risky than short-term bonds.
  4. D) If market interest rates are higher than a bond's coupon interest rate, then the bond will sell above its par value.
  5. E) None of the above.

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?

  1. A) As the maturity date of a bond approaches, the market value of a bond will become more volatile.
  2. B) Long-term bonds have less interest rate risk than do short-term bonds.
  3. C) Bond prices move in the same direction as market interest rates.
  4. D) If market interest rates are above a bond's coupon interest rate, then the bond will sell below its par value.
  5. E) None of the above.

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?

  1. A) The market value of a bond moves in the opposite direction of market interest rates.
  2. B) As the maturity date of a bond approaches, the market value of a bond will become more volatile.
  3. C) Long-term bonds are less risky than short-term bonds.
  4. D) If market interest rates are higher than a bond's coupon interest rate, then the bond will sell above its par value.
  5. E) None of the above.

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?

  1. A) A debenture would usually be more risky than a mortgage bond that is issued by the same firm.
  2. B) A bond will sell at a discount if the prevailing required rate of return is more than the bond's coupon rate.
  3. C) A short-term bond will fluctuate less in value than a long-term bond if interest rates fluctuate.
  4. D) Interest rates and bond prices usually move in the same direction.

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?

  1. A) If market interest rates are below a bond's coupon interest rate, then the bond will sell above its par value.
  2. B) Long-term bonds have less interest rate risk than do short-term bonds.
  3. C) Bond prices move in the same direction as market interest rates.
  4. D) As the maturity date of a bond approaches, the market value of a bond will become more volatile.
  5. E) None of the above.

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 Risk-Return 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 Risk-Return 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) Shorter-term bonds have greater interest rate risk than do longer-term bonds.

Answer: FALSE

Diff: 2

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: interest rate risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

23) Why are longer-term bonds more sensitive to changes in interest rates than shorter-term bonds?

Answer: Longer-term bonds are more price-sensitive to changes in interest rates because there are more cash flows remaining whose values are affected by the change. Since shorter-term 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 long-term bonds than for short-term 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:

  1. A) issued in a country different from the one in whose currency the bond is denominated.
  2. B) issued only in Europe.
  3. C) the European equivalent of a junk bond.
  4. D) none of the above.

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?

  1. A) When the bonds mature, the issuing firm is faced with a small cash outflow relative to the cash inflow the firm receives when the bonds are initially issued.
  2. B) Zero coupon bonds are disadvantageous to the issuing firm if interest rates fall.
  3. C) Yields tend to be bid down on zero coupon bonds due to investor demand for the bonds.
  4. D) Zero coupon bonds provide a positive annual cash flow to the issuing firm over the life of the bonds.

Answer: A

Diff: 2

Topic: 9.4 Types of Bonds

Keywords: zero coupon bond

Principles: Principle 1: Money Has a Time Value

3) Eurobonds:

  1. A) are registered with the SEC.
  2. B) are frequently offered to U.S. citizens and residents during their initial distribution.
  3. C) take relatively longer periods of time to issue.
  4. D) have none of the above characteristics.

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?

  1. A) An indenture bond
  2. B) A zero coupon bond
  3. C) A junk bond
  4. D) A eurobond

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?

  1. A) Small cash outflow at maturity
  2. B) Lower yield due to low demand
  3. C) Ability to deduct annual amortization of discount
  4. D) Both A and C
  5. E) All of the above

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 long-term 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?

  1. A) The earning ability of the issuing corporation is of great concern to the bondholder.
  2. B) Debentures are viewed as less risky than secured bonds.
  3. C) Debentures must provide investors with a higher yield than secured bonds.
  4. D) Debentures allow the firm to issue debt and still preserve some future borrowing power.

Answer: B

Diff: 2

Topic: 9.5 Determinants of Interest Rates

Keywords: debenture

Principles: Principle 2: There Is a Risk-Return 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.

  1. A) interest rate risk
  2. B) inflation
  3. C) default
  4. D) maturity

Answer: C

Diff: 1

Topic: 9.5 Determinants of Interest Rates

Keywords: risk

Principles: Principle 2: There Is a Risk-Return 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 Risk-Return 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 Risk-Return 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 Risk-Return 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 Risk-Return 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 Risk-Return 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 Risk-Return 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 Risk-Return 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 Risk-Return 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
Non-diversifiable 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 AAA-rated 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 after-tax cash flows and before-tax 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:

  1. A) The discount rate that makes the NPV positive.
  2. B) The discount rate that equates the present value of the cash inflows with the present value of the cash
  3. C) The discount rate that makes NPV negative and the PI greater than one.
  4. D) The rate of return that makes the NPV positive.

7) Changes in the general economy, like changes in interest rates or tax laws represent what type of risk?

  1. A) Company-unique risk
  2. B) Market risk
  3. C) Unsystematic risk
  4. D) Diversifiable risk

8) In order to maximize firm value, management should invest in new assets

  1. A) so long as a project's IRR is greater or equal to the firm's marginal cost of capital
  2. B) so long as a project's IRR is positive
  3. C) so long as a project's accounting rate of return is greater or equal to the firm's marginal cost of capital
  4. D) b and c

9) The debt ratio is a measure of a firm's

  1. A) leverage
  2. B) profitability
  3. C) liquidity
  4. D) coverage

10) Increased depreciation expenses affect tax-related cash flows by

  1. A) increasing taxable income, thus increasing taxes.
  2. B) decreasing taxable income, thus reducing taxes.
  3. C) decreasing taxable income, with no effect on cash flow since depreciation is a non-cash expense.
  4. D) pushing a corporation into a higher tax bracket.

11) Flotation costs cause a corporation's cost of capital to be lower than its investors' required returns.

  1. A) True
  2. B) False

12) Which of the following is NOT considered in the calculation of incremental cash flows?

  1. A) tax saving due to increased depreciation expense
  2. B) interest payments if new debt is issued
  3. C) increased dividend payments if additional preferred stock is issued
  4. D) B and C

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?

  1. A) liquidity
  2. B) leverage
  3. C) efficiency
  4. D) profitability

14) The discount rate used to value a bond is

  1. A) the coupon interest rate
  2. B) determined by the issuing company
  3. C) fixed for the life of the bond
  4. D) the market rate of interest

15) In general, the least expensive source of capital is:

  1. A) preferred stock.
  2. B) new common stock.
  3. C) debt.
  4. D) retained earnings.

16) Which of the following best describes why cash flows are utilized rather than accounting profits when evaluating capital projects?

  1. A) cash flows have a greater present value than accounting profits
  2. B) cash flows reflect the timing of benefits and costs more accurately than accounting profits
  3. C) cash flows are more stable than accounting profits
  4. D) cash flows improve the tax position of a firm more than accounting profits
  5. E) none of the above

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?

  1. A) Why was money borrowed?
  2. B) Where did profits go?
  3. C) What is the current level of inventory?
  4. D) Were there any new investment activities?

18)The present value of $1,000 to be received in 10 years is ________ if the discount rate is 7.3%.

  1. A) $270
  2. B) $494
  3. C) $370
  4. D) $433

19) Activities of the investment banker include

  1. A) assuming the risk of selling a security issue.
  2. B) selling new securities to the ultimate investors.
  3. C) providing advice to firms issuing securities.
  4. D) all of the above

20) Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average 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.

  1. A) True
  2. B) False

21) Which of the following is false?

  1. A) preferred stock has some characteristics of both common stock and bonds
  2. B) common stockholders are essentially creditors of the firm
  3. C) the pre-emptive right on common stock protects the shareholder from dilution in ownership and value

22) The less-risky investment is always the more desirable choice.

  1. A) True
  2. B) False

23) Which of the following statements best represents the "Agency Problem"?

  1. A) Managers might attempt to benefit themselves in terms of salary and perquisites at the expense of shareholders.
  2. B) The agency problem results from the separation of management and the ownership of the firm.
  3. C) The agency problem may interfere with the implementation of maximizing shareholder wealth.
  4. D) all of the above

24) You are considering investing in a project with the following year-end 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.

  1. A) 14%
  2. B) 10%
  3. C) 32%
  4. D) 24%

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:

  1. A) 10%.
  2. B) 9%.
  3. C) 8%.
  4. D) 6%.

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

  1. A) Company B has more common stock.
  2. B) Company A has a higher debt ratio.
  3. C) Company A has a higher return on assets.
  4. D) Company B has a higher return on assets.

