Fundamentals of Corporate Finance, 3rd Edition Test Bank.pdf (12)

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Test Bank

Resource:

Fundamentals of Corporate Finance

Edition:

3rd Edition

Author(s):

Jonathan Berk Peter DeMarzo Jarrad Harford

Fundamentals of Corporate Finance 3e

Test Bank

Chapter 1: The Financial Manager and the Firm Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: FSA AICPA: Resource Management 1. The financial manager is responsible for making decisions that are in the best interests of the firm's owners.

A) True B) False Ans: A

Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 2. A patent is a productive asset for a technology-based firm.

A) True B) False Ans: A

Format: True/False Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 3. Intangible assets generate most of a manufacturing firm's cash flows.

A) True B) False Ans: B

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Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: FSA AICPA: Resource Management 4. The most fundamental way that a business can grow in size is the reinvestment of cash flows or earnings.

A) True B) False Ans: A

Format: True/False Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 5. When a firm goes bankrupt, it will always be liquidated.

A) True B) False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 6. Capital assets are generally short term in nature.

A) True B) False Ans: B

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Format: True/False Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Budget Preparation AICPA: Resource Management 7. A good capital budgeting or investment decision is one in which the benefits are worth more to the firm than the cost of the asset.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Investment Decisions AICPA: Strategic/Critical Thinking 8. Financing decisions determine how firms raise cash to pay for their investments.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Budget Preparation AICPA: Resource Management 9. The dollar difference between a firm’s total current assets and total liabilities is called its net working capital.

A) True B) False Ans: B

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Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 10. A sole proprietorship is an owner's only business.

A) True B) False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Global Perspective 11. Corporations hold the majority of all business assets and generate the majority of business revenues and profits in the United States.

A) True B) False Ans: A Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 12. Unlimited liability means that the owner of a firm is responsible for paying all the bills of the firm.

A) True B) False Ans: A

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Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 13. The process of transferring ownership of a sole proprietorship is relatively easy compared to a public corporation.

A) True B) False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 14. General partners in a business have limited liability with regard to their firm's obligations.

A) True B) False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 15. C-Corporations do not have their income subject to double taxation.

A) True B) False Ans: B

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Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 16. Privately held corporations are allowed to have stockholders.

A) True B) False Ans: A Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 17. The treasurer of a corporation usually reports to the CFO of the firm.

A) True B) False Ans: A Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Reporting AICPA: Reporting 18. The external auditors of the firm report their findings directly to the CFO of the firm.

A) True B) False Ans: B

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Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Performance Measurement AICPA: Strategic/Critical Thinking 19. Maximizing revenue should be the goal of the firm.

A) True B) False Ans: B Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 20. An agency conflict can arise when the agent of the firm is the sole owner of the firm.

A) True B) False Ans: B Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 21. The owners of a firm are unaffected by agency costs.

A) True B) False Ans: B

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Format: True/False Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Ethics IMA: Business Applications AICPA: Professional Demeanor 22. Corruption in business does not affect the growth of the financial markets.

A) True B) False Ans: B Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 23. To start a business, the owners need A) a market where there is demand for their product.

B) a clear vision of what products or services they want to produce.

C) the know-how to successfully market their product.

D) all of the above.

Ans: D Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 24. A stakeholder is: A) someone geographically close to the firm's headquarters.

B) someone who has a claim on the cash flows of the firm.

C) some government agency.

D) all of the above.

Ans: B

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Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 25. If you have loaned capital to a firm, then you could be A) a manager.

B) a stakeholder.

C) a partner.

D) all of the above.

Ans: B Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 26. Which of the following is a stakeholder?

A) An employee B) A lender C) The IRS D) All of the above Ans: D Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 27. A trademark is an example of: A) a liquid asset.

B) an intangible asset.

C) a contingent asset.

D) none of the above.

Ans: B

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Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 28. Which of the following is a basic source of funds for a firm?

A) Debt B) Equity C) Asset liquidations D) Both A and B Ans: D Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 29. The cash remaining with the firm after paying its operating expenses, making payments to creditors, and taxes is called: A) earnings per share.

B) capital contributed in excess of par.

C) residual cash flows.

D) assets.

Ans: C Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 30. Cash dividends are paid out of: A) residual cash flows.

B) liquidated assets.

C) long-term debt.

D) all of the above.

Ans: A

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Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 31. Current liabilities are liabilities that: A) will be converted to cash within a year.

B) must be paid within a year.

C) will be converted to equity within a year.

D) none of the above.

Ans: B Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Budget Preparation AICPA: Resource Management 32. The capital budgeting decision process addresses A) how a firm's day-to-day financial matters should be managed.

B) how a firm should finance its assets.

C) which productive assets a firm should purchase.

D) all of the above.

Ans: C Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 33. Working capital management decisions help to determine: A) how a firm's day-to-day financial matters should be managed.

B) how a firm should finance its assets.

C) which productive assets a firm should purchase.

D) all of the above.

Ans: A

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Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 34. Capital budgeting decisions generally impact more on: A) the asset portion of the balance sheet.

B) the short-term portion of the balance sheet.

C) the current liability portion of the balance sheet.

D) all of the above.

Ans: A Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Strategic/Critical Thinking 35. A good capital budgeting decision is: A) one in which the benefits of the project are equal to the cost of the asset.

B) one in which the benefits of the project are less than the cost of the asset.

C) one in which the benefits of the project are more than the cost of the asset.

D) all of the above.

Ans: C Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 36. Financial markets in which equity and debt instruments with maturities greater than one year are traded are called: A) money markets.

B) capital markets.

C) Over the counter exchange.

D) none of the above.

Ans: B

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Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 37. The profitability of a firm can be negatively affected by: A) too much inventory.

B) too little inventory.

C) either A or B. D) neither A nor B. Ans: C Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 38. Which of the following business organizational form(s) subject(s) the owner(s) to unlimited liability?

A) Sole proprietorship B) General partnership C) Corporation D) Both A and B Ans: D Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 39. Which of the following business organizational form(s) create(s) a tax liability on income at the personal income tax rate?

A) Sole proprietorship B) Partnership C) Corporation D) Both A and B Ans: D

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Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 40. Which of the following business organizational form(s) is/are the easiest one(s) to raise capital?

A) Sole proprietorship B) Partnership C) Corporation D) Both A and B Ans: C Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 41. Which of the following owners is protected by limited liability?

A) A sole proprietor B) A general partner C) Owner of a corporation D) None of the above Ans: C Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 42. Which of the following cannot be engaged in managing the business?

A) A sole proprietor B) A general partner C) A limited partner D) None of the above Ans: C

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Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Global Perspective 43. Which form of business organization generate(s) the majority of business revenues and profits in the United States?

A) Sole proprietorship B) Partnership C) Corporation D) Both A and B Ans: C Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 44. Which organizational form best enables a firm to sell its securities to the market?

A) Sole proprietorship B) Partnership C) Private corporation D) Public corporation Ans: D Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Legal/Regulatory Perspective 45. Which of the following organizational forms is subject to the Securities and Exchange Commission (SEC) regulations?

A) Sole proprietorship B) Partnership C) Private corporation D) Public corporation Ans: D

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Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 46. Which organizational form best enables the owners of a firm to monitor the professional conduct of each other owners of the firm?

A) Sole proprietorship B) Partnership C) Private corporation D) Public corporation Ans: B Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 47. Which of the following is considered a hybrid organizational form?

A) Sole proprietorship B) Partnership C) Corporation D) Limited liability partnership Ans: D Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Resource Management 48. Which of the following reports directly to the owners of a firm? (Assume that the firm is a public corporation.)

A) CFO B) CEO C) Board of directors D) Audit committee Ans: C

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Resource Management 49. Which of the following is primarily responsible for managing all aspects of a firm’s financial side?

A) CFO B) CEO C) Board of directors D) Audit committee Ans: A Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Reporting; Internal Controls AICPA: Reporting; Resource Management 50. Which of the following is responsible for performing an independent audit of a firm's financial statements?

A) CFO B) CEO C) CPA firm D) Audit committee Ans: C Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Internal Controls; Reporting AICPA: Reporting 51. How is a CPA firm insulated from being pressurized by management?

A) The audit committee approves hiring, firing, and paying fees to external auditors.

B) The chairman of the board approves the external auditor's fees as well as the engagement C) letter.

D) The IRS approves the external auditor's fees as well as the engagement letter.

The CPA firm is not insulated from management.

Ans: A

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Resource Management 52. Who among the following is typically responsible for managing a large corporation’s financial function?

A) The CEO B) The Chairman of the board C) The Vice-President - Production D) The CFO Ans: D Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Performance Measurement AICPA: Strategic/Critical Thinking 53. Which of the following is an appropriate goal for a firm?

A) Profit maximization B) Revenue maximization C) Stockholder’s wealth maximization D) Tax minimization Ans: C Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 54. When analysts and investors determine the value of a firm's stock, they should consider: A) the size of the expected cash flows associated with owning the stock.

B) the timing of the cash flows.

C) the riskiness of the cash flows.

D) all of the above.

Ans: D

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Strategic/Critical Thinking 55. If a firm establishes maximizing profits as the most important goal of the firm, which of the following would not be given proper consideration?

A) Sales revenues B) Profits C) Risk of bankruptcy D) Cost of goods sold Ans: C Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Strategic/Critical Thinking 56. Which of the following helps in maximizing stockholder’s wealth not usually account for?

A) Risk.

B) Government regulation.

C) The timing of cash flows.

D) Amount of cash flows.

Ans: B Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Budget Preparation AICPA: Strategic/Critical Thinking 57. Which of the following factors or activities can be controlled by the management of a firm?

A) Capital budgeting B) The level of economic activity C) The level of market interest rates D) Stock market conditions Ans: A

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Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 58. One reason for the existence of agency problems between managers and stockholders is that: A) there is a significant degree of separation between management and ownership.

B) managers know how to manage the firm better than stockholders.

C) stockholders have unreasonable expectations about managerial performance.

D) none of the above.

Ans: A Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 59. Who among the following is the principal in the agency relationship of a corporation?

A) A company engineer B) The CEO of the firm C) A stockholders D) The board of directors Ans: C Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Legal/Regulation Perspective 60. _____ has (have) a legal responsibility to represent stockholders’ interests.

A) A chairman B) A CEO C) A corporation’s board of directors D) all of the above Ans: C

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Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 61. An example of an agency cost is, A) a manager turning down a value-contributing project because of its risks.

B) a manager expensing a lavish dinner on the company expense report.

C) a manager using too little debt within the firm's capital structure because of the additional risk associated with debt.

D) all of the above.

Ans: B Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Communication IMA: Business Economics AICPA: Leadership 62. Which of the following mechanisms can help to align the behavior of managers with the goals of stockholders?

A) Well-designed management compensation B) Managerial labor market C) An independent board of directors D) All of the above Ans: D Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Comprehension AACSB: Analytic IMA: Internal Controls AICPA: Risk Analysis 63. If a firm has had an agency conflict which is reflected in a poor performing stock for a long period of time, then the firm may become a target of _____ A) an SEC investigation.

B) a corporate raider.

C) an IRS investigation.

D) a bankruptcy lawyer.

Ans: B

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Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 64. Executives that repeatedly put their own interests before that of the firm may find that they have difficulty in finding another job after their current one. This is an example of A) the managerial labor market disciplining managers.

B) the market for corporate control.

C) the board of directors affecting the prospects of a manager.

D) none of the above.

Ans: A Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Resource Management 65. Who among the following is responsible for setting an agenda at meetings of the board of directors?

A) Chairperson of the board of directors B) President C) Nominating committee D) Manager Ans: A Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Resource Management 66. A director who is not an employee of the firm is called A) an executive director.

B) an inside director.

C) an independent director.

D) an official director.

Ans: C

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Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: FSA AICPA: Legal/Regulatory Perspective 67. Which of the following is NOT one of the strategies incorporated in the Sarbanes-Oxley Act of 2002?

A) Attain greater board independence B) Establish compliance programs C) Establish ethics programs D) Dictate maximum compensation levels Ans: D Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Reporting AICPA: Reporting 68. Which of the following unconditional powers does the audit committee have the authority to do?

A) Audit the personal bank account of the CEO B) Question any person employed by the firm C) Audit the compensation files of firms in the same industry D) None of the above Ans: B Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: FSA AICPA: Legal/Regulatory Perspective 69. What is the major complaint concerning the Sarbanes-Oxley Act of 2002 by firms?

A) The legislative maximum allowable compensation for a CEO. B) The legal requirement to disclose project information.

C) The cost of compliance.

D) The cost of maintaining an SEC employed officer at the firm's premises.

Ans: C

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Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Ethics IMA: Business Applications AICPA: Legal/Regulatory Perspective 70. A society's ideas about what actions are right and wrong are termed as: A) rules and policies.

B) ethics.

C) laws.

D) unwritten laws.

Ans: B Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Ethics IMA: Business Applications AICPA: Legal/Regulatory Perspective 71. The golden rule is an example of A) a current law.

B) a civil law.

C) an unworkable rule in financial markets.

D) an ethical norm.

Ans: D Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Global Business AICPA: Industry/Global Perspective 72. An example of an economy that had trouble in establishing a stock market and attracting foreign investment is A) Russia.

B) China.

C) The Czech Republic.

D) Japan.

Ans: A

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Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Ethics IMA: Business Applications AICPA: Legal/Regulatory Perspective 73. Corruption in business A) creates inefficiencies in an economy.

B) inhibits growth in an economy.

C) slows the rate of economic growth in a country.

D) all of the above Ans: D Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Ethics IMA: Business Applications AICPA: Legal/Regulatory Perspective 74. Which corporate officer, when he or she is guilty of serious misconduct, can subject the firm to the heavy losses in financial wealth?

A) Marketing Manager B) CFO C) Chief Technology Officer D) Chief Risk Officer Ans: B Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Ethics IMA: Business Applications AICPA: Legal/Regulatory Perspective 75. An officer of a firm who is a majority owner in a competing firm will probably be subject to A) an IRS audit.

B) a conflict of interest with his stockholders.

C) arbitrage profit returns to the SEC. D) an FBI investigation.

Ans: B

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Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 76. _____ occur(s) when one party in a business transaction has information that is unavailable to the other parties in the transaction.

A) Profits B) Information asymmetry C) Information efficiency D) None of the above Ans: B Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Decision Analysis AICPA: strategic/critical Thinking 77. With regard to information, a central idea of fairness suggests that: A) decisions should be made on an even playing field.

B) insiders should be able to trade whenever they want.

C) insiders should never be able to trade.

D) outsiders should not be allowed to trade since, by definition, they are at a disadvantage.

Ans: A Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Ethics IMA: Business Applications AICPA: Legal/Regulatory Perspective 78. The legal system and market forces impose substantial costs on individuals and institutions that engage in unethical behavior. Which of the following would not be an example of the above?

A) Financial losses B) Legal fines C) Agency conflicts D) Jail time Ans: C

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Format: Essay Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Performance Measurement AICPA: Industry/Sector 79. Explain what should be the goal of a firm.

Perspective Ans: The goal of a firm should be to maximize stockholders’ wealth, which in most cases is equivalent to maximizing the price of the shares of the firm. Note that this is not the same as maximizing profits, since maximizing profits can occur while taking on too much risk (which can lower the value of the stockholders’ investment). Maximizing profits also does not take the timing of the profits into account. Profits, moreover, should not be confused with cash. Maximizing stockholders’ wealth is also not the same as minimizing risk, which can occur without taking any risks.

Format: Essay Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AACSB: Ethics IMA: Performance Measurement AICPA: Strategic/Critical Thinking 80. Explain how agency costs might be found within a firm whose CEO owns no shares in the firm and whose compensation package is unaffected by the profits (cash or accounting profits) of the firm.

Ans: Since the manager has no ownership interest in the firm, he/she has no incentive to make the cash profits of the firm as high as possible. In fact, he/she has a personal incentive to have the firm pay for as many personal luxuries as possible since his/her compensation package will be completely unaffected by the decision to purchase the luxuries. In a firm like the above, we might expect the firm to expend a material amount of resources on items that the manager should probably pay for ownself.

Format: Essay Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Application AACSB: Ethics IMA: Business Applications AICPA: Problem Solving and Decision Making 81. You have a friend who tells you that ethics are completely unimportant in business since a number of laws have been set up for us to know the rules of the game. Comment.

Ans: Despite heavy regulation, the financial sector has a long and rich history of financial scandals. While a good many of the scandals are due to laws that have been disregarded, many of the scandals began as ethical lapses. This suggests that laws are not enough to preclude behavior that is detrimental to the well-functioning of the markets.

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Fundamentals of Corporate Finance 3e

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Chapter 2: The Financial System and the Level of Interest Rates Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 1. The role of the financial system is to gather money from people, businesses and government that have funds to invest and to channel that money to those who need it.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 2. The financial system is nothing more than a collection of financial markets.

A) True B) False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 3. Without a financial market, purchasing a house would require a cash purchase.

A) True B) False Ans: A

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Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Global Perspective 4. Governments are the principal lender-savers in the economy.

A) True B) False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 5. Businesses are the principal borrower-spenders in the economy.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 6. Direct financial markets could be broadly labeled as wholesale markets for funding.

A) True B) False Ans: A

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Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 7. A privately held corporation securing a loan from its regional commercial bank is an example of a direct market transaction.

A) True B) False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: FSA AICPA: Legal/Regulatory Perspective 8. The law that prohibited commercial banks from engaging investment banking activities is the Financial Services Modernization Act of 1999.

A) True B) False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: FSA AICPA: Legal/Regulatory Perspective 9. Today, major money center banks in U.S have been allowed back to provide investment banking services.

A) True B) False Ans: A

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Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 10. A primary market is any financial market in which owners of outstanding securities can resell them to other investors.

A) True B) False Ans: B Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 11. The vast preponderance of securities sales on the New York Stock Exchange are secondary market transactions.

A) True B) False Ans: A Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 12. The existence of an active secondary market for a security will help to enhance the price of that particular security in the primary market.

A) True B) False Ans: A

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Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 13. The downside to a private placement transaction is that, it does not require the fees and expenses associated with an SEC registration.

A) True B) False Ans: B Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 14. Brokers are market specialists who do not bear risk of ownership of securities.

A) True B) False Ans: A Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 15. The term money market reflects the idea that the instruments traded in the money market are highly marketable and easily converted into cash.

A) True B) False Ans: A

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Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 16. Equities with maturity of greater than one year are generally traded in the capital market.

A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 17. Most companies use indirect market from a financial institution to fund their needs.

A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 18. Business finance companies obtain the majority of their funds by selling equity.

A) True B) False Ans: B Format: True/False Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 19. The nominal rate of interest is the rate of interest that is adjusted for inflation.

A) True B) False Ans: B

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2-6

Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 20. Real rates of interest are perfectly observable.

A) True B) False Ans: B Format: True/False Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 21. It is impossible for the nominal rate of interest to be below the real rate of interest.

A) True B) False Ans: B Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Global Perspective 22. An economy with a large flow of funds requires: A) a lot of gold reserves.

B) a frictionless market.

C) an efficient financial system.

D) all of the above.

Ans: C

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 23. Financial markets and financial institutions are both part of: A) the U.S. Treasury.

B) the financial system.

C) the SEC. D) none of the above.

Ans: B Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Global Perspective 24. Savings by _____ in small dollar amounts is the origin of much of the money that funds business loans in an economy.

A) consumers B) the U.S. government C) small businesses D) none of the above Ans: A Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Global Perspective 25. A financial system's primary concern is funneling money from: A) wealthy individuals to non-wealthy B) individuals. lender-savers to borrowerC) spenders. borrower-spenders to lenderD) savers. the government to wealthy Ans: Bindividuals.

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2-8

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Global Perspective 26. _____ are the principal lender-savers in the economy.

A) Households B) Investment banks C) State governments D) Businesses Ans: A Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 27. An important function of the financial system is: A) to direct money to the best investment opportunities in the economy.

B) to allow the federal government to view all financial transactions.

C) to help state governments to coordinate state tax levies.

D) to direct the money from borrower-lenders to lender-savers.

Ans: A Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 28. Direct financing occurs when: A) a lender-savers borrows directly from a borrowerB) spenders. a borrower-spenders borrows directly C) from a lender-savers. a lender-savers borrows from D) the federal government. a borrower-spenders Ans: Bborrows from the federal government.

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 29. Which of the following is a major participant in the direct financial market?

A) Large corporations.

B) Wealthy individuals.

C) Investment banks.

D) All of the above.

Ans: D Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 30. The major players in the direct financial markets are: A) investment banks.

B) money center banks.

C) regional banks.

D) both A and B. Ans: D Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 31. What is the typical minimum denominated transaction size in the direct financial markets?

A) $10,000.

B) $100,000.

C) $1,000,000.

D) $10,000,000.

Ans: C

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: FSA AICPA: Legal/Regulatory Perspective 32. Which of the following act is responsible for rolling back many of the rules against commercial banks offering investment banking activities?

A) The Securities Act of 1933.

B) The Securities Exchange Act of 1934.

C) The Glass-Steagall Act of 1933.

D) The Financial Services Modernization Act of 1999.

Ans: D Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 33. Which of the following is a process by which investment bankers purchase new securities directly from the issuing company and resell them to the investors?

A) Agency marketing.

B) Underwriting.

C) Distribution.

D) Private placement.

Ans: B Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 34. Stocks that are traded in the _____ are typically those of smaller and lesser known firms.

A) National Stock Exchange B) New York Stock Exchange C) American Stock Exchange D) over-the-counter Ans: D

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 35. The financial market where a new security is sold for the first time is: A) a primary market.

B) a secondary market.

C) an indirect financial market.

D) none of the above.

Ans: A Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 36. Secondary financial markets are similar to: A) direct auction markets.

B) new-car markets.

C) used-car markets.

D) direct financial market.

Ans: C Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 37. If you just purchased a share of IBM through a New York Stock Exchange-based transaction, you participated in: A) a primary market transaction.

B) a secondary market transaction.

C) a futures market transaction.

D) none of the above.

Ans: B

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 38. The ease with which a security can be sold and converted into cash is called: A) convertibility.

B) liquidity.

C) marketability.

D) none of the above.

Ans: C Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 39. The presence of a financial market increases the marketability of a financial security by: A) essentially insuring the price of the security.

B) reducing the transaction costs for selling the security.

C) guaranteeing the accuracy of information produced by the issuer of the security.

D) none of the above.

Ans: B Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 40. One of the main services offered by investment banks to companies is: A) helping companies sell new debt or equity issues in the security markets.

B) making loans to companies.

C) taking deposits from companies.

D) all of the above.

Ans: A

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 41. The NYSE is an example of: A) an over-the-counter market exchange.

B) an organized exchange.

C) a commodities exchange.

D) all of the above.

Ans: B Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 42. Which of the following markets has no central trading location?

A) A futures exchange.

B) An over-the-counter market.

C) An auction market.

D) None of the above.

Ans: B Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 43. A highly liquid financial instrument with a maturity of 90 days would be traded in: A) the money market.

B) the bond market.

C) the stock market.

D) none of the above.

Ans: A

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 44. Money market instruments are generally issued by: A) firms in dire need of cash to maintain their credit rating.

B) firms of the highest credit rating.

C) firms of the lower credit ratings.

D) all of the above.

Ans: B Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 45. The term money market is used because: A) firms that issue securities in this market are in dire need of cash.

B) it is a market where stocks are converted into money.

C) the instruments traded in this market are close substitutes for cash.

D) none of the above.

Ans: C Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 46. If a firm needs to adjust its liquidity position, then it would participate in: A) the money market.

B) the bond market.

C) the stock market.

D) the auction market.

Ans: A

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 47. If a firm needs to finance a new corporate headquarters building, then it would most likely seek the funds in the: A) money B) market. capital C) market.

D) futures Ans: Bmarket. all of the above.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 48. The most common reason that corporate firms use the futures and options markets is: A) to hedge risk.

B) to take risk.

C) to make deposits.

D) none of the above.

Ans: A Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 49. Which of the following theories states that security prices reflect all public information, but not all private information?

A) Weak-form efficiency.

B) Semistrong-form efficiency.

C) Strong-form efficiency.

D) Nominal-form efficiency.

Ans: B

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 50. Which of the following theories states that security prices reflect all information, whether public or private?

A) Weak-form efficiency.

B) Semistrong-form efficiency.

C) Strong-form efficiency.

D) Nominal-form efficiency.

Ans: C Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 51. If your firm primarily borrows from commercial banks, then it primarily accesses the capital markets through: A) direct financing.

B) indirect financing.

C) a legal loophole that allows all commercial banks the ability to underwrite securities.

D) none of the above.

Ans: B Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 52. The process of converting financial securities with one set of characteristics into securities with another set of characteristics is called: A) financial bundling.

B) financial intermediation.

C) financial disintermediation.

D) none of the above.

Ans: B

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 53. A line of credit to a corporation is like _____ to an individual.

A) a term loan B) a bond C) a credit card D) a debit card Ans: C Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 54. Which of the following is a primary investment vehicle for the funds in which life insurance companies must invest?

A) CDs. B) Equity securities.

C) Long-term corporate bonds.

D) Both B and C. Ans: D Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 55. Casualty insurance companies sell: A) protection against loss of income in the event of the death of the insured.

B) protection against loss of property from fire, theft, accidents, and other predictable C) causes.

D) protection against a loss of pension revenue for retirees. all of the above.

Ans: B

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 56. Which of the following would not make up a major proportion of a pension fund investment portfolio?

A) Commercial paper.

B) Long-term corporate bonds.

C) Stocks.

D) None of the above.

Ans: A Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 57. A mutual fund is an example of: A) a line of credit.

B) an endowment fund.

C) an investment fund.

D) a pension fund.

Ans: C Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 58. If a small business opts not to borrow funds from a commercial bank, then what will probably be its next best alternative?

A) An insurance company.

B) A pension.

C) An investment fund.

D) A business finance company.

Ans: D

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 59. The cost of borrowing money is called: A) inflation.

B) return.

C) interest.

D) all of the above.

Ans: C Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 60. The nominal rate of interest is made up of: A) the real rate of interest.

B) compensation for inflation.

C) a commodity cross-index return.

D) both A and B .

Ans: D Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 61. The real rate of return can be justified, at a basic level, by: A) compensation for inflation.

B) compensation for deferring consumption.

C) compensation for the level of international borrowing.

D) all of the above.

Ans: B

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Application AACSB: Reflective Thinking IMA: Corporate Finance AICPA: Resource Management 62. If you are a borrower, which would you prefer to occur during the life of your loan?

A) A level of inflation that is higher than that anticipated at the outset of the loan.

B) A level of inflation that is lower than that anticipated at the outset of the loan.

C) A level of inflation that is exactly as anticipated at the outset of the loan.

D) No inflation at all Ans: A Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Application AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 63. If inflation is anticipated to be 5 percent during the next year, while the real rate of interest for a one-year loan is 5 percent, then what should the nominal rate of interest be for a risk-free one-year loan?

A) 5 percent. 10 B) percent.

25 C) percent. None of D) the above.

Ans: B Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 64. The general level of interest rates tends to follow: A) deflation.

B) the business cycle.

C) the default cycle.

D) all of the above.

Ans: B

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective 65. During an economic expansion, we would expect: A) interest rates to increase.

B) interest rates to decrease.

C) interest rates to remain the same.

D) the cost of money to decrease.

Ans: A Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Business Economics AICPA: Industry/Global Perspective 66. In the United States, the real rate of interest has historically been around: A) 1 B) percent.

C) 3 D) percent.

Ans: B5 percent.

7 percent.

Format: Multiple Choice

Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Analysis AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management 67. If the supply of loanable funds decreases relative to the demand for those funds, then we would expect: A) interest rates to remain unchanged.

B) interest rates to increase.

C) interest rates to decrease.

D) the cost of money to remain unchanged.

Ans: B

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 68. If a firm sells common stock to the public for the very first time, it is known as _____.

A) an underwriting B) an initial public offering C) a financial intermediation D) an origination Ans: B Format: Essay Level of Difficulty: Medium Bloomcode: Comprehension AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective Learning Objective: LO 3 69. Explain why secondary markets are so important to businesses that need to raise capital?

Ans: Secondary markets provide liquidity to the buyers of securities. They facilitate the sale of securities because they enable investors to buy and sell securities as frequently as they want. Secondary markets are important to corporations because investors are willing to pay higher prices for securities in primary markets if the securities have active secondary markets. This lowers the cost of capital for the corporations that issue securities.

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Fundamentals of Corporate Finance 3e

Chapter 3: The Financial System and the Level of Interest Rates Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Knowledge Measurement

AACSB:

Analytic

IMA:

Reporting

AICPA:

Generally accepted accounting principles (GAAP) are a set of authoritative guidelines that define accounting practice at a particular point in time.

1.

A) B) Ans:

True False A

Format: True/False Learning Objective: LO 1 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic IMA: Reporting AICPA: Measurement

2. Generally accepted accounting principles determine the rules for how a company can issue stocks to raise money.

A) True B) False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode:Knowledge AACSB: Analytic

IMA: Corporate Finance AICPA: Industry/Sector Perspective

3. The cost principle assumes that the parties to a transaction are economically rational and are free to act independently of each other.

A) True B) False Ans: B

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective

4. The going concern assumption states that a business will be shutting down its operation in the near future.

A) True B) False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy

Bloomcode: Knowledge AACSB: Communication IMA: Reporting 5. The balance sheetAICPA: identifies the productive resources (assets) that a firm uses to generate Reporting income, as well as the sources of funding from creditors (liabilities) and owners (shareholders' equity) that were used to buy the assets.

