Question

1. Which of the following statements is CORRECT?
Select one:
a. The regular payback method recognizes all cash flows over a project's life.
b. The discounted payback method recognizes all cash flows over a project's life, and it also adjusts these cash flows to account for the time value of money.
c. The regular payback method was, years ago, widely used, but virtually no companies even calculate the payback today.
d. The regular payback is useful as an indicator of a project's liquidity because it gives managers an idea of how long it will take to recover the funds invested in a project.
e. The regular payback does not consider cash flows beyond the payback year, but the discounted payback overcomes this defect.

2. Companies HD and LD are both profitable, and they have the same total assets (TA), Sales (S), return on assets (ROA), and profit margin (PM). However, Company HD has the higher debt ratio. Which of the following statements is CORRECT?
Select one:
a. Company HD has a lower total assets turnover than Company LD.
b. Company HD has a lower equity multiplier than Company LD.
c. Company HD has a higher fixed assets turnover than Company B.
d. Company HD has a higher ROE than Company LD.
e. Company HD has a lower operating income (EBIT) than Company LD.

3. A product sells for $750 in the United States. The exchange rate is $1 to 1.65 Swiss francs. If purchasing power parity (PPP) holds, what is the price of the product in Switzerland?
Select one:
a. 123.75 Swiss francs
b. 454.55 Swiss francs
c. 750.00 Swiss francs
d. 1,237.50 Swiss francs
e. 1,650.00 Swiss francs

4. To help finance a major expansion, Castro Chemical Company sold a noncallable bond several years ago that now has 20 years to maturity. This bond has a 9.25% annual coupon, paid semiannually, sells at a price of $1,075, and has a par value of $1,000. If the firm's tax rate is 40%, what is the component cost of debt for use in the WACC calculation?
Select one:
a. 4.35%
b. 4.58%
c. 4.83%
d. 5.08%
e. 5.33%

5. Which of the following statements is CORRECT?
Select one:
a. A major disadvantage of financing with preferred stock is that preferred stockholders typically have supernormal voting rights.
b. Preferred stock is normally expected to provide steadier, more reliable income to investors than the same firm's common stock, and, as a result, the expected after-tax yield on the preferred is lower than the after-tax expected return on the common stock.
c. The preemptive right is a provision in all corporate charters that gives preferred stockholders the right to purchase (on a pro rata basis) new issues of preferred stock.
d. One of the disadvantages to a corporation of owning preferred stock is that 70% of the dividends received represent taxable income to the corporate recipient, whereas interest income earned on bonds would be tax free.
e. One of the advantages to financing with preferred stock is that 70% of the dividends paid out are tax deductible to the issuer.

6. Which of the following statements is CORRECT?
Select one:
a. A hostile takeover is the main method of transferring ownership interest in a corporation.
b. Unlimited liability and limited life are two key advantages of the corporate form over other forms of business organization.
c. A corporation is a legal entity that is generally created by a state, and it has a life and existence that is separate from the lives of its individual owners and managers.
d. Limited liability of its stockholders is an advantage of the corporate form of organization, but corporations have more trouble raising money in financial markets because of the complexity of this form of organization.
e. Although its stockholders are insulated by limited legal liability, the legal status of the corporation does not protect the firm's managers in the same way, i.e., bondholders can sue its managers if the firm defaults on its debt, even if the default is the result of poor economic conditions.

7. If an individual common stock has a beta of 1.3, this indicates the common stock
Select one:
a. will fluctuate in a more exaggerated manner compared to the broad market trend
b. will tend to move in a less exaggerated manner compared to the broad market
c. has a dividend yield that is less than the long-term market average
d. is a secondary issue of stock

8. The Internal Rate of Return for capital budgeting projects is best described as:
Select one:
a. The rate of return required by management
b. The rate of return that would be earned if the company funded the project via operating cash flows instead of external sources of funding
c. The actual rate of return that would be earned based on the projected net cash flow calculations
d. The minimal rate of return required by the IRS to allow a loan not be considered as a gift

9. The MacMillen Company has equal amounts of low-risk, average-risk, and high-risk projects. The firm's overall WACC is 12%. The CFO believes that this is the correct WACC for the company's average-risk projects, but that a lower rate should be used for lower-risk projects and a higher rate for higher-risk projects. The CEO disagrees, on the grounds that even though projects have different risks, the WACC used to evaluate each project should be the same because the company obtains capital for all projects from the same sources. If the CEO's position is accepted, what is likely to happen over time?
Select one:
a. The company will take on too many high-risk projects and reject too many low-risk projects.
b. The company will take on too many low-risk projects and reject too many high-risk projects.
c. Things will generally even out over time, and, therefore, the firm's risk should remain constant over time.
d. The company's overall WACC should decrease over time because its stock price should be increasing.
e. The CEO's recommendation would maximize the firm's intrinsic value.