27) As business goals go, maximization of profits is worthy but it does not adequately consider which of the following?

  1. A) income taxes
  2. B) time frame over which profits are to be measured
  3. C) increases in the cost of raw materials
  4. D) changes in sales revenues

28) All of the following would result in an increase in stockholders equity except

  1. A) The company sold common stock at par value.
  2. B) The company sold common stock above par value.
  3. C) The company purchased treasury stock.
  4. D) The company had positive net income greater than dividends paid.

29) The calculation of incremental free cash flows over a project's life should include

  1. A) labor and material saving.
  2. B) additional revenue.
  3. C) interest to bondholders.
  4. D) A and B.

30) All of the following are equity accounts on a balance sheet except:

  1. A) retained earnings.
  2. B) cash.
  3. C) common stock.
  4. D) paid-in capital.

31)

Preferred dividends are tax deductible whereas common dividends are not.

  1. A) True
  2. B) False

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 well-diversified portfolio?

  1. A) Variance; variance.
  2. B) Standard deviation; beta.
  3. C) Beta; beta.
  4. D) Standard deviation; standard deviation.

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: debt--8 percent; preferred stock--12 percent; common equity--16 percent. Assuming a 40 percent marginal tax rate, what after-tax rate of return must Higgins Office Corp. earn on its investments if the value of the firm is to remain unchanged?

  1. A) 12.40 percent
  2. B) 12.00 percent
  3. C) 11.12 percent
  4. D) 10.64 percent

34) Bill borrowed $100,000 today that he must repay in 10 annual end-of-year installments of $14,902. What annual interest rate is Bill paying on his loan?

  1. A) 4.9%
  2. B) 5.4%
  3. C) 7.5%
  4. D) 8.0%

35) The appropriate measure for risk according to the capital asset pricing model is:

  1. A) the standard deviation of a firm's cash flows.
  2. B) alpha.
  3. C) the standard deviation of a firm's stock returns.
  4. D) beta.

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?

  1. A) $4,165
  2. B) $1,700
  3. C) $5,051
  4. D) $1,922

37) The risk-return relationship for each financial asset is shown on

  1. A) the capital market line
  2. B) the security market line
  3. C) the New York Stock Exchange market line
  4. D) none of the above

38) An IPO (Initial Public Offering) is an example of secondary market transaction.

  1. A) True
  2. B) False

39) Savings are generally transferred to the business firms by

  1. A) direct transfer of funds.
  2. B) indirect transfer using the investment banker.
  3. C) indirect transfer using the financial intermediary.
  4. D) all of the above

40) Which of the following represents an attempt to measure the earnings of the firm's operations over a gIven time period?

  1. A) balance sheet
  2. B) cash flow statement
  3. C) income statement
  4. D) none of the above

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?

  1. A) 2.07
  2. B) l.55
  3. C) 0.48
  4. D) none of the above

42)Which of the following statements about the net present value is true?

  1. A) It produces a percentage result that is easy to describe.
  2. B) It has an inadequate reinvestment assumption.
  3. C) It is likely that there will be more than one NPV for a project.
  4. D) It may be used to select among projects of different sizes.

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

  1. A) $3 million.
  2. B) $2.5 million.
  3. C) $4 million.
  4. D) $3.5 million.

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:

  1. A) Par value.
  2. B) A premium to par value.
  3. C) A discount to par value.
  4. D) Cannot be determined without knowing the number of years to maturity.

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 1-5 of $87,385 per year. You have determined that the current after-tax 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?

  1. A) -$13,876
  2. B) $0
  3. C) $287,692
  4. D) $1,568

46) Which of the following factors tend to encourage management to pursue stock price maximization as a goal?

  1. A) shareholders link management's compensation to comp any performance
  2. B) managers' reactions to the threats of firing and takeover
  3. C) managers do not have goals other than stock price maximization.
  4. D) statements a and b are both correct
  5. E) statements a, b, and c are all correct

47) Capital market instruments include

  1. A) negotiable certificates of deposit.
  2. B) corporate equities.
  3. C) commercial paper.
  4. D) Treasury bills.

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?

  1. A) $25,000
  2. B) $31,060
  3. C) $37,072
  4. D) $34,310
  5. E) $45,000

49) All of the following are criticisms of the payback period criterion except:

  1. A) Time value of money is not accounted for.
  2. B) Cash flows occurring after the payback are ignored.
  3. C) It deals with accounting profits as opposed to cash flows.
  4. D) None of the above; they are all criticisms of the payback period criteria.

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?

  1. A) $35.00
  2. B) $31.82
  3. C) $7.97
  4. D) $3.18

Selected practice questions from Chapters 6 – 8, FIN 335, with Dr. Graham

From Chapter 6 – Bonds and Bond Value

  1. The stated interest payment, in dollars, made on a bond each period is called the bond's:
  2. A)
  3. B) Face value.
  4. C)
  5. D) Yield to maturity.
  6. E) Coupon rate.

Answer: A

  1. The principal amount of a bond that is repaid at the end of the loan term is called the bond's:
  2. A)
  3. B) Face value.
  4. C)
  5. D) Yield to maturity.
  6. E) Coupon rate.

Answer: B

  1. The rate of return required by investors in the market for owning a bond is called the:
  2. A)
  3. B) Face value.
  4. C)
  5. D) Yield to maturity.
  6. E) Coupon rate.

Answer: D

  1. The annual coupon of a bond divided by its face value is called the bond's:
  2. A)
  3. B) Face value.
  4. C)
  5. D) Yield to maturity.
  6. E) Coupon rate.

Answer: E

  1. A bond with a face value of $1,000 that sells for less than $1,000 in the market is called a:
  2. A) Par bond.
  3. B) Discount bond.
  4. C) Premium bond.
  5. D) Zero coupon bond.
  6. E) Floating rate bond.

Answer: B

  1. A bond with a face value of $1,000 that sells for more than $1,000 in the market is called a:
  2. A) Par bond.
  3. B) Discount bond.
  4. C) Premium bond.
  5. D) Zero coupon bond.
  6. E) Floating rate bond.

Answer: C

  1. The long-term bonds issued by the United States government are called:
  2. A) Treasury bonds.
  3. B) Municipal bonds.
  4. C) Floating rate bonds.
  5. D) Junk bonds.
  6. E) Zero coupon bonds.

Answer: A

  1. A bond that makes no coupon payments (and thus is initially priced at a deep discount to par value) is called a _______ bond.
  2. A) Treasury
  3. B) municipal
  4. C) floating rate
  5. D) junk
  6. E) zero coupon

Answer: E

  1. A bond which, at the election of the holder, can be swapped for a fixed number of shares of common stock at any time prior to the bond's maturity is called a _____________ bond.
  2. A) zero coupon
  3. B) callable
  4. C) putable
  5. D) convertible
  6. E) warrant

Answer: D

  1. The annual coupon payment of a bond divided by its market price is called the:
  2. A) Coupon rate.
  3. B) Current yield.
  4. C) Yield to maturity.
  5. D) Bid-ask spread.
  6. E) Capital gains yield.

Answer: B

  1. The price a dealer is willing to accept for selling a security to an investor is called the:
  2. A) Equilibrium price.
  3. B) Auction price.
  4. C) Bid price.
  5. D) Ask price.
  6. E) Bid-ask spread.

Answer: D

  1. A bond with a face value of $1,000 has annual coupon payments of $100 and was issued 10 years ago. The bond currently sells for $1,000 and has 8 years remaining to maturity. This bond's ______________ must be 10%.
  1. yield to maturity
  2. market premium

III. coupon rate

  1. A) I only
  2. B) I and II only
  3. C) III only
  4. D) I and III only
  5. E) I, II and III

Answer: D

  1. If you divide a bond's annual coupon payment by its current yield you get the ___________.
  2. A) yield to maturity
  3. B) investors' required rate of return
  4. C) annual coupon rate
  5. D) cost of capital
  6. E) bond price

Answer: E

  1. Which of the following statements regarding bond pricing is true?
  2. A) The lower the discount rate, the more valuable the coupon payments are today.
  3. B) Bonds with high coupon payments are generally (all else the same) more sensitive to changes in interest rates than bonds with lower coupon payments.
  4. C) When market interest rates rise, bond prices will also rise, all else the same.
  5. D) Bonds with short maturities are generally (all else the same) more sensitive to changes in interest rates than bonds with longer maturities.
  6. E) All else the same, bonds with larger coupon payments will have a lower price today.

