Finance Review
Finance Review
2) The interest on corporate bonds is typically paid: A) semiannually. B) annually. C) quarterly. D) monthly.
3) On any given day, a bond can be issued at: A) a discount. B) a premium. C) par. D) all of the above.
4) Mortgage bonds: A) are a type of debenture. B) are secured by a lien on real property. C) usually pay little or no interest. D) can only be issued by financial institutions.
5) Bondholders have a priority claim on assets ahead of: A) common stockholders. B) preferred stockholders. C) both A and B. D) none of the above. 6) Which type of value is shown on the firm's balance sheet? A) Book value B) Liquidation value C) Market value D) Intrinsic value 7) Which of the following is generally NOT a characteristic of a bond? A) Voting rights B) Par value C) Claims on assets and income D) Indenture 8) Common indenture provisions include: A) restrictions on the issuance of common stock dividends. B) restrictions on the sale or purchase of fixed assets. C) constraints on additional borrowing. D) all of the above. 9) The issuance of bonds to raise capital for a corporation: A) magnifies the returns to the stockholders.
B) increases risk to the stockholders. C) is a cheaper form of capital than the issuance of common stock. D) all of the above. (mich) E) none of the above.
10) A(n)________ is used to outline the issuing company's contractual obligations to bondholders. A) mortgage B) debenture C) bond rating D) indenture 11) Junk bonds: A) are high yield bonds. B) have higher default risk. C) were used to finance "fallen angels." D) all of the above.
12) Which of the following investors incurs the least risk? A) Bondholders B) Preferred stockholders C) Common stockholders D) All of the above bear equal risk 1) The yield to maturity on a bond: A) is fixed in the indenture. B) is lower for higher-risk bonds. C) is the required return on the bond. D) is generally equal to the coupon interest rate. 2) All of the following affect the value of a bond EXCEPT: A) investors' required rate of return. B) the recorded value of the firm's assets. C) the coupon rate of interest. D) the maturity date of the bond. 3) A $1,000 par value 10-year bond with a 10% coupon rate recently sold for $900. The yield to maturity: A) is 10%. B) is greater than 10%. C) is less than 10%. D) cannot be determined. 4) Sterling Corp. bonds pay 10% annual interest and are selling at 97. The market rate of interest: A) is less than 10%. B) is greater than 10%. C) equals 10%. D) cannot be determined. 5) The Blackburn Group has recently issued 20-year, unsecured bonds rated BB by Moody's. These bonds are: A) low-risk bonds. B) debentures. C) premium bonds. D) mortgage bonds.
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): A) $1,173. B) $743. C) $1,000. D) $827. 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. A) $751 B) $1,177 C) $1,220 D) $976 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. A) $956.42 B) $1,000.00 C) $1,168.31 D) $1,213.19 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): A) 12.00%. B) 11.76%. C) 10.12%. D) 11.29%. 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. A) 5% B) 14% C) 12% D) 11% 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. A) 13% B) 14% C) 15% D) 16% 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. A) 18% B) 13% C) 16% D) 17% 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. A) $320 B) $500 C) $810 D) $790
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. A) $970 B) $1,330 C) $330 D) $1,000 15) Bond ratings are usually not affected by: A) the company's fiscal year end. B) profitable operations. C) variability in earnings. D) firm size.
16) The discount rate used to value a bond is: A) the coupon interest rate. B) determined by the issuing company. C) fixed for the life of the bond. D) the market rate of interest. 17) As interest rates, and consequently investors' required rates of return, change over time, the ________ of outstanding bonds will also change. A) maturity date B) coupon interest payment C) par value D) price 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%. A) $1,516.18 B) $973.33 C) $1,027.17 D) $950.00 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%. A) $1,114.70 B) $1,149.39 C) $894.06 D) $1,000.00 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? A) 7.750% B) 11.072%
C) 9.375% D) 8.675%
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. A) $715 B) $1,171 C) $1,225 D) $697 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. A) $1,050 B) $932 C) $681 D) $1,111 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.) A) 3% B) 5% C) 7% D) 9% 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? A) 8.50% B) 14.38% C) 11.11% D) 7.67% 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? A) 15.80% B) 10.47% C) 9.24% D) 7.90% E) 4.62% 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? A) $654.98 B) $735.15 C) $814.42 D) $941.87 27) A $1,000 par value bond is currently listed as selling at 92 1/8. This means: A) that you can buy the bond for $92.125. B) that you can buy the bond for $921.25.
C) that if you purchase the bond today, you will receive $921.25 when the bond matures. D) none of the above. 28) You paid $865.50 for a corporate bond that has a 6.75% coupon rate. What is the bond's current yield? A) 8.375% B) 7.800% C) 15.001% D) 6.667% 29) A $1,000 par value bond with a 12% coupon rate currently selling for $825 has a current yield of: A) 14.55%. B) 12.44%. C) 7.27%. D) 5.61%. 30) Bond ratings are favorably affected by: A) a greater reliance on equity in financing the firm. B) high variability in past earnings. C) large firm size. D) both A and C. 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.) A) $1,196 B) $1,042 C) $1,000 D) $946 Answer: A 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: A) 7.20%. B) 9%. C) 10.12%. D) 14.40%. 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: A) 10%. B) 8.75%. C) 11.63%. D) 7.24%. 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: A) 10.00. B) 6.76. C) 5. D) unable to be determined based on the information given. 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? A) $619 B) $674 C) $761 D) $828 E) $902 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? A) $1,111 B) $1,450 C) $1,352 D) $675 E) $1,000 37) Dry Seal plans to issue bonds to expand operations. The bonds will have a par value of $1,000, a 10year maturity, and a coupon interest rate of 9%, paid semiannually. Current market conditions are such that the bonds will be sold to net $937.79. What is the yield-to-maturity of these bonds? A) 11% B) 10% C) 9% D) 8% E) 7% 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? A) 11.3% B) 7.4% C) 6.5% D) 10.5% E) 9.1% 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? A) 11.3% B) 8.5% C) 6.5% D) 7.9% E) 9.1%
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? A) The bonds will sell at a premium and decline in value until maturity. B) The bonds will sell at a discount and rise in value until maturity. C) The bonds will sell at a premium and rise in value until maturity. D) The bonds will sell at a discount and fall in value until maturity. 7) Which of the following statements is true? 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. 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.
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. 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. 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%. A) yield to maturity B) current yield C) coupon rate D) current yield and coupon rate E) yield to maturity and current yield 9) A bond has a coupon rate of 10% and yield to maturity of 12%. Which of the following must be true? A) The bond is selling at a discount. B) The bond is selling at a premium. C) The bond's current yield is less than the coupon rate. D) Both A and C. E) Both B and C. 10) Which of the following statements about bonds is true? A) Bond prices move in the same direction as market interest rates. B) If market interest rates change, long-term bonds will fluctuate more in value than short-term bonds. C) Long-term bonds are less risky than short-term bonds. D) If market interest rates are higher than a bond's coupon interest rate, then the bond will sell above its par value. E) None of the above. 11) Which of the following statements about bonds is true? A) As the maturity date of a bond approaches, the market value of a bond will become more volatile. B) Long-term bonds have less interest rate risk than do short-term bonds. C) Bond prices move in the same direction as market interest rates. D) If market interest rates are above a bond's coupon interest rate, then the bond will sell below its par value. E) None of the above. 12) Which of the following statements about bonds is true? A) The market value of a bond moves in the opposite direction of market interest rates. B) As the maturity date of a bond approaches, the market value of a bond will become more volatile. C) Long-term bonds are less risky than short-term bonds. D) If market interest rates are higher than a bond's coupon interest rate, then the bond will sell above its par value. E) None of the above. 1) Eurobonds are: A) issued in a country different from the one in whose currency the bond is denominated. B) issued only in Europe. C) the European equivalent of a junk bond. D) none of the above. 2) Which of the following statements about zero coupon bonds is FALSE? 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. B) Zero coupon bonds are disadvantageous to the issuing firm if interest rates fall. C) Yields tend to be bid down on zero coupon bonds due to investor demand for the bonds.