A) True B) False Ans: A

Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy

Bloomcode: Knowledge AACSB: Communication IMA: Reporting 6. The balance sheetAICPA: identity can be stated as: Total assets = Total liabilities + Total stockholders' Reporting equity.

A) True B) False Ans: A

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy

Bloomcode: Knowledge AACSB: Communication IMA: Reporting 7. In a balance sheet,AICPA: assets are listed in order of their liquidity.

Measurement A) True B) False Ans: A

Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Measurement

8. During rising prices, a company using the LIFO method assumes that the sale is from the newest, highest-cost inventory.

A) True B) False Ans: A Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management

9. During rising prices, a company using the FIFO method will sell its newest, highest-cost inventory first.

A) True B) False Ans: B

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Fundamentals of Corporate Finance 3e

Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy

Bloomcode: Knowledge AACSB: Analytic IMA: Reporting 10. Book value is the AICPA: amount a firm paid for its assets at the time of purchase.

Reporting A) True B) False Ans: A

Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy

Bloomcode: Knowledge AACSB: Analytic IMA: Reporting AICPA: 11. The net book value of an asset is the historical cost less the accumulated depreciation.

Measurement A) True B) False Ans: A

Format: True/False Learning Objective: LO Level of Difficulty: Easy

3

Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management

12. The current market value of an asset is the amount that a firm would receive for the asset if it were sold on the open market.

A) True B) False Ans: A

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Communication IMA: Reporting AICPA: Reporting

13. Preparing a marked-to-market balance sheet is rather straightforward because it is easy to obtain market values for all assets and liabilities.

A) True B) False Ans: B Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy

Bloomcode: Knowledge AACSB: Analytic IMA: Reporting AICPA: 14. The income statement identifies the major sources of revenues generated by the firm and the Reporting corresponding expenses that were needed to generate those revenues.

A) True B) False Ans: A

Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic IMA: Reporting AICPA: Measurement 15. Depreciation and amortization are examples of prepaid expenses.

A) True B) False Ans: B

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3-5

Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy

Bloomcode: Knowledge AACSB: Communication IMA: Reporting AICPA: 16. The net cash provided by operating activities is another term used for net income.

Reporting A) True B) False Ans: B

Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic IMA: Reporting AICPA: Measurement

17. Cash flows from operations are the net cash flows that support a firm's principal business activities.

A) True B) False Ans: A

Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic IMA: Reporting AICPA: Measurement

18. Cash flows from operating activities involve buying and selling of long-term assets.

A) True B) False Ans: B

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3-6

Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management

19. Making and collecting loans, issuing and paying out on insurance contracts, and buying and selling debt or equity instruments of other firms are examples of financing activities.

A) True B) False Ans: B Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode:Knowledge AACSB: Analytic

IMA: Corporate Finance AICPA: Resource Management

20. Typical financing activities include cash payments on the principal of long-term debt, cash payments of dividends to shareholders, and cash purchases of treasury stock.

A) True B) False Ans: A Format: True/False Learning Objective: LO 6 Level of Difficulty: Easy

Bloomcode: Knowledge AACSB: Communication IMA: Reporting AICPA: that ties the other three statements together is the statement of cash 21. The key financial statement Reporting flows, which summarizes changes in the balance sheet from the beginning of the year to the end. A) B) True False Ans: A

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3-7

Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 7 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Communication IMA: Reporting AICPA: Reporting

22. Rent and insurance are examples of depletion expenses.

A) True B) False Ans: B Format: True/False Learning Objective: LO 8 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic IMA: Reporting AICPA: Measurement

23. The average tax rate is the total taxes divided by the taxable income.

A) True B) False Ans: A Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Knowledge AACSB: Communication IMA: Reporting AICPA: 24. Which of the following sections do annual reports typically contain?

Reporting A) Financial summary related to the past year's performance

B) Information about the company, its products, and its activities C) Audited financial statements, including limited historical financial data D) All three of the above sections are included in the annual report.

Ans: D

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3-8

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Knowledge AACSB: Communication IMA: Reporting AICPA: 25. Annual reports are prepared by a firm's management to: Reporting A) communicate to its shareholders the firm's failures in the previous year.

B)

provide a good overview of the firm's financial and operating performance.

C) highlight the performance of its chief competitors.

D) provide a forecast of the economy in the coming years.

Ans: B Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Knowledge AACSB: Analytic IMA: Reporting AICPA: 26. The generally accepted accounting principles (GAAP) are: Measurement A) rules that outline how a firm can operate ethically.

B) C) D)

rules on how the firm will be valued in the event of a merger. rules and procedures that define how companies are to maintain financial records and prepare financial statements. rules for how a company can issue stock to raise money.

Ans: C

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Knowledge AACSB: Analytic IMA: Reporting AICPA: 27. Accounting standards prescribed by generally accepted accounting principles (GAAP) are Measurement important because: A) B) C) D)

they make the financial statements of all firms standardized. they allow one to examine a firm's performance with ease over a period of time. they make it possible for management or analysts to compare a firm's performance with that of other competitors.

All of the above.

Ans: D

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3-9

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium

Bloomcode: Knowledge AACSB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective

28. The assumption of arm's-length transaction states that: A) both parties to a transaction can act independently of each other and make economically B) rational decisions.

C) both parties to a transaction must have had previous transactions.

D) one of the parties to the transaction is a bank that has full knowledge of the firm's creditworthiness.

None of the above.

Ans: A Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Application AACSB: Analytic IMA: Business Economics AICPA: Industry/Sector Perspective

29. Your uncle, who has a second home in Bethany Beach, Delaware, is planning to sell it in the next few weeks. You are interested in buying this beachside property, so your agent negotiates a price for the house with your uncle's agent. This transaction is an example of: A) the cost principle.

B) the assumption of arm's-length transactions.

C) the realization principle.

D) the going concern assumption.

Ans: B Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Knowledge AACSB: Analytic IMA: Budget Preparation AICPA: Industry/Sector Perspective

30. The going concern assumption implies that: A) a firm will continue to be in business for the foreseeable future.

B) a firm will be going out of business in the near future.

C) a firm will continue to operate in the near future, but only after being acquired by another D) firm.

None of the above.

Ans: A

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3-10

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic IMA: Cost Management AICPA: Strategic/Critical Thinking

32. The matching principle calls for the accountant of a firm to: A) identify an asset with each liability of the firm.

B) associate the revenue generated from a sale to the costs or expenses incurred to produce C) the product.

D) match each item of inventory with the historical cost at which it was acquired.

None of the above.

Ans: B Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium

Bloomcode: Application AACSB: Analytic IMA: Reporting AICPA: Measurement

33. Tyson Corporation bought raw materials on April 23, 2008 and also on July 2, 2008. Products produced during the months of May were sold in July. The firm uses FIFO to value its inventory. According to the matching principle, the firm's accountant should associate: A) the inventory acquired on July 2 with the products sold.

B) the inventory acquired on April 23 with the products sold.

C) neither of these dates is valid because the products were sold in July.

D) None of the above.

Ans: B Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Communication IMA: Reporting AICPA: Reporting

34. According to the realization principle, revenue from a sale of a firm's products are recognized: A) when the products are shipped to the buyer.

B) when the buyer orders the goods.

C) when cash is realized from the sale of the products.

D) at the time of the sale whether or not cash is actually received.

Ans: D

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3-11

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium

Bloomcode: Application AACSB: Communication IMA: Reporting AICPA: Reporting

35. On June 23, 2008, Mikhal Cosmetics sold $250,000 worth of its products to Rynex Corporation, with the payment to be made in 90 days on September 20. The goods were shipped to Rynex on July 2. The firm's accountants should recognize the sale on: A) June 23, 2008.

B) July 2, 2008.

C) September 20, 2008.

D) None of the above Ans: A Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Knowledge AACSB: Communication IMA: Reporting AICPA: Reporting

36. The cost principle states that an asset should be recognized on the balance sheet: A) at the market value of the asset.

B) at the market value less the accumulated depreciation on the asset.

C) at its historical cost.

D) at its historical cost plus the accumulated depreciation on the asset.

Ans: C Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium

Bloomcode: Application AACSB: Analytic IMA: Reporting AICPA: Measurement

37. Trekkers Footwear bought a piece of machinery on January 1, 2006 at a cost of $2.3 million, and the machinery is being depreciated annually at an amount of $230,000 for 10 years. Its market value on December 31, 2008 is $1.75 million. The firm's accountant is preparing its financial statement for the fiscal year end on December 31, 2008. The net value of the asset that should be reported on the balance sheet is: A) $2.3 million.

B) $1.61 million.

C) $230,000.

D) $1.75 million.

Ans: B

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3-12

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Communication IMA: Reporting AICPA: Reporting

38. The conventional way of preparing a balance sheet is to list all assets in the order of their: A) market value.

B) risk.

C) liquidity.

D) historical cost.

Ans: C Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium

Bloomcode: Application AACSB: Analytic IMA: Reporting AICPA: Reporting

39. Petra, Inc., has $400,000 as current assets, $1.225 million as plant and equipment, and $250,000 as goodwill. In preparing the balance sheet, these assets should be listed in which of the following orders?

A) Current assets, goodwill, and plant and B) equipment. Current assets, plant and C) equipment, and goodwill. Goodwill is not an D) asset and is not listed here. None of the Ans: Babove.

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium

Bloomcode: Analysis AACSB: Analytic IMA: Reporting AICPA: Measurement

40. When prices are rising, valuing ending inventory using the FIFO method rather than LIFO gives: A) B)inventory a higher value but lowers net income.

C) D) inventory a lower value and also lowers net income. both inventory and net income a higher value. inventory a lower value and net income a higher value.

Ans: C

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3-13

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic IMA: Reporting AICPA: Measurement

41. When prices are falling, valuing inventory using the LIFO method rather than FIFO gives: A) inventory a higher value but lowers net income.

B) inventory a lower value and also lowers net income.

C) both inventory and net income a higher value.

D) inventory a lower value and net income a higher value.

Ans: C Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Communication IMA: Reporting AICPA: Reporting

42. Which of the following is NOT true about goodwill?

A) It is an intangible asset.

B) It represents the value of all unrecorded assets acquired in a merger.

C) It equals the premium paid over the fair market value of the assets acquired in a merger.

D) When goodwill appears on a firm's balance sheet, it reduces the firm's net worth by that amount.

Ans: D Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Resource Management

43. Which of the following is NOT true about treasury stock?

A) It is a firm's own shares repurchased in the market by the firm.

B) It can be reissued under stock option and other employee benefit plans.

C) It lowers the value of the company.

D) It increases the net worth of the company.

Ans: C

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3-14

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium

Bloomcode: Application AACSB: Analytic IMA: Reporting AICPA: Measurement

44. Maddux, Inc., has completed its fiscal year and reported the following information. The company had current assets of $153,413, net fixed assets of $412,331, and other assets of $7,822. The firm also has current liabilities worth $65,314, long-term debt of $178,334, and common stock of $162,000. Calculate the amount of retained earnings.

A) $405,64 B) 8 C) $243,64 D) 8 Ans: C$167,91 8 Feedback: $573,56 Total assets = $153,413 + $412,331 + $7,822 = $573,566 6 Total liabilities = $65,314 + $178,334 = $243,648 Total stockholders' equity = Total assets – Total liabilities Total stockholders' equity = $573,566 – $243,648 = $329,918 Retained earnings = Total stockholders' equity – Common stock Retained earnings = $329,918 – $162,000 = $167,918 Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium

Bloomcode: Application AACSB: Analytic IMA: Reporting AICPA: Measurement

45. Galan Associates prepared its financial statement for 2008 based on the information given here.

The company had cash worth $1,234, inventory worth $13,480, and accounts receivables worth $7,789. The company's net fixed assets are $42,331, and other assets are $1,822. It had accounts payables of $9,558, notes payables of $2,756, common stock of $22,000, and retained earnings of $14,008. How much long-term debt does the firm have?

A) $54,34 B) 2 C) $76,34 D) 2 Ans: D$12,31 4 Feedback: $18,33 Current assets = $1,234 + $7,789 + $13,480 = $22,503 4 Total assets = $22,503 + $42,331 + $1,822 = $66,656 Current liabilities = $9,558 + $2,756 = $12,314 Total stockholders' equity = $22,000 + $14,008 = $36,008 Long-term debt = Total assets – Current liabilities – Total stockholders' equity Long-term debt = $66,656 – $12,314 – $36,008 = $18,334

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3-15

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium

Bloomcode: Application AACSB: Analytic IMA: Reporting AICPA: Measurement

46. Tumbling Haven, a gymnastic equipment manufacturer, provided the following information to its accountant. The company had current assets of $145,332, net fixed assets of $356,190, and other assets of $4,176. The firm has long-term debt of $76,445, common stock of $200,000, and retained earnings of $134,461. What amount of current liabilities does this firm have?

A) $94,792 B) $505,678 C) $171,217 None D) of the above.

Ans: A Feedback: Total assets = $145,332 + 356,190 + $4,176 = $505,698 Total stockholders' equity = $200,000 + $134,461 = $334,461 Current liabilities = Total assets – Long-term debt – Total stockholders' equity Current liabilities = $505,698 – $76,445 – $334,461 = $94,792 Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium

Bloomcode: Application AACSB: Analytic IMA: Reporting AICPA: Measurement

47. Teakap, Inc., has current assets of $1,456,312 and total assets of $4,812,369 for the year ending September 30, 2006. It also has current liabilities of $1,041,012, common equity of $1,500,000, and retained earnings of $1,468,347. How much long-term debt doesA)the firm have? $1,844,02 B) 2 C) $2,303,01 D) 0 Ans: D$2,123,61 2 Feedback: $803,010 Total Stockholders' equity = $1,500,000 + $1,468,347 = $2,968,347 Long-term debt = Total assets – Current liabilities – Total Stockholders' equity Long-term debt = $4,812,369 – $1,041,012 – $2,968,347 = $803,010

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3-16

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium

Bloomcode: Application AACSB: Analytic IMA: Reporting AICPA: Measurement

48. Chandler Sporting Goods produces baseball and football equipment and lines of clothing. This year the company had cash and marketable securities worth $335,485, accounts payables worth $1,159,357, inventory of $1,651,599, accounts receivables of $1,488,121, short-term notes payable worth $313,663, and other current assets of $121,427. What is the company's net working capital?

A) $3,596,63 B) 2 C) $1,801,78 D) 4 Ans: C$2,123,61 2 Feedback: $1,673,42 Total current assets = $335,485 + 1,488,121 + $1,651,599 + $121,427 = $3,596,632 1 Total current liabilities = $1,159,357 + $313,663 = $1,473,020 Net working capital = $3,596,632 – $1,473,020 = $2,123,612 Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium

Bloomcode: Application AACSB: Analytic IMA: Reporting AICPA: Measurement

49. Tre-Bien Bakeries generated net income of $233,412 this year. At year end, the company had accounts receivables of $47,199, inventory of $63,781, and cash of $21,461. It also had accounts payables of $51,369, short-term notes payables of $11,417, and accrued taxes of $6,145. The net working capital of the firm is A) $68,931.

B) $63,510.

C) $69,655. None D) of the above Ans: B Feedback: Total current assets = $21,461 + $47,199 +$63,781 = $132,441 Total current liabilities = $51,369 + $11,417 + $6,145 = $68,931 Net working capital = $132,441 – $68,931 = $63,510

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3-17

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium

Bloomcode: Application AACSB: Analytic IMA: Reporting AICPA: Measurement

50. Spartan, Inc., is a manufacturer of automobile parts located in Greenville, South Carolina. At the end of the current fiscal year, the company had net working capital of $157,903. The company showed accounts payables of $94,233, accounts receivables of $83,112, inventory of $171,284, and cash and marketable securities of $12,311. Calculate the amount of notes payables. (Assume that notes payable and accounts payable are the only two current liabilities of the company.)

A) $14,571 $26,882 B) $15,471 None of C) the above D) Ans: A Feedback: Total current assets = $12,311 + $83,112 + $171,284 = $266,707 Net working capital = $266,707 – Total current liabilities = $157,903 Total current liabilities = $266,707 – $157,903 = $108,804 Total current liabilities = $108,804 = Accounts payable + Notes payable Notes payable = $108,804 – $94,233 = $14,571 Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic IMA: business Economics AICPA: Industry/Sector Perspective

51. The major disadvantages of market-value accounting include: A) the difficulty in estimating the current value for some assets.

B) the difficulty in applying some of the valuation models used to estimate market values.

C) the resulting numbers are potentially open to abuse.

D) All of the above are disadvantages of market-value accounting.

Ans: D

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3-18

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy

Bloomcode: Comprehension AACSB: Communication IMA: Reporting AICPA: Reporting

52. Which of the following is the best example of how a market-value balance sheet item differs from the firm’s book-value balance sheet item?

A) A firm issued long-term bonds five-years ago that currently sell for par value.

B) A firm sold common stock twenty-years ago for $20.00 a share. The firm’s common C) stock is currently selling for $96.50 per share.

D) A firm has $5 million of accrued liabilities on the books.

A firm issued preferred stock ten-years ago. These shares of preferred stock currently are selling for par value.

Ans: B Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic IMA: Reporting AICPA: Measurement

53. Which of the following statements is NOT a limitation associated with market valuation of balance sheet accounts?

A) It can be difficult to identify the market value of an asset, particularly if there are few B) transactions involving comparable assets.

C) The estimates of market value can involve complex financial modeling, and the resulting D) numbers can be open to manipulation and abuse.

Marking to market provides decision makers with a better chance of making the correct economic decision, given the information available.

Mark-to-market accounting can become inaccurate if market prices deviate from the “fundamental” values of assets and liabilities.

Ans: C Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Communication IMA: Reporting AICPA: Reporting

54. Which of the following does NOT belong to an income statement?

A) Depreciation expense B) Goodwill C) Extraordinary items D) Amortization expense Ans: B .

3-19

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic IMA: Budget Preparation AICPA: Measurement

55. Which of the following is NOT a noncash item?

A) Depreciation B) Taxes C) Prepaid expenses D) Prepaid taxes Ans: B Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Application AACSB: Analytic IMA: Reporting AICPA: Measurement

56. Centennial Brewery produced revenues of $1,145,227 in 2008. It has expenses (excluding depreciation) of $812,640, depreciation of $131,335, and interest expense of $81,112. It pays an average tax rate of 34 percent. What is the firm's net income after taxes? Round your final answer to the nearest dollar.

A) $120,14 B) 0 C) $248,47 D) 5 Ans: C$79,292 $40,848 Feedback: Earnings before taxes = $1,145,227 – ($812,640 + $131,335 + $81,112) = $120,140 Net income = $120,140 (1 – 0.34) = $79,292

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3-20

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Analysis AACSB: Analytic IMA: Reporting AICPA: Measurement

57. Simplex Healthcare had net income of $5,411,623 after paying taxes at 34 percent. The firm had revenues of $20,433,770.Its interest expense for the year was $1,122,376, while depreciation expense was $2,079,112. What was the firm's operating expenses excluding depreciation? Round your intermediate calculations and final answer to the nearest dollar.

A) $8,199,429 B) $9,032,853 C) $9,321,805 D) None of the above Ans B : Feedback: Earnings before taxes = Net income / (1 – Tax rate) = $5,411,623 / (1 – 0.34) = $8,199,429 EBIT = EBT + Interest expense = $8,199,429 + $1,122,376 = $9,321,805 Revenues – Operating expenses – Depreciation = EBIT Operating expenses = Revenues – Depreciation – EBIT = $20,433,770 – $2,079,112 – $9,321,805 = $9,032,853

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3-21

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard

Bloomcode: Analysis AACSB: Analytic IMA: Reporting AICPA: Measurement

58. Triumph Trading Company provided the following information to its auditors. For the year ended March 31, 2008, the company had revenues of $1,122,878, operating expenses (excluding depreciation and leasing expenses) of $612,663, depreciation expenses of $231,415, leasing expenses of $126,193, and interest expenses of $87,125. If the company's average tax rate was 34 percent, what is its net income after taxes? Round your final answer to the nearest dollar.

A) B) $43,218 C) D) Ans$65,482 : Feedback: EBIT = $1,122,878 – ($612,663 + $231,415 $152,607 + $126,193) None = $152,607 Earnings before taxes = ($152,607 of the– above. $87,125) A = $65,482 Net income = $65,482 (1 – 0.34) = $43,218

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3-22

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard

Bloomcode: Analysis AACSB: Analytic IMA: Reporting AICPA: Measurement

59. Parrino Corporation has announced that its net income for the year ended June 30, 2008, is $1,824,214. The company had an EBITDA of $5,174,366, and its depreciation and amortization expense was equal to $1,241,790. The company's average tax rate is 34 percent. What is the amount of interest expense for the firm?

A) $2,763,96 B) 1 C) $939,747 D) $1,187,72 Ans: D0 $1,168,61 Feedback: 5 EBITDA Amount Less: Depreciation and amortization $5,174,366.00 EBIT 1,241,790.00 Less: Interest $3,932,576.00 EBT 1,168,615.39** Less: Taxes (34%) $2,763,960.61* Net income 939,746.61 *EBT = Net income / (1 – Tax rate) = $1,824,214.00 $1,824,214 / 0.66 = $2,763,960.61 **Interest = EBIT – EBT = $3,932,576 − $2,763,960.61 = $1,168,615.39

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Application AACSB: Analytic IMA: Reporting AICPA: Measurement

60. Arco Steel, Inc. generated total sales of $45,565,200 during fiscal 2010. Depreciation and amortization for the year totaled $2,278,260, and cost of goods sold was $27,339,120. Interest expense for the year was $9,641,300 and selling, general, and administrative expenses totaled $4,556,520 for the year. What is Arco’s EBIT for 2010?

A) B) C) D) Ans:

$9,641,300 $11,391,30 0 $13,275,03 0 $18,490,00 Feedback: 0B Net sales Cost of goods sold Gross Profit Selling, general and administrative expenses .

$ 45,565,200 27,339,120 $ 18,226,080 4,556,520 3-23

Test Bank

Fundamentals of Corporate Finance 3e

Depreciation and amortization Earnings Before Interest and Taxes (EBIT)

2,278,260 $ 11,391,300

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy

Bloomcode: Knowledge AACSB: Communication IMA: Reporting AICPA: Reporting

61. Which of the following is an income statement item?

A) Accounts payable B) Accrued taxes C) Retained earnings D) Selling and administrative expenses Ans: D Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Communication IMA: Reporting AICPA: Reporting

62. Which of the following is NOT a cash flow from operating activities?

A) Cash payments on the principal of long-term debt B) Payments for utilities and rent C) Payments to purchase raw materials D) Cash receipts from selling goods and services Ans: A Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Hard

Bloomcode: Comprehension AACSB: Analytic IMA: Reporting AICPA: Measurement

63. Cash flows from financing activities include all but one of the following: A) Cash payments on the principal of long-term debt B) Buying and selling bonds or stock of other firms C) Cash purchases of treasury stock D) Cash proceeds from a bank loan Ans: B

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3-24

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Hard

Bloomcode: Comprehension AACSB: Analytic IMA: Reporting AICPA: Measurement

64. Which of the following is NOT a cash flow from investing activities?

A) Buying and selling bonds of other firms B) Buying or selling of land, buildings, and plant and equipment C) Cash payments of dividends to shareholders D) Buying and selling stocks of other firms Ans: C Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium

Bloomcode: Application AACSB: Communication IMA: Reporting AICPA: Reporting

65. Trident Corporation had the following cash flows in the current year. Which of the following will be categorized under the financing activities section of the statement of cash flows?

A) Rent on a warehouse amounting to $1.1 million B) Purchase of $125,000 worth of five-year bonds issued by Towson Utilities C) Preferred dividends of $330,000 paid to shareholders D) Lease income received on a piece of land Ans: C Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Hard

Bloomcode: Application AACSB: Analytic IMA: Reporting AICPA: 66. During 2008, Towson Recording Company increased its investment in marketable Measurement securities by $36,845, funded fixed assets acquisition by $109,455, and had marketable securities of $14,215 mature. What is the net cash provided by (used in) investing activities?

A) $132,085 B) $145,940 C) – D) $132,085 Ans: C– $145,940 Feedback: Cash inflows from investing activities = $14,215 Cash outflows from investing activities = $36,845 + $109,455 = $146,300 Net cash flows used in investing activities = $14,215 – $146,300 = $(132,085)

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3-25

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Hard

Bloomcode: Application AACSB: Analytic IMA: Reporting AICPA: 67. Trident Manufacturing Company's treasurer identified the following cash flows during this year Measurement as significant.

The company repaid existing debt of $425,110, while raising additional debt capital of $750,000. It also repurchased stock in the open markets for a total of $63,250 and paid $233,144 in dividends to its shareholders. What is the net cash provided by (used in) financing activities?

A) $28,496 B) $91,746 C) – D) $28,496 Ans: A– $91,746 Feedback: Cash inflows from financing activities = $750,000 Cash outflows from financing activities = $425,110 + $63,250 + $233,144 = $721,504 Net cash flows from financing activities = $750,000 – $721,504 = $28,496

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Test Bank

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Hard

Bloomcode: Application AACSB: Analytic IMA: Reporting AICPA: 68. Super Grocers, Inc., provided the following financial information for the quarter ending Measurement September 30, 2006:

Depreciation and amortization – $133,414 Net income – $341,463 Increase in receivables – $112,709 Increase in inventory – $81,336 Increase in accounts payables – $62,411 Decrease in marketable securities – $31,225 What is the cash flow from operating activities generated during this quarter by the firm?

A) $308,458 B) $374,468 C) – D) $374,468 Ans: B– $308,458 Feedback: Statement of Cash Flows For the quarter ended on September 30, 2006 Operating Activities Net income $341,463 133,414 Additions (sources of cash) 62,411 Depreciation and amortization 31,225 Increase in accounts payable (112,709) Decrease in marketable securities (81,336) Subtractions (uses of cash) $374,468 Increase in accounts receivable Increase in inventories Net cash provided by operating activities

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Reference 3-1: Use the following information to answer questions 69 - 71: Thunderbird Amusement Park—Balance Sheet as of June 30 Assets 2007 2008 Cash $ 13,221 $ 11,729 Accounts receivables 31,323 37,909 Inventory 77,244 91,617 $121,788 $141,255 Total current assets 444,712 563,323 Fixed assets (100,000) (172,487) Less: Accumulated depreciation 344,712 390,836 Net fixed assets $466,500 $532,091 Total assets Liabilities and Stockholders' Equity Accounts payable Notes payable Deferred taxes

$ 38,549 $ 42,881 12,004 16,753 21,934 16,788 $ 72,487 $ 76,422 Total current liabilities 78,445 61,290 Long-term debt 125,000 175,000 Common stock 190,568 219,379 Retained earnings $466,500 $532,091 Total liabilities and stockholders' equity The company had a net income of $248,462, and depreciation expenses were equal to $72,487.

Reference: Ref 3-1 Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Hard

Bloomcode: Application AACSB: Analytic IMA: Reporting AICPA: Measurement

69. What is the firm's net cash flow from operating activities?

A) $304,322 B) $299,176 C) $192,602 D) None of the above.

Ans: B Feedback: Operating Activities Net income $248,462 Additions (sources of cash) 72,487 Depreciation and amortization 4,332 (6,586) Increase in accounts payable (14,373) Subtractions (uses of cash) (5,146) Increase in accounts receivable $299,176 Increase in inventories Decrease in deferred taxes Net cash provided by operating activities

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Reference: Ref 3-1 Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Hard

Bloomcode: Application AACSB: Analytic IMA: Reporting 70. What is the firm'sAICPA: net cash flow from (used in) investing activities?

Measurement A) $0

B) $46,124 C) –$46,124 D) None of the above Ans: C Feedback: Cash inflows from investing activities = $0 Cash outflows from investing activities = $390,836 − $344,712 = $46,124 Net cash flows from investing activities = –$46,124

Reference: Ref 3-1 Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Hard

Bloomcode: Application AACSB: Analytic IMA: Reporting AICPA: 71. What is the firm's cash flow from financing activities?

Measurement –$66,405 A) B) $61,656 C) –$61,656 D) −$182,057 Ans: D Feedback: Cash inflows from financing activities = Increase in notes payable + Increase in common stock = $4,749 + $50,000 = $54,749 Net income – Dividends = Increase in retained earnings Increase in retained earnings = $219,379 − $190,568 = $28,811 Cash dividends = $248,462 – $28,811 = $219,651 Cash outflows from financing activities = Decrease in long-term debt + Cash dividends paid = $17,155 + $219,651 = $236,806 Net cash flows from financing activities = $54,749 – $236,806 = $(182,057)

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Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Communication IMA: Reporting AICPA: Reporting

72. Which of the following is a cash flow from investing activities?

A) Cash payment of dividends to shareholders B) Cash from sale of products C) Purchase of plant and equipment D) Rent received from industrial property owned Ans: C Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium

Bloomcode: Application AACSB: Analytic IMA: Reporting AICPA: Measurement

73. Natural Lite, Inc. reported the following items during fiscal 2010. The firm purchased marketable securities of $87,500, paid down a long-term loan in the amount of $650,000, purchased $4,250,000 of new equipment. The firm also issued $6,250,000 of common stock, paid $350,225 in dividends to its common shareholders, and repurchased $1,250,000 of common stock in the open market. What is the net cash provided by financing activities?