Answer: A

  1. Your broker offers you the opportunity to purchase a bond with coupon payments of $90 per year and a face value of $1000. If the yield to maturity on similar bonds is 8%, this bond should:
  2. A) Sell for the same price as the similar bond regardless of their respective maturities.
  3. B) Sell at a premium.
  4. C) Sell at a discount.
  5. D) Sell for either a premium or a discount but it's impossible to tell which.
  6. E) Sell for par value.

Answer: B

  1. When pricing bonds, if a bond's coupon rate is less than the required rate of return, then:
  2. A) The holder of the bond is assured of a profit regardless of when the bond is eventually sold.
  3. B) The holder of the bond will realize a capital gain if the bond is held to maturity.
  4. C) The bond sells at par because the required rate of return is adjusted to reflect the discrepancy.
  5. D) The bond sells at a premium if it has a long maturity and at a discount if it has a short maturity.
  6. E) The bond sells at a discount if it has a long maturity and at a premium if it has a short maturity.

Answer: B

  1. All else the same, a(n) __________ will decrease the required return on a bond.
  2. A) call provision
  3. B) lower bond rating
  4. C) sinking fund
  5. D) increase in inflation
  6. E) increase in the size of a bond issuance

Answer: C

  1. Which of the following items generally appears in a corporate bond quote from The Wall Street Journal?
  2. A) Yield to maturity
  3. B) Original issue price
  4. C) Current yield
  5. D) Name of the trustee
  6. E) Bond rating

Answer: C

  1. For a discount bond, the current yield is _________ the yield to maturity, and the coupon rate is _____________ the yield to maturity.
  2. A) less than; less than
  3. B) less than; greater than
  4. C) greater than; less than
  5. D) greater than; greater than
  6. E) equal to; equal to

Answer: A

  1. For a premium bond, the required return is less than the:
  1. Current yield.
  2. Yield to maturity.

III. Coupon rate.

  1. A) I only
  2. B) I and II only
  3. C) II and III only
  4. D) I and III only
  5. E) I, II, and III
  1. If investors are uncertain that they will be able to sell a corporate bond quickly, the investors will demand a higher yield in the form of a(n) ____________.
  2. A) inflation premium
  3. B) liquidity risk premium
  4. C) interest rate risk premium
  5. D) default risk premium
  6. E) increased real rate of interest

Answer: B

  1. Dizzy Corp. bonds bearing a coupon rate of 12%, pay coupons semiannually, have 3 years remaining to maturity, and are currently priced at $940 per bond. What is the yield to maturity?
  2. A) 00%
  3. B) 99%
  4. C) 54%
  5. D) 25%
  6. E) 57%

Answer: C

Response: $940 = 1000 FV, 60 PMT, 6 N, -940 PV, CPT I/Y = 7.27%;

YTM = 7.27% x 2 = 14.54%

  1. Whitesell Athletic Corporation's bonds have a face value of $1,000 and a 9% coupon paid semiannually; the bonds mature in 8 years. What current yield would be reported in The Wall Street Journal if the yield to maturity is 7%?
  2. A) 4%
  3. B) 5%
  4. C) 6%
  5. D) 7%
  6. E) 8%

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%

  1. D&G Enterprises issues bonds with a $1,000 face value that make coupon payments of $30 every 3 months. What is the coupon rate?
  2. A) 30%
  3. B) 00%
  4. C) 00%
  5. D) 00%
  6. E) 00%

Answer: D

Response: coupon rate = ($30 x 4) / 1,000 = 12%

  1. Suppose you purchase a zero coupon bond with face value $1,000, maturing in 25 years, for $180. What is the implicit interest, in dollars, in the first year of the bond's life?
  2. A) $ 86
  3. B) $ 84
  4. C) $12.78
  5. D) $19.27
  6. E) $30.00

Answer: C

1000 FV, 25 N, -180 PV, CPT I/Y = YTM = 7.1%; Year 1 interest = $180 x .071 = $12.78

  1. Suppose you purchase a zero coupon bond with a face value of $1,000 and a maturity of 25 years, for $180. If the yield to maturity on the bond remains unchanged, what will the price of the bond be 5 years from now?
  2. A) $253.64
  3. B) $287.52
  4. C) $310.91
  5. D) $380.58
  6. E) $500.00

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

  1. What is the yield to maturity on an 18-year, zero coupon bond selling for 30% of par value?
  2. A) 86%
  3. B) 86%
  4. C) 37%
  5. D) 92%
  6. E) 00%

Answer: D

1000 FV, 18 N, -300 PV, CPT I/Y = YTM = 6.92%

  1. J&J Enterprises wants to issue sixty 20-year, $1,000 zero-coupon bonds. If each bond is to yield 7%, how much will J&J receive (ignoring issuance costs) when the bonds are first sold?
  2. A) $11,212
  3. B) $12,393
  4. C) $15,505
  5. D) $18,880
  6. E) $20,000

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 29-40 below? Recognizing the algebra is important, and extending that recognition to the keystrokes is “key.”

  1. J&J Enterprises wants to issue 20-year, $1,000 face value zero-coupon bonds. If each bond is to yield 7%, what is the minimum number of bonds J&J must sell if they wish to raise $5 million from the sale? (Ignore issuance costs.)
  2. A) 17,290
  3. B) 19,349
  4. C) 20,164
  5. D) 23,880
  6. E) 26,159

Answer: B

Response: price = $1,000 / 1.0720 = $258.42; # of bonds = $5,000,000 / 258.42 = 19,349

  1. What is the market value of a bond that will pay a total of fifty semiannual coupons of $80 each over the remainder of its life? Assume the bond has a $1,000 face value and a 12% yield to maturity.
  2. A) $ 86
  3. B) $ 26
  4. C) $1,135.90
  5. D) $1,315.24
  6. E) $1,545.62

Answer: D

50 N, 80 PMT, 1000 FV, 12/2 = I/Y, CPT PV = -1,315

  1. J&J Manufacturing just issued a bond with a $1,000 face and a coupon rate of 8%. The bond has a life of 20 years, annual coupons, and a yield to maturity is 7.5%, what will the bond sell for?
  2. A) $ 975
  3. B) $1,020
  4. C) $1,051
  5. D) $1,087
  6. E) $1,162

Answer: C

1000 FV, 80 PMT, 20 N, 7.5 I/Y, CPT PV = -1,051

  1. J&J Manufacturing just issued a bond with a $1,000 face value and a coupon rate of 8%. If the bond has a life of 20 years, pays annual coupons, and the yield to maturity is 7.5%, what percent of the bond's total price is represented by the present value of the coupons?
  2. A) 7%
  3. B) 1%
  4. C) 6%
  5. D) 2%
  6. E) 0%

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%.