D) Zero coupon bonds provide a positive annual cash flow to the issuing firm over the life of the bonds. 3) Eurobonds: A) are registered with the SEC. B) are frequently offered to U.S. citizens and residents during their initial distribution. C) take relatively longer periods of time to issue. D) have none of the above characteristics. 4) Which of the following bonds is sold by a corporation at a discount and pays no interest? A) An indenture bond B) A zero coupon bond C) A junk bond D) A eurobond 5) Which of the following is an advantage of zero coupon bonds? A) Small cash outflow at maturity B) Lower yield due to low demand C) Ability to deduct annual amortization of discount D) Both A and C E) All of the above
1) Which of the following statements about debentures is FALSE? A) The earning ability of the issuing corporation is of great concern to the bondholder. B) Debentures are viewed as less risky than secured bonds. C) Debentures must provide investors with a higher yield than secured bonds. D) Debentures allow the firm to issue debt and still preserve some future borrowing power. 2) Government bonds have lower yield to maturity than do corporate bonds of the same maturity because the ________ premium is lower for government bonds. A) interest rate risk B) inflation C) default D) maturity
3) Green Company's common stock is currently selling at $24.00 per share. The company recently paid dividends of $1.92 per share and projects growth at a rate of 4%. At this rate, what is the stock's expected rate of return? A) 4.08% B) 8.00% C) 12.00% D) 8.80% Required return = D1/P0 + g = 1.92 X 1.04/24 + 4% = 12% 4) Common stockholders are essentially: A) creditors of the firm. B) managers of the firm. C) owners of the firm. D) all of the above. 5) Butler, Inc.'s return on equity is 17% and management retains 75% of earnings for investment purposes. Based on this information, what will be the firm's growth rate? A) 4.25%
B) 22.67% C) 44.12% D) 12.75% Growth rate = Return on equity X retention rate = 17% X 0.75 = 12.75% 6) If a company has a return on equity of 25% and wants a growth rate of 10%, how much of ROE should be retained? A) 40% B) 50% C) 60% D) 70% Growth rate = Return on equity X retention rate 10% = 25% X retention rate Retention rate = 10%/25% = 40% 7) ________ gives minority shareholders more power to elect board of directors. A) Preemptive right B) Majority voting C) Proxy fights D) Cumulative voting The votes can be cumulated and so can be used for electing one director. 8) You are evaluating the purchase of Cellars, Inc. common stock that just paid a dividend of $1.80. You expect the dividend to grow at a rate of 12% for the next three years. You plan to hold the stock for three years and then sell it. You estimate that a required rate of return of 17.5% will be adequate compensation for this investment. Calculate the present value of the expected dividends. Round to the nearest $0.10. A) $4.90 B) $11.50 C) $9.80 D) $6.10 The present value of expected dividends is Growth PV factor Year rate Dividend at 17.5% 0 1.8 1 2 3 12% 12% 12% 2.02 2.26 2.53 0.851064 0.72431 0.616434 Total
PV
9) You are evaluating the purchase of Holdings, Inc. common stock that just paid a dividend of $1.80, and the dividend will be $1.80 per share per year for the next ten years. You plan to hold the stock for three years and then sell it. You expect the price of the company's stock to rise to $51.50 at the end of your threeyear holding period. You estimate that a required rate of return of 17.5% will be adequate compensation for this investment. Calculate the present value of the expected future stock price. Round to the nearest $.25. A) $64.00 B) $55.25
C) $31.75 D) $103.00 PV of expected stock price = 51.50/(1+17.5%)^3 = 31.75 10) CEO naming friends to the board of directors and paying them more than the norm is an example of the: A) agency problem. B) preemptive right. C) majority voting feature. D) proxy fights. The CEO is not acting in the interest of the shareholders 11) Little Feet Shoe Co. 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 of per share of LFS stock. A) $20.63 B) $21.24 C) $15.00 D) $55.00 Current value = D1/(Required return growth rate) = 1.65 X 1.03/(11%-3%) = 21.24 12) Marshall Manufacturing has common stock which paid a dividend of $1.00 a share last year. You expect the stock to grow at 5% per year. If the appropriate rate of return on this stock is 12%, how much are you willing to pay for the stock today? A) $13.00 B) $15.00 C) $17.00 D) $19.00 Current value = D1/(Required return growth rate) = 1.00 X 1.05/(12%-5%) = 15 13) Marble Corporation's ROE is 17%. Their dividend payout ratio is 20%. The last dividend, just paid, was $2.58. If dividends are expected to grow by the company's sustainable growth rate indefinitely, what is the current value of Marble common stock if its required return is 18%? A) $14.33 B) $18.27 C) $47.67 D) $66.61 Sustainable growth rate= ROE X (1 - dividend-payout ratio) = 17%X(1-.2) =13.6% Current value = D1/(Required return growth rate) = 2.58 X (1+13.6%)/(18%-13.6%) = 66.61 14) Fris B. Corporation stock is currently selling for $42.86. It is expected to pay a dividend of $3.00 at the end of the year. Dividends are expected to grow at a constant rate of 3% indefinitely. Compute the required rate of return on FBC stock. A) 10% B) 33% C) 7% D) 4.3% Required return = D1/P0 + g
= 3/42.86 + 3% = 10% 15) You are evaluating the purchase of Cool Toys, Inc. common stock that just paid a dividend of $1.80. You expect the dividend to grow at a rate of 12%, indefinitely. You estimate that a required rate of return of 17.5% will be adequate compensation for this investment. Assuming that your analysis is correct, what is the most that you would be willing to pay for the common stock if you were to purchase it today? Round to the nearest $.01. A) $36.65 B) $91.23 C) $51.55 D) $74.82 Price = D1/(required return growth rate) = 1.80 X 1.12/(17.5%-12%) = 36.65 16) A stock currently sells for $63 per share, and the required return on the stock is 10%. Assuming a growth rate of 5%, calculate the stock's last dividend paid. A) $1 B) $3 C) $5 D) $7 Required return = D1/P0 + g 10% = D1/63 + 5% D1 = 3.15 D0 = 3.15/1.05 = $3 17) A decrease in the ________ will cause an increase in common stock value. A) growth rate B) required rate of return C) last paid dividend D) both B and C If required rate of return decreases, the PV of dividends will increase and so the value 18) Acme Consolidated has a return on equity of 12%. If Acme distributes 60% of earnings as dividends, then we would expect the common shareholders' investment in the firm and the value of the common stock to grow by: A) 4.80%. B) 7.20%. C) 12%. D) 6%. Answer: A Growth rate = ROE X retention ratio = 12% X (1-0.6) = 4.8% 19) An investor is contemplating the purchase of common stock at the beginning of this year and to hold the stock for one year. The investor expects the year-end dividend to be $2.00 and expects a year-end price for the stock of $40. If this investor's required rate of return is 10%, then the value of the stock to this investor is: A) $36.36. B) $38.18. C) $33.06. D) $34.88.
Value = (2+40)/1.10 = 38.18 20) A firm just paid $2.00 on its common stock and expects to continue paying dividends, which are expected to grow 5% each year, from now to infinity. If the required rate of return for this stock is 9%, then the value of the stock is: A) $50.00. B) $40.00. C) $54.50. D) $52.50. Price = D1/(required return growth rate) = 2.00 X 1.05/(9%-5%) = $52.5 21) An issue of common stock currently sells for $40.00 per share, has an expected dividend to be paid at the end of the year of $2.00 per share, and has an expected growth rate to infinity of 5% per year. The expected rate of return on this security is: A) 5%. B) 10.25%. C) 13.11%. D) 10%. Required return = D1/P0 + g = 2/40 + 5% = 10% 22) White Sink, Inc. just paid a dividend of $5.55 per share on its common stock, and the firm is expected to generate constant growth of 12.25% over the foreseeable future. The common stock is currently selling for $73.75 per share. The firm's dividend payout ratio is 40%, and White's marginal tax rate is 40%. What is the rate of return that common stockholders expect? Round to the nearest 0.1%. A) 8.5% B) 20.7% C) 15.5% D) 4.8% Required return = D1/P0 + g = 5.55 X (1+12.25%)/73.75 + 12.25% = 20.7% 23) KDP's most recent dividend was $2.00 per share and is selling today in the market for $70. The dividend is expected to grow at a rate of 7% per year for the foreseeable future. If the market return is 10% on investments with comparable risk, should you purchase the stock? A) No, because the stock is overpriced $1.33. B) No, because the stock is overpriced $3.33. C) Yes, because the stock is underpriced $1.33. D) Yes, because the stock is underpriced $3.33. Price = D1/(required return growth rate) = 2.00 X 1.07/(10%-7%) = 71.33 Current price is 70, so stock is under price by 1.33 24) An issue of common stock currently sells for $50.00 per share, has an expected dividend to be paid at the end of the year of $2.50 per share, and has an expected growth rate to infinity of 5% per year. If investors' required rate of return for this particular security is 12% per year, then this security is: A) overvalued and offering an expected return higher than the required return. B) undervalued and offering an expected return higher than the required return. C) overvalued and offering an expected return lower than the required return. D) undervalued and offering an expected return lower than the required return.