A) $4,575,21 B) 0 C) $1,733,28 D) 5 Ans: C$3,999,77 5 Feedback: $2,467,91 Cash inflows from financing activities = $6,250,000 5 Cash outflows from financing activities = $650,000 + $1,250,000 + $350,225 = $2,250,225 Net cash flows from financing activities = $6,250,000 – $2,250,225 = $3,999,775

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Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Communication IMA: Reporting AICPA: Reporting

74. Which of the following presents a summary of the changes in a firm’s balance sheet from the beginning of an accounting period to the ending of an accounting period?

A) The statement of retained earnings B) The statement of working capital C) The statement of cash flows D) The statement of net worth Ans: C

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Hard

Bloomcode: Application AACSB: Analytic IMA: Reporting AICPA: 75. Trimeton Corporation announced that in the year ended June 30, 2008, its earnings before taxes Measurement amounted to $2,367,045. Calculate its taxes using the following table. Round your final answer to the nearest dollar.

Tax Rate Taxable Income 15% $0 to $50,000 25 50,001 – 75,000 34 75,001 – 100,000 39 100,001 – 335,000 34 335,001 – 10,000,000 35 10,000,001 – 15,000,000 38 15,000,001 – 18,333,333 35 More than $18,333,333 A) $804,795 B) $690,895 C) $713,145 D) None of the above Ans: A Feedback: Earnings before tax = $2,367,045 Tax rate 15% 25 34 39 34 35 38 35

.

Income $0 to $50,000 50,001 – 75,000 75,001 – 100,000 100,001 – 335,000 335,001 – 10,000,000 10,000,001 – 15,000,000 15,000,001 – 18,333,333 More than $18,333,333 Total taxes payable

Tax $ 7,500 6,250 8,500 91,650 690,895

$804,795

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Hard

Bloomcode: Application AACSB: Analytic IMA: Budget Preparation AICPA: Measurement 76. Chartworth Associates' financial statements indicated that the company had EBITDA of

$3,145,903. It had depreciation of $633,000, and its interest rate on debt of $1.25 million was 7.5 percent. Calculate the amount of taxes the company is likely to owe. Round your final answer to the nearest dollar.

Tax Rate

Taxable Income

15% 25 34 39 34 35 38 35

$0 to $50,000 50,001 – 75,000 75,001 – 100,000 100,001 – 335,000 335,001 – 10,000,000 10,000,001 – 15,000,000 15,000,001 – 18,333,333 More than $18,333,333

A) $1,069,607 B) $1,037,732 C) $822,512 D) none of the above Ans: C Feedback: EBITDA $3,145,903 Depreciation (633,000) Interest (93,750) EBT $2,419,153 Tax rate Income 15% $0 to $50,000 25 50,001 – 75,000 75,001 34 – 100,000 100,001 – 39 335,000 335,001 – 34 10,000,000 10,000,001 35 – 15,000,000 38 15,000,001 – 35 18,333,333 More than $18,333,333 Total taxes payable

.

Tax $ 7,500 6,250 8,500 91,650 708,612

$822,512

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Hard

Bloomcode: Application AACSB: Analytic IMA: Reporting Associates’ AICPA:financial statements indicated that the company has EBITDA of 77. Chartworth Measurement $3,145,903.

It had depreciation of $633,000, and its interest rate on debt of $1.25 million was 7.5%. The company is likely to owe $822,512 in taxes. What are the marginal and average tax rates for this company?

Tax Rate

Taxable Income

15% 25 34 39 34 35 38 35

$0 to $50,000 50,001 – 75,000 75,001 – 100,000 100,001 – 335,000 335,001 – 10,000,000 10,000,001 – 15,000,000 15,000,001 – 18,333,333

More than $18,333,333 A) 34%, 35% 35%, B) 34% 34%, 34% C) none of the D) above Ans: C Feedback: Marginal tax rate =34% =Total taxes payable ÷ Total Taxable income Average tax rate =$822,512 ÷ $2,419,153 =34% Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic IMA: Reporting AICPA: Measurement

78. Which of the following best represents cash flows to investors?

A) Cash flow from operating activity, plus cash flow generated from net working capital B) Earnings before interest and taxes times 1 minus the firm’s tax rate C) Net income minus dividends paid to preferred stockholders.

D) Cash flow from operating activity minus cash flow invested in net working capital minus cash flow invested in long-term assets.

Ans: D

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Format: Multiple Choice Learning Objective: LO 8 Level of Difficulty: Medium

79.

Bloomcode: Application AACSB: Analytic IMA: Budget Preparation AICPA: Measurement

Clarity Music Company has a marginal tax rate of 34 percent and an average tax rate of 32 percent this year. It is planning to construct a new recording studio next year. The appropriate tax rate to be applied on the income generated from the new studio is: A) the average tax rate.

B) the marginal tax rate.

C) either one.

D) None of the above.

Ans: B Format: Multiple Choice Learning Objective: LO 8 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic IMA: Corporate Finance AICPA: Measurement

80. Which of the following statements is true?

A) Only 20 percent of interest income is taxable for a corporation.

B) Dividend income is fully taxable.

C) Interest paid on debt obligations is a tax-deductible business expense.

D) Dividends paid to stockholders are a tax-deductible business expense.

Ans: C

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Format: Multiple Choice Learning Objective: LO 8 Level of Difficulty: Medium

Bloomcode: Analysis AACSB: Analytic IMA: Reporting AICPA: Measurement

81. United Brands Corp. just completed their latest fiscal year. The firm had sales of $16,650,000.

Depreciation and amortization was $832,500, interest expense for the year was $825,000, and selling general and administrative expenses totaled $1,665,000 for the year, and cost of goods sold was $9,990,000 for the year. Assuming a federal income tax rate of 34%, what was the United Brands net income after-tax?

A) $2,202,75 B) 0 C) $1,745,32 D) 5 Ans: A$3,505,10 0 Feedback: $2,813,00 United Brands Corp.

Net 0 sales $ 16,650,000 Cost of goods sold 9,990,000 Gross Profit $ 6,660,000 Selling, general and administrative expenses 1,665,000 Depreciation and amortization 832,500 Earnings Before Interest and Taxes (EBIT) 4,162,500 $ Interest expense 825,000 $ Earnings Before Taxes (EBT) 3,337,500 $ Income Taxes 1,134,750 Net Income after-tax 2,202,750

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Format: Essay Learning Objective: LO 1 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic IMA: Reporting AICPA: Reporting

82. Identify and explain the five fundamental principles that form the basis of accounting standards in United States.

Ans:

The U.S. GAAP is based on a set of five principles. These include the assumption of arm's-length transaction, the cost principle, the realization principle, the matching principle, and the going concern assumption.

• The assumption of arm's-length transaction assumes that the two parties involved in a transaction have the ability to make economic decisions independently and rationally without having any influence on the other party's decision making.

• The cost principle calls for recording the value of an asset at its cost at the time of acquisition. At any point in time, the book value represents a fair value of the asset. This book value is determined by depreciating the cost of the asset over its estimated useful life.

• • •

.

The realization principle reflects the fact that the revenue from a sale is recognized only when the sale of a firm's product or service is virtually completed and can be reliably confirmed.

The matching principle requires that any revenue generated from a sale is matched with the costs associated with producing the revenue.

The going concern assumption refers to the idea that a firm is expected to continue functioning for a foreseeable future.

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Format: Essay Learning Objective: LO 2 Level of Difficulty: Easy

Bloomcode: Comprehension AACSB: Analytic IMA: Reporting AICPA: Measurement

83. Explain the differences while using FIFO versus LIFO method of valuation in accounting for inventory.

Ans: There are two common approaches that firms can use to value inventory. The first one is referred to as FIFO, or first-in, first-out, which requires a firm making a sale to associate the sale with the oldest inventory on the balance sheet. The second method is called LIFO, or last-in, first-out, and the firm using this approach is required to associate any sale with the newest inventory on the balance sheet. Although firms may switch from one approach to another, the switch cannot occur except under extraordinary circumstances.

Choosing one approach over the other has an impact on a firm's balance sheet and the income statement, especially during the time of changing prices. When prices are rising, a firm using FIFO accounting has a lower cost of goods sold and a higher net income. In addition, the ending inventory will be valued at the more recent cost, which will result in a higher inventory value on the balance sheet. When prices are declining, firms using LIFO will benefit because LIFO provides the highest inventory valuation and net income.

Format: Essay Learning Objective: LO 3 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic IMA: Reporting AICPA: Measurement

84. What are the advantages and disadvantages of using market-value accounting?

Ans: Using market-value method of accounting to prepare financial statements has several advantages. Having current information about a firm's financial condition and the information about expected cash flows a company can generate, will allow a firm's management to make better decisions. It allows investors and creditors to better evaluate the firm, and it improves its ability to raise capital.

There are also some negatives associated with market-value accounting. First of all, assessing the market value of some of the assets becomes quite difficult, and accountants would wary of making estimates. Second, the valuation models used in practice are not easy to use and could result in unreliable values. Third, unscrupulous executives could very well use these estimates to their advantage.

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Fundamentals of Corporate Finance 3e

Format: Essay Learning Objective: Difficulty: Medium

LO

4

Level

of

Bloomcode: Comprehension AACSB: Communication IMA: Reporting AICPA: Reporting

Explain the following income statement 85. items. a.

Amortization expense b.

Extraordinary items c.

EBITDA Ans: a. Amortization expense is similar to depreciation; however it is concerned with intangible assets. Just as depreciation is used to write off the cost of real assets such as plant and equipment, amortization is used for writing off expenses for intangible assets—such as patents, licenses, copyrights, trademarks, and goodwill.

The costs are assigned to the fiscal periods in which the firm is assumed to have benefited from these intangible assets. b. Extraordinary items are also expenses that are unusual and unlikely to occur frequently. These are gains or losses that do not arise from operations but because of occurrences such as floods, fires, and earthquakes.

EBITDA is the acronym of earnings before interest, taxes, depreciation, and c. amortization. It represents a firm's earnings after accounting for cost of goods sold, but not expenses related to the asset base that was used to produce the revenues for the firm. The higher the value of the EBITDA, the more efficient the firm’s operations are.

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Format: Essay Learning Objective: LO 5 Level of Difficulty: Medium

Bloomcode: Comprehension AACSB: Analytic IMA: Reporting AICPA: Reporting

86. Identify the noncash items that a firm may have on its financial statements and explain their impact on the shareholders of the firm.

Ans: Several noncash items can be found on a firm's financial statement. Although some firms may have all of these items, others may not. But one noncash item that all firms will have is the depreciation. This is typically the largest noncash item. Another noncash item is amortization. Other noncash items include the following: • Depletion charges, which are similar to depreciation but apply to extractive natural resources, such as crude oil, natural gas, timber, and mineral deposits.

Deferred taxes, which are the portion of a firm's income tax expense that is • postponed because of differences in the accounting policies adopted for management financial reporting and tax reporting.

Prepaid expenses, such as prepaid rent and insurance.

• Deferred revenues, which are revenues received as cash but not yet earned. An • example of deferred revenue would be subscriptions received in advance towards magazines by a publishing company.

The noncash expenses on a firm's income statement reduce the taxable income and hence the tax paid by the firm. This in turn increases the cash flow available to its shareholders. Noncash revenue items reduce the cash flow available to the firm but are typically nowhere near the magnitude of the largest noncash expenses.

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Chapter 4: Analyzing Financial Statements Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: FSA AICPA: Measurement 1. Financial statement analysis can help us determine why a firm's cash flows are increasing or decreasing.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: FSA AICPA: Measurement 2. Stockholders are primarily concerned on the value of their stock, but not on how much cash they can expect to receive from dividends and/or capital appreciation over time.

A) True B) False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: FSA AICPA: Measurement 3. Managers' decisions regarding financing, investment, and working capital are reflected in the financial statements.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic

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IMA: FSA AICPA: Measurement 4. A financial statement analysis conducted over a period of time is called trend analysis.

A) True B) False Ans: A Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 5. A typical way in which a common-size income statement is constructed is by dividing all expense items in an income statement by net income.

A) True B) False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 6. The most frequent method used for creating a common-size balance sheet is to divide each of the accounts by total assets, expressing each account as a percentage of total assets.

A) B) True Ans: False A Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 7. Liquidity ratios are concerned with a firm's ability to pay its current bills without putting the firm in financial difficulty.

A) True B) False Ans: A

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Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 8. A firm's current ratio changed from 1.4 times in the previous year to 1.6 times in the current year. Based on this information, we can conclude that the firm's liquidity has improved.

A) B) Ans:

True False A

Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 9. A company can improve its liquidity by increasing its accounts payable, while maintaining the other accounts constant.

A) True B) False Ans: B Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 10. The purchase of additional inventory by a firm should decrease a firm's quick ratio.

A) True B) False Ans: A Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: FSA

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AICPA: Measurement 11. Turnover ratios are useful for managers in identifying inefficient use of current and long-term assets.

A) True B) False Ans: A Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 12. A firm increased its day’s sales outstanding from 35 days to 43 days. This implies the firm is more efficient in collecting the debts.

A) True B) False Ans: B Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: FSA AICPA: Measurement 13. Total asset turnover is more relevant for service-industry firms, while the fixed asset turnover ratio is more relevant for manufacturing industry firms.

A) True B) False Ans: A Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 14. Financial leverage refers to the use of preferred stock in a firm's capital structure.

A) True B) False Ans: B

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Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: FSA AICPA: Measurement 15. The equity multiplier of a firm is computed by dividing the total equity by its total assets.

A) True B) False Ans: B Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 16. The higher the times-interest-earned ratio, the more comfortable a firm is in meeting its interest obligations.

A) True B) False Ans: A Format: True/False Learning Objective: LO 3 Level of Difficulty: Hard Bloomcode: Analysis AASCB: Analytic IMA: FSA AICPA: Measurement 17. For a given share price of a firm's stock, the lower the EPS the lower the price-earnings ratio.

A) True B) False Ans: B

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Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 18. A firm that has no debt will have its return on assets (ROA) equal to its return on equity (ROE).

A) True B) False Ans: A Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: FSA AICPA: Measurement 19. For a given level of after-tax income, the lower the level of equity a firm has, the higher the return on equity its shareholders will earn.

A) True B) False Ans: A Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 20. The DuPont equation relates a firm's net profit margin, total asset turnover ratio, and equity multiplier to determine its return on equity.

A) True B) False Ans: A

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Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 21. Firms with a lower return on assets (ROA) and higher leverage will have a lower return on equity (ROE) than firms with a higher return on assets (ROA) and lower leverage.

A) True B) False Ans: B Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 22. In a peer group analysis, the benchmark for financial statement analysis is the performance of a competitor that is roughly the same size and that offer a similar range of products.

A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehenison AASCB: Analytic IMA: FSA AICPA: Measurement 23. While doing an industry group analysis, you form the comparison group by choosing firms that are larger than the firm being compared.

A) True B) False Ans: B Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement

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24. The Standard Industrial Classification (SIC) codes are four-digit numbers in which the last two digits describe the type of business or industry in which the firm is engaged.

A) True B) False Ans: B Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: FSA AICPA: Measurement 25. The three different perspectives on financial statement analysis are those of the: A) manager, regulator, and bondholder.

B) manager, shareholder, and creditor.

C) regulator, shareholder, and creditor.

D) shareholder, creditor, and regulator.

Ans: B Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 26. Shareholders analyze financial statements in order to: A) assess the cash flows that the firm will generate from its operations.

B) determine the firm's profitability, their return for that period, and the dividend they are C) likely to receive.

D) focus on the value of the stock they hold.

All of the above Ans: D Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 27. The creditors of a firm analyze financial statements so that they can focus on: A) the firm's amount of debt.

B) the firm's ability to generate sufficient cash flows to meet its legal obligations first and still have sufficient cash flows to meet debt repayment and interest payments.

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C) the firm's ability to meet its short-term obligations.

D) All of the above.

Ans: D Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 28. A firm's management analyzes financial statements so that: A) they can get feedback on their investing, financing, and working capital decisions by identifying trends in the various accounts that are reported in the financial statements.

B) similar to shareholders, they can focus on profitability, dividend, capital appreciation, C) and return on investment.

D) they can get more stock options.

Both a and b Ans: D Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: FSA AICPA: Measurement 29. Anyone analyzing a firm's financial statements should: A) use audited financial statements.

B) do a trend analysis.

C) perform a benchmark analysis.

D) All of the above.

Ans: D

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Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement of the 30. An individual analyzing a firm's financial statements should do all butone which following?

A) Use unaudited financial statements B) Perform a trend analysis C) Perform a benchmark analysis D) Compare the firm's performance to that of its direct competitors Ans: A Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 31. Which of the following is NOT true of common-size balance sheets?

A) Each asset and liability item on the balance sheet is standardized by dividing it by total assets.

B) Balance sheet accounts are represented as percentages of total assets.

C) Each asset and liability item on the balance sheet is standardized by dividing it by sales.

D) Common-size balance sheets allow us to make meaningful comparisons between the balance sheets of two firms that are different in size.

Ans: C Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 32. Which of the following is NOT true of common-size income statements?

A) Each income statement item is standardized by dividing it by total assets.

B) Income statement accounts are represented as percentages of net sales.

C) Each income statement item is standardized by dividing it by net sales.

D) Common-size income statements analysis is a specialized application of ratio analysis.

Ans: A

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Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 33. Common-size financial statements: A) are a specialized application of ratio analysis.

B) allow us to make meaningful comparisons between the financial statements of two firms C) that are different in size.

D) are prepared by having each financial statement item expressed as a percentage of some base number, such as total assets or total revenues.

All of the above are true.

Ans: D Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 34. Which of the following is a benefit of a common-size income statement?

A) It is very useful to assess how effectively a firm collected its accounts receivable.

B) It reveals a great deal of information about the adequacy of a firm’s net working capital.

C) It can tell the analyst a great deal about a firm’s efficiency and profitability.

D) It reveals how effectively a firm has increased its assets.

Ans: C Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 35. Which of the following is true of ratio analysis?

A) A ratio is computed by dividing one balance sheet item or income statement item by another.

B) The choice of the scale determines the story that can be garnered from the ratio.

C) D) Ratios can be calculated based on the type of firm being analyzed or the kind of analysis being performed.

All of the above are true.

Ans: D

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 36. Which of the following is NOT true of liquidity ratios?

A) They measure the ability of a firm to meet short-term obligations with short-term assets without putting the firm in financial trouble.

B) There are two commonly used ratios to measure liquidity—current ratio and quick ratio.

C) For manufacturing firms, quick ratios will tend to be much larger than current ratios.

D) The higher the liquidity ratios, the more liquid the firm and the better its ability to pay its short-term bills.

Ans: C Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 37. Which of the following is true about the quick ratio?

A) The quick ratio is calculated by dividing the least liquid of current assets by current liabilities.

B) Service firms that tend not to carry too much inventory will see significantly higher C) quick ratios than current ratios.

D) Inventory, being not very liquid, is subtracted from total current assets to determine the most liquid assets.

Quick ratios will tend to be much larger than current ratio for manufacturing firms or other industries that have a lot of inventory.

Ans: C

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 38. Which of the following does NOT change a firm's current ratio?

A) The firm collects its accounts receivables.

B) The firm purchases inventory by taking a short-term loan.

C) The firm pays down its accounts payables.

D) None of the above.

Ans: A Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 39. All else being equal, which of the following will decrease a firm's current ratio?

A) A decrease in the net fixed assets B) A decrease in depreciation expense C) An increase in accounts payable D) None of the above Ans: C Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 40. Which of the following is NOT true about the inventory turnover ratio?

A) It is calculated by dividing inventory by cost of goods sold.

B) It measures how many times the inventory is turned over into saleable products.

C) The more times a firm can turnover its inventory, the better.

D) Too high a turnover or too low a turnover could be a warning sign.

Ans: A Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension

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AASCB: Analytic IMA: FSA AICPA: Measurement 41. Which one of the following statements is NOT true?

A) The accounts receivables turnover ratio measures how quickly the firm collects its credit B) C) sales.

D) One ratio that measures the efficiency of a firm's collection policy is day’s sales outstanding.

The more days that it takes a firm to collect on its receivables, the more efficient the firm is.

Day’s sales outstanding measures in days, the time a firm takes to convert its receivables into cash.

Ans: C Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 42. Which of the following statements is NOT true of the asset turnover ratio?

A) Asset turnover ratio measures the dollar amount of sales per dollar of assets that the firm has.

B) The fixed assets turnover ratio is less significant for equipment-intensive manufacturing C) industry firms than the total assets turnover ratio.

D) The higher the total asset turnover, the more efficiently management is using total assets.

The ratio is quite useful in identifying the inefficient use of current and long-term assets.

Ans: B Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 43. Which of the following statements is correct?

A) The lower the level of a firm's debt, the higher the firm's leverage.

B) The lower the level of a firm's debt, the lower the firm's equity multiplier.

C) The lower the level of a firm's debt, the higher the firm's equity multiplier.

D) The tax benefit from using debt financing reduces a firm's risk.

Ans: B

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: FSA AICPA: Measurement 44. If firm A has a higher debt-to-equity ratio than firm B, then: A) firm A has a lower equity multiplier than firm B. B) firm B has a lower equity multiplier than firm A. C) firm B has higher financial leverage than firm A. D) None of the above.

Ans: B Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 45. Which one of the following statements is NOT correct?

A) A leveraged firm is riskier than a firm that is not leveraged.

B) A leveraged firm is less risky than a firm that is not leveraged.

C) A firm that uses debt magnifies the return to its shareholders.

D) A firm that does not use debt incurs opportunity cost of increasing value of shares.

Ans: B Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 46. Coverage ratios, like times interest earned and cash coverage ratio, allow: A) a firm's management to assess how well they meet short-term liabilities.

B) a firm's shareholders to assess how well the firm will meet its short-term liabilities.

C) a firm's creditors to assess how well the firm will meet its interest obligations.

D) a firm's creditors to assess how well the firm will meet its short-term liabilities other than interest expense.

Ans: C

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 47. Lionel, Inc., has current assets of $623,122, including inventory of $241,990, and current liabilities of $378,454. What is the quick ratio? Round your final answer to two decimal places.

A) 1.65 B) 0.64 C) 1.01 D) None of the above Ans: C Feedback: Current assets = $623,122 Current liabilities = $378,454 Inventory = $241,990

Current assets - Inventory Current liabilities $623,122 − $241, 990 = $378, 454 = 1.01

Quick ratio=

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 48. Bathez Corp. has receivables of $334,227, inventory of $451,000, cash of $73,913, and accounts payables of $469,553. What is the firm's current ratio? Round your final answer to two decimal places.

A) 1.83 B) 0.73 C) 1.67 D) None of the above Ans: A Feedback: Current assets = $73,913 + $451,000 +$334,227 = $859,140 Current liabilities = $469,553

Current assets Current liabilities $859, 140 = $469, 553 = 1.83

= Current ratio

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 49. Zidane Enterprises has a current ratio of 1.92, current liabilities of $272,934, and inventory of $197,333. What is the firm's quick ratio? Round your final answer to two decimal places.

A) 0.72 B) 1.20 C) 1.92 D) None of the above Ans: B Feedback: Current ratio = 1.92 times Current liabilities = $272,934 Inventory = $197,333

Current assets Current ratio= Current liabilites Current assets 1.92 = Current liabilites Current assets = 1.92$272,934=$524,033 Current assets - Inventory Quick ratio= Current liabilities $524, 033 − $197, 333 = $272, 934 = 1.20

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 50. Ronaldinho Trading Co. is required by its bank to maintain a current ratio of at least 1.75, and its current ratio now is 2.1. The firm plans to acquire additional inventory to meet an unexpected surge in the demand for its products and will pay for the inventory with short-term debt. How much inventory can the firm purchase without violating its debt agreement, if their total current assets equal $3.5 million? Round your final answer to the nearest dollar.

A) $0 B) $777,777 C) $1 million D) None of the above Ans: B Feedback: Let "X" represent the additional borrowing against the firm's line of credit (which also equals the addition to current assets). We can solve for that level of "X" that forces the firm's current ratio to be at 1.75 $3,500,000 / Current liabilities = 2.1 Current liabilities = $1,666,667 1.75 = ($3,500,000 + X) / ($1,666,667 + X) (1.75 × $1,666,667) + 1.75X = $3,500,000 + X 0.75X = $3,500,000 − $2,916,667 X = $777,777

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 51. If Randolph Corp. has accounts receivables of $654,803 and net sales of $1,932,349, what is its accounts receivable turnover? Round your final answer to two decimal places.

A) 0.34 times B) 1.78 times C) 2.95 times D) None of the above Ans: C Feedback: Accounts receivables = $654,803 Net sales = $1,932,349

Net sales = Accountsreceivables turnover Accounts receivables $1,932,349 = $654, 803 = 2.95 times

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 52. If Viera, Inc., has an accounts receivable turnover of 3.9 times and net sales of $3,436,812, what is its level of receivables? Round your final answer to the nearest dollar.

A) $881,234 B) $13,403,567 C) $1,340,357 D) $81,234 Ans: A Feedback: Accounts receivables turnover = 3.9 times Net sales = $3,436,812 Accounts receivables turnover = 3.9 = Accountsreceivables =

.

= $881,234

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 53. Gateway Corp. has an inventory turnover ratio of 5.6. What is its day’s sales in inventory?

Round your final answer to nearest day.

A) 65 days B) 64 days C) 61 days D) 57 days Ans: A Feedback: Inventory turnover ratio = 5.6 times

= Day ' ssales in inventory

.

365 = 65.2 days 5.6

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 54. Jet, Inc., has net sales of $712,478 and accounts receivable of $167,435. What are the firm's accounts receivable turnover and day’s sales outstanding? Round your accounts receivable turnover to two decimal places and day’s sales outstanding to nearest day.

A) 0.24 times; 79 days B) 4.26 times; 86 days C) 5.2 times; 61 days D) None of the above.

Ans: B Feedback: Net sales = $712,478 Accounts receivable = $167,435

Net sales = Accounts receivable turnover Accounts receivable

$712, = 4.26 times .

478 $167, Day’s sales outstanding = 365 ÷ Accounts receivable turnover 435 =

= 365 ÷ 4.26 = 85.7 days

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 55. Ellicott City Manufacturers, Inc., has sales of $6,344,210, and a gross profit margin of 67.3 percent. What is the firm's cost of goods sold? Round your final answer to the nearest dollar.

A) $2,074,557 B) $2,745,640 C) $274,560 D) None of the above.

Ans: A Feedback: Sales = $6,344,210 Gross profit margin = 67.3

Sales-Cost of goods sold Sales $6,344,210−Cost of Goods Sold 0.673 = $6,344,210 = $6, 344, 210 − (0.673  $6, 344, 210) Cost of goods sold = $2, 074, 557

= Gross profit margin

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 56. Deutsche Bearings has total sales of $9,745,923, inventories of $2,237,435, cash and equivalents of $755,071, and day’s sales outstanding of 49 days. If the firm's management wanted its day’s sales outstanding (DSO) to be 35 days, by how much will the accounts receivable have to change? Round your final answer to two decimal places.

A) $373,816.23 B) −$373,816.23 C) −$379,008.12 D) $379,008.12 Ans: B Feedback: Sales = $9,745,923; Inventory = $2,237,435 Cash and equivalents = $755,071; DSO = 49 Days

365 365 = Net sales/Accounts recievable Accounts recievable turnover 365Accounts recievables DSO= Net sales DSO Net sales 49$9,745,923 = = Accounts recievables 365 365 =$1,308,356.79 Target DSO= 35 Days DSO Net sales 359,745,923 = New accounts recievables= 365 365 = $934, 540.56  Accounts recievables=$1,308,356.79-$934,540.56 DSO=

-$373, 816.23

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 57. Trident Corp., has debt of $3.35 million with an interest rate of 6.875 percent. The company has an EBIT of $2,766,009. What is its times-interest-earned ratio? Round your final answer to nearest number.

A) 13 times B) 12 times C) 11 times D) None of the above Ans: B Feedback: Debt = $3.35 million Interest Rate = 6.875 percent EBIT = $2,766,009 Interest expense = $3,350,000 × 0.06875 = $230,312.50

$2, 766, 009 EBIT = = Interest Times interest earned expense $230, 312.50 = 12 times

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 58. Sectors, Inc., has an EBIT of $7,221,643 and interest expense of $611,800. Its depreciation for the year is $1,434,500. What is its cash coverage ratio? Round your final answer to two decimal places.

A) 15.42 times B) 18.34 times C) 14.15 times D) None of the above Ans: C Feedback: Depreciation = $1,434,500 Interest expenses = $611,800 EBIT = $7,221,643

EBIT + Depreciation EBITDA = Interest = Cash coverage rates expense Interest expense $7, 221, 643 + $1, 434, 500 = $611, 800 = 14.15 times

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 59. Fahr Company had depreciation expenses of $630,715, interest expenses of $112,078, and an EBIT of $1,542,833 for the year ended June 30, 2006. What are the times interest earned and cash coverage ratios for this company? Round your final answers to one decimal place.