  1. J&J Manufacturing just issued a bond with a $1,000 face value and a coupon rate of 8%. If the bond has a life of 20 years, pays annual coupons, and the yield to maturity is 7.5%, what is the present value of the bond's face value?
  2. A) $ 41
  3. B) $ 15
  4. C) $ 56
  5. D) $1,000.00
  6. E) $1,050.97

Answer: A, Response: PV of par = $1,000 / 1.07520 = $235.41

(1000 FV, 20 N, 7.5 I/Y, CPT PV = 235.41)

  1. J&J Manufacturing just issued a bond with a $1,000 face value and a coupon rate of 8%. If the bond has a life of 20 years, pays annual coupons, and the yield to maturity is 7.5%, what is the total present value of the bond's coupon payments?
  2. A) $ 41
  3. B) $ 15
  4. C) $ 56
  5. D) $1,000.00
  6. E) $1,050.97

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

  1. The market price of a bond is $1,236.94, it has 14 years to maturity, a $1,000 face value, and pays an annual coupon of $100 in semiannual installments. What is the yield to maturity?
  2. A) 18%
  3. B) 26%
  4. C) 37%
  5. D) 11%
  6. E) 27%

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%

  1. What would you pay for a bond that pays an annual coupon of $45, has a face value of $1,000, matures in 11 years, and has a yield to maturity of 10%?
  2. A) $642.77
  3. B) $775.34
  4. C) $800.18
  5. D) $910.14
  6. E) $976.38

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

  1. King Noodles' bonds have a 9% coupon rate. Interest is paid quarterly and the bonds have a maturity of 10 years. If the appropriate discount rate is 10% on similar bonds, what is the price of King Noodles' bonds?
  2. A) $937.24
  3. B) $938.55
  4. C) $971.27
  5. D) $989.63
  6. E) $991.27

Answer: A

1000 FV, 90/4 = 22.5 PMT, 10 x 4 = 40 N, 10/4=2.5 I/Y, CPT PV = -937.24

  1. Cornerstone Industries has a bond outstanding with an 8% coupon rate and a market price of $874.68. If the bond matures in 6 years and interest is paid semiannually, what is the YTM?
  2. A) 9%
  3. B) 9%
  4. C) 9%
  5. D) 9%
  6. E) 9%

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%

  1. The make-believe bonds of Facebook carry a 12% annual coupon, have a $1,000 face value, and mature in 5 years. Bonds of equivalent risk yield 9%. What is the market value of Facebook bonds?
  2. A) $1,011.20
  3. B) $1,087.25
  4. C) $1,095.66
  5. D) $1,116.69
  6. E) $1,160.25

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

  1. If the following bonds are identical except for coupon, what is the price of bond B?
  1. A) $ 58
  2. B) $ 31
  3. C) $1,037.86
  4. D) $1,150.00
  5. E) $1,279.47

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

  1. If corporate bond yields are at 8.4% and you are in the 34% federal marginal income tax bracket, at what level of municipal bond yields would you be indifferent between owning corporate bonds or muni bonds? Ignore the impact of state and local taxes.
  2. A) 95%
  3. B) 54%
  4. C) 03%
  5. D) 67%
  6. E) 11%

Answer: B

Response: 8.4(1 - .34) = 5.54%

CHAPTER 7 QUESTIONS BEGIN HERE

  1. The stock valuation model that determines the current stock price as the next dividend divided by the (discount rate less the dividend growth rate) is called the:
  2. A) Zero growth model.
  3. B) Dividend growth model.
  4. C) Capital Asset Pricing Model.
  5. D) Earnings capitalization model.

Answer: B

  1. A stock's next expected dividend divided by the current stock price is the:
  2. A) Current yield.
  3. B) Total yield.
  4. C) Dividend yield.
  5. D) Capital gains yield.
  6. E) Earnings yield.

Answer: C

  1. The rate at which the stock price is expected to appreciate (or depreciate) is the:
  2. A) Current yield.
  3. B) Total yield.
  4. C) Dividend yield.
  5. D) Capital gains yield.
  6. E) Earnings yield.

Answer: D

  1. Payments made by a corporation to its shareholders, in the form of either cash, stock, or payments in kind, are called:
  2. A) Retained earnings.
  3. B) Net income.
  4. C)
  5. D)
  6. E) Infused equity.

Answer: C

  1. The market in which new securities are originally sold to investors is the ________ market.
  2. A) dealer
  3. B) auction
  4. C) over-the-counter (OTC)
  5. D) secondary
  6. E) primary

Answer: E

  1. The market in which previously issued securities are traded among investors is the:
  2. A) Dealer market.
  3. B) Auction market.
  4. C) Over-the-counter (OTC) market.
  5. D) Secondary market.
  6. E) Primary market.

Answer: D

  1. Common stock valuation requires, among other things, information regarding the:
  2. Expected dividend growth rate.
  3. Current dividend payment.

III. Par value of the common stock.

  1. A) I only
  2. B) I and II only
  3. C) I and III only
  4. D) II and III only
  5. E) I, II, and III

Answer: B

  1. As illustrated using the dividend growth model, the total return on a share of common stock is comprised of a ___________.
  2. A) capital gains yield and a dividend growth rate
  3. B) capital gains growth rate and a dividend growth rate
  4. C) dividend payout ratio and a required rate of return
  5. D) dividend yield and the present dividend
  6. E) dividend yield and a capital gains yield

Answer: E

  1. Which of the following items would usually appear for a stock quote in The Wall Street Journal?
  2. A) Capital gains rate
  3. B) Dividend yield
  4. C) Number of shares outstanding
  5. D) Par value of the stock
  6. E) Dividend growth rate

Answer: B

  1. If dividends on a common stock are expected to grow at a constant rate forever, and if you are told the most recent dividend paid, the dividend growth rate, and the appropriate discount rate today, you can calculate ___________.
  2. the price of the stock today
  3. the dividend that is expected to be paid ten years from now

III. the appropriate discount rate ten years from now

  1. A) I only
  2. B) I and II only
  3. C) I and III only
  4. D) II and III only
  5. E) I, II, and III

Answer: B

  1. Which of the following statements regarding dividend yields is true?
  2. A) It measures how much the stock's price will increase in a year.
  3. B) It incorporates the par value of the stock into the calculation.
  4. C) It is analogous to the current yield for a bond.
  5. D) It is always greater than the stock's capital gains yield.
  6. E) It measures the total annual return an investor can expect to earn by owning the stock.

Answer: C

  1. Which of the following is (are) true?
  2. The dividend yield on a stock is the annual dividend divided by the par value.
  3. When the constant dividend growth model holds, g = capital gains yield.

III. The total return on a share of stock = dividend yield + capital gains yield.

  1. A) I only
  2. B) II only
  3. C) I and II only
  4. D) II and III only
  5. E) I, II, and III

Answer: D

  1. If some shareholders have greater voting power than others, it must be that:
  2. A) The company has both preferred stock and common stock outstanding.
  3. B) The company has outstanding debentures.
  4. C) The company is located outside the United States in a tax-haven locale.
  5. D) The company has multiple classes of common stock.
  6. E) The company is in bankruptcy proceedings.

Answer: D

  1. What would you pay for a share of ABC Corporation stock today if the next dividend will be $3 per share, your required return on equity investments is 15%, and the stock is expected to be worth $90 one year from now?
  2. A) $78.26
  3. B) $80.87
  4. C) $82.56
  5. D) $90.00
  6. E) $98.12

Answer: B

Response: P0 = $3 / 1.15 + 90 / 1.15 = $80.87

  1. The dividend on Simple Motors common stock will be $3 in 1 year, $4.25 in 2 years, and $6.00 in 3 years. You can sell the stock for $100 in 3 years. If you require a 12% return on your investment, how much would you be willing to pay for a share of this stock today?
  2. A) $75.45
  3. B) $77.24
  4. C) $81.52
  5. D) $85.66
  6. E) $91.30

Answer: C

Response: P0 = $3.00 / 1.12 + 4.25 / 1.122 + 106 / 1.123 = $81.52

  1. A stock that pays a constant dividend of $1.50 forever currently sells for $10.71. What is the required rate of return?
  2. A) 10%
  3. B) 12%
  4. C) 13%
  5. D) 14%
  6. E) 15%

Answer: D

Response: $10.71 = $1.50 / R; R = 14%

  1. ABC Company's preferred stock is selling for $30 a share. If the required return is 8%, what will the dividend be two years from now?
  2. A) $2.00
  3. B) $2.20
  4. C) $2.40
  5. D) $2.80
  6. E) $3.25

Answer: C

Response: $30 = D / .08; D = $2.40

  1. What would you pay today for a stock that is expected to make a $2 dividend in one year if the expected dividend growth rate is 5% and you require a 12% return on your investment?
  2. A) $28.57
  3. B) $29.33
  4. C) $31.43
  5. D) $43.14
  6. E) $54.30

Answer: A

Response: P0 = $2 / (.12 - .05) = $28.57

  1. The stock of MTY Golf World currently sells for $90 per share. The firm has a constant dividend growth rate of 6% and just paid a dividend of $5.09. If the required rate of return is 12%, what will the stock sell for one year from now?
  2. A) $ 00
  3. B) $ 52
  4. C) $ 40
  5. D) $ 80
  6. E) $112.78