Price = D1/(required return growth rate) = 2.50/(12%-5%) = 35.71 Current price = 50, which gives a return of 2.50/50 + 5% = 10%
25) You are considering the purchase of Miller Manufacturing, Inc.'s common stock. The stock is selling for $21.00 per share. The next dividend is expected to be $2.10, and you expect the dividend to keep growing at a constant rate. If the stock is returning 15%, calculate the growth rate of dividends. A) 3% B) 5% C) 8% D) 10% Required return = D1/P0 + g 15% = 2.10/21 + g g = 5% 26) ABC, Inc. just paid a dividend of $2. ABC expects dividends to grow at 10%. The return on stocks like ABC, Inc. is typically around 12%. What is the most you would pay for a share of ABC stock? A) $100 B) $110 C) $120 D) $130 Price = D1/(required return growth rate) = 2X1.10/(12%-10%) = $110 27) Marjen, Inc. just paid a dividend of $5. Marjen stock currently sells for $73.57. The return on stocks like Marjen, Inc. is around 10%. What is the implied growth rate of dividends. A) 1% B) 3% C) 5% D) 7% Required return = D1/P0 + g 10% = 5 X (1+g)/73.57 + g g = 3% 28) Which investor incurs the greatest risk? A) Mortgage bondholder B) Preferred stockholder C) Common stockholder D) Debenture bondholder 29) What allows common stockholders the right to cast a number of votes equal to the number of directors being elected? A) The majority voting provision B) The casting feature C) The cumulative voting provision D) The proxy method In majority voting the votes are equal to the number of directors. 30) The shareholder can cast all votes for a single candidate or split them among various candidates through:
A) proxy fights. B) cumulative voting. C) call provisions. D) majority voting. This is a feature of cumulative voting 31) You are considering the purchase of common stock that just paid a dividend of $6.50 per share. Security analysts agree with top management in projecting steady growth of 12% in dividends and earnings over the foreseeable future. Your required rate of return for stocks of this type is 18%. How much should you expect to pay for this stock? A) $86 B) $94 C) $108 D) $121 E) $242 Price = D1/(required return growth rate) = 6.50 X 1.12/(18%-12%) = 121 32) You are considering the purchase of Wahoo, Inc. The firm just paid a dividend of $4.20 per share. The stock is selling for $115 per share. Security analysts agree with top management in projecting steady growth of 12% in dividends and earnings over the foreseeable future. Your required rate of return for stocks of this type is 17.5%. If you were to purchase and hold the stock for three years, what would the expected dividends be worth today? A) $12.60 B) $9.21 C) $17.12 D) $15.55 E) $11.46 PV factor
Year 0 1 2 3
Growth
PV
33) A share of common stock just paid a dividend of $3.25 per share. The expected long-run growth rate for this stock is 18%. If investors require a rate of return of 24%, what should the price of the stock be? A) $57.51 B) $62.25 C) $71.86 D) $63.92 E) $44.94 Price = D1/(required return growth rate) = 3.25 X 1.18/(24%-18%) = 63.92 34) Common stockholders expect greater returns than bondholders because:
A) they have no legal right to receive dividends. B) they bear greater risk. C) in the event of liquidation, they are only entitled to receive any cash that is left after all creditors are paid. D) all of the above. All of the above result in asking for higher return 35) WSU Inc. is a young company that does not yet pay a dividend. You believe that the company will begin to pay dividends 5 years from now, and that the company will then be worth $50 per share. If your required rate of return on this risky stock is 20%, what is the stock worth today? A) $40 B) $10 C) $20.09 D) $0.00 Price now = 50/1.2^5 = 20.09 1) If a stock has a much higher than normal P/E ratio, investors probably expect: A) slow growth in earnings. B) rapid growth in earnings. C) large increases in the price of the stock. D) a declining stock price P/E ratio reflects future earnings and a higher P/E would mean higher future earnings 2) Which of the following factors will influence a firm's P/E ratio? A) The investors' required rate of return B) Firm investment opportunities C) General market conditions D) All of the above All would affect 3) The P/E ratio is calculated by dividing: A) the current stock price by stockholders' equity. B) total assets by net income. C) the current stock price by earnings per share. D) the current stock price by operating cash flow per share. P/E = Price/EPS 4) The GAP's most recent earnings per share were $1.75. Analysts forecast next year's earnings per share at $1.88. If the appropriate P/E ratio is 15, a share of GAP stock should be valued at: A) $28.20. B) $26.25. C) $27.23. D) $8.57. Price should be 1.88 X 15 = 28.20 5) The retail analyst at Morgan-Sachs values stock of the GAP at $28.00 per share. They are using the average industry P/E ratio of 15. Their forecasted earnings per share for next year is: A) $0.54. B) $1.50. C) $1.87.
D) There is not enough information calculate earnings per share. EPS = 28/15 = 1.87 6) Home Depot stock is currently selling for $30 per share. Next year's dividend is expected to be $1.00; next year's earnings per share are expected to be $2.14. Home Depot's P/E ratio is: A) .07. B) 14. C) 2.14. D) 30. P/E ratio = 30/2.14 = 14 7) McDonald's stock currently sells for $77.50. It's expected earnings per share are $4.50. The average P/E ratio for the industry is 23.3. If investors expected the same growth rate and risk for McDonald's as for an average firm in the same industry, it's stock price would: A) stay about the same. B) rise. C) fall. D) there is not enough information. The price should be 4.50 X 23.3 = 104.85 8) If the ROE on a new investment is less than the firm's required rate of return: A) the investment increases the firm's value. B) the investment leaves the firm's value unchanged. C) the effect on the firm's value is unpredictable. D) the investment reduces the firm's value. The return earned is less than the required return 9) Zorba's is a small chain of of restaurants whose stock is not publicly traded. The average P/E ratio for similar restaurant chains is 16.5; the P/E ratio for the S&P 500 Index is 15.2. This year's earnings were $1.10 per share; next's earnings are expected to be $1.21 per share. A reasonable price for a share of Zorba's stock is: A) $19.97. B) $18.15. C) $20.23. D) $16.72. The price would be based on industry P/E Price = 1.21 X 16.5 = 19.97 10) Apple stock is now selling for $315.32 per share. The P/E ratio based on current earnings is 23.72 and the P/E ratio based on expected earnings is 17.48. The expected growth rate in Apples earnings must be: A) -26%. B) 36%. C) 7.6%. D) 5.5%.