A) 19.4 times; 12.7 times B) 17.3 time; 11.4 times C) 13.8 times; 19.4 times D) None of the above Ans: C Feedback: Depreciation = $630,715 Interest expenses = $112,078 EBIT = $1,542,833

EBIT = $1,542,833 = Interest Times interest earned expense $112, 078 = 13.8 times EBIT + Depreciation EBITDA = Interest = Cash coverage rates expense Interest expense =

$1, 542, 833 + $630, 715 $112, 078

= 19.4 times

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 60. Your firm has an equity multiplier of 2.47. What is its debt-to-equity ratio? Round your final answer to two decimal places.

A) 0.60 B) 1.47 C) 1.74 D) 3.47 Ans: B Feedback: Equity multiplier = 2.47 Equity multiplier = 1 + Debt-to-equity Debt-to-equity = Equity multiplier – 1 = 2.47 – 1 = 1.47 Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 61. What will be a firm's equity multiplier given a debt ratio of 0.45? Round your final answer to two decimal places.

A) 1.82 B) 1.28 C) 2.22 D) None of the above Ans: A Feedback: Debt Ratio = 0.45

Equity multiplier=

Total assets= Equity

1 Equity/Total assets

1 1 = 1− Debt/Total assets1− 0.45 = 1.818

=

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard 62. Dreisen Traders has total debt of $1,233,837 and total assets of $2,178,990. What are the firm's equity multiplier and debt-to-equity ratio? Round your final answers to two decimal places.

A) 2.31; B) 1.31 C) 1.75; D) 0.75 Ans: A0.75; 1.75 Feedback: Debt =1.31; $1,233,837 2.31 = $2,178,990 Total Assets Debt ratio = $1,233,837 ÷ $2,178,990 = 0.57 Equity multiplier = Total assets ÷ Equity = 1 ÷ (Equity / Total assets) = 1 ÷ (1 – Debt / Total assets) = 1 ÷ (1 – 0.57) = 2.31 Equity multiplier = 1 + (Debt-to-equity) Debt-to-equity ratio = Equity multiplier – 1 = 2.31 – 1 = 1.31

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 63. RTR Corp. has reported a net income of $812,425 for the year. The company's share price is $13.45, and the company has 312,490 shares outstanding. Compute the firm's price-earnings ratio. Round your final answer to two decimal places.

A) 4.87 times B) 8.12 times C) 5.17 times D) None of the above Ans: C Feedback: Net income = $812,425 Share price = $13.45 Shares outstanding = 312,490 EPS = $812,425 ÷ 312,490 = $2.60 per share

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 64. Perez Electronics Corp. has reported that its net income for 2006 is $1,276,351. The firm has 420,000 shares outstanding and a PE ratio of 11.2 times. What is the firm's share price?

Round your intermediate and final answer to two decimal places.

A) $34.05 B) $3.68 C) $11.20 D) $36.80 Ans: A Feedback: Net income = $1,276,351 Share outstanding = 420,000 EPS = $1,276,351 ÷ 420,000 = $3.04 per share PE ratio = 11.2 times Price-earnings ratio = Price per share ÷ EPS 11.2 = Price per share ÷ $3.04 Price per share = 11.2 × $3.04 = $34.05

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 65. Juventus Corp has total assets of $4,744,288, total debt of $2,912,000, and net sales of $7,212,465. Their net profit margin for the year is 18 percent. What is Juventus's return on assets (ROA)? Round intermediate calculations to nearest dollar and percentage answer to one decimal place.

A) 25.6% B) 18% C) 27.4% D) None of the above Ans: C Feedback: Total assets= $4,744,288; Total debt= $2,912,000 Net sales= $7,212,465; Net profit margin= 18%

= Net income Net profit margin Sales = Net income 0.18  $7, 212, 465 = $1, 298, 244 Net income Total assets $1, 298, = ROA= = 27.4% $4, 244 744, 288

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 66. GenTech Pharma has reported the following information: Sales/Total assets = 2.89; ROA = 10.74%; ROE = 20.36% What are the firm's profit margin and equity multiplier? Round your profit margin answer to one decimal place, and equity multiplier answer to 2 decimal places.

A) 7.1%; 0.53 B) 7.1%; 1.90 C) 3.7%; 0.53 D) 3.7%; 1.90 Ans: D Feedback: Total assets turnover = 2.89 ROA = Net income ÷ Total assets = 10.74% ROE = Net income ÷ Total equity = 20.36% (1÷ROA) * Total assets turnover = 1 ÷ Profit margin 9.31 * 2.89 = 1 ÷ Profit margin Profit margin = 3.7% Equity multiplier = Total assets ÷ Total equity Equity multiplier = ROE ÷ ROA

ROE 0.203 = 1.90 Equity multiplier= ROA = 6 0.107 4

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 67. Tigger Corp. has reported the financial results for the year-ended 2006. Based on the information given, calculate the firm's gross profit margin and operating profit margin. Round your final answers to one decimal place.

Net sales = $4,156,700 Cost of goods sold = $2,715,334 A) 34.7%; 32.6% B) 32.6%; 18.7% C) 34.7%; 18.7% D) None of the above.

Ans: A Feedback: Net sales = $4,156,700 Net income = $778,321 Cost of goods sold = $2,715,334 EBIT = $1,356,098

Net income = $778,321 EBIT = $1,356,098

- Cost of goods sold = Net salesNet Gross profit margin sales =

$4,156, 700 − $2, 715, 334 = 34.6757% $4,156, 700

EBIT = $1, 356, = Net = 32.6243% Operating profit margin sales 098 $4,156, 700

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 68. Andrade Corp has debt of $2,834,950, total assets of $5,178,235, sales of $8,234,121, and net income of $812,355. What is the firm's return on equity? Round your final answer to one decimal place.

A) 7.1% B) 34.7% C) 28.1% D) 43.2% Ans: B Feedback: Debt = $2,834,950 Sales = $8,234,121 Total Assets = $5,178,235 Net Income = $812,355 Total equity = Total assets – Total liabilities = $5,178,235 − $2,834,950 = $2,343,285 Return on equity = Net income ÷ Total equity = ($812,355 ÷ $2,343,285 ) = 34.67%

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: FSA AICPA: Measurement 69. Why is the quick ratio considered by some to be a better measure of liquidity than the current ratio?

A) The quick ratio more accurately reflects a firm's profitability.

B) It omits the least liquid current asset from the numerator of the ratio.

C) The current ratio does not include accounts receivable.

D) It measures how "quickly" cash flows through the firm.

Ans: B Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 70. In the latest year, Photon, Inc. reported $276,000 in net income. The firm maintains a debt ratio of 30% and has total assets of $3,000,000. What is Photon's return on equity? (Round your percentage answer to one decimal place.)

A) 13.1% B) 14.6% C) 22.5% D) 18.7% Ans: A Feedback: Net Income = $276,000 Debt Ratio = 30% Total assets = $3,000,000

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 71. Which of the following is true of a firm that has no debt in its capital structure?

Its return on equity (ROE) will be greater than its return on asset (ROA).

A) Its return on equity (ROE) will be lesser than its return on asset (ROA).

B) Its return on equity (ROE) will be equal to its return on asset (ROA).

C) None D)of the above.

Ans: C Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 72. Which of the following is true of a firm that has both debt and equity?

A) Its return on equity (ROE) will be greater than its return on asset (ROA).

B) Its return on equity (ROE) will be lesser than its return on asset (ROA).

C) Its return on equity (ROE) will be equal to its return on asset (ROA).

D) None of the above.

Ans: A Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 73. Which one of the following statements is NOT correct?

A) The DuPont system is based on two equations that relate a firm's return on asset (ROA) and return on equity (ROE).

B) The DuPont system is a set of related ratios that links the items of balance sheet and the C) income statement.

D) Both management and shareholders can use this tool to understand the factors that drive a firm's return on equity (ROE).

All of the above are correct.

Ans: D

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: FSA AICPA: Measurement 74. The DuPont equation shows that a firm's (return on equity) ROE is determined by three factors: A) net profit margin, total asset turnover, and the equity multiplier.

B) operating profit margin, return on assets (ROA), and the total assets turnover.

C) net profit margin, total asset turnover, the return on assets (ROA).

D) return on assets (ROA), total assets turnover, and the equity multiplier.

Ans: A Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: FSA AICPA: Measurement 75. Which one of the following is a criticism of equating the goals of maximizing the return on equity (ROE) of a firm and maximizing the firm's shareholder wealth?

A) ROE is based on after-tax earnings, not cash flows.

B) ROE does not consider risk.

C) ROE ignores the size of the initial investment as well as future cash flows.

D) All of the above are criticisms of ROE as a goal.

Ans: D Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 76. Which one of the following is NOT an advantage of using return on equity (ROE) as a goal?

A) ROE is highly correlated with shareholder wealth maximization.

B) ROE and the DuPont analysis allow management to break down the performance and C) identify areas of strengths and weaknesses.

D) ROE does not consider risk.

All of the above are advantages of using ROE as a goal.

Ans: C

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 77. Saunders, Inc., has a ROE of 18.7 percent, an equity multiplier of 2.53 times, sales of $2.75 million, and a total assets turnover of 2.7 times. What is the firm's net income? Round your final answer to two decimal places.

A) $75,281.80 B) $514,250.00 C) $51,425.00 D) $7,528.10 Ans: A Feedback: ROE = 18.7 percent Equity multiplier = 2.53 times Sales = $2.75 million Total assets turnover = 2.7 times

Sales = $2,750,000 = Total assets turnover Total assets Total assets $2, 750, 000 2.7 = Total assets $2,750,000 = $1, 018, 518.52 Total assets= 2.7

Total assets Equity $1,018,518.52 2.53= Equity EM =

Equity =

$1,018,519 = $402, 576.49 2.53

Net income Equity Net income= ROE  Equity = 0.187  $402, 577 = $75, 281.80 ROE =

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: FSA AICPA: Measurement 78. Sorenstam Corp. has an equity multiplier of 2.34 times, total assets of $4,512,895, a ROE of 17.5 percent, and a total assets turnover of 3.1 times. Calculate the firm's ROA. Round your percentage answer to two decimal places.

A) 6.23% B) 4.53% C) 7.48% D) 5.79% Ans: C Feedback: Equity multiplier = 2.34 times Total assets = $4,512,895 ROE = 17.5 percent Total assets turnover = 3.1 times

Sales = Total assets turnover Total assets Sales 3.1= $4, 512, 895 = $13, 989, 975 Sales= 3.1 $4, 512, 895 Total assets Equity $4, 512, 895 2.34= Equity $4, 512, 895 = $1, 928, 588 Equity = 2.34 EM =

NI Equity NI = R  OE Equity = 0.175 $1,928,588 = $337, 503

ROE =

ROA=

NI = $337, 503 = 7.48% Total assets $4, 512, 895

Format: Multiple Choice

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Fundamentals of Corporate Finance 3e

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Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: FSA AICPA: Measurement 79. There are people who believe that the analysis of financial statements has limitations. Which of the statements below would qualify as a limitation of financial statement analysis?

Ratio analysis requires the analyst to evaluate a firm’s performance over a period of time A) B) to be of any value.

C) Proper ratio analysis requires the analyst to rely upon audited financial statements, which D) can be easily manipulated.

Thorough ratio analysis requires the analyst to refer to benchmarking, which is very easy to misinterpret.

Ratio analysis requires the analyst to utilize accounting data that is based on historical costs instead of current market values.

Ans: D Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 80. Which one of the following statements about trend analysis is NOT correct?

A) The benchmark for trend analysis is based on a firm's historical performance.

B) It allows management to examine each ratio over time and determine whether the trend C) is good or bad for the firm.

D) It uses the Standard Industrial Classification (SIC) System to benchmark firms.

A ratio value that is changing typically prompts the financial manager to sort out the issues surrounding the change.

Ans: C

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Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 81. Peer group analysis can be performed by: A) management choosing a set of firms that are similar in size or sales, or who compete in the same market.

B) using the average ratios of this peer group, which would then be used as the benchmark.

C) D) identifying firms in the same industry that are grouped by size, sales, and product lines in order to establish benchmark ratios.

Only a and b relate to peer group analysis.

Ans: D Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 82. Which of the following is NOT a method of “benchmarking”?

A) Conducting an industry group analysis.

B) Utilizing the DuPont system to analyze a firm’s performance.

C) Evaluating a single firm’s performance over time.

D) Identifying a group of firms that compete with the company being analyzed.

Ans: B Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Comprehehension AASCB: Analytic IMA: FSA AICPA: Measurement 83. Which of the following is a limitation of ratio analysis?

A) Ratios depend on accounting data based on historical costs.

B) Differences in accounting practices like FIFO versus LIFO make comparison difficult.

C) Trend analysis could be distorted by financial statements affected by inflation.

D) All of the above are limitations of ratio analysis.

Ans: D

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Format: Essay Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Analysis AASCB: Analytic IMA: FSA AICPA: Measurement 84. Compare how a firm's creditor would analyze a firm's financial statements relative to those of a firm's shareholders.

Ans: A firm's creditors’ primary concern is the ability of the firm to repay their loans with interest on a timely manner. They analyze the firm's financial statements to gauge the ability of the firm to generate sufficient cash flows to meet not only the legal financial obligations, but also the creditors’ debt obligations. Shareholders, on the other hand, want to know how much cash they can expect to receive for their stocks, what their return on investment will be, and/or how much their stock is worth in the market.

Format: Essay Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 85. What are some of the main limitations of ratio analysis?

Ans: While financial ratio analysis can provide management with useful information to improve a firm's performance, there are some serious limitations to its usefulness. First, ratio analysis depends on accounting data based on historical costs. Management or investors will get a truer picture of the firm's financial condition if market value is the basis of the analysis.

Second, there is no theoretical backing in making judgments based on financial statement and ratio analysis. Judgment calls made based on experience or common sense will not work all the time. Third, when doing industry or peer group analysis you are often confronted with large, diversified firms that do not fit into any one SIC code or classification. Fourth, trend analysis could be distorted by financial statements affected by inflation. Finally, multinational firms deal with many accounting standards. Financial reports that are created based on different accounting standards make it difficult to compare. Even among domestic firms, differences in accounting practices, like FIFO versus LIFO, make comparison difficult.

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Fundamentals of Corporate Finance 3e

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Format: Essay Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: FSA AICPA: Measurement 86. Explain the different ways that a firm's ratios can be benchmarked.

Ans: Benchmark data can be obtained in three different ways—trend analysis, industry average analysis, and peer group analysis. Trend analysis involves evaluating a single firm's performance over time. This sort of analysis allows management to see whether a given ratio value has increased or decreased over time and whether there has been any significant changes in the value of the ratios being analyzed. A ratio value that is changing typically is a signal to the financial manager to take a closer look at the ratio and to make decisions depending on whether the change is favorable or unfavorable to the firm.

A second way to establish a benchmark is to conduct an industry group analysis. We do this by identifying a group of firms that have the same product line, compete in the same market, and are about the same size. The average ratio values for the group will be our benchmarks.

The third way to establish benchmark information is to identify a group of firms that compete with the company you are analyzing. Ideally, the firms are in similar lines of business, are about the same size, and are direct competitors of the target firm. These firms form a peer group of firms in the same industry. Once a peer group has been identified, you can obtain their annual reports and compute average ratio values and can compare its performance with the competitors’.

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Fundamentals of Corporate Finance 3e

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Chapter 5: The Time Value of Money Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 1. The time value of money is based on the belief that people have a positive time preference for consumption.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 2. The value of a dollar invested at a positive interest rate grows over time.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 3. The value of a dollar invested at a positive interest rate grows over time but at a slower rate further into the future.

A) True B) False Ans: B

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Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 4. The further in the future you receive a dollar, the more it is worth today.

A) True B) False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 5. The higher the rate of interest, the more likely you will elect to invest your funds and forgo current consumption.

A) True B) False Ans: A Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 6. The future value technique uses discounting to find the future value of each cash flow at the end of a project's life.

A) True B) False Ans: B

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 7. The process of converting the initial amount into future value is called discounting.

A) True B) False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 8. Compounding is the process by which interest earned on an investment is reinvested so that in future periods, interest is earned on the interest previously earned as well as the original principal.

A) True B) False Ans: A Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 9. Compound interest consists of both simple interest and interest on interest.

A) True B) False Ans: A

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Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 10. Compound interest increases as the number of year decreases.

A) True B) False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 11. Compounding accelerates the growth of the total interest earned.

A) True B) False Ans: A Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 12. Due to compounding effects, the growth in the future value of an investment over time is linear.

A) True B) False Ans: B

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 13. The growth in the future value of an investment over time is not linear, but exponential.

A) True B) False Ans: A Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 14. William invested $5,000 in an account earning 10 percent for one year. If he had left his investment in that account for another two years, he would expect the total interest earned over the three years to be higher by exactly $1,000.

A) True B) False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 15. The higher the interest rate on an investment, the more money that is accumulated for any time period.

A) True B) False Ans: A

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Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 16. The more frequently the interest payments are compounded, the larger the future value of $1 for a given time period.

A) True B) False Ans: A Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 17. If Bank A pays interest on a monthly basis and Bank B pays the same interest on a quarterly basis, then investing $1,000 in Bank B will lead to a higher future value than investing the same amount in Bank A. A) True B) False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 18. The future value of an investment of $5,000 earning an annual interest of 10 percent equals $6,000 at the end of one year.

A) True B) False Ans: B

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 19. The future value of an investment of $5,000 to be received in three years at a discount rate of 10 percent is $6,655.

A) True B) False Ans: A Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 20. The future value factor for 10 years at 15% is calculated as (1 10 +.0.15) A) True B) False Ans: A Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 21. To calculate the present value of a future amount, we divide the future amount by the future value factor.

A) True B) False Ans: A

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Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 22. The present value is simply the current value of a future cash flow that has been discounted at an appropriate discount rate.

A) True B) False Ans: A Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 23. The present value technique uses discounting to find the present value of each cash flow at the beginning of a project.

A) True B) False Ans: A Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 24. The present value factor increases as the number of period decreases.

A) True B) False Ans: A

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5-8

Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 25. The process of calculating the present value of a future cash flow is called compounding.

A) True B) False Ans: B Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 26. The present value of $3,000 to be received in two years at a discount rate of 10 percent is $3,630.

A) True B) False Ans: B Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comrpehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 27. The higher the discount rate, the lower the present value of a future cash flow.

A) True B) False Ans: A

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5-9

Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 28. The farther in the future a dollar will be received, the less it is worth today.

A) True B) False Ans: A Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 29. If you had a choice of choosing a payment of $5,000 to be received in five years being discounted at 8 percent or at 10 percent, you should always choose the higher rate because it gives you the higher present value.

A) True B) False Ans: B Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 30. Future value focuses on the valuation of cash flows received over time, while present value focuses only on the valuation of cash flows received at a point in time.

A) True B) False Ans: B

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Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 31. The present value factor 1 / (1 + i)n is the reciprocal of the future value factor (1 + i)n.

A) True B) False Ans: A Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 32. The Rule of 72 allows one to calculate the return earned on an investment over six years.

A) True B) False Ans: B Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 33. The Rule of 72 allows one to calculate the approximate time needed to double an investment.

A) True B) False Ans: A

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Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 34. Compound growth occurs when the initial value of a number increases or decreases each period by the factor (1 + growth rate).

A) True B) False Ans: A Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 35. The compound annual growth rate (CAGR) is the average annual growth rate over a specified period of time.

A) True B) False Ans: A Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 36. The time value of money refers to the issue of: A) what the value of the stream of future cash flows is today.

B) why a dollar received tomorrow is worth more than a dollar received today.

C) what the time required to double an amount of money.

D) why people prefer to consume things at some time in the future rather than today.

Ans: A

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 37. Which of the following statements is true of the time value of money?

A) It means a dollar received today is worth less than a dollar received tomorrow.

B) It assumes that inflation rate remains constant for the foreseeable future.

C) It refers to the fact that higher cash flows in earlier years are less desirable.

D) It is based on the assumption that people prefer to consume things at some time in the future rather than today.

Ans: A Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 38. Which of the following statements is true?

A) The value of a dollar invested at a positive interest rate decreases over time.

B) The further in the future you receive a dollar, the less it is worth today.

C) A dollar in hand today is worth less than a dollar to be received in the future.

D) The higher the rate of interest, the more likely an investor will elect to consume at present and forgo invest his funds.

Ans: B

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 39. Which of the following statements is true of time value of money?

A) A dollar received today is worth more than a dollar to be received in the future because future dollars are not affected by inflation.

B) A dollar received today is worth less than a dollar to be received in the future because C) future dollars are not affected by inflation.

D) A dollar received today is worth more than a dollar to be received in the future because funds received today can be invested to earn a return.

A dollar to be received in the future is worth more than a dollar received today because it would have less risk associated with it.

Ans: C Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 40. Future value measures: A) what one or more cash flows are worth at the end of a specified period.

B) what one or more cash flows that is to be received in the future will be worth today.

C) the value of an investment after subtracting interest earned on it for one or more periods.

D) the value of an investment’s worth today.

Ans: A

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 41. Which of the following equations is used to compute the future value for continuous compounding?

A) FV ∞= P V × e i × n FV∞ = PV ÷ e i × n B) FV ∞= ei ÷ PV C) FV=∞ ei × PV D) Ans: A Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 42. The process of converting an amount given at the present time into a future value is called: A) annualizing.

B) discounting.

C) compounding.

D) capital budgeting.

Ans: C Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 43. Which of the following is true of the future value of an investment?

A) The higher the interest rate, the higher the future value of an investment.

B) The higher the inflation rate, the lower the future value of an investment.

C) The lower the number of compounding periods, the higher the future value of an investment.

D) The lower the present value of an investment, the higher the future value of an investment.

Ans: A

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Hard Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 44. Which of the following investments will have the highest future value?

A) $1,300 invested at an annual interest rate of 10% for 5 years B) $1,000 invested at an quarterly interest rate of 2.25% for 10 years C) $1,300 invested at an quarterly interest rate of 2.25% for 5 years D) $1,000 invested at an annual interest rate of 10% for 10 years Ans: D Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 45. Which of the following statements is true?

A) The longer the time period that funds are invested, the greater the future value.

B) The lower the discount rate that funds are invested at, the greater the future value.

C) The shorter the time period that funds are invested, the greater the future value.

D) The higher the interest rate, the slower the value of an investment will grow.

Ans: A

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Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 46. Joseph Ray just received an inheritance of $35,775 from his great aunt. He plans to invest the funds for retirement. If Joseph can earn 4.75% per year with quarterly compounding for 32 years, how much will he have accumulated? (Round off to the nearest dollar.)

A) $237,416 B) $71,550 C) $184,622 D) $162,113 Ans: D Feedback: Amount invested today = PV = $35,775 Frequency of compounding = m = 4 Interest rate = i = 4.75% ÷ 4 = 1.1875% Duration of investment = n = 32 years × 4 = 128 periods Value of investment after 7 years, or 128 periods = FV128 = $162,113.25 mn

4 32

 0.0475  i =$35,7751+ FV 32 = PV 1+    m 4   = $35,775 (1.011875)128 = $35,775 4.531467 = $162, 113.25

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 47. Your aunt is looking to invest a certain amount today. Which of the following choices will give the maximum interest?

A) Three-year CD at 6.5% annual rate B) Three-year CD at 6.75% annual rate C) Three-year CD at 6.25% annual rate D) Three-year CD at 7% annual rate Ans: D

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 48. You are interested in investing $15,000, a gift from your grandparents, for the next four years in a mutual fund that will earn an annual return of 8 percent. What will your investment be worth at the end of four years? (Round to the nearest dollar.)

A) $18,816 B) $20,407 C) $20,221 D) $18,089 Ans: B Feedback: Present value of the investment = PV = $15,000 Return on mutual fund = i = 8% No. of years = n = 4 0 1 2 3 4 ├───┼───┼───┼────┤ −$15,000 FV=?

FV=4 PV × (1 + i)n = $15,000 × (1.08)4 = $20,07.3 4 3

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5-18

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 49. Juan Vinson is planning to buy a house in five years. He is looking to invest $25,000 today in an index mutual fund that will provide him a return of 12 percent annually. How much will he have at the end of five years? (Round to the nearest dollar.)

A) $45,000 B) $28,000 C) $44,059 D) $28,530 Ans: C Feedback: Present value of the investment = PV = $25,000 Return on mutual fund = i = 12% No. of years = n = 5 0 1 2 3 4 5 ├───┼───┼───┼────┼───┤ –$25,000 FV = ?

5 FV 5= PV × (1 + i)n = $25,000 × (1.12) = $44,058.54

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 50. Carlos Lopes is looking to invest for the next three years. He is looking to invest $7,500 today in a bank CD that will earn interest at 5.75 percent annually. How much will he have at the end of three years? (Round to the nearest dollar.)

A) $8,870 B) $8,575 C) $8,681 D) $8,990 Ans: A Feedback: Present value of the investment = PV = $7,500 Interest rate on CD = i = 5.75% No. of years = n = 3 0 1 2 3 ├───┼───┼───┤ –$7,500 FV=?

FV 3 = PV (1+ i)n = $7,500(1.0.0575)3 $8, 869.57 =

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 51. Kevin Robertson would like to buy a condo in Florida in six years. He is looking to invest $75,000 today in a stock that is expected to earn a return of 18.3 percent annually. How much will he have at the end of six years? (Round to the nearest dollar.)

A) $205,575 B) $157,350 C) $184,681 D) $273,620 Ans: A Feedback: Present value of the investment = PV = $75,000 Return on stock = i = 18.3% No. of years = n = 6 0 1 2 3 4 5 6 ├───┼───┼────┼───┼───┼───┤ –$75,000 FV=?

FV 6 = PV (1+ i)n = $75,000(1.183)6 $205, 574.73 =

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Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 52. Lori Willis plans to invest for retirement, which she hopes will be in 20 years. She is planning to invest $25,000 today in U.S. Treasury bonds that will earn interest at 6.25 percent annually.

How much will she have at the end of 20 years? (Round to the nearest dollar.)

A) $68,870 B) $50,625 C) $84,046 D) $75,000 Ans: C Feedback: Present value of the investment = PV = $25,000 Return on Treasury bonds = i = 6.25% No. of years = n = 20 0 1 2 3 19 20 ├───┼───┼───┼……………─┼────┤ –$25,000 FV=?

20 FV 20= PV × (1 + i)n = $25,000 × (1.0625) = $84,046.34

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5-22

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 53. Your brother has asked you to help him to choose an investment. He has $6,000 to invest today for a period of two years. You identify a bank CD that pays an interest rate of 4.25 percent with the interest being paid quarterly. What will be the value of the investment in two years?

A) $6,550 B) $6,529 C) $6,107 D) $6,216 Ans: B Feedback: 0 2 years ├────────────────────┤ PV = $5,000 FV = ?

Amount invested today = PV = $6,000 Interest rate on CD = i = 4.25% Duration of investment = n = 2 years Frequency of compounding = m = 4 Value of investment after 4 years = FV4 2×4 FV=2 PV × (1 + i/mmn ) = $6,000 × (1 + (0.0425/4)) = $6,529.37

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5-23

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 54. Dynoxo Textiles has a cash inflow of $1 million, which it needs for a long-term investment, at the end of one year. It plans to deposit the money in a bank CD that pays daily interest at 4.50 percent. What will be the value of the investment at the end of the year? (Round to the nearest dollar.)

A) $1,020,475 B) $1,000,103 C) $1,037,500 D) $1,046,025 Ans: D Feedback: 0 1 ├────────────────────┤ PV = $1,000,000 FV = ?

Amount invested today = PV = $1,000,000 Interest rate on CD = i = 4.50% Duration of investment = n = 1 year Frequency of compounding = m = 365 Value of investment after 1 year = FV1 FV=1 PV × (1 + i/m)mn = $1,000,000 × (1 + (0.0450/365))365×1 = $1,046,024.96

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 55. Your mother is trying to choose one of the following bank CDs to deposit $10,000. Which will have the highest future value if she plans to invest for three years?

A) 3.50% compounded daily B) 3.25% compounded monthly C) 3.40% compounded quarterly D) 3.75% compounded annually Ans: D Feedback:

A) Interest rate on CD = i = 3.50% Frequency of compounding = m = 365 Value of investment after 3 years = FV3 FV 3= PV × (1+ i/m)m×n = $10,000 × (1+ 0.035/365)365×3 = $10,000 × (1.00009589)1,095 = $11,107.05 B) Interest rate on CD = i = 3.25% Frequency of compounding = m = 12 Value of investment after 3 years = FV3 12×3 36 FV 3= PV × (1+ i/mm×n ) = $10,000 × (1+ 0.0325/12) = $10,000 × (1.0027908333) = $11,022.66 C) Interest rate on CD = i = 3.40% Frequency of compounding = m = 4 Value of investment after 3 years = FV3 4×3 12 FV 3= PV × (1+ i/mm×n ) = $10,000 × (1+ 0.034/4) = $10,000 × (1.0085) = $11,069.06 D) Interest rate on CD = i = 3.75% Frequency of compounding = m = 1 Value of investment after 3 years = FV3

.

5-25

Fundamentals of Corporate Finance 3e

Test Bank

FV3 = PV × (1+ i/m)m×n = $10,000 × (1+ 0.0375) = $10,000 × (1.0375)3 = $11,167.71 Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 56. Lorene Buckley wants to invest $3,500 today in a money market fund that pays a quarterly interest at 5 percent. She plans to fund a scholarship with the proceeds at her alma mater, Towson University. How much will Lorene have at the end of seven years? (Round to the nearest dollar.)