Answer: C

Response: P1 = P0(1 + g) = $90 (1.06) = $95.40

  1. Llano's stock is currently selling for $40.00. The expected dividend one year from now is $2 and the required return is 13%. What is this firm's dividend growth rate assuming the constant dividend growth model is appropriate?
  2. A) 8%
  3. B) 9%
  4. C) 10%
  5. D) 11%

Answer: A

Response: g = .13 - ($2 / 40) = 8%

  1. The current price of XYZ stock is $80.00. Dividends are expected to grow at 5% indefinitely and the most recent dividend was $2.75. What is the required rate of return on XYZ stock?
  2. A) 3%
  3. B) 7%
  4. C) 5%
  5. D) 6%
  6. E) 2%

Answer: B

Response: R = ($2.89 / 80) + .05 = 8.7%

  1. ABC Corporation's common stock dividend yield is 3.61%, it just paid a dividend of $2.75, and is expected to pay a dividend of $2.89 one year from now. Dividends are expected to grow at a constant rate indefinitely. What is the required rate of return on ABC stock?
  2. A) 3%
  3. B) 7%
  4. C) 5%
  5. D) 6%
  6. E) 2%

Answer: B

Response: ($2.89 - 2.75) / 2.75 = .051; R = .036 + .051 = 8.7%

  1. If Big Amp, Inc. stock closed at $36 and the current quarterly dividend is $0.75 per share, what dividend yield would be reported for the stock in The Wall Street Journal?
  2. A) 0%
  3. B) 6%
  4. C) 7%
  5. D) 6%
  6. E) 3%

Answer: E

Response: DY = ($0.75 x 4) / 36 = 8.3%

  1. Suppose NoGro, Inc. has just issued a dividend of $3.25 per share. Subsequent dividends will remain at $3.25 indefinitely. Returns on the stock of firms like NoGro are currently running 10%. What is the value of one share of stock?
  2. A) $22.50
  3. B) $27.25
  4. C) $32.50
  5. D) $37.25
  6. E) $39.75

Answer: C

Response: P0 = $3.25 / .10 = $32.50

  1. Suppose Pale Hose, Inc. has just paid a dividend of $1.80 per share. Sales and profits for Pale Hose are expected to grow at a rate of 8% per year. Its dividend is expected to grow by the same amount. If the required return is 14%, what is the value of a share of Pale Hose?
  2. A) $18.00
  3. B) $25.20
  4. C) $27.80
  5. D) $30.60
  6. E) $32.40

Answer: E

Response: P0 = [$1.80(1.08)] / (.14 - .08) = $32.40

  1. Suppose that you have just purchased a share of stock for $40. The most recent dividend was $2 and dividends are expected to grow at a rate of 7% indefinitely. What must your required return be on the stock?
  2. A) 45%
  3. B) 00%
  4. C) 25%
  5. D) 35%
  6. E) 65%

Answer: D

Response: R = [$2(1.07)] / 40 + - .07 = 12.35%

  1. The preferred stock of the Limbaugh Institute pays a constant annual dividend of $4 and sells for $50. You believe the stock will sell for $32 in one year. You must, therefore, believe that the required return on the stock will be _____ percentage points ________ in one year.
  2. A) 8; higher
  3. B) 8; lower
  4. C) 5; higher
  5. D) 5; lower
  6. E) 5; higher

Answer: E

Response: current: $50 = $4 / R; R = 8%; future: $32 = $4 / R; R = 12.5

  1. A firm's stock has a required return of 12%. The stock's dividend yield is 5%. What is the dividend the firm is expected to pay in one year if the current stock price is $50?
  2. A) $2.00
  3. B) $2.50
  4. C) $3.00
  5. D) $3.50
  6. E) $4.00

Answer: B

Response: D1 = $50 (.05) = $2.50

  1. A firm's stock has a required return of 12%. The stock's dividend yield is 5%. What dividend did the firm just pay if the current stock price is $50?
  2. A) $2.18
  3. B) $2.34
  4. C) $2.50
  5. D) $2.87
  6. E) $3.60

Answer: B

Use the following to answer questions 30-36:

  1. Duke stock must have closed at ___________ per share on the previous trading day.
  2. A) $29.64
  3. B) $30.76
  4. C) $30.99
  5. D) $31.55
  6. E) $32.11

Answer: B

Response: 30.76 - 0.56 = 30.20

  1. For the current year, the expected dividend per share is:
  2. A) $0.25
  3. B) $1.00
  4. C) $2.00
  5. D) $3.30
  6. E) $4.00

Answer: B

Doing the algebra? Expected DPS = Yld x Close = .033 x 30.20 = 1

  1. Assume the expected growth rate in dividends is 10%. Then the constant growth model suggests that the required return on Duke stock is:
  2. A) 4%
  3. B) 9%
  4. C) 0%
  5. D) 6%
  6. E) 8%

Answer: D

Response: R = [($1.00 x 1.10) / 30.20] + .10 = 13.6%

  1. Based on the quote, a good estimate of EPS over the last four quarters is:
  2. A) $0.80
  3. B) $1.21
  4. C) $1.68
  5. D) $1.91
  6. E) $2.54

Answer: C

Response: EPS = $30.20 / 18 = $1.68

  1. On this trading day, the number of Duke shares which changed hands was:
  2. A) 209
  3. B) 2,092
  4. C) 20,925
  5. D) 209,250
  6. E) 2,092,500

Answer: E

The algebra? How about 20,925 x 100 = 2,092,500

  1. Assume that Duke paid a $0.92 annual dividend in the previous period. What is the dividend growth rate based on this quote?
  2. A) 8%
  3. B) 0%
  4. C) 2%
  5. D) 7%
  6. E) 9%

Answer: D : Response: g = ($1.00 / 0.92) - 1 = 8.7%

  1. You believe that the required return on Duke stock is 16% and that the expected dividend growth rate is 12%, which is expected to remain constant for the foreseeable future. Is the stock currently overvalued, undervalued, or fairly priced?
  2. A) Overvalued
  3. B) Undervalued
  4. C) Fairly priced
  5. D) Cannot tell without more information

Answer: A

Response: P0 = [$1.00 (1.12) ] / (.16 - .12) = $28.00; overvalued at $30.20 in the market

CHAPTER 8 QUESTIONS BEGIN HERE

  1. The difference between the market value of an investment and its cost is the:
  2. A) Net present value.
  3. B) Internal rate of return.
  4. C) Payback period.
  5. D) Profitability index.
  6. E) Discounted payback period.

Answer: A

  1. The net present value (NPV) rule can be best stated as:
  2. A) An investment should be accepted if, and only if, the NPV is exactly equal to zero.
  3. B) An investment should be rejected if the NPV is positive and accepted if it is negative.
  4. C) An investment should be accepted if the NPV is positive and rejected if its is negative.
  5. D) An investment with greater cash inflows than cash outflows, regardless of when the cash flows occur, will always have a positive NPV and therefore should always be accepted.

Answer: C

  1. The length of time required for an investment to generate cash flows sufficient to recover its initial cost is the:
  2. A) Net present value.
  3. B) Internal rate of return.
  4. C) Payback period.
  5. D) Profitability index.
  6. E) Discounted payback period.

Answer: C

  1. The payback rule can be best stated as:
  2. A) An investment is acceptable if its calculated payback period is less than some prespecified number of years.
  3. B) An investment should be accepted if the payback is positive and rejected if it is negative.
  4. C) An investment should be rejected if the payback is positive and accepted if it is negative.
  5. D) An investment is acceptable if its calculated payback period is greater than some prespecified number of years.

Answer: A

  1. The discount rate that makes the net present value of an investment exactly equal to zero is the:
  2. A) Payback period.
  3. B) Internal rate of return.
  4. C) Average accounting return.
  5. D) Profitability index.
  6. E) Discounted payback period.

Answer: B

  1. The internal rate of return (IRR) rule can be best stated as:
  2. A) An investment is acceptable if its IRR is exactly equal to its net present value (NPV).
  3. B) An investment is acceptable if its IRR is exactly equal to zero.
  4. C) An investment is acceptable if its IRR is less than the required return, else it should be rejected.
  5. D) An investment is acceptable if its IRR exceeds the required return, else it should be rejected.