Current earnings = 315.32/23.72 = 13.29 Expected earnings = 315.32/17.48 = 18.04 Growth rate = 18.04/13.29 = 36%
1) UVP preferred stock pays $5.00 in annual dividends. If your required rate of return is 13%, how much will you be willing to pay for one share? A) $38.46 B) $26.26 C) $65.46 D) $46.38 Price = Dividend/Required return = 5/13% = 38.46 2) Green Corp.'s preferred stock is selling for $20.83. If the company pays $2.50 annual dividends, what is the expected rate of return on its stock? A) 8.33% B) 12.00% C) 2.50% D) 20.00% Rate of return = Annual Dividend/Price = 2.50/20.83 = 12% 3) Sacramento Light & Power issued preferred stock in 1998 that had a par value of $85. The preferred stock pays a dividend of 5.75%. Investors require a rate of return of 6.50% today on this stock. What is the value of the preferred stock today? Round to the nearest $1. A) $100 B) $85 C) $75 D) $16 Annual Dividend = 85 X 5.75% = 4.8875 Price = 4.8875/6.5% =75 4) Which of the following statements is true? A) Preferred stockholders are entitled to dividends before common stockholders can receive dividends. B) Preferred stock, like common stock, usually has no maturity; i.e., the corporation does not pay back the investment. C) The market value of preferred stock, like bonds, will usually fluctuate in value primarily as the result of market rates of interest. D) All of the above. All are true for preferred stock 5) Which of the following statements concerning preferred stock is correct? A) Preferred stock generally is more costly to the firm than common stock. B) Most issues of preferred stock have a cumulative feature. C) Preferred dividend payments are tax-deductible. D) Preferred stock is a riskier form of capital to the firm than bonds. Preferred stock may skip dividends and so most is cumulative 6) World Wide Interlink Corp. has decided to undertake a large project. Consequently, there is a need for additional funds. The financial manager plans to issue preferred stock with an annual dividend of $5 per share. The stock will have a par value of $30. If investors' required rate of return on this investment is currently 20%, what should the preferred stock's market value be? A) $10 B) $15 C) $20 D) $25
Market value = 5/20% = $25 7) Davis Gas & Electric issued preferred stock in 1985 that had a par value of $50. The stock pays a dividend of 7.875%. Assume that shares are currently selling for $62.50. What is the preferred stockholder's expected rate of return? Round to the nearest 0.01%. A) 6.30% B) 7.88% C) 10.25% D) 5.02% Annual dividend = 50 X 7.875% = 3.9375 Required return = 3.9375/62.5 = 6.3% 8) Murky Pharmaceuticals has issued preferred stock with a par value of $100 and a 5% dividend. The investors' required yield is 10%. What is the value of a share of Murky preferred? A) $100 B) $75 C) $50 D) $25 Annual Dividend = 100 X 5% = 5 Value per share = 5/10% = $50 9) Edison Power of light has an outstanding issue of cumulative preferred stock with an annual fixed dividend of $2.00 per share. It has not paid the preferred dividend for the last 3 years, but intends to pay a dividend on the common stock in the coming year. Before Edison can pay a dividend on the common stock A) preferred shareholders may cast all their votes for a single director. B) preferred shareholders must receive dividends totaling $8.00 per share. C) preferred shareholders must receive $2.00 per share. D) will not necessarily receive any dividend. Since it is cumulative, four years of dividends would be paid 10) Which of the following provisions is unique to preferred stockholders and usually NOT available to common stockholders? A) Cumulative dividends feature B) Voting rights C) Fixed dividend D) Both A and C Preferred stock dividend is usually fixed and cumulative Chapter 11 1) Which of the following are typical consequences of good capital budgeting decisions? A) The firm increases in value. B) The firm gains knowledge and experience that may be useful in future decisions. C) Good capital budgeting decisions help a company define its core competencies. D) All of the above. 2) Errors in capital budgeting decisions: A) tend to average out over time. B) decrease the firm's value. C) are diminished because the time value of money makes future cash flows less important. D) are easily reversed.
Capital budgeting if it is not proper would reduce firm value by negative NPV 3) Which of the following factors is least important to capital budgeting decisions.? A) The time value of money B) The risk-return tradeoff C) Net income based on accrual accounting principles D) Cash flows directly resulting from the decision Capital budgeting uses cash flows and not income 4) Which of the following would NOT be considered a capital budgeting decision? A) Walmart purchases inventory for resale to customers. B) Morgan Stanley installs elevators to comply with the Americans With Disabilities Act. C) Caterpillar replaces manufacturing equipment with more efficient new equipment. D) Pfizer develops a new therapy and brings it to market. 5) Which of the following is a typical capital budgeting decision? A) Purchase of office supplies B) Granting credit to a new customer C) Replacement of manufacturing equipment with more modern and efficient equipment D) Financing the firm with more long-term debt and less equity 6) Good capital investment opportunities are most likely to exist when: A) many firms compete to sell similar products. B) interest rates are high and rising. C) goods and services can be produced cheaply using readily available tools and technologies. D) a line of business is expensive to enter and uses proprietary technology. This would result in higher cash flows and NPV 1) Project Sigma requires an investment of $1 million and has a NPV of $10. Project Delta requires an investment of $500,000 and has a NPV of $150,000. The projects involve unrelated new product lines. A) Both projects should be accepted because they have positive NPV's. B) Neither project should be accepted because they might compete with one another. C) Only project Delta should be accepted. Alpha's NPV is too low for the investment. D) The company should look at other investment criteria, not just NPV. Since both have positive NPV, both are acceptable 2) ABC Service can purchase a new assembler for $15,052 that will provide an annual net cash flow of $6,000 per year for five years. Calculate the NPV of the assembler if the required rate of return is 12%. (Round your answer to the nearest $1.) A) $1,056 B) $4,568 C) $7,621 D) $6,577 NPV = 6,000 X PVIFA (5,12%) 15,052 = 6,577 3) Central Mass Ambulance Service can purchase a new ambulance for $200,000 that will provide an annual net cash flow of $50,000 per year for five years. Calculate the NPV of the ambulance if the required rate of return is 9%. (Round your answer to the nearest $1.) A) $50,000 B) $(5,061) C) $(5,517) D) $5,517
NPV = 50,000 X PVIFA (5,9%) 200,000 = -5,517 4) Central Mass Ambulance Service can purchase a new ambulance for $200,000 that will provide an annual net cash flow of $50,000 per year for five years. The salvage value of the ambulance will be $25,000. Assume the ambulance is sold at the end of year 5. Calculate the NPV of the ambulance if the required rate of return is 9%. (Round your answer to the nearest $1.) A) $(10,731) B) $10,731 C) $(5,517) D) $5,517 NPV = 50,000 X PVIFA (5,9%) + 25,000 X PVIF (5,9%) 200,000 = 10,731 5) Fitchminster Armored Car can purchase a new vehicle for $200,000 that will provide annual net cash flow over the next five years of $40,000, $45,000, $50,000, $55,000, $60,000. The salvage value of the vehicle will be $25,000. Assume that the vehicle is sold at the end of year 5. Calculate the NPV of the ambulance if the required rate of return is 9%. (Round your answer to the nearest $1.) A) $7,390 B) $6,048 C) $6,780 D) $19,483 The PV of cash flows = 40,000/1.09 + 45,000/1.09^2 + 50,000/1.09^3 + 55,000/1.09^4 + (60,000+25,000)/1.09^5 = 207,389 NPV = 207,389 200,000 = 7,389 6) Project H requires an initial investment of $100,000 and the produces annual cash flows of $50,000, $40,000, and $30,000. Project T requires an initial investment of $100,000 and the produces annual cash flows of $30,000, $40,000, and $50,000. If the required rate of return is greater than 0% and the projects are mutually exclusive: A) H will always be preferable to T. B) T will always be preferable to H. C) H and T are equally attractive. D) The project rankings will change with different discount rates. H has higher cash flows initially and so would have a higher NPV 7) Project H requires an initial investment of $100,000 and the produces annual cash flows of $45,000 per year for each of the next 3 years. Project T also requires an initial investment of $100,000 and produces cash flows of $30,000 in year 1, $40,000 in year 2, and $70,000 in year 3. If the discount rate is 10% and the projects are mutually exclusive: A) Project H should be chosen. B) Project T should be chosen. C) H and T are equally attractive. D) Both projects should be chosen. NPV of H is 45,000 X PVIFA (3,10%) 100,000 = 11,908 NPV of T = 30,000/1.1 + 40,000/1.1^2 + 70,000/1.1^3 100,000 = 12,922 Choose T 8) Project H requires an initial investment of $100,000 and the produces annual cash flows of $45,000 per year for each of the next 3 years. Project T also requires an initial investment of $100,000 and produces cash flows of $30,000 in year 1, $40,000 in year 2, and $70,000 in year 3. If the discount rate is 10% and the projects are not mutually exclusive: A) Project H should be chosen.