A) $5,091 B) $3,849 C) $4,956 D) $5,075 Ans: C Feedback:

Amount invested today = PV = $3,500 Interest rate on money market account = i = 5% Duration of investment = n = 7 years Frequency of compounding = m = 4 Value of investment after 7 years = FV7 28 FV7 = PV × (1+ i/m)m×n = $3,500 × (1+0.05 4×7 / 4)= $3,500 × (1.0125) = $4,955.97

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Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 57. Paul Springer plans to save for a down payment for a house in 10 years. He will be able to invest $12,000 today in a money market account that will pay him an interest of 5.50 percent on a monthly basis. How much will he have at the end of 10 years?

A) $12,640 B) $20,773 C) $24,859 D) $23,080 Ans: B Feedback:

Amount invested today = PV = $12,000 Interest rate on money market account = i = 5.50% Duration of investment = n = 10 years Frequency of compounding = m = 12 Value of investment after 10 years = FV10 12×10 120 FV 10 = PV × (1+ i/mm×n ) = $12,000 × (1+0.0550/4) = $12,000 × (1.04583) = $20,772.92

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 58. Jack Palomo has deposited $2,500 today in an account paying 6 percent interest annually. What would be the simple interest earned on this investment in five years? If the account paid compound interest, what would be the interest on interest in five years?

A) $750; $95.56 B) $150; $845.56 C) $150; $95.56 D) $95.56; $845.56 Ans: A Feedback: Deposit today = PV = $2,500 Interest rate = i = 6% No. of years = n = 5 Simple interest: Simple interest per year = $2,500 × (0.06) = $150.00 Simple interest for 5 years = $150 × $750.00 5= Future value with compound interest: 5 FV 5 = $2,500 (1 + 0.06) = $3,345.56 Simple interest = $750 Interest on interest = $3,345.56 – $2,500 – $750 = $95.56

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5-28

Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 59. Camille Noah is investing $5,000 in an account paying 6.75 percent annually for three years.

What is the interest on interest if interest is compounded?

A) $1,012.5 B) 0 C) $1,082.3 D) 8 $82.38 Ans: D$69.88 Feedback: Deposit today = PV = $5,000 Interest rate = i = 6.75% No. of years = n = 3 Simple interest: Simple interest per year = $5,000 × (0.0675) = $337.50 Simple interest for 3 years = $337.50 × 3 = $1,012.50 Future value with compound interest: 3 FV 3 = $5,000 (1 + 0.0675) = $6,082.38 Simple interest = $1,012.50 Interest on interest = $6,082.38 – $5,000 – $1,012.50 = $69.88

.

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Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 60. Richard McLean wants to invest $3,000 in an account paying 5.25 percent compounded quarterly. What is the interest on interest after four years?

A) $695.98 B) $65.98 C) $630.00 D) $157.50 Ans: B Feedback: Deposit today = PV = $3,000 Interest rate = i = 5.25% No. of years = n = 4 Frequency of compounding = m = 4 Simple interest: Simple interest per year = $3,000 (0.0525) = $157.50 Simple interest for 4 years = $157.50 × 4 = $630 Future value with compound interest: mn

44

i    0.0525 FV 4 = PV 1+  =$3,0001+  m  4   = $3,000 (1.013125)16 = $3, 695.98

Simple interest = $630 Interest on interest = $3,695.98 – $3,000 – $630 = $65.98

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5-30

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 61. Dat Nguyen is depositing $17,500 in an account paying an annual interest rate of 8.25 percent compounded monthly. What is the interest on interest after six years?

A) $8,662.50 B) $10,925.44 C) $2,497.63 D) $1,092.48 Ans: C Feedback: Deposit today = PV = $17,500 Interest rate = i = 8.25% No. of years = n = 6 Frequency of compounding = m = 2 Simple interest: Simple interest per year = $17,500 (0.0825) = $1,443.75 Simple interest for 6 years = $1,443.75 × 6 = $8,662.50 Future value with compound interest: mn

126

 i  0.0825 =$17,5001+ FV 6 = PV 1+    m 12    = $17, 500 (1.006875)72 = $28, 660.13

Simple interest = $8,662.50 Interest on interest = $28,660.13 – $17,500 – $8,662.50 = $2,497.63

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5-31

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 62. Shawn Bowker invested $10,000 in a money market account that will pay 5.75 percent compounded daily. How much will the interest on interest be after two years?

A) $1,218.63 B) $1,150.00 C) $33.06 D) $68.63 Ans: D Feedback: Deposit today = PV = $10,000 Interest rate = i = 5.75% No. of years = n = 2 Frequency of compounding = m = 365 Simple interest: Simple interest per year = $10,000 (0.0575) = $575 Simple interest for 2 years = $575 × $1,150 2= Future value with compound interest: mn

3652

i    0.0575 FV 2 = PV 1+  =$10,0001+  m  365   = $10, 000 (1.000157534)730 = $11, 218.63

Simple interest = $575 Interest on interest = $11,218.63 – $10,000 – $1,150 = $68.63 Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 63. Which of the following equations is used to calculate the future value of an investment?

A) FV n= PV ÷ (1 + i) n B) FV n= PV × (1 + i) n FV n= (1 + ni) + PV C) FV n= (1 + ni) ÷ PV D)

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Ans: B Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 64. Which of the following equations is used to calculate the future value of an investment when interest is compounded m times a year?

FV n= PV ÷ (1 + )m×n A) i B) FV n= PV × (1 + i/m)m×n FV n= (1 + )m×n i C) + PV D) FV n= (1 + i)m×n÷ PV Ans: B

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 65. Joseph Harris is considering an investment that pays 6.5 percent annually. How much must he invest today such that he will have $25,000 in seven years? (Round to the nearest dollar.)

A) $17,474 B) $18,850 C) $16,625 D) $16,088 Ans: D Feedback: 0 7 years ├────────────────────┤ PV = ? i = 6.5% FV = $25,000 Value of investment after 7 years = FV7 = $25,000 Return expected from investment = i = 6.5% Duration of investment = n = 7 years Amount to be invested today = PV

PV=

.

FV n $25, 000 = =$16,087.66 i (1.065)7 (1+)n

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 66. Which of the following statements is true?

A) Present value calculations involve converting the initial amount into a future amount.

B) The present value (PV) is often called the compounded value of future cash payments.

C) The present value is calculated by using the discount factor.

D) The future value of an investment is the reciprocal of its present value.

Ans: C Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 67. When discount rate: A) decreases, the present value of the future cash flow does not change.

B) decreases, the present value of any future cash flow increases.

C) increases, the present value of any future cash flow increases.

D) increases, the present value of any future cash flow does not change.

Ans: B Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 68. When discount rate: A) increases, the present value of a future cash flow decreases.

B) increases, the present value of a future cash flow increases.

C) decreases, the present value of a future cash flow will remain the same.

D) decreases, the present value of a future cash flow decreases.

Ans: A

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 69. Which of the following statements is true with respect to the present value of a future amount?

A) The higher the discount rate, the higher the present value of a single sum for a given time period.

B) The relation between present value and time is exponential.

C) D) The greater the time period, the higher the present value of a single sum for a given interest rate.

The lower the discount rate, the lower the present value of a single sum for a given time period.

Ans: B Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 70. Juan and Rachel Burpo plan to buy a time-share in six years of $16,860. In order to have adequate funds to do so, the Burpo want to make a deposit to their money market fund today.

Assume that they will be able to earn an investment rate of 5.75%, compounded annually. How much will Juan and Rachel need to deposit today to achieve their goal? (Round off to the nearest dollar.)

A) $11,138 B) $8,885 C) $12,055 D) $14,243 Ans: C Feedback: Amount needed = FV = $16,860 Interest rate = i = 5.75% Duration of investment = n = 6 years Present Value = PV6 = $12,055.22

FV $16,860 PV6 = (1+ i)n = (1.0575)6 = $16, 860 1.398564 = $12, 055.22

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 71. Steve Fisher is saving for a new car. He needs to have $ 21,000 for the car in three years. How much will he have to invest today in an account paying 8 percent annually to achieve his target?

(Round to nearest dollar.)

A) $22,680 B) $26,454 C) $16,670 D) $19,444 Ans: C Feedback: 0 3 years ├────────────────────┤ PV = ? i = 8% FV = $21,000 Value of investment after 3 years = FV3 = $21,000 Return expected from investment = i = 8% Duration of investment = n = 3 years Amount to be invested today = PV

PV=

.

FV n $21, 000 = =$16,670.48 i (1.08)3 (1+)n

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 72. Jacob’s friend, Albert, borrows today with a promise to repay $7,418.87 in four years. If Jacob could earn 5.45 percent annually on the any investment he makes today, how much would he be willing to lend Albert today? (Round to nearest dollar.)

A) $6,000 B) $7,035 C) $6,500 D) $7,150 Ans: A Feedback: 0 4 years ├────────────────────┤ PV = ? i = 5.45% FV = $7,418.87 Loan repayment amount after 4 years = FV4 = $7,418.87 Return expected from loan = i = 5.45% Duration of loan = n = 4 years Amount to be loaned today = PV

PV=

.

FV n $7, 418.87 = =$6,000 i (1.0545)4 (1+)n

5-37

Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 73. Joyce Thomas wants to buy a house in six years. She hopes to have $25,000 at that time. If the bank CD she wants to invest in will pay 7.5 percent annually, how much will she have to invest today? (Round to the nearest dollar.)

A) $18,472 B) $13,987 C) $16,199 D) $23,256 Ans: C Feedback: 0 6 years ├────────────────────┤ PV = ? i = 7.5% FV = $25,000 Amount needed for down payment after 6 years = FV6 = $25,000 Return expected from investment = i = 7.5% Duration of investment = n = 6 years Amount to be invested today = PV

PV=

.

FV n

(1+) i

n

=

$25, 000 =$16,199 (1.075)6

5-38

Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 74. Robert Kelly wants to start a business in 10 years. He hopes to have $100,000 at that time to invest in the business. To reach his goal, he plans to invest a certain amount today in a bank CD that will pay him 9.50 percent annually. How much will he have to invest today to achieve his target? (Round to the nearest dollar.)

A) $54,233 B) $63,837 C) $91,324 D) $40,351 Ans: D Feedback: 0 10 years ├────────────────────┤ PV = ? i = 9.5% FV = $100,000 Value of investment after 10 years = FV10 = $100,000 Return expected from investment = i = 9.5% Duration of investment = n = 10 years Amount to be invested today = PV

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5-39

Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 75. Leroy Diaz plans to invest some money today so that he will receive $7,500 in three years. If the investment he is considering will pay 3.65 percent compounded daily, how much will he have to invest today?

A) $5,276 B) $6,722 C) $6,897 D) $7,140 Ans: B Feedback: 0 3 years ├────────────────────┤ PV = ? i = 3.65% FV = $7,500 Return expected from investment = i = 3.65% Duration of investment = n = 3 years Frequency of compounding = m = 365 Target investment proceeds in 3 years = FV3 = $7,500 Present value of amount = PV

PV =

FV3

mn

=

i   1+   m = $6, 722.15

.

$7, 500 $7, 500 = 3653 (1.0001)1095  0.0365  1+  365 

5-40

Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 76. You need to have $15,000 in five years to payoff a home equity loan. You can invest in an account that pays 5.75 percent compounded quarterly. How much will you have to invest today to attain your target in five years? (Round to the nearest dollar.)

A) $4,903 B) $11,275 C) $13,184 D) $12,250 Ans: B Feedback: 0 5 years ├────────────────────┤ PV = ? i = 5.75% FV = $15,000 Return expected from investment = i = 5.75% Duration of investment = n = 5 years Frequency of compounding = m = 4 Target investment proceeds in 5 years = FV5 = $15,000 Present Value of amount = PV

PV =

FV n

mn

=

$15, 000 = $15, 000 54 (1.014375)20  0.0575 + 1   4  

i   1+   m = $11, 275.10

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5-41

Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 77. Tamera Watson is saving for her daughter's college education. She wants to have $50,000 available when her daughter graduates from high school in four years. If the investment she is considering will pay 8.25 percent compounded monthly, how much will she have to invest today to reach her target? (Round to the nearest dollar.)

A) $35,987 B) $39,659 C) $41,275 D) $36,450 Ans: A Feedback: 0 4 years ├────────────────────┤ PV = ? i = 8.25% FV = $50,000 Return expected from investment = i = 8.25% Duration of investment = n = 4 years Frequency of compounding = m = 12 Target investment proceeds in 4 years = FV4 = $50,000 Present value of amount = PV

FV4

$50, 000 $50, 000 = 124 (1.006875)48 i    0.0825  + + 1  1  12   m  = $35, 986.80

PV =

.

mn

=

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 78. Michael Peterson is seeking to accumulate $25,000 in six years to invest in a real estate venture. He can earn 6.35 percent annual interest with monthly compounding in a private investment. How much will he have to invest today to reach his goal? (Round to the nearest dollar.)

A) $18,527 B) $23,015 C) $17,097 D) $19,648 Ans: C Feedback: 0 6 years ├────────────────────┤ PV = ? i = 6.35% FV = $25,000 Return expected from investment = i = 6.35% Duration of investment = n = 6 years Frequency of compounding = m = 12 Target investment proceeds in 6 years = FV6 = $25,000 Present value of amount = PV 12×6 PV = FV /n (1+i/m)mn= $25,000 / (1+(0.005292/12)) = $17,096.61

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 79. Celesta Frank wants to go on a cruise in three years. She could earn 8.2 percent compounded monthly in an account if she were to deposit the money today. She needs to have $10,000 in three years. How much will she have to deposit today? (Round to the nearest dollar.)

A) $6,432 B) $7,826 C) $8,148 D) $7,763 Ans: B Feedback: 0 3 years ├────────────────────┤ PV = ? i = 8.2% FV = $10,000 Return expected from investment = i = 8.2% Duration of investment = n = 3 years Frequency of compounding = m = 12 Target investment proceeds in 3 years = FV3 = $10,000 Present value of amount = PV

PV =

FV n

mn

=

i   1+   m = $7, 825.77

$10, 000 $10, 000 = 123 36 (1.0068333)  0.082  + 1  12 

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 80. The process of converting future cash flows to what its present value is called: A) annualizing.

B) discounting.

C) compounding.

D) capital budgeting.

Ans B :

.

5-44

Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 81. Which of the following equations is used to calculate the present value of a sum to be received in future?

PV = FVn ÷ (1 + i)n A) PV = FVn × (1 + i)n B) PV = (1 + i)n + FVn C) PV = (1 + i)n ÷ FVn D) An A s : Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 82. As per the rule of 72, the time to double your money (TDM) approximately equals: A) 72/n.

B) 72/i.

C) 72/Initial investment.

D) 72/Future value.

Ans B :

.

5-45

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 83. Which of the following statements is true of the rule of 72?

A) It can be used to determine the amount of time it takes to double an investment.

B) It is fairly accurate for interest rates between 25 and 50 percent.

C) It states that the time to double your money (TDM) approximately equals 72/i, where i represents the years it takes to double your investment.

D) It can be used to estimate approximate compound interest earned for a period of 72 days.

Ans: A

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 84. Your tuition for the coming year is due today. You borrow $8,000 from your uncle and agree to repay in the three years an amount of $9,250. What is the interest rate on this loan? Round to the nearest percent.

A) 5% B) 6% C) 7% D) 8% Ans: A Feedback: 0 3 years ├────────────────────┤ PV = $8,000 FV = $9,250 Amount to be borrowed = PV = $8,000 Amount to be paid back after 3 years = FV3 = $9,250 Interest rate on investment = i = ?

Duration of investment = n = 3 years Present value of investment = PV

PV =

FV n (1+)i n

$8,000=

$9, 250 (1+ i)3

(1+ i)3 =

$9, 250 =1.15625 $8,000 1

(1+)i = (1.15625) 3 =1.0496 4.96% i=

.

5-47

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 85. Anne Morgan wants to borrow $6,000 for a period of four years. She has two choices. Her bank is offering to lend her the amount at 7.25 percent compounded annually. She can also borrow from her firm and will have to repay a total of $8,130.93 at the end of four years. Should Anne go with her bank or the firm, and what is the interest rate if she borrows from her firm? (Round to the nearest percent.)

A) She should borrow from the bank as the bank is charging a higher interest of 9%.

B) She should borrow from her firm as it is charging a lower interest of 7%.

C) She should borrow from the bank as the bank is charging a higher interest of 8%.

D) She should borrow from her firm as it is charging a lower interest of 6%.

Ans: C Feedback: 0 4 years ├────────────────────┤ PV = $6,000 FV = $8,130.93 Amount to be borrowed = PV = $6,000 Amount to be paid back after 4 years = FV = $8,130.93 Interest rate on investment = i = ?

Duration of investment = n = 4 years Present value of investment = PV

PV =

FV n (1+)i n

$6, 000=

$8,130.93 (1+ i)4

(1+ i)4 =

$8,130.93 =1.355155 $6, 000 1

(1+)i = (1.355155) 4 =1.07894 7.89% i= Since borrowing from her firm results in a loan rate of 8 percent, she should take the bank loan at 7.25 percent.

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5-48

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 86. Patrick Smith has $5,000 to invest in a small business venture. His partner has promised to pay him back $8,200 in five years. What is the return earned on this investment?

A) 9.3% B) 8.7% C) 11.1% D) 10.4% Ans: D Feedback: 0 5 years ├────────────────────┤ PV = $5,000 FV = $8,200 Amount being invested = PV = $5,000 Amount to be paid back after 5 years = FV = $8,200 Interest rate on investment = i = ?

Duration of investment = n = 5 years Present value of investment = PV

PV =

FV n (1+)i n

$5,000=

$8, 200 (1+ i)5

(1+ i)5 =

$8, 200 =1.6400 $5,000 1

(1+)i = (1.6400) 5 =1.103999 10.4% i=

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5-49

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 87. Winston Baker wants to invest $25,000 in a spa that his sister is starting. He will triple his investment in six years. What is the rate of return that Winston is being promised? (Rounded to the nearest percent.)

A) 18% B) 20% C) 12% D) 25% Ans: B Feedback: 0 6 years ├────────────────────┤ PV = $25,000 FV = $75,000 Amount being invested = PV = $25,000 Amount to be paid back after 6 years = FV = $75,000 Interest rate on investment = i = ?

Duration of investment = n = 6 years Present value of investment = PV

PV =

FV n (1+)i n

$25,000=

$75, 000 (1+ i)6

(1+ i)6 =

$75, 000= 3.0000 $25, 000 1

(1+)i = ( 3.0000 6) = 1.200937 i = 20%

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5-50

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 88. Michael Harper has $3,000 to invest for three years. He wants to receive $5,000 at the end of the three years. What invest rate would his investment have to earn to achieve his goal? (Round to the nearest percent.)

A) 19% B) 21% C) 13% D) 16% Ans: A Feedback: 0 3 years ├────────────────────┤ PV = $3,000 FV = $5,000 Amount being invested = PV = $3,000 Amount to be paid back after 3 years = FV = $5,000 Interest rate on investment = i = ?

Duration of investment = n = 3 years Present value of investment = PV

PV =

FV n (1+)i n

$3,000=

$5,000 (1+ i)3

(1+i)3 =

$5,000 =1.66667 $3,000 1

(1+i) = (1.6667) 3 =1.1856 i = 18.6%

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5-51

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 89. Finor Traps manufactures an innovative mouse trap. Total sales for the current year is $325,000. The company expects its sales to go up to $500,000 in five years. What is the expected growth rate in sales for this firm? (Round to the nearest percent.)

A) 9% B) 11% C) 6% D) 12% Ans: A Feedback: 0 5 years ├────────────────────┤ PV = $325,000 FV = $500,000 Current sales = PV = $325,000 Expected sales five years from now = $500,000 To calculate the expected sales growth rate, we set up the future value equation.

FV 5 = PV  (1+ g) 5

$500, 000= $325, 000(1 + g )5 $500, 000 (1+ g )5 = $325, 000=1.538461538 1

g = (1.538461538) 5 −1 8.99% =

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5-52

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 90. Bovic Inc. is a growing company with sales of $1.25 million this year. The company expects to grow at an annual rate of 25 percent for the next three years, followed by a growth of 20 percent per year for the next two years. What will be Bovic’s sales at the end of five years?

(Round to the nearest percent.)

A) $2,160,000 B) $3,515,625 C) $1,875,000 D) $2,929,688 Ans: B Feedback: 0 5 years ├────────────────────┤ g1-3 = 25% g4-5 = 20% PV = $1.25 million FV = ?

Current sales = PV = $1,250,000 Expected sales five years from now = FV To calculate the expected sales, we set up the future value equation.

FV 5= PV × (1+g)3(1+g)2 1 2= ($1,250,000)(1.25)3(1.20)2 = $3,515,625

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5-53

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 91. Manufic, a detergent manufacturer, has announced this year's net income as $832,500. It expects its net earnings to grow at a rate of 15 percent per year for the next two years, before dropping to 12 percent for each of the following two years. What is the firm's net income after four years? (Round to the nearest dollar.)

A) $1,381,071 B) $1,266,128 C) $1,233,099 D) $1,072,260 Ans: A Feedback: 0 4 years ├────────────────────┤ g1-2 = 15% g3-4 = 12% PV = $832,500 FV = ?

Current net income = PV = $832,500 Expected net income four years from now = FV To calculate the expected net earnings, we set up the future value equation.

FV 4 = PV  (1+ g 1)2 (1+ g 2)2

2 = $832, 500(1.15) 2 (1.12) = $1, 381, 070.88

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5-54

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 92. Genor Peterson Electrical Supplies has generated a net income of $161,424 this year. The firm expects to see an annual growth of 30 percent for the next five years, followed by a growth rate of 15 percent for each of the next three years. What will be the firm's expected net income in eight years? (Round to the nearest dollar.)

A) $319,157 B) $241,329 C) $911,546 D) $689,259 Ans: C Feedback: 0 5 8 years ├────────────────┼────────────┤ g1-5 = 30% g6-8 = 15% FV = ?

PV = $161,424 Current net income = PV = $161,424 Expected net income four years from now = FV To calculate the expected net earnings, we set up the future value equation.

FV 8 = PV  (1+ g 1)5(1+ g 2 ) 3 3 = $161,424(1.30)5(1.15) = $911, 545.58

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5-55

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 93. Locil Agencies is a fast-growing advertising agency. Currently, its sales is at $700,000. The company expects its sales to grow at an annual rate of 35 percent in the next two years, followed by an annual rate of 25 percent in years 3 through 7. Finally, its growth rate would slow down to 10 percent in years 8–10. What will be its sales as of year 10? (Round to the nearest dollar.)

A) $1,698,023 B) $2,843,323 C) $3,893,280 D) $5,181,956 Ans: D Feedback: 0 5 10 years ├────────────────┼──────────────────┤ g1-2 = 35% g3-7 = 25% g8-10 = 10% PV = $700,000 FV = ?

Current sales = PV = $700,000 Expected sales 10 years from now = FV To calculate the expected sales, we set up the future value equation.

FV10 = PV  (1+ g 1)2(1+ g2)5 (1+ g3 ) 3 3 = $700, 000(1.35)2 (1.25)5 (1.10) = $5, 181, 955.72

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5-56

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 94. Your uncle is looking to double his investment of $10,000. He claims he can get earn 14 percent on his investment. How long will it take to double his investment? Use the Rule of 72 and round to the nearest year.

A) 5 years B) 14 years C) 10 years D) 7 years Ans: A Feedback: Initial investment = $10,000 Rate of return on investment = i = 14% Time to double the investment = TDM = 72/i = 72 / 14 = 5.14 years Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 95. Animist Designers has generated sales of $625,000 for the current year. If it can grow the sales at a rate of 12 percent every year, how long will it take to triple the sales? (Round off to the nearest year.)

A) 8 years B) 7 years C) 10 years D) 9 years Ans: C Feedback: By entering the following data into a financial calculator, the required number of years can be calculated as 9.69.

–$625,000 12 0 $1,875,000 PV N i PMT FV

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5-57

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 96. Transent Foods announced that its current sales is $1,233,450 this year. The company forecasts a growth rate of 16 percent for the foreseeable future. How long will it take the firm to produce earnings of $3 million? (Round off to the nearest year.)

A) 7 years B) 6 years C) 8 years D) 10 years Ans: B Feedback: By entering the following data into a financial calculator, the required number of years can be calculated as 5.99.

–$1,233,450 16 0 $3,000,000 PV N i PMT FV

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5-58

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 98. Nickole wants to invest in a bank CD that will pay her 7.8 percent annually. If she invests $11,500 today, when will she reach her goal of $15,000? (Round off to the nearest year.)

A) 5 years B) 7 years C) 2 years D) 4 years Ans: D Feedback: By entering the following data into a financial calculator, the required number of years can be calculated as 3.54.

N

7.8 i

0 PMT

–$11,500 PV

$15,000 FV

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 97. Albend Holmes wants to deposit $4,500 in a bank account that pays 8.25 percent annually.

How many years will it take for his investment to grow to $10,000? (Round off to the nearest year.)

A) 8 years B) 11 years C) 10 years D) 12 years Ans C : Feedback: By entering the following data into a financial calculator, the required number of years can be calculated as 10.07.

N

.

8.25 i

0 PMT

–$4,500 PV

$10,000 FV

5-59

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 99. Amanda Sorenson is planning her retirement. She is presently investing in a 401(k) but needs an additional $500,000 to reach her retirement goal. As luck would have it, Amanda just won a brand new car that is worth $36,000 in a raffle. If Amanda were to sell the car and invest the $36,000 proceeds at a rate of 6.50%, compounded annually, how long will it be before Amanda could retire? (Round off to the nearest 1/10 of a year) A) 36.6 years B) 41.8 years C) 52.2 years D) 24.0 years Ans B : Feedback: Present Value = PV = $36,000 Future Value = FV = $500,000 Interest rate = i = 6.50% Number of Periods = n = 41.8 years

FV=PV(1+i)n n

=

FV n =(1+i) n PV

$500, 000 = (1.065)n = (1.065)n = 13.88889 $36, 000 nLN (1.065) = LN (13.88889) n=

.

LN(13.888889) 2.631089 = = years .062975 41.78 LN(1.065)

5-60

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 100. Omniva Inc. just generated earnings per share of $3.75 for the fiscal year ending September 30, 2014. The firm is expected to achieve earnings per share of $8.76 in 5-years. At what rate will Omniva Inc.’s earnings per share be growing over this 5-year period? (Round off to the nearest 1/10 percent) A) 15.7% B) 18.5% C) 21.3% D) 13.4% Ans B : Feedback: Present Value = PV = $3.75 Period = n = 5 years Future Value = FV5 = $8.76 Interest rate = i = 18.49% 1

 FV  − 1 i=  PV 5  1  $8.765 −  1 =  $3.75  1

= (2.336)5 −1 = 1.184935− 1 = .184935 Format: Essay Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 101. Explain the difference between simple interest and compound interest.

Ans: Simple interest refers to the interest earned on the initial investment over the investment period. Compound interest includes not only simple interest but also interest earned on the reinvestment of previously earned interest. Thus, compound interest includes both the simple interest and the interest on interest.

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Essay Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 102. Explain how the future and the present value equations are related.

Ans: To get the future value (FVn) of funds invested for n years, we multiply the original investment by (1+ i)n. To find the present value of a future payment (PV), we divide FVn by (1 + i)n.

Format: Essay Learning Objective: LO 4 Level of Difficulty: Hard Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 103. Suppose you win $10 million in a lottery. You have a choice of how you will receive your

winnings. The first choice is to receive a certain lump sum today. The second choice is to receive a certain amount at the end of five years. How will you evaluate your choices to make your decision?

Ans: In order to make the correct choice, one has to make the comparison on the same basis.

That is, you calculate the future value of the lump sum invested today at your opportunity cost and compare it to the future value under your second choice. Or you discount the future value of the amount in your second choice to its present value and compare it to the lump sum in your first choice. Either of the two approaches would allow you to select the choice that provides you the highest amount.

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5-62

Fundamentals of Corporate Finance 3e

Test Bank

Format: Essay Learning Objective: LO 4 Level of Difficulty: Hard Bloomcode: Analysis AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 104. Suppose that you just attended a lecture on Time Value of Money. On your way home, you stopped in to get a cup of coffee. One of your classmates, who missed the lecture, joined you for coffee and asked you to explain to her the key concepts of time value of money and how you could use it to solve some of practical financial problems. What would you tell her?

Ans: Time value of money has to do with making decisions about investments; e.g., how much should one pay today for a share of common stock, for an apartment building, etc.

This amount is known as the present value. The answer involves a number of important concepts: (1.) the expected/required rate of return; this is known as rate. (2.) The expected time that the investment will be held; this is known as number of periods. (3.)

The expected cash flow(s); this is known as future value, or if a series of future values it is known as payments. (4) The frequency at which the rate is compounded or discounted; i.e., annually, quarterly, monthly, etc. The way in which these types of problems can be solved is by usage of mathematical formulas, financial calculators, or spreadsheet models.

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5-63

Fundamentals of Corporate Finance 3e

Test Bank

Chapter 6: Discounted Cash Flows and Valuation Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement 1. Calculating the present and future values of multiple cash flows is relevant only for individual investors.