Answer: D

  1. A situation in which taking one investment prevents the taking of another is called:
  2. A) Net present value profiling.
  3. B) Operational ambiguity.
  4. C) Mutually exclusive investment decisions.
  5. D) Issues of scale.
  6. E) Multiple rates of return.

Answer: C

  1. The present value of an investment's future cash flows divided by its intial cost is the:
  2. A) Net present value.
  3. B) Internal rate of return.
  4. C) Average accounting return.
  5. D) Profitability index.
  6. E) Payback period.

Answer: D

  1. The profitability index (PI) rule can be best stated as:
  2. A) An investment is acceptable if its PI is greater than one.
  3. B) An investment is acceptable if its PI is less than one.
  4. C) An investment is acceptable if its PI is greater than the internal rate of return (IRR).
  5. D) An investment is acceptable if its PI is less than the net present value
  1. Which of the following statements is true?
  2. A) NPV should never be used if the project under consideration has nonconventional cash flows.
  3. B) NPV is similar to a cost/benefit ratio.
  4. C) If the financial manager relies on NPV in making capital budgeting decisions, she acts in the shareholders' best interests.
  5. D) NPV can normally be directly observed in the marketplace.
  6. E) IRR is generally preferred to NPV in making correct capital budgeting acceptance decisions.

Answer: C

  1. Net present value _____________.
  2. A) is equal to the initial investment in a project
  3. B) is equal to the present value of the project benefits
  4. C) is equal to zero when the discount rate used is equal to the IRR
  5. D) is simplified by the fact that future cash flows are easy to estimate
  6. E) requires the firm set an arbitrary cutoff point for determining whether an investment is acceptable

Answer: C

  1. The _______ decision rule is considered the "best" in principle.
  2. A) internal rate of return
  3. B) payback period
  4. C) average accounting return
  5. D) net present value
  6. E) profitability index

Answer: D

  1. Which of the following decision rules is best for evaluating projects for which cash flows beyond a specified point in time, and the time value of money, can both be ignored?
  2. A) Payback
  3. B) Net present value
  4. C) Average accounting return
  5. D) Profitability index
  6. E) Internal rate of return

Answer: A

  1. An investment generates $1.10 in present value benefits for each dollar of invested costs. This conclusion was most likely reached by calculating the project's:
  2. A) Net present value
  3. B) Profitability index
  4. C) Internal rate of return
  5. D) Payback period
  6. E) Average accounting return

Answer: B

  1. The use of which of the following would lead to correct decisions when comparing mutually exclusive investments?
  1. Profitability index
  2. Net present value

III. Average accounting return

  1. A) I only
  2. B) II only
  3. C) III only
  4. D) I and II only
  5. E) I and III only

Answer: B

  1. You own some manufacturing equipment that must be replaced. Two different suppliers present a purchase and installation plan for your consideration. This is an example of a business decision involving _____________ projects.
  2. A) mutually exclusive
  3. B) independent
  4. C) working capital
  5. D) positive NPV
  6. E) crossover

Answer: A

  1. If a project with conventional cash flows has an IRR less than the required return, then:
  2. A) The profitability index is less than one.
  3. B) The IRR must be zero.
  4. C) The AAR is greater than the required return.
  5. D) The payback period is less than the maximum acceptable period.
  6. E) The NPV is positive.

Answer: A

  1. Calculate the NPV of the following project using a discount rate of 10%:

Yr 0 = –$800; Yr 1 = –$80; Yr 2 = $100; Yr 3 = $300; Yr 4 = $500; Yr 5 = $500

  1. A) $ 04
  2. B) $ 28
  3. C) $208.04
  4. D) $459.17
  5. E) $887.28

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.

  1. You are considering a project that costs $600 and has expected cash flows of $224, $250.88 and $280.99 over the next three years. If the appropriate discount rate for the project's cash flows is 12%, what is the net present value of this project?
  2. A) The NPV is negative
  3. B) $ 00
  4. C) $ 34
  5. D) $49.34
  6. E) $84.75

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.

  1. A project costs $300 and has cash flows of $75 for the first three years and $50 in each of the project's last three years. What is the payback period of the project?
  2. A) The project never pays back
  3. B) 75 years
  4. C) 50 years
  5. D) 25 years
  6. E) 50 years

Answer: C

Response: recover $275 in 4 years, need $25 / 50 = 4.50 years

  1. Suppose a project costs $2,500 and produces cash flows of $400 over each of the following 8 years. What is the IRR of the project?
  2. A) There is not enough information; a discount rate is required
  3. B) 27%
  4. C) 84%
  5. D) 61%
  6. E) 06%

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.

  1. A project has an initial investment of $25,000, with $6,500 annual inflows for each of the subsequent 5 years. If the required return is 12%, what is the NPV?
  2. A) –$6,500.00
  3. B) –$2,447.02
  4. C) –$1,568.95
  5. D) $ 46
  6. E) $1,763.81

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.

  1. What is the NPV of the following set of cash flows if the required return is 15%?
  1. A) The NPV is negative
  2. B) $ 27
  3. C) $ 44
  4. D) $1,247.90
  5. E) $4,656.12

Answer: B

CF0 = -10000

CO1 = -1000

FO1 = 1

CO2 = 10000

FO2 = 2

CO3 = -5000

I = 15

NPV = 408.27

  1. Would you accept a project which is expected to pay $2,500 a year for 6 years if the initial investment is $10,000 and your required return is 8%?
  2. A) Yes; the NPV is $1,557
  3. B) Yes; the NPV is $928
  4. C) Yes; the NPV is $63
  5. D) No; the NPV is –$346
  6. E) No; the NPV is –$1,221

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.

  1. What is the payback period of a $15,000 investment with the following cash flows?
  1. A) 75 years
  2. B) 50 years
  3. C) 75 years
  4. D) 50 years
  5. E) 75 years

Answer: B

Response: recover $12,000 in 3 years, need $3,000 / 6,000 = 3.50 years

  1. You are considering an investment which has the following cash flows. If you require a 5 year payback period, should you take the investment?
  1. A) Yes, the payback is 3.000 years.
  2. B) Yes, the payback is 3.75 years.
  3. C) Yes, the payback is 4.25 years.
  4. D) No, the payback is 5.25 years.
  5. E) No, the payback is 5.75 years.

Answer: C

Response: recover $27,500 in 4 years, need $2,500 / 10,000 = 4.25 years

  1. Your required return is 15%. Should you accept a project with the following cash flows?
  1. A) No, because the IRR is 5%.
  2. B) No, because the IRR is 10%.
  3. C) Yes, because the IRR is 20%.
  4. D) Yes, because the IRR is 30%.
  5. E) Yes, because the IRR is 40%.

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%

  1. You are going to choose between two investments. Both cost $50,000, but investment A pays $25,000 a year for 3 years while investment B pays $20,000 a year for 4 years. If your required return is 12%, which should you choose?
  2. A) A because it pays back sooner.
  3. B) A because its IRR exceeds 12%.
  4. C) A because it has a higher IRR.
  5. D) B because its IRR exceeds 12%.
  6. E) B because it has a higher NPV.

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

  1. Using the profitability index, which of the following projects would you choose if you have limited funds?

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

  1. A) Project 1
  2. B) Project 2
  3. C) Project 3
  4. D) Project 4
  5. E) Project 5

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

  1. You have a choice between 2 mutually exclusive investments. If you require a 15% return, which investment should you choose?
  1. A) Project A, because it has a smaller initial investment.
  2. B) Project B, because it has a higher NPV.
  3. C) Either one, because they have the same profitability indexes.
  4. D) Project A, because it has the higher internal rate of return.
  5. E) Project B, because it pays back faster.

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

  1. For a project with an initial investment of $8,000 and cash inflows of $2,000 each year for 6 years, calculate NPV given a required return of 13%.
  2. A) –$846
  3. B) –$263
  4. C) $ 0
  5. D) $149
  6. E) $552

Answer: C

Response: NPV = -$8,000 + 2,000 [(1 - 1/1.136) / .13] = $0 (actual -$4.90)

Use your TVOM keys with equally-sized 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.