B) Project T should be chosen. C) H and T are equally attractive. D) Both projects should be accepted. NPV of H is 45,000 X PVIFA (3,10%) 100,000 = 11,908 NPV of T = 30,000/1.1 + 40,000/1.1^2 + 70,000/1.1^3 100,000 = 12,922 Choose T 9) Project H requires an initial investment of $100,000 and the produces annual cash flows of $45,000 per year for each of the next 3 years. Project T also requires an initial investment of $100,000 and produces cash flows of $30,000 in year 1, $40,000 in year 2, and $70,000 in year 3. If the discount rate increases from 10% to 16%: A) Project T should be chosen. B) Both projects should be rejected. C) H and T are equally attractive. D) The project rankings will change. NPV of H is 45,000 X PVIFA (3,16%) 100,000 = 1,065 NPV of T = 30,000/1.16 + 40,000/1.16^2 + 70,000/1.16^3 100,000 = 434 Now Project H is more attractive 10) A machine costs $1,000, has a three-year life, and has an estimated salvage value of $100. It will generate after-tax annual cash flows (ACF) of $600 a year, starting next year. If your required rate of return for the project is 10%, what is the NPV of this investment? (Round your answer to the nearest $10.) A) $490 B) $570 C) $900 D) -$150 PV of cash flows = 600 X PVIFA (3,10%) + 100 X PVIF(3,10%) -1,000 = 570 11) Suppose you determine that the NPV of a project is $1,525,855. What does that mean? A) In all cases, investing in this project would be better than investing in a project that has an NPV of $850,000. B) The project would add value to the firm. C) Under all conditions, the project's payback would be less than the profitability index. D) Other investment criteria might need to be considered. NPV is the surplus generated which adds to the value of the firm. 12) Project January has a NPV of $50,000, project December has a NPV of $40,000. Which of the following circumstances could make it possible to choose December over January? A) January has a shorter payback period. B) The projects are mutually exclusive. C) The projects have unequal lives. D) The projects are mandated. In this case we would look at NPV per year 13) The present value of the total costs over a five year period for Project April is $50,000. The net present value of total costs over a 4 year period for Project October is $40,000. The company uses a discount rate of 9%. Which project should it choose and why? A) April because it has a higher NPV. B) April because is has a higher EAC. C) October because it has a shorter life.
D) October because it has a lower EAC. Since the projects have unequal lives, we calculate the EAC EAC for April = 50,000/PVIFA (5,9%) = 12,854 EAC for October = 40,000/PVIFA (4,9%) = 12,346 14) Warchester Inc. is considering the purchase of copying equipment that will require an initial investment of $15,000 and $4,000 per year in annual operating costs over the equipment's estimated useful life of 5 years. The company will use a discount rate of 8.5%. What is the equivalent annual cost? A) $4,000 B) $7,000 C) $6,152.51 D) $7,806.49 EAC for 15,000 = 15,000/PVIFA (5,8.5%) = 3,806 Total EAC = 3,806 + 4,000 = 7,806 15) Artie's Soccer Ball Company is considering a project with the following cash flows: Initial outlay = $750,000 Incremental after-tax cash flows from operations Years 1-4 = $250,000 per year Compute the NPV of this project if the company's discount rate is 12%. A) $9,337 B) $7,758 C) $4,337 D) $2,534 NPV = 250,000 X PVIFA (4,12%) 750,000 = 9,337 Use the following to answer the following question(s). The information below describes a project with an initial cash outlay of $10,000 and a required return of 12%. After-tax cash inflow Year 1 $6,000 Year 2 $2,000 Year 3 $2,000 Year 4 $2,000 16) Which of the following statements is correct? A) The project should be accepted since its NPV is $353.87. B) The project should be rejected since its NPV is -$353.87. C) The project should be accepted since it has a payback of less than four years. D) The project should be rejected since its NPV is -$23.91. NPV = 6,000/1.12 + 2,000/1.12^2 + 2,000/1.12^3 + 2,000/1.12^4 10,000 = -353.87 17) You have been asked to analyze a capital investment proposal. The project's cost is $2,775,000. Cash inflows are projected to be $925,000 in Year 1; $1,000,000 in Year 2; $1,000,000 in Year 3; $1,000,000 in Year 4; and $1,225,000 in Year 5. Assume that your firm discounts capital projects at 15.5%. What is the project's NPV? A) $101,247 B) $285,106 C) $473,904 D) $582,380 NPV = 925,000/1.155^1 + 1,000,000/1.155^2 + 1,000,000/1.155^3 + 1,000,000/1.155^4 +
1,225,000/1.155^5 2,775,000 = 582,380 18) Which of the following is a correct equation to solve for the NPV of the project that has an initial outlay of $30,000, followed by incremental cash inflows in the next 3 years of $15,000, $20,000, and $30,000? Assume a discount rate of 10%. A) NPV = - $30,000 + $15,000(1.10)1 + $20,000(1.10)2 + $30,000(1.10)3 B) NPV = - $30,000 + $15,000/(1.10)1 + $20,000/(1.10)2 + $30,000/(1.10)3 C) NPV = - $30,000 + $15,000/(1.01).10 + $20,000/(1.02).10 + $30,000/(1.03).10 D) NPV = - $30,000 + $15,000/(1.1).10 + $20,000(1.2).10 + $30,000(1.3).10 NPV = - Initial Investment + PV of cash flows 19) Project EH! requires an initial investment of $50,000, and has a net present value of $12,000. Project BE requires an initial investment of $100,000, and has a net present value of $13,000. The projects are mutually exclusive. The firm should accept: A) project EH!. B) project BE. C) both projects. D) neither project. Project BE has a higher NPV 20) Project Eh! requires an initial investment of $50,000, and has a net present value of $12,000. Project B requires an initial investment of $100,000, and has a net present value of $13,000. The projects are proposals for increasing revenue and are not mutually exclusive. The firm should accept: A) project Eh!. B) project B. C) both projects. D) neither project. Since both have positive NPV and are not mutually exclusive 21) A machine has a cost of $5,375,000. It will produce cash inflows of $1,825,000 (Year 1); $1,775,000 (Year 2); $1,630,000 (Year 3); $1,585,000 (Year 4); and $1,650,000 (Year 5). At a discount rate of 16.25%, what is the NPV? A) $81,724 B) $257,106 C) $416,912 D) $190,939 NPV = 1,825,000/1.1625 + 1,775,000/1.1625^2 + 1,630,000/1.1625^3 + 1,585,000/1.1625^4 + 1,650,000/1.1625^5 5,375,000 = 190,939 22) A machine has a cost of $5,575,000. It will produce cash inflows of $1,825,000 (Year 1); $1,775,000 (Year 2); $1,630,000 (Year 3); $1,585,000 (Year 4); and $1,650,000 (Year 5). At a discount rate of 16.25%, the project should be: A) accepted. B) rejected. C) discounted at a lower rate. D) abandoned after the first year. NPV = 1,825,000/1.1625 + 1,775,000/1.1625^2 + 1,630,000/1.1625^3 + 1,585,000/1.1625^4 + 1,650,000/1.1625^5 5,575,000 = -9,060 Reject as the NPV is negative
23) Which of the following is the correct equation to solve for the NPV of the project that has an initial outlay of $30,000, followed by three years of $20,000 in incremental cash inflow? Assume a discount rate of 10%. A) NPV = -30,000 + (3 20,000)/(1.10)3 B) NPV = -$30,000 + $20,000/(1.10)1 + $20,000/(1.10)2 + $20,000/(1.10)3 C) NPV = -$30,000 + $20,000/(1.01).10 + $20,000/(1.02).10 + $20,000/(1.03).10 D) NPV = -$30,000 + $20,000/(1.1).10 + $20,000(1.2).10 + $20,000(1.3).10 NPV = - initial investment + PV of cash flows 24) Project Full Moon has an initial outlay of $30,000, followed by positive cash flows of $10,000 in year 1, $15,000 in year 2, and $15,000 in year 3. The project should be accepted if the required rate of return is: A) greater than 0. B) less than 14.6%. C) less than 16.25%. D) greater than 12%. The IRR comes to 14.81% With a discount rate lower than IRR, the NPV would be positive 25) Which of the following is the correct equation to solve for the net present value of a project. A) NPV = CF0 + CF1/(1 + k)1 + CF2/(1 + k)2+...CFn/(1 + k)n B) NPV = CF0 + CF1(1 + k)1 + CF2(1 + k)2+...CFn(1 + k)n C) NPV = CF0 - CF1/(1 + k)1 - CF2/(1 + k)2-...CFn/(1 + k)n D) NPV = CF1/(1 + k)1 + CF2/(1 + k)2 +...CFn/(1 + k)n We find the PV of cash flows and subtract the initial investment 26) WSU Inc. has various options for replacing a piece of manufacturing equipment. The present value of costs for option Ell is $84,000. Option Ell has a useful life of 5 years; annual operating costs were discounted at 9%. What is the equivalent annual cost? A) $16,800 B) $21,595.77 C) $14,035.77 D) $18,312 EAC = 84,000/PVIFA (5,9%) = 21,595 27) The equivalent annual cost method is most appropriate in which of the following situations? In each case, assume that several mutually exclusive options are available. A) Introducing a new product line B) Adding another store to a chain of retail stores C) Installation of federally mandated safety equipment D) Equipment to reduce production costs We would expect different equipment to have different lives 1) Webley Corp. is considering two expansion options, but does not have enough capital to undertake both, Project W requires an investment of $100,000 and has an NPV of $10,000. Project D requires an investment of $80,000 and has an NPV of $8,200. If Webley use the profitability index to decide, it should: A) choose D because it has a higher profitability index. B) choose W because it has a higher profitability index.