10. Three $1,000 face value bonds that mature in 10 years have the same level of risk, hence their YTMs are equal. Bond A has an 8% annual coupon, Bond B has a 10% annual coupon, and Bond C has a 12% annual coupon. Bond B sells at par. Assuming interest rates remain constant for the next 10 years, which of the following statements is CORRECT?
Select one:
a. Bond A's current yield will increase each year.
b. Since the bonds have the same YTM, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until maturity.
c. Bond C sells at a premium (its price is greater than par), and its price is expected to increase over the next year.
d. Bond A sells at a discount (its price is less than par), and its price is expected to increase over the next year.
e. Over the next year, Bond A's price is expected to decrease, Bond B's price is expected to stay the same, and Bond C's price is expected to increase.

11. Consider the following information and then calculate the required rate of return for the Global Investment Fund, which holds 4 stocks. The market’s required rate of return is 13.25%, the risk-free rate is 7.00%, and the Fund's assets are as follows:
Stock Investment Beta
A $200,000 1.50
B $300,000 -0.50
C $500,000 1.25
D $1,000,000 0.75
Select one:
a. 9.58%
b. 10.09%
c. 10.62%
d. 11.18%
e. 11.77%

12. Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.)
Select one:
a. The remaining balance after three years will be $125,000 less one third of the interest paid during the first three years.
b. Because the outstanding balance declines over time, the monthly payments will also decline over time.
c. Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant.
d. The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from now than it will be the first year.
e. The outstanding balance declines at a faster rate in the later years of the loan's life.

13. Which of the following financial ratios/percentages would be the most likely reason for a bank to NOT approve a company’s application for a line of credit to fill temporary cash shortfalls?
Select one:
a. Return on Equity percentage growing less than 10% annually
b. Current ratio at 2.5:1
c. Number of times interest to Annual Operating Cash Flow = 6
d. Debt-to-asset ratio at 0.68

14. Consider some bonds with one annual coupon payment of 7.25%. The bonds have a par value of $1,000, a current price of $1,125, and they will mature in 13 years. What is the yield to maturity on these bonds?
Select one:
a. 5.56%
b. 5.85%
c. 6.14%
d. 6.45%
e. 6.77%

15. Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
A B
Required return 10% 12%
Market price $25 $40
Expected growth 7% 9%
Select one:
a. These two stocks should have the same price.
b. These two stocks must have the same dividend yield.
c. These two stocks should have the same expected return.
d. These two stocks must have the same expected capital gains yield.
e. These two stocks must have the same expected year-end dividend.

16. The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to
Select one:
a. Maximize the stock price per share over the long run, which is the stock's intrinsic value.
b. Maximize the firm's expected EPS.
c. Minimize the chances of losses.
d. Maximize the firm's expected total income.
e. Maximize the stock price on a specific target date.

17. In evaluating long-term capital budgeting decisions using the discounted cash flow method, the net present value calculation that produces a negative (less than $0) amount is interpreted correctly in only one of the following (choose the correct item):
Select one:
a. A definite signal to invest in the project regardless of other issues
b. A project that does not produce a positive return on investment
c. A project that does not exceed the required rate of return
d. None of the above are correct

18. Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements st be true about these securities? (Assume market equilibrium.)
Select one:
a. When held in isolation, Stock A has more risk than Stock B.
b. Stock B must be a more desirable addition to a portfolio than A.
c. Stock A must be a more desirable addition to a portfolio than B.
d. The expected return on Stock A should be greater than that on B.
e. The expected return on Stock B should be greater than that on A.

19. One drawback of switching from a partnership to the corporate form of organization is the following:
Select one:
a. It subjects the firm to additional regulations.
b. It cannot affect the amount of the firm's operating income that goes to taxes.
c. It makes it more difficult for the firm to raise additional capital.
d. It makes the firm's investors subject to greater potential personal liabilities.
e. It makes it more difficult for the firm's investors to transfer their ownership interests.

20. Which of the following would be most likely to lead to higher interest rates on all debt securities in the economy?
Select one:
a. Households start saving a larger percentage of their income.
b. The economy moves from a boom to a recession.
c. The level of inflation begins to decline.
d. Corporations step up their expansion plans and thus increase their demand for capital.
e. The Federal Reserve uses monetary policy in an attempt to stimulate the economy.