  1. What is the IRR of an investment that costs $18,500 and pays $5,250 a year for 5 years?
  2. A) 13%
  3. B) 15%
  4. C) 19%
  5. D) 25%
  6. E) 28%

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 equally-sized cash-flows or 12.92%

  1. What is the profitability index of the following investment if the required return = 10%?
  1. A) 94
  2. B) 09
  3. C) 18
  4. D) 27
  5. E) 45

Answer: B

Response: PV = $50 / 1.1 + 75 / 1.12 + 75 / 1.13 = $163.79; PI = $163.79 / 150 = 1.09

  1. What is the payback period for the following investment?
  1. A) 4 years
  2. B) 3 years
  3. C) 2 years
  4. D) 1 year
  5. E) The investment doesn't payback

Answer: E

Response: recover $10,000 + 8,000 + 4,000 + 2,000 = $24,000; never pays back

Use the following to answer questions 35-38:

Bill plans to open a do-it-yourself dog bathing center in a storefront. The bathing equipment will cost $50,000. Bill expects the after-tax 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.

  1. What is the project's payback period?
  2. A) 67 years
  3. B) 33 years
  4. C) 67 years
  5. D) 33 years
  6. E) 67 years

Answer: B

Response: payback = $50,000 / 15,000 = 3.33 years

  1. Assume the required return is 10%. What is the project's NPV?
  2. A) $ 887
  3. B) $13,322
  4. C) $22,759
  5. D) $30,024
  6. E) $45,001

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 18-22.

  1. Assume the required return is 20%. What is the project's IRR? Should it be accepted?
  2. A) 15%; yes
  3. B) 15%; no
  4. C) 25%; yes
  5. D) 25%; no
  6. E) 20%; indifferent

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%

  1. Assume the required return is 20%. What is the project's PI? Should it be accepted?
  2. A) 85; yes
  3. B) 85; no
  4. C) 00; indifferent
  5. D) 15; yes
  6. E) 15; no

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 long-term 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

S-type 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 short-term 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, credit-rating 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, credit-rating 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 semi-annually, 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

  1. Which one of the following has a maturity value?
  2. Assets b. Bonds c. Common stock d. Preferred stock
  1. a bond indenture:
  2. Contains the legal agreement between the firm and the trustee. b. States the bond’s current rating. c. States the yield to maturity of the bond d. Allows the sale of accounts receivable
  1. A bond has a 1-% coupon rate, a par value of $1000, and a market price of $800. What is the current yield of this bond?
  2. 10% b. 11.4% c. 12.2% d. 12.5%
  1. Which type of value is shown on the firm’s balance sheet?
  2. Liquidation value b. Book value c. Market value d. Intrinsic value
  1. the present value of the expected future cash flows of an asset represents the asset’s:
  2. Liquidation value. b. Book value c. Intrinsic value d. Par value
  1. in an efficient securities market, the market value of a security is equal to its:
  2. liquidation value, b. book value c. intrinsic value d. par value
  1. What is the value of a bond that has a par value of $1000, a coupon of $80(annually), and matures in 11 years? Assume a required rate of return of 11%, and round your answer to the nearest $10.
  2. $320 b. $500 c. $810 d. $790
  1. the interest on corporate bonds is typically paid:
  2. semi-annually b. annually c. quarterly d. monthly
  1. Terminator bug company bonds have a 14% coupon rate. Interest is paid semi-annually. The bonds have a par value of $1000 and will mature 10 years from now. Compute the value of terminator bonds if investors’ required rate of return is 12%, rounded to the nearest dollar.
  2. $1115 b. $1149 c. $1000 d. $894
  1. Cassel corporation bonds pay an annual coupon rate of 10%. If investors’ required rate of return is now *% on these bonds, they will be priced at:
  2. par value b. a premium to par value c. a discount to par value d. asset value
  1. How is preferred stock similar to a bond?
  2. Preferred stock always contains a maturity date b. Dividends are limited in amount c. Both contain a growth factor similar to common stock d. Dividends are deductible for tax purposes
  1. cumulative preferred stock:
  2. provides for the right to vote b. provides for the right to vote cumulatively c. provides for a claim to dividends after common stock d. requires dividends in arrears to be carried over into the next period
  1. valuation methods treat preferred stock as a:
  2. perpetuity b. capital asset c. common stock d. long-term bond
  1. Style corporation preferred stock pays a dividend of $3.15 a year. What is the value of the stock if the required rate of return is 8.5%? (round your answer to the nearest$1)
  1. 23 b. 27 c. 33 d. 37
  1. What is the value of a preferred stock that pays a $2.10 dividend annually to an investor with a required rate of return of 11%? (round your answer to the nearest $1)
  2. $17 b. $19 c. $21 d. $23
  1. Common stock involves ____________the Corporation.
  2. Ownership in b. Personally managing c. Being a creditor of d. The maturity of
  1. Common stock dividends must be ________ before issued.
  2. Approved by common stockholders b. Registered with the SEC c. Approved by preferred stockholders d. Declared by the firm’s board of directors
  1. Which of the following is an example of the internal growth factor of common stock?
  2. Acquiring a loan to fund an investment in Germany b. Two strong companies merging together to increase their economy of scale c. Issuing new stock to provide capital for future growth d. Retaining profits in order to reinvest into the firm.
  1. Little feet Shoe Company just paid a dividend of $1.65 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 this stock.
  2. $15 b. $20.63 c. $21.25 d. $55
  1. What is the expected rate of return for a stock with a current market price of $35, if the expected dividend at the conclusion of this year is $1.75, and earnings are growing at a 10% annual rate? (Assume that the dividends are anticipated to grow at the same rate.)
  2. 25% b. 15% c. 10% d. 5%
  1. What is the payback period for a $20000 project that is expected to return $6000 per year for the first two years and $3000 per year for years three through five?