A) True B) False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 2. Calculating the present and future values of multiple cash flows is relevant for businesses only.

A) True B) False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement 3. In computing the present and future value of multiple cash flows, each cash flow is discounted or compounded at a same rate.

A) True B) False Ans: A

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6-1

Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement 4. The present value of multiple cash flows is greater than the sum of those cash flows.

A) True B) False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 5. Jacob Oram pay the same amount every month as insurance premium for a term life policy for a period of five years, the stream of cash flows is called a perpetuity.

A) True B) False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: Corporate Finance

AICPA: 6. Allen BellMeasurement pay the same amount every month on a car loan for a period of three years, the stream of cash flows is called an annuity.

A) True B) False Ans: A

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6-2

Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement 7. In today's financial markets, the best example of a perpetuity is the common stock issued by firms.

A) True B) False Ans: B Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance

AICPA: 8. Since theMeasurement issuers of preferred stock promise to pay investors a fixed dividend, usually quarterly, forever, these are the most important perpetuities in the financial markets.

A) True B) False Ans: A Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 9. The present value of a perpetuity is the promised constant cash payment divided by the interest rate (i).

A) True B) False Ans: A

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6-3

Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement 10. In ordinary annuities, cash flows occur at the beginning of each period.

A) True B) False Ans: B Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 11. In an annuity due, cash flows occur at the beginning of each period.

A) True B) False Ans: A Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement 12. The lease payments by a business of a warehouse rental are an example of an annuity due.

A) True B) False Ans: A

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6-4

Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 2, LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement

13. The present value of an annuity due is less than the present value of an ordinary annuity.

A) True B) False Ans: B Format: True/False Learning Objective: LO 2, LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement

14. The present value of an annuity due is equal to the present value of an ordinary annuity.

A) True B) False Ans: B Format: True/False Learning Objective: LO 2, LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement

15. The future value of an annuity due is greater than the future value of an ordinary annuity.

A) True B) False Ans: A

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6-5

Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 2, LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement

16. The future value of an annuity due is equal to the future value of an ordinary annuity.

A) True B) False Ans: B Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement

growing 17. Cash flow streams that increase at a constant rate over time are calledannuitiesor growing perpetuities.

A) True B) False Ans: A Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement

18. A fertilizer manufacturing company enters into a contract with a county parks and recreation department that calls for the company to sell 10 percent more of its best lawn feed every year for the next five years. If they also agree to maintain the total price as constant over the contract period, this growth in revenue is an example of a growing perpetuity.

A) True B) False Ans: B

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6-6

Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement

19. You have received news about an inheritance that will pay you $5,000 next year. Beginning the following year, your inheritance will increase by 5 percent every year forever. This is a growing perpetuity.

A) True B) False Ans: A Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement

20. Natalia Greenberg opened a pizza place last year. She expects to increase her revenue from last year by 7 percent every year for the next 10 years. This is an example of a growing annuity.

A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement 21. The annual percentage rate (APR) is the annualized interest rate using compound interest.

A) True B) False Ans: B

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6-7

Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement

22. The annual percentage rate (APR) is defined as the simple interest charged per period multiplied by the number of periods per year.

A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement 23. The correct way to annualize an interest rate is to compute the effective annual interest rate.

A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Knkowledge AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement

24. The correct way to annualize an interest rate is to compute the annual percentage rate (APR).

A) True B) False Ans: B

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6-8

Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement

25. The effective annual interest rate (EAR) is defined as the annual growth rate that takes compounding into account.

A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement

26. The effective annual interest rate (EAR) is the true cost of borrowing and lending.

A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement 27. The quoted interest rate is by convention a simple annual interest rate, such as the annual percentage rate (APR).

A) True B) False Ans: A

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6-9

Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement 28. The quoted interest rate is by definition a simple annual interest rate, such as the effective annual interest rate (EAR).

A) True B) False Ans: B Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance

AICPA: Legal/Regulatory Perspective

29. The Truth-in-Lending Act and the Truth-in-Savings Act require by law that the annual percentage rate (APR) be disclosed on all consumer loans and savings plans and that it be prominently displayed on advertising and contractual documents.

A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance

AICPA: 30. Only theMeasurement annual percentage rate (APR) or some other quoted rate should be used as the interest rate factor for present or future value calculations.

A) True B) False Ans: B

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Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: Corporate Finance

Measurement 31. AAICPA: car manufacturer enters into a contract for 25-years lease of warehouse rental that adjusts annually for the expected rate of inflation over the life of the contract. This is an example of growing perpetuity.

A) True B) False Ans: B Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance

Measurement 32. AAICPA: growing annuity for an infinite period is called a growing perpetuity.

A) True B) False Ans: A Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement 33. For computation of the present value of growing annuity with n periods, the cash flow for the current period is used and not the cash flow to be received in the next period.

A) True B) False Ans: B

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Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement 34. Growing perpetuity is widely used in the valuation of common stock of firms that have a policy and history of paying dividends that grow at a constant rate.

A) True B) False Ans: A Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance

AICPA: Measurement

35. The present value of growing perpetuity is computed as the cash flow occurring at the end of the first period divided by the difference between interest or discount rate and growth rate.

A) True B) False Ans: A Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance

AICPA:ofMeasurement 36. Which the following is used as the denominator while calculating the present value for a growing perpetuity that begins next period (PVP)?

A) The difference between i (the discount or interest rate) and g (the constant rate of growth B) of the cash flow) C) i (the discount or interest rate) D) g (the constant rate of growth of the cash flow) The addition of i (the discount or interest rate) and g (the constant rate of growth of the cash flow) Ans: A

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6-12

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 37. The present value of future cash flows are computed by multiplying future value with the: A) discounting factor.

B) compound factor.

C) interest rate.

D) number of periods.

Ans: A Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 38. Nick invested $2,000 in a bank savings account today and another $2000 a year from now. If the bank pays interest of 10 percent per year, how much money will Nick have at the end of two years?

A) $4,210 B) $4,200 C) $4,000 D) $4,620 Ans: D Feedback: Future value of two cash flows = [PV × (1 + i)2]+ [PV × (1 + i)] = [$2,000 × (1 + 0.10)2] + [$2,000 × (1 + 0.10)] = [$2,000 × (1.10)2] + [$2,000 × (1.10)] = [$2,000 × 1.21]+ [$2,000 × 1.10] = $2,420 + $2,200 = $4,620

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6-13

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 39. Which of the following is true of discounting factor?

A) Discounting factor is the reciprocal of compounding factor.

B) Discounting factor is the sum of 1 and the rate of interest.

C) Discounting factor is period n times the rate of interest.

D) Discounting factor is computed by dividing period n by the sum of 1 and the rate of interest.

Ans: A Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: easy Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 40. William deposited $25,000 today that would earn an interest at the rate of 3% for a period of 2 years. The amount of $25,000 represents the: A) present value of an annuity B) future value of an annuity C) present value D) future value Ans: C Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 41. In computing the present and future value of multiple cash flows: A) each cash flow is discounted or compounded at the same rate.

B) each cash flow is discounted or compounded at a different rate.

C) earlier cash flows are discounted at a higher rate.

D) later cash flows are discounted at a higher rate.

Ans: A

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6-14

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 42. Anna would receive $15,000 from a bank deposit after 2 years which had an interest of 3.5%.

The amount of $15,000 represents the: A) present value of an annuity B) future value of an annuity C) present value D) future value Ans: D Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 43. The present value of multiple cash flows is: A) greater than the sum of the cash flows.

B) equal to the sum of all the cash flows.

C) less than the sum of the cash flows.

D) higher or lower than the cash flows depending on the interest rate.

Ans: C Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 44. The future value of multiple cash flows is: A) greater than the sum of the cash flows.

B) equal to the sum of all the cash flows.

C) less than the sum of the cash flows.

D) higher or lower than the cash flows depending on the interest rate.

Ans: A

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6-15

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 45. If your investment pays the same amount at the end of each year for a period of six years, the cash flow stream is called: A) a perpetuity.

B) an ordinary annuity.

C) an annuity due.

D) a growing perpetuity.

Ans: B Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 46. If your investment pays the same amount at the beginning of each year for a period of 10 years, the cash flow stream is called: A) a perpetuity.

B) an ordinary annuity.

C) an annuity due.

D) a growing perpetuity.

Ans: C Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Comrpehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 47. A preferred stock would be an ideal example of: A) a perpetuity.

B) an ordinary annuity.

C) an annuity due.

D) a growing annuity.

Ans: A

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6-16

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 48. Cash flows associated with annuities are considered to be: A) an uneven cash flow stream.

B) a constant cash flow stream.

C) a mix of constant and uneven cash flow streams.

D) a cash flow stream with decreasing trend.

Ans: B Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 49. Which of the following statements is true of amortization?

A) Amortization solely refers to the total value to be paid by the borrower at the end of maturity.

B) The amortization schedule represents only the interest portion of the loan.

C) D) The computation of loan amortization is wholly based on the computation of simple interest.

The amortization schedule provides the data of equated monthly payments for which the classification of principal and interest along with unpaid principal balance is provided.

Ans: D

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6-17

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 50. Which of the following statements is true of amortization?

A) With an amortized loan, a periodical payment of principal portion gradually decreases over a period.

B) Amortization schedule represents only the interest portion of the loan.

C) D) With an amortized loan, a bigger proportion of each month's payment goes toward interest in the early periods.

The computation of loan amortization is wholly based on the computation of simple interest.

Ans: C Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 51. Which of the following statements is true of amortization?

A) With an amortized loan, a bigger proportion of each month's payment goes toward interest in the early periods.

B) With an amortized loan, a bigger proportion of each month's payment goes toward C) interest in the later periods.

D) With an amortized loan, a smaller proportion of each month's payment goes toward interest in the early periods.

With an amortized loan, the interest portion of each month’s payment remains unchanged.

Ans: A

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6-18

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 52. The annuity transformation method is used to transform: A) a present value annuity to a future value annuity.

B) a present value annuity to an annuity due.

C) an ordinary annuity to an annuity due.

D) a perpetuity to an annuity.

Ans: C Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 53. A firm receives a cash flow from an investment that will increase by 10 percent annually for an infinite number of years. This cash flow stream is called: A) an annuity due.

B) a growing perpetuity.

C) an ordinary annuity.

D) a growing annuity.

Ans: B Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 54. Your investment in a small business venture will produce cash flows that increase by 15 percent every year for the next 25 years. This cash flow stream is called: A) an annuity due.

B) a growing perpetuity.

C) an ordinary annuity.

D) a growing annuity.

Ans: D

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6-19

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 55. Which of the following statements is true about the effective annual rate (EAR)?

A) The effective annual interest rate (EAR) is defined as the annual growth rates that do not take compounding into account.

B) The EAR is the annualized interest rate using simple interest. It ignores the interest C) earned on interest associated with compounding periods of less than one year.

D) The EAR is the simple interest charged per period multiplied by the number of periods per year.

The EAR is the interest rate actually paid (or earned) after accounting for compounding.

Ans: D Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 56. The true cost of borrowing is the: A) annual percentage rate.

B) effective annual rate.

C) quoted interest rate.

D) periodic rate.

Ans: B Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 57. The true cost of lending is the: A) annual percentage rate.

B) effective annual rate.

C) quoted interest rate.

D) interest rate per period.

Ans: B

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6-20

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 58. Which of the following statements is true of annual percentage rate (APR)?

A) The APR is similar to quoted interest rate which is a simple annual rate.

B) The APR calculation adjusts for the effects of compounding and, hence, the time value C) of money.

D) The APR is the true cost of borrowing and lending.

The APR takes compounding into account.

Ans: A Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 59. Which of the following statements is true of annual percentage rate (APR)?

A) The Truth-in-Savings Act was passed by Congress to ensure that the true cost of credit was disclosed to consumers.

B) The Truth-in-Lending Act was passed to provide consumers an accurate estimate of the C) return they would earn on an investment.

D) The Truth-in-Savings Act and Truth-in-Lending Act require by law that the APR be disclosed on all consumer loans and savings plans.

The annual percentage rate (APR), and not the effective annual interest rate (EAR), represents the true economic interest rate.

Ans: C Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 60. What is the appropriate interest rate to use when making future or present value calculations?

A) The effective annual interest rate (EAR) B) The annual percentage rate (APR) C) The quoted interest rate D) The simple interest Ans: A

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6-21

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 61. Krysel Inc. is expecting a new project to start producing cash flows, beginning at the end of this year. They expect cash flows to be as follows: 1 $663,547

2 $698,214

3 $795,908

4 5 $798,326 $755,444

If they can reinvest these cash flows to earn a return of 9.2 percent, what is the future value of this cash flow stream at the end of five years? (Round to the nearest dollar.)

A) $4,368,692 B) $4,429,046 C) $4,468,692 D) $4,529,046 Ans: B Feedback: 0 1 2 3 4 5 ├─────────┼────────┼─────────┼────────┼─────── $755,444 $663,547 $698,214 $795,908 $798,326 n=5

i = 9.20%

FV5= $663,547(1.092)4 + $698,214(1.092)3 + $795,908(1.092)2 + $798,326(1.092)1 + $755,444 = $943,544.19 + $909,193.80 + $949,091.64 + $871,771.99 + $755,444.00 = $4,429,045.62

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6-22

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 62. Phosfranc Inc., is expecting the following cash flows starting at the end of the year—$133,245, $152,709, $161,554, and $200,760. If their opportunity cost is 9.4 percent, find the future value of these cash flows. (Round to the nearest dollar.)

A) $734,731 B) $756,525 C) $734,231 D) $776,252 Ans: A Feedback: 0 1 2 3 4 ├─────────┼────────┼─────────┼────────┼ $133,245 $152,709 $161,554 $200,760 n=4

i = 9.40%

FV4= $133,245(1.094)3 + $152,709(1.094)2 + $161,554(1.094)1 + $200,760 = $174,462.82 + $182,767.63 + $176,740.08 + $200,760.00 = $734,730.53

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6-23

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 63. Robert White will receive from his investment cash flows of $4,450, $4,775, and $5,125. If he can earn 7 percent on any investment that he makes, what is the future value of his investment cash flows at the end of three years? (Round to the nearest dollar.)

A) $15,329 B) $15,427 C) $16,427 D) $14,427 Ans: A Feedback:

$4,450 n=4

$4,775

$5,125

i = 7.0%

FV3= $4,450(1.094)2 + $4,775(1.094)1 + $5,125 = $5,094.81 + $5,109.25 + $5,125.00 = $15,329.06

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6-24

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 64. Scottie Barnes has invested in an investment that will pay him $6,400, $6,450, $7,225, and $7,500 over the next four years. If his opportunity cost is 10 percent, what is the future value of the cash flows he will receive? (Round to the nearest dollar.)

A) $27,150 B) $32,020 C) $30,455 D) $31,770 Ans: D Feedback:

n = 4;

$6,400

$6,450 i = 10%

$7,225

$7,500

FV 4= $6,400(1.10)3 + $6,450(1.10)2 + $7,225(1.10)1 + $7,500 = $8,518.40 + $7,804.50 + $7,947.50 + $7,500 = $31,770.40

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6-25

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 65. Global Shippers Inc. has forecast earnings of $1,233,600, $1,345,900, and $1,455,650 for the next three years. What is the future value of these earnings if the firm's opportunity cost is 13 percent? (Round to the nearest dollar.)

A) $4,214,360 B) 4,551,701 C) $3,900,865 D) $4,362,428 Ans: B Feedback:

1,233,600

1,345,900

1,455,650

1 FV 3= $1,233,600(1.13)2+ 1,345,900(1.13) + $1,455,650 = 1,575,183.84 + $1,520,867.00 + $1,455,650.00 = $4,551,700.84

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6-26

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 66. Damien McCoy has loaned money to his brother at an interest rate of 5.85 percent. He expects to receive $987, $1,012, $1,062, and $1,162 at the end of the next four years as complete repayment of the loan with interest. How much did he loan out to his brother? (Round to the nearest dollar.)

A) $3,785 B) $3,757 C) $3,657 D) $3,685 Ans: C Feedback:

$987 n=4

=

$1,012

$1,062

$1,162

i = 5.85%

$1,162 $987 $1,012 $1,062 + 2 + 3 + 4 (1.0585) (1.0585) (1.0585) (1.0585)

= $932.45 + $903.23 + $895.47 + $925.64 = $3,656.80

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6-27

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 67. Newship Inc. has borrowed from its bank at a rate of 8 percent and will repay the loan with interest over the next five years. Its scheduled payments, starting at the end of the year are as follows—$450,000, $560,000, $750,000, $875,000, and $1,000,000. What is the present value of these payments? (Round to the nearest dollar.)

A) $2,735,200 B) $2,989,351 C) $2,431,224 D) $2,815,885 Ans: D Feedback:

$450,000+ $560,000+ $750,000+ $875,000+ $1,000,000 (1.08)5 (1.08)4 (1.08)2 (1.08)3 (1.08) = $416, 666.67 + $480,109.74 + $595, 374.18 + $643,151.12 + $680, 583.20 = $2, 815, 884.91

PV =

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6-28

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 68. David Stephens has made an investment that will pay him $11,455, $16,376, and $19,812 at the end of the next three years. His investment was to fetch him a return of 14 percent. What is the present value of these cash flows? (Round to the nearest dollar.)

A) $37,712 B) $36,022 C) $41,675 D) $39,208 Ans: B Feedback:

$11,455+ $16,376+ $19,812 (1.14)3 (1.14)2 (1.14) = $10, 048.25 + $12, 600.80 + $13, 372.54 = $36, 021.58

PV =

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6-29

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 69. Nutech Corp. is expecting the following cash flows—$79,000, $112,000, $164,000, $84,000, and $242,000—over the next five years. If the company’s opportunity cost is 15 percent, what is the present value of these cash flows? (Round to the nearest dollar.)

A) $429,560 B) $485,097 C) $480,906 D) $477,235 Ans: A Feedback:

$79,000+ $112,000+ $164,000+ $84,000+ $242,000 (1.15)5 (1.15)2 (1.15)3 (1.15)4 (1.15) = $68, 695.65 + $84, 688.09 + $107, 832.66 + $48, 027.27 + $120, 316.77 = $429, 560.45

PV =

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6-30

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 70. Helen Ashley is expecting cash flows of $50,000, $75,000, $125,000, and $250,000 from an inheritance over the next four years. If she can earn 11 percent on any investment that she makes, what is the present value of her inheritance? (Round to the nearest dollar.)

A) $361,998 B) $414,454 C) $412,372 D) $434,599 Ans: A Feedback:

= $45,045.05 + $60,871.68 + $91,398.92 + $164,682.74 = $361,998.39

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6-31

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 71. Ransport Company has made an investment in another company that will guarantee it a cash flow of $37,250 each year for the next five years. If the company uses a discount rate of 15 percent on its investments, what is the present value of this investment? (Round to the nearest dollar.)

A) $101,766 B) $124,868 C) $251,154 D) $186,250 Ans: B Feedback:

Annual payment = PMT = $37,250 No. of payments = n = 5 Required rate of return = 15% Present value of investment = PVA5

 1  1− + i)n   PVAn =PMT   (1 i      1   −  1 (1.15)5=  $37, 250  3.3522 = $37, 250   0.15   = $124, 867.78

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6-32

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 72. Ryan Campbell has invested in a fund that will provide him a cash flow of $11,700 for the next 20 years. If his opportunity cost is 8.5 percent, what is the present value of this cash flow stream? (Round to the nearest dollar.)

A) $234,000 B) $132,455 C) $110,721 D) $167,884 Ans: C Feedback:

 1  1− + i)n   PVAn =PMT   (1 i       1 1− (1.085)20 =  $11,7009.4633 = $11, 700   0.085   = $110, 721.04

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6-33

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 73. Moore’s Inc. will be making lease payments of $3,895.50 for a 10-year period, starting at the end of this year. If the firm uses a 9 percent discount rate, what is the present value of this annuity? (Round to the nearest dollar.)

A) $23,250 B) $29,000 C) $25,000 D) $20,000 Ans: C Feedback:

 1  1− + i)n   PVAn =PMT   (1 i     1    10 = 1− = $3,895.50  (1.09)  $3, 895.50  6.4177  0.09   = $24, 999.99

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6-34

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 74. Graciela Treadwell won a lottery. She will have a choice of receiving $25,000 at the end of each year for the next 30 years, or a lump sum today. If she can earn a return of 10 percent on any investment she makes, what is the minimum amount she should be willing to accept today as a lump-sum payment? (Round to the nearest hundred dollars.)

A) $750,000 B) $334,600 C) $212,400 D) $235,700 Ans: D Feedback:

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6-35

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 75. Insulor Inc. is expecting cash flows of $67,000 at the end of each year for the next five years. If the firm's discount rate is 17 percent, what is the present value of this annuity? (Round to the nearest dollar.)

A) $214,356 B) $241,653 C) $278,900 D) $197,776 Ans: A Feedback:

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6-36

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 76. Lloyd Harris is planning to invest $3,500 every year for the next six years in an investment paying 13 percent annually. What will be the amount he will have at the end of the six years?

(Round to the nearest dollar.)

A) $21,000 B) $29,129 C) $24,670 D) $26,124 Ans: B Feedback:

n = 6;

i = 13%

= $3,500 × (1.13)6 – 1 0.13 = $3,500 × 8.3227 = $29129.47

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6-37

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 77. Shaun Barringer has started on his first job. He plans to start saving for retirement. He will invest $5,000 at the end of each year for the next 45 years in a fund that will earn a return of 10 percent. How much will Shaun have at the end of 45 years? (Round to the nearest dollar.)

A) $2,667,904 B) $3,594,524 C) $1,745,600 D) $5,233,442 Ans: B Feedback:

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6-38

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 78. John Mason decided to save $2,250 at the end of each of the next three years to pay for a vacation. If he invests it at 8 percent, how much will he have at the end of three years? (Round to the nearest dollar.)

A) $7,304 B) $7,403 C) $6,297 D) $7,010 Ans: A Feedback:

$2,250 n=3

$2,250

$2,250

i = 8.0%

= $2,250 × (1.08)3– 1 0.08 = $7,304.40 × 3.2464 = $7,304.40

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6-39

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 79. Barbara Lakey is saving to buy a new car in four years. She will save $5,500 at the end of each of the next four years. If she invests her savings at 7.75 percent, how much will she have after four years? (Round to the nearest dollar.)

A) $22,000 B) $23,345 C) $27,556 D) $28,692 Ans: D Feedback:

=$5,500 × (1.0775)4 – 1 0.0775 = $5,500 × 4.4895 = $24,692.25

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6-40

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 80. Rosalia White will invest $3,000 in an IRA for the next 30 years starting at the end of this year.

The investment will earn 13 percent annually. How much will she have at the end of 30 years?

(Round to the nearest dollar.)

A) $879,598 B) $912,334 C) $748,212 D) $1,233,450 Ans: A Feedback:

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Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 81. Viviana Carroll needs to have $25,000 in five years. If she can earn 8 percent on any investment, what is the amount that she will have to invest every year at the end of each year for the next five years? (Round to the nearest dollar.)

A) $5,000 B) $4,261 C) $4,640 D) $4,445 Ans: B Feedback:

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Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 82. Cassandra Dawson wants to save for a trip to Australia. She will need $12,000 at the end of four years. She can invest a certain amount at the beginning of each of the next four years in a bank account that will pay her 6.8 percent annually. How much will she have to invest annually to reach her target? (Round to the nearest dollar.)

A) $3,000 B) $2,980 C) $2,538 D) $2,711 Ans: C Feedback:

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Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 83. Dawson Electricals has borrowed $27,850 from its bank at an annual rate of 8.5 percent. It plans to repay the loan in eight equal installments, beginning at the end of next in a year. What is its annual loan payment? (Round to the nearest dollar.)

A) $4,708 B) $5,134 C) $4,939 D) $4,748 Ans: C Feedback:

PVAn = $27,850

n = 8;

i = 8.5%

Present value of annuity = PVA = $27,850 Return on investment = i = 8.5% Payment required to meet target = PMT Using the PVA equation:

 1  1−  PVAn =PMT   (1+i)n  i      $27, 850 = $27, 850 PMT =  −  5.6392 1 1 (1.085)8    0.085    = $4, 938.66

Each payment made by Dawson Electricals will be $4,938.66, starting at the end of next year.

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 84. Tim Dodson has borrowed $8,600 to pay for his new car. The annual interest rate on the loan is 9.4 percent, and the loan needs to be repaid in four payments. What will be his annual payment if he begins his payment beginning now? (Round to the nearest dollar.)

A) $2,229 B) $2,304 C) $2,850 D) $2,448 Ans: D Feedback:

PVAn = $8,600

n = 4;

i = 9.4%

Present value of annuity = PVA = $8,600 Return on investment = i = 9.4% Payment required to meet target = PMT Type of annuity = Annuity due Using the PVA equation:

PMT =

$8,600

=

$8,600 3.2115×1.094 = $2,447.80 Each payment made by Tim Dodson will be $2,447.80, starting today.

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Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 85. James Perkins wants to have a million dollars at retirement, which is 15 years away. He already has $200,000 in an IRA earning 8 percent annually. How much does he need to save each year, beginning at the end of this year to reach his target? Assume he could earn 8 percent on any investment he makes. (Round to the nearest dollar.)

A) $13,464 B) $14,273 C) $10,900 D) $16,110 Ans: A Feedback: Retirement investment target in 15 years = $1,000,000 Amount invested in IRA account now = PV = $200,000 Return earned by investment = i = 8% Value of current investment in 15 years = FV15 15 FV15 = PV(1 + i )15= $200,000(1.08) = $634, 433.82

Balance of money needed to reach his target of having million dollars = $1,000,000 – $634,433.82 = $365,566.18 = FVA Payment needed to reach target = PMT

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 86. Stuart Weddle’s father is 55 years old and wants to set up a cash flow stream that would be forever. He would like to receive $15,000 every year, beginning at the end of this year. If he could invest in account earning 9 percent, how much would he have to invest today to receive his perpetual cash flow? (Round to the nearest dollar.)

A) $166,667 B) $200,000 C) $222,222 D) $135,200 Ans: A Feedback: Annual payment needed = PMT = $15,000 Investment rate of return = i = 9% Term of payment = Perpetuity Present value of investment needed = PV

= $15,000 0.09 = $166,666.67

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 87. A lottery winner was given a perpetual payment of $25,362. She could invest the cash flows at 7.5 percent. What is the present value of this perpetuity? (Round to the nearest dollar.)

A) $338,160 B) $390,215 C) $238,160 D) $201,356 Ans: A Feedback: Annual payment needed = PMT = $25,362 Investment rate of return = i = 7.5% Term of payment = Perpetuity Present value of investment needed = PV

= $25,362 0.075 = $338,160

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 88. Brandon Ramirez wants to set up a scholarship at his alma mater. He is willing to invest $320,000 in an account earning 11 percent. What will be the annual scholarship that can be given from this investment? (Round to the nearest dollar.)

A) $50,000 B) $32,600 C) $35,200 D) $40,300 Ans: C Feedback: Annual payment needed = PMT Present value of investment = PVA = $320,000 Investment rate of return = i = 11% Term of payment = Perpetuity

PMT = = =

PV of Perpetuity × i $320,000 × 0.11 $35,200

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 89. Sid Phillips has funded a retirement investment with $250,000 earning a return of 6.75 percent.

What is the value of the payment that he can receive in perpetuity? (Round to the nearest dollar.)

A) $12,150 B) $15,250 C) $16,875 D) $14,900 Ans: C Feedback: Annual payment needed = PMT Present value of investment = PVA = $250,000 Investment rate of return = i = 6.75% Term of payment = Perpetuity

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= $250,000 × 0.0675 = $16,875 Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 90. Ralf Wilson wants to receive $25,000 in perpetuity and will invest his money in an investment that will earn a return of 14 percent annually. What is the value of the investment that he needs to make today to receive his perpetual cash flow stream? (Round to the nearest dollar.)

A) $640,225 B) $252,325 C) $144,350 D) $178,571 Ans: D Feedback: Annual Payment needed = PMT = $25,000 Investment rate of return = i = 14% Term of payment = Perpetuity Present value of investment needed = PV

= $25,000 0.14 = $178,571.43

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Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 91. You plan to save $1,400 for the next four years, beginning now, to pay for a vacation. If you can invest it at 6 percent, how much will you have at the end of four years? Round to the nearest dollar.

A) $6,124 B) $5,618 C) $4,019 D) $6,492 Ans: D Feedback: 0 1 2 3 4 ├───────┼────────┼───────┼────────┤ $1,400 $1,400 $1,400 $1,400 n = 4; i = 6%

(1+i)n FVA = PMT    (1+i)  i   (1.06)4− 1 = $1,400 (1.06)   0.06    = $1,400 4.37461.06 = $6, 491.93

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 92. Jeff Lovett has a five-year loan on which he will make annual payments of $2,235, beginning now. If the interest rate on the loan is 8.3 percent, what is the present value of this annuity?

(Round to the nearest dollar.)