21. Scheuer Enterprises has a beta of 1.10, the real risk-free rate is 2.00%, investors expect a 3.00% future inflation rate, and the market risk premium is 4.70%. What is Scheuer's required rate of return?
Select one:
a. 9.43%
b. 9.67%
c. 9.92%
d. 10.17%
e. 10.42%

22. Zhdanov Inc. forecasts that its free cash flow in the coming year, i.e., at t = 1, will be -$10 million, but its FCF at t = 2 will be $20 million. After Year 2, FCF is expected to grow at a constant rate of 4% forever. If the weighted average cost of capital is 14%, what is the firm's value of operations, in millions?
Select one:
a. $158
b. $167
c. $175
d. $184
e. $193

23. Which of the following statements is CORRECT?
Select one:
a. A sunk cost is any cost that must be expended in order to complete a project and bring it into operation.
b. A sunk cost is any cost that was expended in the past but can be recovered if the firm decides not to go forward with the project.
c. A sunk cost is a cost that was incurred and expensed in the past and cannot be recovered if the firm decides not to go forward with the project.
d. Sunk costs were formerly hard to deal with but now that the NPV method is widely used, it is possible to simply include sunk costs in the cash flows and then calculate the PV of the project.
e. A good example of a sunk cost is a situation where Home Depot opens a new store, and that leads to a decline in sales of one of the firm's existing stores.

24. Which of the following statements is CORRECT?
Select one:
a. Net working capital is defined as current assets minus the sum of payables and accruals, and any increase in the current ratio automatically indicates that net working capital has increased.
b. Although short-term interest rates have historically averaged less than long-term rates, the heavy use of short-term debt is considered to be an aggressive strategy because of the inherent risks associated with using short-term financing.
c. If a company follows a policy of "matching maturities," this means that it matches its use of common stock with its use of long-term debt as opposed to short-term debt.
d. Net working capital is defined as current assets minus the sum of payables and accruals, and any decrease in the current ratio automatically indicates that net working capital has decreased.
e. If a company follows a policy of "matching maturities," this means that it matches its use of short-term debt with its use of long-term debt.

25. Which of the following statements is CORRECT?
Select one:
a. If a security analyst saw that a firm's days' sales outstanding (DSO) was higher than the industry average and was also increasing and trending still higher, this would be interpreted as a sign of strength.
b. If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding (DSO) will increase.
c. There is no relationship between the days' sales outstanding (DSO) and the average collection period (ACP). These ratios measure entirely different things.
d. A reduction in accounts receivable would have no effect on the current ratio, but it would lead to an increase in the quick ratio.
e. If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding will decline.

26. Which of the following statements is CORRECT?
Select one:
a. The internal rate of return method (IRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
b. The payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
c. The discounted payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
d. The net present value method (NPV) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
e. The modified internal rate of return method (MIRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.

27. A box of candy costs 28.80 Swiss francs in Switzerland and $20 in the United States. Assuming that purchasing power parity (PPP) holds, what is the current exchange rate?
Select one:
a. 1 U.S. dollar equals 0.69 Swiss francs
b. 1 U.S. dollar equals 0.85 Swiss francs
c. 1 U.S. dollar equals 1.21 Swiss francs
d. 1 U.S. dollar equals 1.29 Swiss francs
e. 1 U.S. dollar equals 1.44 Swiss francs

28. You were hired as a consultant to Giambono Company, whose target capital structure is 40% debt, 15% preferred, and 45% common equity. The after-tax cost of debt is 6.00%, the cost of preferred is 7.50%, and the cost of common using retained earnings is 12.75%. The firm will not be issuing any new stock. What is its WACC?
Select one:
a. 8.98%
b. 9.26%
c. 9.54%
d. 9.83%
e. 10.12%

29. Edwards Enterprises follows a moderate current asset investment policy, but it is now considering a change, perhaps to a restricted or maybe to a relaxed policy. The firm's annual sales are $400,000; its fixed assets are $100,000; its target capital structure calls for 50% debt and 50% equity; its EBIT is $35,000; the interest rate on its debt is 10%; and its tax rate is 40%. With a restricted policy, current assets will be 15% of sales, while under a relaxed policy they will be 25% of sales. What is the difference in the projected ROEs between the restricted and relaxed policies?
Select one:
a. 4.25%
b. 4.73%
c. 5.25%
d. 5.78%
e. 6.35%

30. Based on the corporate valuation model, Bernile Inc.'s value of operations is $750 million. Its balance sheet shows $50 million of short-term investments that are unrelated to operations, $100 million of accounts payable, $100 million of notes payable, $200 million of long-term debt, $40 million of common stock (par plus paid-in-capital), and $160 million of retained earnings. What is the best estimate for the firm's value of equity, in millions?
Select one:
a. $429
b. $451
c. $475
d. $500
e. $525

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