C) choose D because it has a lower profitability index. D) choose W because it has a higher profitability index. PI for W = 110,000/100,000 = 1.1 PI for D = 88,200/80,000 = 1.1025 2) If a project has a profitability index greater than 1, A) the npv will also be positive. B) the irr will be higher than the required rate of return. C) the present value of future cash flows will exceed the amount invested in the project. D) all of the above. All would be correct 3) A project has an initial outlay of $4,000. It has a single payoff at the end of Year 4 of $6,996.46. What is the IRR for the project (round to the nearest percent)? A) 16% B) 13% C) 21% D) 15%
4) Given the following annual net cash flows, determine the IRR to the nearest whole percent of a project with an initial outlay of $1,520. Year Net Cash Flow 1 $1,000 2 $1,500 3 $500 A) 48% B) 40% C) 32% D) 28% 5) Initial Outlay -$4,000 1 $1,546.17 Cash Flow in Period 2 3 $1,546.17 $1,546.17
4 $1,546.17
The IRR (to the nearest whole percent) is: A) 10%. B) 18%. C) 20%. D) 16%. 6) Your company is considering a project with the following cash flows: Initial outlay = $1,748.80 Cash flows Years 1-6 = $500 Compute the IRR on the project. A) 9% B) 11% C) 18% D) 24% 7) Project Black Swan requires an initial investment of $115,000. It has positive cash flows of $140,000 for each of the next two years. Because of major demolition and environmental clean-up costs, cash flow for the third and final year of the project is $(170,000). If the company 's required rate of return is 12%, the project should be:
A) rejected because the IRR is less than 12%. B) accepted because the NPV is positive at 16%. C) the project is unacceptable at any discount rate. D) rejected because there may be more than one IRR. NPV = 140,000/1.12 + 140,000/1.12^2 170,000/1.12^3 115,000 = 604.50 8) Project Black Swan requires an initial investment of $115,000. It has positive cash flows of $140,000 for each of the next two years. Because of major demolition and environmental clean-up costs, cash flow for the third and final year of the project is $(170,000). A) All possible IRR's for this project are negative. B) It is not possible to compute an IRR for this project. C) The project is unacceptable at any required rate of return. D) This project might have more than one IRR. Since there are two sign changes, there would be 2 IRR 9) Compute the payback period for a project with the following cash flows, if the company's discount rate is 12%. Initial outlay = $450 Cash flows: Year 1 = $325 Year 2 = $65 Year 3 = $100 A) 3.43 years B) 3.17 years C) 2.88 years D) 2.6 years We recover 325+65 = 390 in two years and balance 60 in year 3 Payback period = 2 + 60/100 = 2.6 years 10) Project Black Swan requires an initial investment of $115,000. It has positive cash flows of $140,000 for each of the next two years. Because of major demolition and environmental clean-up costs, cash flow for the third and final year of the project is $(170,000). A) All possible IRR's for this project are negative. B) It is not possible to compute an IRR for this project. C) This project might have more than one IRR, but only one MIRR. D) The project is unacceptable at any required rate of return. This project might have more than one IRR. MIRR is always 1 11) Project Black Swan requires an initial investment of $115,000. It has positive cash flows of $140,000 for each of the next two years. Because of major demolition and environmental clean-up costs, cash flow for the third and final year of the project is $(170,000). The company accepts all projects with a payback period of 2 years or less. A) The payback rule would reject this project because of its risks are too high. B) The payback rule would reject this project because all negative cash flows are added together. C) If strictly applied, the payback rule would reject this project. D) If strictly applied, the payback rule would accept this project. The payback period is less than 1 year 12) Consider a project with the following cash flows: After-Tax After-Tax Accounting Cash Flow Year Profits from Operations
1 $799 $750 2 $150 $1,000 3 $200 $1,200 Initial outlay = $1,500 Terminal cash flow = 0 Compute the profitability index if the company's discount rate is 10%. A) 15.8 B) 1.61 C) 1.81 D) 0.62 PV of cash flows = 750/1.1 + 1,000/1.1^2 + 1,200/1.1^3 = 2,410 PI = 2,410/1,500 = 1.61 13) Manheim Candles is considering a project with the following incremental cash flows. Assume a discount rate of 10%. Year Cash Flow 0 ($20,000) 1 0 2 $30,000 3 $30,000 Calculate the project's MIRR. (Round to the nearest whole percentage.) A) 31% B) 47% C) 53% D) 61% MIRR comes to 47% 14) Project H requires an initial investment of $100,000 and produces annual cash flows of $50,000, $40,000, and $30,000. Project T requires an initial investment of $100,000 and the produces annual cash flows of $30,000, $40,000, and $50,000. The projects are mutually exclusive. The company accepts projects with payback periods of 3 years or less. A) Project H will be accepted. B) Project T will be accepted. C) H and T will both be accepted. D) Neither projected will be accepted. Project H has a lower payback period than Project T 15) A new forklift under consideration by Home Warehouse requires an initial investment of $100,000 and produces annual cash flows of $50,000, $40,000, and $30,000. Which of the following will not change if the required rate of return is increased from 10% to 12%. A) The net present value. B) The internal rate of return. C) The profitability index. D) The modified internal rate of return. The IRR does not depend on the required rate of return. 30) The owner of a small construction business has asked you to evaluate the purchase of a new front end loader. You have determined that this investment has a large, positive, NPV, but are afraid that your client will not understand the method. A good alternative method in this circumstance might be A) the payback method B) the profitability index C) the internal rate of return
D) the modified internal rate of return Payback method is simple to understand 33) Aroma Candles, Inc. is evaluating a project with the following cash flows. The project involves a new product that will not affect the sales of any other project. Which two methods would always lead to the same accept/reject decision for this project, regardless of the discount rate. Year Cash Flows 0 ($120,000) 1 $30,000 2 $70,000 3 $90,000 A) Payback and Discounted Payback B) NPV and Payback C) NPV and IRR D) Discounted Payback and IRR If NPV is positive, then IRR would be greater than discounting rate 3) With respect to the capital budgeting practices of large U. S. corporations: A) the profitability index has been gaining in popularity. B) IRR and NPV have been gaining in popularity. C) payback and discounted payback have been gaining in popularity. D) IRR and NPV have declined in popularity. More corporations are using these techniques Chapter 12 1) Incremental cash flows from a project = A) Firm cash flows without the project plus or minus changes in net income. B) Firm cash flows with the project plus firm cash flows without the project. C) Firm cash flows with the project minus firm cash flows without the project. D) Firm cash flows without the project plus or minus changes in revenue with the project. The change in cash flows is the incremental cash flows. 2) Which of the following is NOT one of the categories for a project's relevant after-tax cash flows? A) Financing flows B) Initial cash outflow C) Differential flows over the project's life D) Terminal cash flow Financing flows are not shown separately, these are accounted for in the discounting rate 3) Which of the following is NOT part of a project's initial cash outflow? A) The asset's purchase price B) Funds committed to support increased inventory levels due to expected increased sales if the firm adopts the project C) A marketing survey completed last year to determine the project's feasibility D) Expenses incurred to install the asset Marketing survey would be a sunk cost 4) Relevant incremental cash flows include: A) sales captured from the firm's competitors.