A) $9,588 B) $8,854 C) $8,612 D) $9,122 Ans: A Feedback: 0 1 2 3 4 5 ├───────┼────────┼───────┼────────┼───────┤ $2,235 $2,235 $2,235 $2,235 $2,235 n = 5; i = 8.3% Annual payment = PMT = $2,235 No. of payments = n = 5 Required rate of return = 8.3% Present value of investment = PVA5

1    1(1+i)n − PVA= PMT  (1+i ) i        1 − 1 (1.083)5 = $2, 235     (1.083)  0.083    = $2,2353.96131.083 = $9, 588.44

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 93. : Ann Chang is investing $2,500 today and will do so at the beginning of each of the next six years for a total of seven payments. If her investment can earn 12 percent, how much will she have at the end of seven years? (Round to the nearest dollar.)

A) $25,223 B) $28,249 C) $31,127 D) $29,460 Ans: B Feedback: 0 1 2 3 6 7 ├───────┼────────┼───────┼………………┼───────┤ PMT PMT PMT PMT PMT n = 7; i = 12% Present value of annuity = PVA Return on investment = i = 12% Payment required to meet target = $2,500 Type of annuity = Annuity due

(1+i)n FVA = PMT    (1+i)  i 

 (1.12)7− 1 = $2,500 (1.12)   0.12    = $2,50010.08901.12 = $28, 249.23

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 94. Your inheritance will pay you $100,000 a year for five years beginning now. You can invest it in a CD that will pay 7.75 percent annually. What is the present value of your inheritance?

(Round to the nearest dollar.)

A) $399,356 B) $401,916 C) $433,064 D) $467,812 Ans: C Feedback: 0 1 2 3 4 5 ├───────┼────────┼───────┼────────┼───────┤ $100,000 $100,000 $100,000 $100,000 $100,000 n = 5; i = 7.75% Annual payment = PMT = $100,000 No. of payments = n = 5 Required rate of return = 7.75% Present value of investment = PVA5

 1  1− (1+ i)n  PVA= PMT    (1+ i ) i    

 1  −  1 (1.0775)5 = $100, 000  (1.0775)   0.0775    = $100,000 4.01921.0775 = $433, 064.19

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 95. Noel Klinger is planning to invest in an insurance company product. The product will pay $12,500 at the end of this year. Thereafter, the payments will grow annually at a 2.5 percent rate forever. Jack will be able to invest his cash flows at a rate of 5.5 percent. What is the present value of this investment cash flow stream? (Round to the nearest dollar.)

A) $326,908 B) $312,766 C) $416,667 D) $446,667 Ans: C Feedback: Cash flow at t=1 = CF1 = $12,500 Annual growth rate = g = 2.5% Discount rate = i = 5.5% Present value of growing perpetuity = PVP PVA∞ = CF1 = $12,500 (i – g) (0.055 – 0.03) = $416,666.67

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 96. Bryant Investments is putting out a new product. The product will pay out $32,000 in the first year, and after that the payouts will grow by an annual rate of 2.75 percent forever. If you can invest the cash flows at 7.25 percent, how much will you be willing to pay for this perpetuity?

(Round to the nearest dollar.)

A) $721,111 B) $633,111 C) $531,111 D) $711,111 Ans: D Feedback: Cash flow at t = 1 = CF1 = $32,000 Annual growth rate = g = 2.75% Discount rate = i = 7.25% Present value of growing perpetuity = PVP PVA∞ = CF1 = $12,500 (0.0725 – 0.0275) (i – g) = $711,111.11

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 97. Shelton Enterprises is expecting tremendous growth from its newest boutique store. Next year the store is expected to bring in net cash flows of $675,000. The company expects its earnings to grow annually at a rate of 13 percent for the next 15 years. What is the present value of this growing annuity if the firm uses a discount rate of 18 percent on its investments? (Round to the nearest dollar.)

A) $6,448,519 B) $6,750,000 C) $7,115,449 D) $5,478,320 Ans: A Feedback: Time of growth = n = 15 years Next year's expected net cash flow = CF1 = $675,000 Expected annual growth rate = g = 13% Firm's required rate of return = i = 18% Present value of growing annuity = PVAn

= $13,500,000 × 0.477668109 = $6,448,519.47

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 98. Foodelicious Corp. is evaluating whether it should take over the lease of an ethnic restaurant in Manhattan. The current owner had originally signed a 25-year lease, of which 16 years still remain. The restaurant has been growing steadily at a 7 percent growth for the last several years. Foodelicious Corp. expects the restaurant to continue to grow at the same rate for the remaining lease term. Last year, the restaurant brought in net cash flows of $310,000. If the firm evaluates similar investments at 15 percent, what is the present value of this investment?

(Round to the nearest dollar.)

A) $2,966,350 B) $2,838,182 C) $3,109,460 D) $2,709,124 Ans: B Feedback: Time for lease to expire = n = 16 years Last year's net cash flow = CF0 = $310,000 Expected annual growth rate = g = 7% Firm's required rate of return = i = 15% Expected cash flow next year = CF1 = $310,000(1 + g) = $310,000(1.07) = $331,700 Present value of growing annuity = PVAn n 16 CF1   1 + g   $331, 700  1.0    1−  PVAn =  1 −  =  (i−g)    1 + i  (0.15 − 0.07)  7    1.1 = $4,146, 250  0.684518 5 = $2, 838, 181.52

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Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 99. Beautinator Cosmetics borrowed $152,300 from a bank for three years. If the quoted rate (APR) is 11.75 percent, and the compounding is daily, what is the effective annual rate (EAR)?

(Round to one decimal place.)

A) 11.7% B) 14.3% C) 12.5% D) 11.6% Ans: C Feedback: Loan amount = PV = $152,300 Interest rate on loan = i = 11.75% Frequency of compounding = m = 365 Effective annual rate = EAR m1

365

i   0.1175 365 − 1 −1=1+ EAR = + 1    m = 1.12455−1=12.46%

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Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 100. Surreal Corp. has borrowed to invest in a project. The loan calls for a payment of $17,500 every month for three years. The lender quoted Surreal a rate of 8.40 percent with monthly compounding. At what rate would you discount the payments to find amount borrowed by Surreal Corp.? (Round to two decimal places.)

A) 8.40% B) 8.73% C) 8.95% D) 8.44% Ans: B Feedback: Loan amount = PV Interest rate on loan = i = 8.4% Frequency of compounding = m = 12 Effective annual rate = EAR m1

12

 0.084 i  EAR = + 1 m −1=1+  −1 12     = 1.0873−1=8.73 % To discount present or future value of cash flows, the most appropriate rate is the EAR, that is, 8.73 percent.

Format: Essay Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 101. How is an annuity due different from the ordinary annuity?

Ans: When constant cash flows are received or paid at the end of each period for a length of time, we have an ordinary annuity. If the same cash flows happen at the beginning of each period, we call it an annuity due. Cash flows received at the beginning of each period earn interest for an extra period compared to cash flows received at the end of each period for an investment of the same time frame. Thus, annuity dues have higher values than ordinary annuities.

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Format: Essay Learning Objective: LO 5 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 102. The annual percentage rate (APR) is not the appropriate rate to perform present or future value calculations. Explain this statement.

Ans: The APR is the annualized interest rate using simple interest. In other words, the APR is the simple interest charged per period multiplied by the number of periods per year.

However, the APR ignores the impact of compounding on cash flows. This makes it an inappropriate discount rate for doing present and future value calculations. An appropriate rate for such calculations is the effective annual rate (EAR).

Format: Essay Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Legal/Regulatory Perspective 103. What was the purpose behind the passage of the two consumer protection acts discussed in this chapter?

Ans: In 1968, Congress passed the Truth-in-Lending Act to ensure that all borrowers receive meaningful information about the cost of credit so they can make intelligent economic decisions. The act applies to all lenders that extend credit to consumers, and it covers credit card loans, auto loans, home mortgage loans, home equity loans, home improvement loans, and some small business loans. Similar legislation, the so-called Truth-in-Savings Act, applies to consumer savings vehicles such as consumer certificates of deposits (CDs). These two pieces of legislation require by law that the APR be disclosed on all consumer loans and savings plans and that it be prominently displayed on advertising and contractual documents.

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Format: Essay Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA:are Measurement 104. What the three ways of interest rate quoted in the market place?

Ans: The interest rates in the marketplace are quoted in three ways.

1. The quoted interest rate. This is an interest rate that has been annualized by multiplying the rate per period by the number of compounding periods. The annual percentage rate (APR) is an example. All consumer borrowing and lending rates are annualized in this manner.

2. The interest rate per period. The bank credit card rate of 1 percent per month is an example of this kind of rate. You can find the interest rate per period by dividing the quoted interest rate by the number of compounding periods.

3. The effective annual interest rate (EAR). This is the interest rate actually paid (or earned) after accounting for compounding. Sometimes it is difficult to distinguish a quoted rate from an EAR. Generally, however, an annualized consumer rate is an APR rather than an EAR.

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Chapter 07: Risk and Return Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Measurement 1. The rate of return that investors require for an investment depends on the risk associated with that investment.

A) True b) False Ans: A Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 2. The capital appreciation component of a stock's return considers the change in price of a stock divided by the initial price of the stock.

A) True B) False Ans: A Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Measurement 3. If the price of an asset has not increased or decreased since the original purchase of the asset, then the total return of the asset (if no dividends were paid during the period) is equal to the capital appreciation component return.

A) True B) False Ans: A

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Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 4. The income component of return for a common stock comes from the cash dividend a firm pays.

A) True B) False Ans: A Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy 5. If the capital appreciation return from owning a stock is positive, then the total return from owning the same stock can be negative.

A) True B) False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 6. In order to keep the total return of a stock equal to 100 percent, the income component for that stock must be zero.

A) True B) False Ans: B

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Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 7. Robert paid $100 for a stock one year ago. The total return on the stock was 10 percent.

Therefore, the stock must be selling for $110 today.

A) True B) False Ans: B Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 8. Whenever the outcome of an event has a number of different possibilities that have equal probability of occurrence, then the expected value of the outcome is equal to the simple average of the individual events.

A) True B) False Ans: A Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 9. You have placed a wager such that you will either receive nothing if you lose the bet or you will receive $10 if you win the bet. If the expected cash receipt is $9, then there is a 100 percent probability that you will win the wager.

A) True B) False Ans: B

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Format: True/False Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 10. The expected return on the market portfolio is equal to the market risk premium.

A) True B) False Ans: B Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 11. The variance of a distribution can be a negative value.

A) True B) False Ans: B Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 12. The standard deviation of a distribution can be a negative value.

A) True B) False Ans: B

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Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 13. The normal distribution is completely described by its mean and standard deviation where 50 percent of the distribution's probability is less than the mean and 50 percent greater than the mean.

A) True B) False Ans: A Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 14. The variance is denominated in squared units, whereas the standard deviation is denominated in the same units as the expected value.

A) True B) False Ans: A Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Measurement 15. The best measure of assessing a risk within an investment is its variance.

A) True B) False Ans: B

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Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 16. Variance is equal to the square root of standard deviation.

A) True B) False Ans: B Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 17. If you are calculating the variance and standard deviation of returns on a stock, the variance will always be larger than the standard deviation.

A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 18. The coefficient of variation divides the variance of the returns of an asset by the expected rate of return of that asset.

A) True B) False Ans: B

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Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Measurement 19. The coefficient of variation is a good measure of the amount of risk that an asset will contribute to a diversified portfolio of assets.

A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Measurement 20. If you are building a portfolio, then you desire those assets to have a correlation coefficient of one.

A) True B) False Ans: B Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Measurement 21. If the returns on two assets have a correlation coefficient of one, then there are no benefits of diversification by combining these assets in a two-asset portfolio.

A) True B) False Ans: A

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Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Measurement 22. Utilizing the fact that values of two or more assets do not always move in the same direction at the same time in order to reduce the risk of a portfolio is called diversification.

A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Measurement 23. If you are trying to determine whether to purchase Security A or Security B as the only holding in your portfolio, then you can consider the coefficient of variation in order to understand the risk-return relationship of the individual securities.

A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: corporate Finance AICPA: Measurement 24. The coefficient of variation is useful when deciding which individual stocks to add to your diversified portfolio.

A) True B) False Ans: B

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Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Measurement 25. If two assets with return on correlation coefficients of less than one make up a portfolio, then the portfolio does not take advantage of any diversification benefits.

A) True B) False Ans: B Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 26. If the covariance between the returns on two assets is equal to zero, then the correlation coefficient must also be zero.

A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 27. If the distribution of returns on an asset has a variance of zero, then covariance of returns between that asset and the returns on any other asset must be equal to zero.

A) True B) False Ans: A

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 28. If you were to completely diversify your portfolio by purchasing a portion of every asset in the investment universe, then the expected return of your portfolio is equal to the risk-free rate.

A) True B) False Ans: B Format: True/False Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Measurement 29. Complete diversification means that the portfolio is no longer subject to market risk.

A) True B) False Ans: B Format: True/False Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 30. Given the historical information in the chapter, the beta of a small stock should be greater than the beta of a corporate bond.

A) True B) False Ans: A

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 31. The appropriate measure of risk for a diversified portfolio is beta.

A) True B) False Ans: A Format: True/False Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 32. The market risk-premium is equal to the expected return on the market less the risk-free rate of return.

A) True B) False Ans: A Format: True/False Learning Objective: LO 7 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 33. If you know the risk-free rate, the market risk-premium, and the beta of a stock, then using the Capital Asset Pricing Model (CAPM) you will be able to calculate the expected rate of return for the stock.

A) True B) False Ans: A Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Measurement

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Fundamentals of Corporate Finance 3e

34.

Test Bank

Which of the following statements is correct?

A) The greater the risk associated with an investment, the lower the return investors expect B) from it.

C) When choosing between two investments that have the same level of risk, investors D) prefer the investment with the higher return.

If two investments have the same expected return, investors prefer the riskiest alternative.

When choosing between two investments that have the same level of risk, investors prefer the investment with the lower return.

Ans: B Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 35. Gunther earned a 62.5 percent return on a stock that he purchased one year ago. The stock is now worth $12, and he received a dividend of $1 during the year. How much did Gunther originally pay for the stock?

A) $7.00 B) $7.50 C) $8.00 D) $8.50 Ans: C Feedback:

$12− $X + $1 = 0.625, $X = $8 $X

Original price of the stock = $8

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 36. Moshe purchased a stock for $30 last year. He found out today that he had a –100 percent return on his investment. Which of the following must be true?

A) The stock is worth $30 today.

B) The stock is worth $0 today.

C) The stock paid no dividends during the year.

D) Both B and C must be true.

Ans: D

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Measurement 37. Barbra purchased a piece of real estate last year for $85,000. The real estate is now worth $102,000. If Barbra needs to have a total return of 25 percent during the year, then what is the dollar amount of income that she needs to have to reach her objective?

A) $3,750 B) $4,250 C) $4,750 D) $5,250 Ans: B Feedback:

$102,000− $85,000+ $ X = 0.25, $X = $4, 250 $85, 000

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 38. Books Brothers stock was priced at $15 per share two years ago. The stock sold for $13 last year and now it sells for $18. What was the total return for owning Books Brothers stock during the most recent year? Assume that no dividends were paid. Round your answer to the nearest percent.

A) 17% B) 20% C) 23% D) 38% Ans: D Feedback:

$18− $13 = 0.3846 $13

Total rate of return38.46% = OR 38% (rounded).

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 39. George Wilson purchased Bright Light Industries common stock for $47.50 on January 31, 2010. The firm paid dividends of $1.10 during the last 12 months. George sold the stock today (January 30, 2011) for $54.00. What is George’s holding period return?

A) 16.00% B) 14.00% C) 11.00% D) 19.00% Ans: A Feedback:

R1=

P1 −P 0 +CF 1 $54.00− $47.50+ $1.10 = =.1600=16.00% P0 $4 7.5 0

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 40. In a game of chance, the probability of winning a $50 prize is 40 percent, and the probability of winning a $100 prize is 60 percent. What is the expected value of the prize in the game?

A) $50 B) $75 C) $80 D) $100 Ans: C Feedback: Expected value = $50 × (0.4) + $100 × (0.6) = $80

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 41. In a game of chance, the probability of winning a $50 is 40 percent and the probability of losing a $50 prize is 60 percent. What is the expected value of the prize in the game?

A) $10 B) $0 C) $10 D) $25 Ans: A Feedback: Expected value = $50 × (0.4) – $50 × (0.6) = $10 Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 42. Use the following table to calculate the expected return from an asset.

Return Probability 0.1 0.25 0.2 0.5 0.25 0.25 A) 15.00% B) 17.50% C) 18.75% D) 20.00% Ans: C Feedback: Expected return from an assets = (0.1) × (0.25) + (0.2) × (0.5) + (0.25) × (0.25) = 0.1875 = 18.75%

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 43. Use the following table to calculate the expected return from an asset.

Return Probability 0.05 0.1 0.1 0.15 0.15 0.5 0.25 0.25 A) 12.50% B) 13.75% C) 15.75% D) 16.75% Ans: C Feedback: Expected return from an asset = (0.05) × (0.1) + (0.1) × (0.15) + (0.15) × (0.5) + (0.25) × (0.25) = 0.1575 = 15.75% Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 44. The expected return for Stock Z is 30 percent. If we know the following information about Stock Z, then what return will it produce in the Lukewarm state of the world?

Return Probability 0.2 0.25 Poor ?

0.5 Lukewarm 0.4 0.25 Dynamite A) 20% B) 30% C) 40% D) It is impossible to determine.

Ans: B Feedback: Expected return from stock Z in Lukewarm state of the world = (0.2) × (0.25) + (X) × (0.5) + (0.4) × (0.25) = 0.3 , X = 0.3

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 45. The expected return for Stock V is 24.5 percent. If we know the following information about Stock Z, then what is the probability of the Dynamite state of the world occurring?

Return Probability 0.15 0.2 Poor 0.28 0.7 Lukewarm 0.19 ?

Dynamite A) 5% B) 10% C) 15% D) 20% Ans: B Feedback: Probability of the Dynamite state of the world occurring = 0.2 + 0.7 + X = 1.0 ===> X = 0.1 or 10% Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 46. Ahmet purchased a stock for $45 one year ago. The stock is now worth $65. During the year, the stock paid a dividend of $2.50. What is the total return to Ahmet from owning the stock?

A) 5% B) 44% C) 35% D) 50% Ans: D Feedback:

$65 − $45 + $2.50 = 0.5 = 50% $45

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 47. Julio purchased a stock one year ago for $27. The stock is now worth $32, and the total return to Julio for owning the stock was 37 percent. What is the dollar amount of dividends that he received for owning the stock during the year? Round your final answer to nearest whole dollar.

A) $4 B) $5 C) $6 D) $7 Ans: B Feedback:

$32−$27+$X $27

=0.37, $X =$5

Dividend paid = $5 Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 48. Francis purchased a stock one year ago for $20, and it is now worth $24. The stock paid a dividend of $3 during the year. What was the stock's rate of return from capital appreciation during the year?

A) 17% B) 20% C) 29% D) 35% Ans: B Feedback:

$24 − $20 = 0.20 $20

Capital appreciation percentage = 20 %

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 49. Gwen purchased a stock one year ago for $25, and it is now worth $31. The stock paid a dividend of $1.50 during the year. What was the stock's rate of return from dividend income during the year?

A) 6% B) 15% C) 24% D) 26% Ans: A Feedback:

$1.50 =.06 $25

Stock’s rate of return = 6 % Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Measurement 50. Genaro needs to capture a return of 40 percent for his one-year investment in a property. He believes that he can sell the property at the end of the year for $150,000 and that the property will provide him with rental income of $25,000. What is the maximum amount that Genaro should be willing to pay for the property?

A) $112,500 B) $125,000 C) $137,500 D) $150,000 Ans: B Feedback:

$150, 000 − $ X + $25, 000 =0.4, $X =$125,000 $X

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 51. Serox stock was selling for $20 two years ago. The stock sold for $25 one year ago, and it is currently selling for $28. Serox pays a $1.10 dividend per year. What was the rate of return for owning Serox in the most recent year? (Round to the nearest percent.)

A) 12% B) 16% C) 32% D) 40% Ans: B Feedback:

$28 − $25 + $1.1 = 0.164 $25

Total rate of return = 16% (Rounded off) Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 52. Security Analysts that have evaluated Concordia Corporation, have determined that there is a 15% chance that the firm will generate earnings per share of $2.40; a 60% probability that the firm will generate earnings per share of $3.10; and a 25% probability that the firm will generate earnings per share of $3.80. What are the expected earnings per share for Concordia Corporation? (Round off to the nearest $0.01) A) $3.10 B) $3.17 C) $2.75 D) $2.91 Ans: B Feedback: Probability Projected Expected EPS EPS 15.00% 60.00% 25.00% 100.00%

.

$ 2.40 3.10 3.80

$ 0.36 1.86 0.95 $ 3.17

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 53. Niles is making an investment with an expected return of 12 percent. If the standard deviation of the return is 4.5 percent, and if Niles is investing $100,000, then what dollar amount is Niles 90 percent sure that he will have at the end of the year? (Do not round intermediate computations).

A) $100,000.00 B) $104,597.50 C) $116,500.00 D) $119,402.50 Ans: B Feedback: { 1 + [0.12 – 1.645 (0.045)]} × $100,000 = $104,597.50 Number of standard deviations from mean for 90% observations is 1.645 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 54. Given the historical information in the chapter, which of the following investment classes had the greatest average return?

A) Intermediate-Term Government Bonds B) Long-Term Government Bonds C) Large U.S. Stocks D) Small U.S. Stocks Ans: D

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 55. Given the historical information in the chapter, which of the following investment classes had the greatest variability in returns?

A) Intermediate-Term Government Bonds B) Long-Term Government Bonds C) Large U.S. Stocks D) Small U.S. Stocks Ans: D Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 56. The expected return for an asset is 18.75 percent. If the return distribution for the asset is described as in the following table, what is the variance for the asset's returns? Round intermediate computations and final answer to 6 decimal places.

Return Probability 0.10 0.25 0.20 0.50 0.25 0.25 A) 0.00296 B) 9 C) 0.00061 D) 3 Ans: A0.01519 5 Feedback: (0.25) 0.05448 × (0.1 – 0.1875)2 + (0.5) × (0.2– 0.1875) 2 + (0.25) × (0.25 – 0.1875) 2 = 0.002969 6

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 57. The expected return for the asset shown in the following table is 18.75 percent. If the return distribution for the asset is described as below, what is the standard deviation for the asset's returns? Round intermediate computations and final answer to 6 decimal places.

Return Probability 0.10 0.25 0.20 0.50 0.25 0.25 A) 0.002969 B) 0.000613 C) 0.015195 D) 0.054486 Ans: D Feedback: Standard Deviation = { (0.25) × (0.10 – 0.1875)2 + (0.5) × (0.2 – 0.1875) 2 + (0.25) × (0.25 – 0.1875) 2 }1/2 = 0.054486 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 58. You have observed that the average size of a particular goldfish is 1.5 inches long. The standard deviation of the size of the goldfish is 0.25 inches. What is the size of a goldfish such that 90 percent of the goldfish are smaller from such size? Assume a normal distribution for the size of goldfish. Round your final answer to two decimal places.

A) 1.01 inches B) 1.09 inches C) 1.91 inches D) 1.99 inches Ans: C Feedback: 1.5 + 1.645 × (0.25) = 1.91 inches Number of standard deviations from mean for 90% observations is 1.645

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 59. You know that the average college student eats 0.75 pounds of food at lunch. If the standard deviation is 0.2 pounds of food, then what is the total amount of food that a cafeteria should have on hand to be 90 percent confident that it will not run out of food when feeding 50 college students?

A) 17.90 pounds B) 21.05 pounds C) 53.95 pounds D) 57.10 pounds Ans: C Feedback: 50 students × {0.75 pounds per student + 1.645 × (0.2 pounds per student)} = 53.95 pounds of food required.

Number of standard deviations from mean for 90% observations is 1.645 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 60. If a random variable follows a normal distribution, what is the probability that the random variable is larger than 1.96 standard deviations larger than the mean?

A) 1.25% B) 2.50% C) 3.75% D) 5.00% Ans: B

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 61. If a random variable follows a normal distribution, what is the probability that the random variable is larger than 1.96 standard deviations below the mean?

A) 95.00% B) 96.25% C) 97.50% D) 98.75% Ans: C Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 62. Tommie has made an investment that will generate returns that are subject to the state of the economy during the year. Use the following information to calculate the standard deviation of the return distribution for Tommie's investment. Do not round intermediate computations.

Round your final answer to four decimal places.

State Return Probability Weak 0.13 0.30 OK 0.20 0.40 Great 0.25 0.30 A) 0.0453 B) 0.0467 C) 0.0481 D) 0.0495 Ans: B Feedback: E(R) = (0.30 × 0.13) + (0.40 × 0.20) + (0.30 × 0.25) = 0.194 Var (R) = 0.30 × (0.13 – 0.194)2 + 0.4 × (0.20 – 0.194)2 + 0.30 × (0.25 – 0.194)2 = 0.002184 Std (R) = √(0.002184)= 0.0467 (rounded)

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 63. Elrond has made an investment that will generate returns that are subject to the state of the economy. Use the following information to calculate the variance of the return distribution for Elrond's investment. Do not round intermediate computations. Round your final answer to four decimal places.

State Return Probability Weak OK Great

0.10 0.17 0.28

0.8 0.1 0.1

A) 0.0536 B) 0.0543 C) 0.0550 D) 0.0031 Ans: D Feedback: E(R) = (0.8 × 0.10) + (0.1 × 0.17) + (0.1 × 0.28) = 0.125 Var(R) = 0.8 × (0.10 – 0.125)2 + 0.1 × (0.17 – 0.125)2 + 0.1 × (0.28 – 0.125)2 = 0.0031 (rounded) Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 64. Stock A has exhibited a standard deviation in stock returns of 0.5, whereas Stock B has exhibited a standard deviation of 0.6. The correlation coefficient between the stock returns is 0.5. What is the variance of a portfolio composed of 70 percent Stock A and 30 percent Stock B? A) 0.1549 B) 0.2179 C) 0.4668 D) 0.5500 Ans: B Feedback:

Var( port) = 1x22 +2x22 2+2x1x21212 1

= (0.7)2 (0.5)2 + (0.3)2 (0.6)2 + 2(0.7)(0.3)(0.5)(0.6)(0.5) = 0.2179

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Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 65. Aquaman Stock has exhibited a standard deviation in stock returns of 0.7, whereas Green Lantern Stock has exhibited a standard deviation of 0.8. The correlation coefficient between the stock returns is 0.1. What is the standard deviation of a portfolio composed of 70 percent Aquaman and 30 percent Green Lantern? Round the answer to five decimal points.

A) 0.32122 B) 0.54562 C) 0.56676 D) 0.75000 Ans: C Feedback: 22 Var(port) = 11 x2 2+ x22 + 2x1x21212

= (0.7)2 (0.7)2 + (0.3)2 (0.8)2 + 2(0.7)(0.3)(0.7)(0.8)(0.1) = 0.32122 Std ( port =) Sqrt (Var ( port )) = Sqrt(0.32122)= 0.566763 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: IMA: Quantitative Methods AICPA: Measurement 66. View Point Industries has forecast a rate of return of 20.00% if the economy booms (25.00% probability); a rate of return of 15.00% if the economy is in a growth phase (45.00% probability); a rate of return of 2.50% if the economy is in decline (20.00% probability); and a rate of return of –15.00% if the economy is in a depression (10.00% probability). What is View Point’s standard deviation of returns? Do not round intermediate computations. Round your final answer to two decimal points.

A) 17.31% B) 9.25% C) 15.00% D) 10.29% Ans: D Feedback: State of the Rate of Probability Expected Deviation Squared Economy return return deviation Probability × (Expected return Rate of return)^2

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Fundamentals of Corporate Finance 3e

Boom Growth Decline Depressio n

0.2 0.15 0.025 −0.15

0.25 0.45 0.2 0.1

0.05 0.0675 0.005 −0.015 0.1075

0.15 0.0225 0.0825 0 0.02 0.0068 −0.135 1 0.0004 Mean Variance 0 Std Devn Total variance = 1.059% Standard deviation = √(1.059) = 0.0182 10.29% 3

0.00563 0.00306 0.00008 0.00182 0.0105903 10.29%

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 67. Braniff Ground Services stock has an expected return of 9 percent and a variance of 0.25 percent. What is the coefficient of variation for Braniff? Round your final answer to four decimal places.

A) 0.0278 B) 0.5556 C) 1.8001 D) 36.0002 Ans: B Feedback: σ √(0.0025) 0.09 Coefficient of Variation= = =0.5556 (rounded) E(R)

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: IMA: Quantitative Methods AICPA: Measurement 68. Sayers purchased a stock with a coefficient of variation equal to 0.125. The expected return on the stock is 20 percent. What is the variance of the stock?

A) 0.000625 B) 0.025000 C) 0.625000 D) 0.790500 Ans: A Feedback:

(2)2=  = 1

Coefficient of Variation= E(R)

0.20

0.125, 2 = 0.000625

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 69. You have invested 40 percent of your portfolio in an investment with an expected return of 12 percent and 60 percent of your portfolio in an investment with an expected return of 20 percent.

What is the expected return of your portfolio?