a.3.5 b. b.4.5 c. c.4.66 d. d.5

  1. Rymer, inc. is considering a new assembler, which costs $180,000 installed, and has a depreciable life of 5 years. The expected annual after-tax cash flows for the assembler are $60,000 in each of the 5 years and nothing thereafter. Calculate the net present value (NPV) of the assembler if the required rate of return is 14%. Round to the nearest ten dollars.
  2. $25,200 b. $25,980 c. $51,960 d. $120,000
  1. Which of the following is considered in the calculation of incremental cash flow?
  2. Re-engineering and installation costs b. Repayment of principal if new debt is issued c. Increased dividend payments if additional common stock issued d. Interest charges associated with raising funds.
  1. An old machine was purchased for $20,000, at a book value of $5,000, and sold for $9,000. The firm’s marginal tax rate is 25%. What is the amount of taxes due?
  2. $9000 b. $5000 c. $2250 d. $1000
  1. A firm purchased an asset with a 5-year life for $90,000, and it cost $10,000 for shipping and installation. Using the simplified straight-line method, what is the annual depreciation?
  2. $20000 b. $18000 c. $10000 d. $5000
  1. The Acu Punct Corporation is considering the purchase of a new machine with an initial outlay of $4500 and expected cash flows in years 1-4 of $2200 per year. The risk-adjusted discount rate for the firm is 12%, and the risk-free rate is 5%. Compute the net present value of this project.
  2. 4300 b. 2181 c. 1899 d. 1535
  1. J&B, Inc. has $5 million of debt outstanding with a coupon rate of 12%. Currently the yield to maturity on these bonds is 12%. If the firm’s tax rate is 40%, what is the cost of debt to J&B?
  2. 14% b. 12% c. 8.4% d. 5.6%
  1. Vipsu Corporation plans to issue 10-year bonds with a par value of $1000 that will pay $55 every six months. The net amount of capital to the firm from the sale of each bond is $840.68. If Vipsu is in the 25% tax bracket and its before-tax cost of capital is 14%, what is the after-tax cost of debt?
  2. 7 b. 10.5 c. 11.5 d. 14
  1. XYZ Corporation is trying to determine the appropriate cost of preferred stock to use in determining the firm’s cost of capital. This firm’s preferred stock is currently selling for $36, and pays a perpetual annual dividend of $2.60 per share. Underwriters of a new issue of preferred stock would charge $6 per share in flotation costs. The firm’s tax rate is 30%. Compute the cost of new preferred stock for XYZ. a. 6.2% b. 7.2% c. 8.7% d. 16.7%
  1. Shawhan supply plans to maintain is optimal capital structure of 30% debt, 20% preferred stock, and 50% common stock far into the future. The required return on each component is: debt 10%, preferred stock 11%, and common stock 18%. Assuming a 40% marginal tax rate, what is the firm’s weighted average cost of capital?
  2. 10% b. 12% c. 13% d. 14.2%
  1. Use the percent of sales method to forecast next year’s accounts payable. Current year slaes are $24,500,000 and sales are expected to rise by 25%. The firm’s accounts payable balance is $1,701,600. what is the projection for next year’s accounts payable?
  2. $1,000,600 b. $2,127,000 c. $3,981,250 d. $6,125,000
  1. A firm has a return on equity (ROE)of 15%. Dividend payout is 25% of net income. Leverage is 1.20. What is the sustainable rate of growth?
  2. 3.75% b. 4.28% c. 11.25% d. 13.50%
  1. A company collects 60% of its sales during the month of sale, 30% one month after the sale, and 10% two months after the sale. Expected sales are: $10,000 in August, $20,000 in September, $30,000 in October, and $40,000 in November. How much cash is expected to be collected in October?
  2. $15000 b. $25000 c. $35000 d. $60000
  1. A 6-month loan of $5000 at 6% interest would require an interest payment of :
  2. $900 b. $600 c. $300 d. $150
  1. Atlas Tire Irons, Inc. is considering borrowing $5000 for a 90-day period. The firm will repay the $5000 principle amount plus $150 in interest. What is the effective annual rate of interest? Use a 360-day year.
  2. 7% b. 12% c. 15% d. 25%
  1. The effective annual cost of not taking advantage of the 3/10, net 30 terms offered by a supplier is (Use a 360 day year.)
  2. 55.7% b. 45.4% c. 40.5% d. 32.3%
  1. Assume that liquid funds can be invested to yield 12%. If annual remittance checks total $2 billion, what is it worth for the firm to reduce float by 1 day?
  2. $54,833 b. $657,534 c. $1,000,000 d. $24,000,000
  1. If you compare the yield of a municipal bond with that of a treasury bond, what is the equivalent before-tax yield of a municipal bond yielding 6% per year for an investor in the 25% tax bracket?
  2. 4.0% b. 7.5% c. 8.0% d. 9.5%
  1. Determine the effective annualized cost of foregoing the trade discount on terms 2/10 net 45, rounded to the nearest tenth of a percent.
  2. 16.0% b. 16.3% c. 21.0% d. 25.9%
  1. Stern Corporation uses semi-hex joints in its manufacturing process. If stern’s total demand for the joints for next year is estimated to be 15,000 units, and if the cost per order is $80, what is stern’s economic order quantity of semi-hex joints? Assume that carrying costs for semi-hex joints are $.51 per unit and round to the nearest 100 units.
  2. 1500 b. 1700 c. 2000 d. 2200
  1. Crisp international purchased 30,000 cases of French wine at a cost of 3,136,000 euros. If the current exchange rate is .7445 euros to the US dollar, what is the purchase price in US dollars?
  2. $2,106,111 b. $2,334,752 c. $3,333,333 d. $4,212,223
  1. Assume the british pound is worth $1.9459. if a new jaguar costs $49,500, what is the cost in british pounds?
  2. 12,719 b. 25,438 c. 48,161 d. 96,322

Financial Management: Principles and Applications,

Chapter 7 An Introduction to Risk and Return-History 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?

  1. A) 35.00%
  2. B) 12.50%
  3. C) 17.50%
  4. D) 25.00%

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 Risk-Return 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.)

  1. A) $60
  2. B) $65
  3. C) $58
  4. D) $70

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 Risk-Return 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?

  1. A) 12%
  2. B) 13%
  3. C) 14%
  4. D) 15%

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 Risk-Return 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.

  1. A) 9.8%
  2. B) 7.0%
  3. C) 8.3%
  4. D) 6.3%

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 Risk-Return 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?

  1. A) 0%
  2. B) 2%
  3. C) 6%
  4. D) 10%

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 Risk-Return 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.

  1. A) 3.68%
  2. B) 1.23%
  3. C) 8.47%
  4. D) 6.66%

Answer: A

Diff: 2

Topic: 7.1 Realized and Expected Rates of Return and Risk

Keywords: standard deviation

Principles: Principle 2: There Is a Risk-Return 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?

  1. A) 15.0%
  2. B) 11.7%
  3. C) 14.5%
  4. D) 25.0%

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 Risk-Return Tradeoff

8) Which of the following best measures the risk of holding an asset in isolation (i.e., stand-alone risk)?

  1. A) The mean co-variance
  2. B) The standard deviation
  3. C) The coefficient of optimization
  4. D) The standard asset pricing model
  5. E) The correlation

Answer: B

Diff: 2

Topic: 7.1 Realized and Expected Rates of Return and Risk

Keywords: standard deviation

Principles: Principle 2: There Is a Risk-Return 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 Risk-Return 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 Risk-Return 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 Risk-Return 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 Risk-Return 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 Risk-Return 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 Risk-Return 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 Risk-Return Tradeoff

7.2 A Brief History of Financial Market Returns

1) The risk-return 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 Risk-Return 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 Risk-Return 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 Risk-Return 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 Risk-Return 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 Risk-Return 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 Risk-Return 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 Risk-Return 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 Risk-Return 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 Risk-Return 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?

  1. A) There is insufficient information to derive an answer.
  2. B) 2.98%
  3. C) 3.73%
  4. D) 3.95%

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?

  1. A) There is insufficient information to derive an answer.
  2. B) 2.98%
  3. C) 3.73%
  4. D) 3.95%

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?

  1. A) 2.42%
  2. B) 3.96%
  3. C) 5.18%
  4. D) 15.1%

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?

  1. A) 3.38%
  2. B) 4.63%
  3. C) 6.96%
  4. D) 8.78%

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.?

  1. A) $12,014.88
  2. B) $12,398.42
  3. C) $13,663.47
  4. D) $14,184.73

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?

  1. A) 1.92%
  2. B) 3.98%
  3. C) 6.47%
  4. D) 7.11%

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?

  1. A) -2.33%
  2. B) .59%
  3. C) 3.67%
  4. D) 4.88%

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?

  1. A) $71,423.85
  2. B) $73,419.66
  3. C) $75,628.75
  4. D) $80,333.40

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:

  1. A) There is publicly available information that Boeing Aircraft has procured a contract to build 25 planes for the U.S. Government and the price of Boeing quickly goes up.
  2. B) ACG, Inc. performed well for the past six months, but they just lost a major distribution contract, but the price of ACG stock continues to go up.
  3. C) Louisville Slugger, Inc., gets a contract to supply bats for Little League play, a contract it never had before, and stock price remains stable.
  4. D) Disney corporation, a growth company, opens a new theme park, which investors expect will do tremendously well, and the stock price stays stable, while Urban Electric Company, which has a set infrastructure, and generates 95% of its earnings from assets it owns, outperforms Disney.

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 semi-strong 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 semi-strong 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 Return-Capital 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%

  1. A) Investment A
  2. B) Investment B
  3. C) Investment C
  4. D) Cannot be determined

Answer: D

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: risk, return

Principles: Principle 2: There Is a Risk-Return Tradeoff

2) You are considering investing in U.S. Steel. Which of the following is an example of nondiversifiable risk?

  1. A) Risk resulting from foreign expropriation of U.S. Steel property
  2. B) Risk resulting from oil exploration by Marathon Oil (a U.S. Steel subsidy)
  3. C) Risk resulting from a strike against U.S. Steel
  4. D) None of the above

Answer: D

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: diversifying risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

3) You are considering buying some stock in Continental Grain. Which of the following is an example of nondiversifiable risk?

  1. A) Risk resulting from a general decline in the stock market
  2. B) Risk resulting from a news release that several of Continental's grain silos were tainted
  3. C) Risk resulting from an explosion in a grain elevator owned by Continental
  4. D) Risk resulting from an impending lawsuit against Continental

Answer: A

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: diversifying risk

Principles: Principle 2: There Is a Risk-Return 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?

  1. A) 12%
  2. B) 13%
  3. C) 14%
  4. D) 15%

Answer: B

FIN 100 Principles of Finance Part 1

FIN 100 Principles of Finance Part 2

FIN 100 Principles of Finance Part 3

FIN 100 Principles of Finance Part 4

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