B) retained sales that would have been lost to new competing products. C) incremental sales brought to the firm as a whole. D) all of the above. All are incremental 5) Which of the following is NOT considered in the calculation of incremental cash flows? A) Depreciation tax shield B) Sunk costs C) Opportunity costs D) Both A and B Sunk costs are costs already incurred and so are not included 6) Which of the following cash flows should be included as incremental costs when evaluating capital projects? A) Investment in working capital that is directly related to a project B) Expenses that are incurred in order to modify a firm's production facility in order to invest in a project C) Overhead expenses that are directly related to a project D) Opportunity costs that are directly related to a project E) All of the above All are relevant costs 7) Depreciation expenses affect tax-related cash flows by: A) increasing taxable income, thus increasing taxes. B) decreasing taxable income, thus reducing taxes. C) decreasing taxable income, but not altering cash flows since depreciation is not a cash expense. D) all of the above. Depreciation provides the tax shield 8) Which of the following would be considered a termination cash flow? A) The expected salvage value of the asset B) Any tax payments or refunds associated with the salvage value of the asset C) Recapture of any investment in working capital that was included as an incremental cash outlay D) All of the above
All are terminal cash flows 9) How is interest expense that is associated with a project treated in the capital budgeting process? A) It is treated as a cash outflow when estimating the incremental cash flows associated with a project. B) It is built into the discount rate. C) It is considered a synergistic incremental cash flow. D) Interest expense is not relevant to any capital budgeting decisions. The discount rate incorporates the interest cost 10) Which of the following best describes why cash flows are utilized rather than accounting profits when evaluating capital projects? A) Cash flows have a greater present value than accounting profits. B) Cash flows reflect the timing of benefits and costs more accurately than accounting profits. C) Cash flows are more stable than accounting profits. D) Cash flows improve the tax position of a firm more than accounting profits. E) None of the above.
Investors are to be paid in cash and so cash is better 11) Which of the following is the best example of an incremental cash inflow/outflow? A) Cash flows that are achieved by diverting sales from other projects of the firm B) Cash flows that are associated with the financing of a project C) Cash flows that occur a little at a time D) What the total cash flows will be to the company if the project is undertaken as opposed to what they would have been if the project had not been undertaken Incremental cash flows are which change due to the project. 12) Which of the following is an example of a sunk cost? A) Overhead costs that are associated with a project B) Interest expense associated with a project C) Market study expenses incurred in order to decide if a firm should accept a project D) Income taxes associated with a project E) Depreciation expenses associated with a project Market study is done prior to project acceptance and so is a suck cost. 13) Which of the following cash flows should be included as incremental costs when evaluating capital projects? A) Overhead expenses that are directly related to a project B) Interest expense that is directly related to the financing of a project C) Sunk costs that are related to a project D) Principal payments that are directly related to the financing of a project Overhead is incremental 14) The calculation of differential cash flows over a project's life should include which of the following? A) Labor and material savings B) Additional revenues attributable to the project C) Investment in net working capital D) All of the above E) None of the above All are incremental 15) Which of the following cash flows are NOT considered in the calculation of the initial outlay for a capital investment proposal? A) Increase in accounts receivable B) The cost of shipping new equipment C) The cost of issuing new bonds if the project is financed by a new bond issue D) The cost of installing new equipment E) All of the above should be considered. Issue of bonds is financing and so is not included 16) Which of the following expenses should be included when estimating cash flows for investment projects? A) Interest expense related to financing a project B) Sunk costs C) Required principal payments related to financing a project D) Opportunity costs Opportunity costs are included.
17) When evaluating Capital Budgeting decisions, which of the following items should NOT be included in the construction of cash flow projections for purposes of analysis? A) Net salvage value B) Land and building expenses C) Changes in net working capital requirements D) Shipping and installation costs E) All of the above should be included. All are incremental 18) Holding all other variables constant, which of the following would INCREASE net working capital for given year on a project? A) Allowing customers less time to pay for purchases B) Taking longer to pay suppliers C) Increasing inventory levels D) Both A and C Increase in inventory would increase working capital 19) If an investment project would make use of land which the firm currently owns, the project should be charged with: A) a sunk cost. B) an opportunity cost. C) amortization. D) interest. E) abuse of power. The cost of land would be opportunity cost 20) The owner of a convenience store is considering adding a take-out sandwich section to her offerings. The new activity will occupy 25% of the space and account for 30% of total revenues. Property insurance on the building is $9,000 per year and will not change because of the new activity. How much of the insurance premium should be allocated to the new product line? A) $2,700 B) $2,475 C) $2,250 D) $0.00 Since the insurance cost will not change and so it is not incremental 21) Mr. Smith included the cost of test marketing before production in the calculation of the initial outlay. Apparently, Mr. Smith does not understand the concept of: A) side-effect costs. B) opportunity costs. C) sunk costs. D) variable costs. It is a sunk cost as it is already incurred 1) Thaler & Co. anticipates an increase of $1,000,0000 in Net Operating Income from first year sales of a new product. Taxes will be $350,000 and the company took $150,000 in depreciation expense. Operating cash flow equals A) $1,000,000 B) $500,000 C) $800,000
D) $650,000 Answer: C Operating cash flow = 1,000,000-350,000 + 150,000 = 800,000 2) Schiller Construction Inc. has estimated the following revenues and expenses related phase I of a proposed new housing development? Incremental sales= $5,000,000, total cash expenses $3,500,000, depreciation $500,000, taxes 35%, interest expense, $200,000. Operating cash flow equals A) $650,000 B) $1,000,000 C) $1,150,000 D) $975,000 Answer: C Income before tax = 5,000,000-3,500,000-500,000=1,000,000 Net Income = 650,000 Operating cash flow = 650,000+500,000 = 1,150,000 3) Incremental cash flows include all of the following EXCEPT: A) research and development costs . B) increased labor costs from the project. C) advertising costs . D) both B and C. R&D would usually be sunk costs 4) Diamond Inc. has estimated that a new building will cost $2,500,000 to construct. Land was purchased a year ago for $500,000 and could be sold today for $550,000. An environmental impact study required by the state was performed at a cost of $48,000. For capital budgeting purposes, what is the relevant cost of the new building? A) $2,500,000 B) $3,048,000 C) $3,050,000 D) $3,098,000 Cost = 2,500,000 + 550,000 = 3,050,000 5) If SuperMart decides to offer a line of groceries at its discount retail outlet, inventories are expected to increase by $1,200,000, accounts receivable by $300,000 and accounts payable by $500,000. What is the cash outflow for working capital requirements? A) $2,000,000 B) $1,700,000 C) $1,500,000 D) $1,000,000 Amount = 1,200,000+300,000-500,000 = 1,000,000 6) If depreciation expense is taken over 5 years rather than 3 years, all things equal, A) net present value will go down. B) depreciation has no effect on net present value. C) net present value will go up. D) the answer depends on the company's marginal tax rate. The tax benefit would be over 5 years and so the PV of tax benefits would be lower as compared to 3 years 7) If the federal income tax rate were increased, the impact of the tax increase on acceptable investment
proposals would be to (ignore the impact of the tax change on the cost of capital): A) decrease the tax shelter from depreciation. B) decrease net present value but the internal rate of return would stay the same. C) increase net present value because the tax shelter from interest and depreciation becomes more valuable. D) decrease both net present value. and internal rate of return. The depreciation tax shield would increase with increase in tax rate 8) Which of the following would increase the net working capital for a project? An increase in: A) accounts receivable. B) fixed assets. C) accounts payable. D) common stock. AR would increase working capital 9) Which of the following should be included in the initial outlay? A) Shipping and installation costs B) Increased working capital requirements C) Cost of employee training associated specifically with the asset being evaluated D) All of the above All are incremental initial investment 10) Depreciation expenses affect capital budgeting analysis by increasing: A) taxes paid. B) incremental cash flows. C) the initial outlay. D) working capital. Depreciation decreases tax and so increases incremental cash flow 11) Which of the following is included in the terminal cash flow? A) The expected salvage value of the asset B) Tax impacts from selling asset C) Recapture of any working capital D) All of the above All are part of incremental cash flow 12) A firm purchased an asset with a 5-year life for $90,000, and it cost $10,000 for shipping and installation. According to the current tax laws the cost basis of the asset at time of purchase is: A) $100,000. B) $95,000. C) $80,000. D) $70,000. Cost basis = 90,000+10,000 = 100,000 13) XYZ, Inc. is considering adding a product line that would utilize unused floor place of their manufacturing plant. The floor space would be considered a(n): A) variable cost. B) opportunity cost. C) sunk cost. D) irrelevant cash flow.
Since there is no change in cost, it is not relevant 14) Which of the following is included in the calculation of the initial outlay for a capital investment? A) Investment in working capital B) Shipping expenses C) Installation D) All of the above All are included 15) Which of the following would decrease free cash flows? A decrease in: A) depreciation expense. B) interest expense. C) incremental sales. D) both A and C. E) all of the above. Decrease in depreciation would reduce tax shield and so reduce cash flows and reduction in sales would also reduce cash flows Use the following information to answer the following question(s). Delta Inc. is considering the purchase of a new machine which is expected to increase sales by $10,000 in addition to increasing non-depreciation expenses by $3,000 annually. Due to the sales increase, Delta expects its working capital to increase $1,000 during the life of the project. Delta will depreciate the machine using the straight-line method over the project's five year life to a salvage value of zero. The machine's purchase price is $20,000. The firm has a marginal tax rate of 34 percent, and its required rate of return is 12 percent. 16) The machine's initial cash outflow is: A) $20,000. B) $21,000. C) $27,000. D) $23,000. Answer: B Initial outflow = 1,000 + 20,000 = 21,000 17) The machine's incremental after-tax cash inflow for year 1 is: A) $6,420. B) $7,980. C) $8,620. D) $5,980. Answer: D Sales = 10,000 Non depreciation expense = 3,000 Depreciation (20,000/5) = 4,000 Income before tax = 3,000 Net Income = 3,000 X (1-0.34) = 1,980 Incremental after tax cash flow = 1,980 + 4,000 = 5,980 18) The machine's after-tax incremental cash flow in year five is: A) $6,980. B) $5,980. C) $7,120.
D) $8,620. Answer: A ? In year 5 there will be recovery of working capital, so after tax cash flow = 5,980+1,000 = 6,980 19) The machine's NPV is: A) $1,556.56. B) $2,556.56. C) $1,123.99. D) $2,123.99. Answer: C NPV = 5,980 X PVIFA (5,12%) + 1,000 X PVIF (5,12%) 21,000 = 1,123.99 20) The machine's IRR is: A) less than 0. B) greater than 12 percent. C) less than 12 percent. D) equal to 12 percent. Answer: B IRR comes to 14% 21) ABC already spent $85,000 on a feasibility study for a machine that will produce a new product. The machine will cost $2,575,000. Required modifications will cost $375,000. ABC will need to invest $75,000 for additional inventory. The machine has an IRS approved useful life of 7 years; it is presumed to have no salvage value. It will only be operated for 3 years, after which it will be sold for $600,000. What is the depreciable cost basis of the machine? A) $3,025,000 B) $2,950,000 C) $2,575,000 D) $2,350,000 Answer: B Depreciable basis = 2,575,000+375,000 = 2,950,000 22) ABC already spent $85,000 on a feasibility study for a machine that will produce a new product. The machine will cost $2,575,000. Required modifications will cost $375,000. ABC will need to invest $75,000 for additional inventory. The machine has an IRS approved useful life of 7 years; it is presumed to have no salvage value. It will only be operated for 3 years, after which it will be sold for $600,000. What is the total investment amount required for the machine? A) $3,025,000 B) $2,950,000 C) $2,575,000 D) $2,350,000 Investment required = 2,575,000+375,000+75,000 = 3,025,000 Answer: A 24) ABC purchased a machine for $2,575,000. Required modifications will cost $375,000. ABC will need to invest $75,000 for additional inventory. The machine has an IRS approved useful life of 7 years; it is presumed to have no salvage value. It will only be operated for 3 years, after-which it will be sold for $600,000. ABC plans to depreciate the machine by using the straight-line method. Assume that the firm's tax rate is 40%. What is the termination (non-operating) cash flow from the machine in year three?
A) $900,623 B) $1,109,286 C) $1,298,114 D) $879,247 Cost of machine = 2,575,000+375,000 = 2,950,000 Depreciation = 2,950,000/7 = 421,428 Depreciation for 3 years = 1,264,286 Book value = 1,685,714 Sale Price = 600,000 Loss on sale = 1,085,714 Tax benefit on loss = 434,285 Net inflow = 600,000+434,285 = 1,034,285+75,000 from inventory = 1,109,286 25) Famous Danish Corp. is replacing an old cookie cutter with a new one. The cookie cutter is being sold for $25,000 and it has a net book value of $75,000. Assume that Famous Danish is in the 34% income tax bracket. How much will Famous Danish net from the sale? A) $61,000 B) $55,000 C) $75,000 D) $42,000 Loss on sale = 50,000 Tax benefit on loss = 50,000 X 0.34 = 17,000 Net inflow = 25,000 + 17,000 = 42,000
28) Woodstock Inc. expects to own a building for five years, then sell it for $1,500,000 net of taxes, sales commissions and other selling costs. Woodstock's cost of capital is 11%. How much will the sale of the building contribute to the NPV of the project? A) $890,177 B) $1,351,351 C) $1,500,000 D) $2,527,587 Contribution will be the PV = 1,500,000/1.11^5 = 890,177 29) Which of the following would cause free cash flow to differ from operating cash flow when an investment project is terminated? A) Sale of assets B) Recovery of net working capital C) Income taxes D) All of the above All would be factors 32) Jefferson Corporation is considering an expansion project. The necessary equipment could be purchased for $15 million and shipping and installation costs are another $500,000. The project will also require an initial $2 million investment in net working capital. The company's tax rate is 40%. What is the project's initial investment outlay (in millions)? A) $15.0 B) $15.5 C) $16.5 D) $17.0 E) $17.5
Initial investment = 15 + 0.5 + 2 = 17.5 34) Wright's Warehouse has the following projections for Year 1 of a capital budgeting project. Year 1 Incremental Projections: Sales Variable Costs Fixed Costs Depreciation Expense Tax Rate Calculate the operating cash flow for Year 1. A) $12,000 B) $32,000 C) $52,000 D) $72,000 Income before tax = 200,000-120,000-40,000-20,000 = 20,000 Net Income = 20,000 X (1-0.4) = 12,000 Operating cash flow = 12,000+20,000 (depreciation) = 32,000 39) Which of the following cash flows are NOT considered in the calculation of the initial outlay for a capital investment proposal? A) Training expense B) Working capital investments C) Installation costs of an asset D) Before-tax selling price of old machine $200,000 $120,000 $40,000 $20,000 40%