A) 15.2% B) 16.0% C) 16.8% D) 17.6% Ans: C Feedback: E(R) = 0.4 × 0.12 + 0.60 × 0.20 = 0.168 = 16.8%

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Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 70. You have invested 20 percent of your portfolio in Homer, Inc., 40 percent in Marge Co., and 20 percent in Bart Resources. What is the expected return of your portfolio if Homer, Marge, and Bart have expected returns of 2 percent, 18 percent, and 3 percent, respectively?

A) 7.7% B) 8.2% C) 8.7% D) 9.2% Ans: B Feedback: E(R) = (0.2 × 0.02) + (0.4 × 0.18) + (0.2 × 0.03) = 0.082 = 8.2% Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 71. You invested $3,000 in a portfolio with an expected return of 10 percent and $2,000 in a portfolio with an expected return of 16 percent. What is the expected return of the combined portfolio?

A) 6.2% B) 12.4% C) 13.0% D) 13.6% Ans: B Feedback:

3,000 2,000 (0.1)+ (0.16)=0.124 5,000 5,000

= 12.4%

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Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 72. Given the returns for two stocks with the following information, calculate the covariance of the returns for the two stocks. Assume the expected return is 10.8 percent for Stock 1 and 9.7 percent for Stock 2.

Prob Stock 1 Stock 2 0.4 0.09 0.11 0.5 0.11 0.08 0.1 0.17 0.13 A) 0.000094 B) 0.000516 C) 0.000321 D) 0.717507 Ans: A Feedback: Cov(R1,R2) = 0.4 × (0.09 − 0.108) × (0.11− 0.097) + 0.5 × (0.11− 0.108) × (0.08 − 0.097) + 0.1 × (0.17 − 0.108) × (0.13 − 0.097) = 0.000094

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 73. Given the returns for two stocks with the following information, calculate the correlation coefficient of the returns for the two stocks. Assume the expected return for Stock 1 is 10.8 percent and 9.7 percent for Stock 2. Do not round intermediate computations.

Prob Stock 1 Stock 2 0.4 0.09 0.11 0.5 0.11 0.08 0.1 0.17 0.13 A) 0.230967 B) –0.00002548 C) 0.00032100 D) 0.17671455 Ans: A Feedback: From the solution to Problem 72, we find that the covariance between the stocks is 0.000094.

We must now solve for the standard deviation of the returns of each individual stock.

= 0.4(0.09− 0.108)2 +0.5(0.11− 0.108)2 +0.1(0.17− 0.108)2 =0.000516, 2 1  = 0.02271563 1

𝜎2= (0.5(0.11−0.144)2+ 0.3(0.17−0.1444)2+ 0.2(0.19−0.144)2 1 𝜎1 = 0.03469870

𝜌𝑅1,2 =

.

=0.001204

0.000094 (0.02271563)(0.01791647) =0.230967

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 74. Given the returns for two stocks with the following information, calculate the covariance of the returns for the two stocks. Assume the expected return is 14.4 percent for Stock 1 and 15.9 percent for Stock 2. Round your final answer to five decimal places.

Stock 2 Prob Stock 1 0.5 0.3 0.2 A) 0.00120 B) 0.00054 C) −0.00079 D) –0.33720 Ans: C Feedback:

0.11 0.17 0.19

0.18 0.15 0.12

Cov(R1,R2) = 0.5 × (0.11 – 0.144) × (0.18 – 0.159) + 0.3 × (0.17 – 0.144) × (0.15 – 0.159) + 0.2 × (0.19 – 0.144) × (0.12 – 0.159) = −0.00079

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 75. Given the returns for two stocks with the following information, calculate the correlation coefficient of the returns for the two stocks. Assume the expected return is 14.4 percent for Stock 1 and 15.9 percent for Stock 2. Do not round intermediate computations.

Prob Stock 1 Stock 2 0.5 0.3 0.2

0.11 0.17 0.19

0.18 0.15 0.12

A) 0.00120 B) 0.00054 C) –0.00271 -0.97169 D) Ans: D Feedback: Cov(R1,R2) = 0.5 × (0.11 – 0.144) × (0.18 – 0.159) + 0.3 × (0.17 – 0.144) × (0.15 – 0.159) + 0.2 × (0.19 – 0.144) × (0.12 – 0.159) = −0.00079 𝜎2=0.5(0.11−0.144)2+ 0.3(0.17−0.144)2+0.2(0.10−0.1444)2 =0.001204 1 𝜎1= 0.03469870

22 = 0.5(0.18− 0.159)2 +0.3(0.15− 0.159)2 +0.2(0.12− 0.15 9)2 =0.000549,  = 0.02343075 2

𝜌𝑅1,2 =

.

−0.00079 (0.03469870)(0.02343075) =−0.9716899

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 76. The covariance of the returns between Stock A and Stock B is 0.0087. The standard deviation of Stock A is 0.26, and the standard deviation of Stock B is 0.37. What is the correlation coefficient between the returns of the two stocks?

A) 0.090437 B) 0.096200 C) 0.90437 D) 0.96200 Ans: A Feedback:

=

Cov(R1, R2) =

 12

0.0087 =0.090437 (0.26)(0.37)

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 77. The covariance of the returns between Wildcat Stock and Sun Devil Stock is 0.09875. The variance of Wildcat is 0.2116, and the variance of Sun Devil is 0.1369. What is the correlation coefficient between the returns of the two stocks?

A) 0.17020 B) 0 C) 0.29334 D) 7 Ans: D0.34082 3 Feedback: 0.58019 𝐶𝑜𝑣(𝑅1,𝑅2) 0.09875 = 9 𝜌= =0.580199 𝜎1𝜎2 √(0.2116× 0.1369)

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 78. Horse Stock returns have exhibited a standard deviation of 0.57, whereas Mod T Stock returns have a standard deviation of 0.63. The correlation coefficient between the returns is 0.078042.

What is the covariance of the returns? Round your answer to six decimal places.

A) 0.028025 B) 0.217327 C) 0.359100 D) 0.993094 Ans: A Feedback: 𝐶𝑜𝑣 (𝑅1𝑅2)= 𝜌12𝜎1𝜎2=(0.078042)×(0.57)×(0.63)=0.028025 Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Measurement 79. Most of the risk-reduction benefits from diversification can be achieved in a portfolio consisting of A) 5 to 10 assets.

B) 10 to 15 assets.

C) 15 to 20 assets.

D) 20 to 25 assets.

Ans C

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Measurement 80. Which of the following investors should be willing to pay the highest price for an asset?

A) An investor with a single-asset portfolio.

B) An investor with a diversified portfolio.

C) An investor who is not completely diversified.

D) An investor who is so risk-averse that he does not recognize the benefits of diversification.

Ans: B Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 81. Which of the following is the best measure of the systematic risk in a portfolio?

A) Variance B) Standard deviation C) Covariance D) Beta Ans: D Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 82. A portfolio with a level of systematic risk is the same as that of the market has a beta that is A) equal to zero.

B) equal to one.

C) less than the beta of the risk-free asset.

D) less than zero.

Ans: B

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Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 83. The beta of Elsenore, Inc., stock is 1.6, whereas the risk-free rate of return is 8 percent. If the expected return on the market is 15 percent, then what is the expected return on Elsenore?

A) 11.20% B) 19.20% C) 24.00% D) 32.00% Ans: B Feedback:

E(R Els ) = Rrf + Els (E(RM ) − Rrf ) = 0.08 +1.6(0.15 − 0.08) = 0.1920

= 19.20% Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Fiancne AICPA: Measurement 84. The beta of Ricci Co.'s stock is 3.2, whereas the risk-free rate of return is 9 percent. If the expected return on the market is 18 percent, then what is the expected return on Ricci Co.?

A) 28.80% B) 37.80% C) 48.60% D) 57.60% Ans: B Feedback:

E(R Ricci ) = Rrf + Ricci (E(RM ) − Rrf ) = 0.09 + 3.2(0.18 − 0.09) = 0.378

= 37.8%

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Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 85. The risk-free rate of return is currently 3 percent, whereas the market risk premium is 6 percent.

If the beta of Lenz, Inc., stock is 1.8, then what is the expected return on Lenz?

A) 8.40% B) 10.80% C) 13.80% D) 19.20% Ans: C Feedback: E(RLenz) = Rrf + βLenz (E(RM) – Rrf) = 0.03 + (1.8 × 0.06) = 0.138 = 13.8 % Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 86. The expected return on Kiwi Computers stock is 16.6 percent. If the risk-free rate is 4 percent and the expected return on the market is 10 percent, then what is Kiwi's beta?

A) 1.26 B) 2.10 C) 2.80 D) 3.15 Ans: B Feedback:

E(R Kiwi ) = 0.166 = Rrf + Kiwi (E(RM ) − Rrf ) = 0.04 + Kiwi (0.10 − 0.04)  Kiwi = 2.1

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 87. The expected return on Mike's Seafood stock is 17.9 percent. If the expected return on the market is 13 percent and the beta for Kiwi is 1.7, then what is the risk-free rate?

A) 4.5% B) 5.0% C) 5.5% D) 6.0% Ans: D Feedback:

E(RMike) = 0.179 = Rrf +Mike(E(RM ) − Rrf ) = Rrf +1.7(0.13− Rrf )  Rrf = 0.06

= 6% Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 88. The expected return on Karol Co. stock is 16.5 percent. If the risk-free rate is 5 percent and the beta of Karol Co is 2.3, then what is the risk premium on the market?

A) 2.5% B) 5.0% C) 7.5% D) 10.0% Ans: B Feedback:

emium =0.05 Risk Pr E(R Karole ) = 0.165 = Rrf + Karol (E(RM ) − Rrf ) = 0.05 + 2.3(Risk Pr emium)

0.05 + 2.3 (Risk premium) = 0.165. Therefore Risk premium = 0.05 = 5%

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 89. Which of the following represents a plot of the relation between expected return and systemic risk?

A) The beta coefficient B) The covariance of returns line C) The security market line D) The variance Ans: C Format: Essay Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Analysis AASCB: Analytic IMA: Investment Decisions AICPA: Measurement 90. Explain the difference between systematic risk and unsystematic risk.

Ans: Systematic risk is the risk that cannot be diversified away and describes the risk that is inherent in the general economic world of investing. Systematic risk cannot be eliminated through diversification. Unsystematic risk is risk that can be diversified away and describes a risk that is unique to a particular investment.

Format: Essay Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Quantitative Methods AICPA: Measurement 91. While performing the regression analysis of historical returns of a stock with a historical return of a general market index, you would plot the line of best fit through those data points. The slope of that line represents the beta of the stock in question. However, in most instances the data points do not lie exactly on that line. Explain the reason.

Ans: The slope of the line of best fit describes the beta of the stock in question that is capturing the systematic risk inherent in investing in that stock. The vertical distance between each point and the line represents the unsystematic, or diversifiable risk in investing in the stock.

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Chapter 8: Bond Valuation and the Structure of Interest Rates Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 1. The largest investors in corporate bonds are state government agencies.

A) True B) False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 2. The largest investors in corporate bonds are big institutional investors such as life insurance companies and pension funds.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 3. Most secondary market transactions for corporate bonds take place on the New York Stock Exchange.

A) True B) False Ans: B

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 4. Most secondary market transactions for corporate bonds take place through dealers in the overthe-counter (OTC) market.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 5. A thin market for a security implies a high frequency of trades for that type of security in the markets.

A) True B) False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 6. Corporate bonds have a thin market relative to market for corporate stocks.

A) True B) False Ans: A

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 7. Prices in the corporate bond market tend to be more volatile than securities sold in markets with greater trading volumes.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 8. Vanilla bonds have coupon payments that are fixed for the life of the bond, with the principal being repaid at maturity.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 9. The face or par value for most corporate bonds is equal to $1,000, and it is the principal amount owed to bondholders at maturity.

A) True B) False Ans: A

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 10. Zero coupon bonds sell well above their par value because they offer no coupons.

A) True B) False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 11. Convertible bonds can be converted into shares of common stock at some predetermined ratio at the discretion of the bondholder.

A) True B) False Ans: A Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 12. The value, or price, of any asset is the present value of its future cash flows.

A) True B) False Ans: A

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 13. The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments equal to the price of the bond.

A) True B) False Ans: A Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Risk Analysis 14. Interest rate risk is the risk that bond prices will fluctuate as interest rate changes.

A) True B) False Ans: A Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 15. As interest rates fall, the prices of bonds decline.

A) True B) False Ans: B

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Risk Analysis 16. Higher coupon bonds have greater interest rate risk.

A) True B) False Ans: B Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 17. All other things being equal, a given change in the interest rates will have a greater impact on the price of a low-coupon bond than a higher-coupon bond with the same maturity.

A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 18. Bonds with a call provision pay lower yields than comparable noncallable bonds.

A) True B) False Ans: B

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 19. The risk that the lender may not receive payments as promised is called default risk.

A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 20. U.S. Treasury securities are the best proxy measure for the risk-free rate.

A) True B) False Ans: A Format: True/False Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 21. Upward-sloping yield curves often occur before the beginning of recession.

A) True B) False Ans: B

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 22. If investors believe inflation will be increasing in the future, the prevailing yield will be downward sloping.

A) True B) False Ans: B Format: True/False Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 23. The real rate of interest varies with the business cycle, with the highest rates seen at the end of a period of business expansion and the lowest at the bottom of a recession.

A) True B) False Ans: A Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 24. Which of the following statements is true?

A) The largest investors in corporate bonds are institutional investors such as life insurance companies and pension funds.

B) The market for corporate bonds is thin compared to the market for corporate stocks.

C) D) Prices in the corporate bond market tend to be more volatile than prices of securities sold in markets with greater trading volumes.

All of the above are true.

Ans: D

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 25. Which one of the following statements is NOT true?

A) Prices in the corporate bond market tend to be more volatile than the markets for stocks or money market securities.

B) Corporate bonds are more marketable than the securities that have higher daily trading C) volumes.

D) The market for corporate bonds is thin compared to the market for corporate stocks.

The largest investors in corporate bonds are life insurance companies and pension funds.

Ans: B

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 26. It is easy for individuals to trade in the corporate bond market because: A) the corporate bond market is considered to be very transparent.

B) prices in the corporate bond market tend to be more stable.

C) centralized reporting of deals between buyers and sellers take place.

D) None of the above statements is true.

Ans: D Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 27. Which one of the following statements about vanilla bonds is NOT true?

A) They have fixed coupon payments.

B) The face value, or par value, for most corporate bonds is $1,000.

C) Coupon payments are usually made quarterly.

D) The bond's coupon rate is calculated as the annual coupon payment divided by the bond's face value.

Ans: C

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 28. Which of the following statements is true of zero coupon bonds?

A) Zero coupon bonds have no coupon payments over its life and only offer a single payment at maturity.

B) Zero coupon bonds sell well below their face value (at a deep discount) because they C) offer no coupons.

D) The most frequent and regular issuer of zero coupon securities is the U.S. Treasury Department.

All of the above are true.

Ans: D

29.

.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement Which of the following statements is true?

A) B) C) D)

To secure the conversion option on a bond, bondholders would be willing to pay a premium.

Typically, the conversion ratio is set so that the firm's stock price must appreciate at least 15 to 20 percent before it is profitable to convert bonds into stock.

Convertible bonds can be converted into shares of common stock at some predetermined ratio at the discretion of the bondholder.

All of the above are true.

Ans: D

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 30. Which of the following statements is true of convertible bonds?

A) The most significant disadvantage to a corporation of issuing convertible bonds is that they increase the cash that the firm must use to make interest payments.

B) The typical conversion ratio is set so that the firm’s stock price must appreciate 5% or C) less before it is profitable for the holder to convert the bond to stock.

D) Firms that issue convertible bonds can do so at a lower interest rate.

The typical issue of convertible bonds allows the holder of the bond to convert it to preferred stock.

Ans: C

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 31. Which of the following statements is most true about zero coupon bonds?

A) They typically sell at a premium over par when they are first issued.

B) They typically sell for a higher price than similar coupon bonds.

C) They are always convertible to common stock.

D) They typically sell at a deep discount below par when they are first issued.

Ans: D

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 32. Which one of the following statements about bonds is NOT true?

A) To compute a bond's price, one needs to calculate the present value of the bond's expected cash flows.

B) The value, or price, of any asset is the future value of its cash flows.

C) The required rate of return, or discount rate, for a bond is the market interest rate called D) the bond's yield to maturity The expected future cash flows are estimated using the coupons that the bond will pay and the maturity value to be received.

Ans: B Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 33. If a bond's coupon rate is equal to the market rate of interest, then the bond will sell: A) at a price equal to its face value.

B) at a price greater than its face value.

C) at a price less than its face value.

D) None of the above is true.

Ans: A Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 34. Bonds sell at a discount when the market rate of interest is: A) less than the bond's coupon rate.

B) greater than the bond's coupon rate.

C) equal to the bond's coupon rate.

D) None of the above is true.

Ans: B

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 35. Bonds sell at a premium when the market rate of interest is: A) less than the bond's coupon rate.

B) greater than the bond's coupon rate.

C) equal to the bond's coupon rate.

D) None of the above is true.

Ans: A Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 36. In calculating the current price of a bond paying semiannual coupons, one needs to A) use double the number of years for the number of payments made.

B) use the semiannual coupon.

C) use the semiannual rate as the discount rate.

D) All of the above need to be done.

Ans: D Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 37. Which one of the following statements about zero coupon bonds is NOT true?

A) Zero coupon bonds have no coupon payments but promise a single payment at maturity.

B) Zero coupon bonds must sell for less than similar bonds that make periodic coupon C) payments.

D) Zero coupon bonds make coupon payments but no principal payment at maturity.

All of the above statements are true.

Ans: C

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 38. Briar Corp is issuing a 10-year bond with a coupon rate of 7 percent. The interest rate for similar bonds is currently 9 percent. Assuming annual payments, what is the present value of the bond? (Do not round intermediate computations. Round your final answer to the nearest dollar.)

A) $872 B) $1,066 C) $990 D) $945 Ans: A Feedback: Years to maturity = n = 10 Coupon rate = C = 7% Annual coupon = $1,000 × 0.07 = $70 Current market rate = i = 9% Present value of bond = PB 0 1 2 3 4 5 6 10 |______|_______|______|______|______|_______|_____...................._____| $70 $70 $70 $70 $70 $70 $70 $1,000 n = 10;

C = 7%; 𝐶2

𝐶1 + PB = (1+𝑖)1 (1+𝑖)2 (1+𝑖)3 1

=C×[

1− (1+𝑖)𝑛 𝑖

𝐶3

]+

+ ……

F (1+𝑖)𝑛

i = YTM = 9%

𝐶𝑛+ 𝐹 𝑛 (1+𝑖)𝑛 1

= $70 × [

1− (1.09)10 0.09

] + $1,000 1.0910

= $449.24 + $422.41 = $871.65

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8-14

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 39. Regatta, Inc., has six-year bonds outstanding that pay a 8.25 percent coupon rate. Investors buying the bond today can expect to earn a yield to maturity of 6.875 percent. What should the company's bonds be priced at today? Assume annual coupon payments. (Do not round intermediate computations. Round your final answer to the nearest dollar.)

A) $972 B) $1,066 C) $1,014 D) $923 Ans: B Feedback: Years to maturity = n = 6 Coupon rate = C = 8.25% Annual coupon = $1,000 × 0.0825 = $82.50 Current market rate = i = 6.875% 0 1 2 3 4 |______|_________|________|________|______|...................._____| $82.50 $82.50 $82.50 $82.50 $82.50 n = 6; PB=

C = 8.25%;

𝐶 𝐶2 1+ (1+𝑖)1 (1+𝑖)2 (1+𝑖)3 1

1− ( 1+𝑖)𝑛

𝐶3

6

i = YTM = 6.875%

𝐶𝑛+ 𝐹𝑛

+ …… (1+𝑖)𝑛

F ] + (1+𝑖)𝑛

= C ×[ 𝑖 PV of bond = $1065.79

1

= $82.50 ×[

1− ( 1.06875)6 $1,000 0.06875 ] + (1.06875)6

= $1066 (rounded)

.

8-15

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 40. Triumph Corp. issued five-year bonds that pay a coupon of 6.375 percent annually. The current market rate for similar bonds is 8.5 percent. How much will you be willing to pay for Triumph's bond today? (Do not round intermediate computations. Round your final answer to the nearest dollar.)

A) $1,023 B) $1,137 C) $916 D) $897 Ans: C Feedback: Years to maturity = n = 5 Coupon rate = C = 6.375% Annual coupon = $1,000 × 0.06375 = $63.75 Current market rate = i = 8.5%

𝑃𝐵=

𝐶1 (1 +𝑖 )

+

𝐶2

(1+𝑖) 2 1

=C × [

………+

1− (1+𝑖)𝑛 ]+ 𝑖

F (1+𝑖)𝑛

𝐶+ 𝑛 𝐹 𝑛 (1+𝑖) 𝑛 1

= $63.75 × [

1− (1.085)5 0 .085

]+

$1,000 (1.085) 5

= $251.22 + $665.05 = $916 (rounded)

.

8-16

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 41. Your friend recommends that you invest in a three-year bond issued by Trimer, Inc., that will pay annual coupons of 10 percent. Similar investments today will yield 6 percent. How much should you pay for the bond? (Do not round intermediate computations. Round your final answer to the nearest dollar.)

A) $1,024 B) $979 C) $886 D) $1,107 Ans: D Feedback: Years to maturity = n = 3 Coupon rate = C = 10% Annual coupon = $1,000 × 0.10 = $100 Current market rate = i = 6%

𝑃𝐵=

𝐶1 (1 +𝑖 )

𝐶2

+

(1+𝑖) 2 1

𝑃𝐵=C × [

.

1− (1+𝑖) 𝑛 𝑖

………

𝐶+ 3 𝐹 3 (1+𝑖)

3

1

]+

1− (1+0.06) 3 F ] + $1,000 𝑛 = $100 × [ (1+𝑖) 0.06 (1+0.06)3

8-17

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 42. Kevin Rogers is interested in buying a five-year bond that pays a coupon of 10 percent on a semiannual basis. The current market rate for similar bonds is 8.8 percent. What should be the current price of this bond? (Do not round intermediate computations. Round your final answer to the nearest dollar.)

A) $1,048 B) $965 C) $1,099 D) $982 Ans: A Feedback: Years to maturity = n = 5 Coupon rate = C = 10% Frequency of payment = m = 2 Semiannual coupon = $1,000 × (0.10/2) = $50.00 Current market rate = i = 8.8% Present value of bond = PB

.

8-18

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 43. Giant Electronics is issuing 20-year bonds that will pay coupons semiannually. The coupon rate on this bond is 7.8 percent. If the market rate for such bonds is 7 percent, what will the bonds sell for today? (Do not round intermediate computations. Round your final answer to the nearest dollar.)

A) $1,037 B) $1,085 C) $861 D) $923 Ans: B Feedback: Years to maturity = n = 20 Coupon rate = C = 7.8% Frequency of payment = m = 2 Semiannual coupon = $1,000 × (0.078/2) = $39.00 Current market rate = i = 7% Present value of bond = PB

.

8-19

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 44. Jane Thorpe has been offered a seven-year bond issued by Barone, Inc., at a price of $943.22.

The bond has a coupon rate of 9 percent and pays the coupon semiannually. Similar bonds in the market will yield 10 percent today. Should she buy the bonds at the offered price? (Do not round intermediate computations. Round your final answer to the nearest dollar.)

A) Yes, the bond is worth more at $1,015.

B) No, the bond is only worth $921.

C) Yes, the bond is worth more at $951.

D) No, the bond is only worth $912.

Ans: C Feedback: Years to maturity = n = 7 Coupon rate = C = 9% Frequency of payment = m = 2 Semiannual coupon = $1,000 × (0.09/2) = $45.00 Current market rate = i = 10% Present value of bond = PB

.

8-20

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 45. Kevin Oh is planning to sell a bond that he owns. This bond has four years to maturity and pays a coupon of 10 percent on a semiannual basis. Similar bonds in the current market will yield 12 percent. What will be the price that he will get for his bond? (Do not round intermediate computations. Round your final answer to the nearest dollar.)

A) $1,044 B) $938 C) $970 D) $1,102 Ans: B Feedback: Years to maturity = n = 4 Coupon rate = C = 10% Frequency of payment = m = 2 Semiannual coupon = $1,000 × (0.10/2) = $50.00 Current market rate = i = 12% Present value of bond = PB

.

8-21

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 46. Jeremy Kohn is planning to invest in a 10-year bond that pays a 12 percent coupon. The current market rate for similar bonds is 9 percent. Assume semiannual coupon payments. What is the maximum price that should be paid for this bond? (Do not round intermediate computations.

Round your final answer to the nearest dollar.)

A) $951 B) $882 C) $1,033 D) $1,195 Ans: D Feedback: Years to maturity = n = 10 Coupon rate = C = 12% Frequency of payment = m = 2 Semiannual coupon = $1,000 × (0.12/2) = $60.00 Current market rate = i = 9% Present value of bond = PB

.

8-22

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 47. Shana Norris wants to buy five-year zero coupon bonds with a face value of $1,000. Her opportunity cost is 8.5 percent. Assuming annual compounding, what would be the current market price of these bonds? (Round your answer to the nearest dollar.)

A) $1,023 B) $665 C) $890 D) $1,113 Ans: B Feedback: Years to maturity = n = 5 Coupon rate = C = 0% Current market rate = i = 8.5%

.

8-23

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 48. The U.S. Treasury has issued 10-year zero coupon bonds with a face value of $1,000. Assume that the bond compounds interest semiannually. What will be the current market price of these bonds if the opportunity cost for similar investments in the market is 6.75 percent? (Round your answer to the nearest dollar.)

A) $684 B) $860 C) $515 D) $604 Ans: C Feedback: Frequency of payment = m = 2 Years to maturity = n = 10 Coupon rate = C = 0% Current market rate = i = 6.75%

.

8-24

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 49. Robertsons, Inc., is planning to expand its specialty stores into five other states and finance the expansion by issuing 15-year zero coupon bonds with a face value of $1,000. If your opportunity cost is 8 percent and similar coupon-bearing bonds will pay semiannually, what will be the price at which you will be willing to purchase these bonds? (Round your answer to the nearest dollar.)

A) $308 B) $383 C) $803 D) $866 Ans: A Feedback: Frequency of payment = m = 2

.

8-25

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 50. Jarmine Corp., is planning to fund a project by issuing 10-year zero coupon bonds with a face value of $1,000. Assuming semiannual compounding of interest, what will be the price of these bonds if the appropriate discount rate is 14 percent? (Round your answer to the nearest dollar.)

A) $852 B) $258 C) $419 D) $841 Ans: B Feedback: Frequency of payment = m = 2 Years to maturity = n = 10 Coupon rate = C = 0% Current market rate = i = 14%

.

8-26

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 51. Which one of the following statements is true of a bond’s yield to maturity?

A) The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments equal to the price of the bond.

B) It is the annual yield that the investor earns if the bond is held to maturity, and all the C) coupon and principal payments are made as promised.

D) A bond's yield to maturity changes daily as interest rates increase or decrease.

All of the above are true.

Ans: D

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 52. The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments: A) exceed the price of the bond.

B) equal to zero.

C) equal to the price of the bond.

D) less than the price of the bond.

Ans: C

.

8-27

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 53. Which one of the following statements is NOT true of realized yield?

A) The realized yield is the return earned on a bond given the cash flows actually received by the investor.

B) The realized yield is equal to the yield to maturity even if the bond is sold prior to C) maturity.

D) It is the interest rate at which the present value of the actual cash flows generated by the investment equals the bond's price at the time of sale of the bond.

All of the above are true.

Ans: B

.

8-28

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 54. Jenny LePlaz is looking to invest in a five-year bond that pays annual coupons of 6.25 percent and currently sells at $912.34. What is the current market yield on such bonds? (Round to the closest answer.)

A) 9.5% B) 8.5% C) 6.5% D) 7.5% Ans: B Feedback: Years to maturity = n = 5 Coupon rate = C = 6.25% Annual coupon = $1,000 × (0.0625) = $62.50 Yield to maturity = i Present value of bond = PB = $912.34 Use the trial-and-error approach to solve for YTM. Since the bond is selling at a discount, we know that the yield to maturity is higher than the coupon rate. Try YTM = 8%:

𝑃𝐵= C(𝑃𝑉𝐼𝐹𝐴𝑖,𝑛) + F(𝑃𝑉𝐼𝐹 ) 𝑖,𝑛 1

$912.34 = $62.50 *[

1− (1+0.08)5 0.08

$1 ,000 (1 .08) 5

]+

= $249.54 + 680.58 ≠ $930.12 Try a higher rate, say YTM = 8.5%:

𝑃𝐵=C(𝑃𝑉𝐼𝐹𝐴𝑖,𝑛)+F(𝑃𝑉𝐼𝐹 $912.34 = $62.50 *[

1− (

1

𝑖,𝑛 )

1+0.085)5]+$1,000

0.085

≅$246.29+665.05 ≅$911.33

(1.085) 5

The YTM is approximately 8.5 percent. Using a financial calculator provided an exact YTM of 8.47 percent.

N = 5 PMT = $62.50 PV = –$912.34 FV = $1,000 CPT I/Y gives the interest rate as 8.47 percent.

.

8-29

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 55. Nathan Akpan is planning to invest in a seven-year bond that pays annual coupons at a rate of 7 percent. It is currently selling at $927.23. What is the current market yield on such bonds?

(Round to the closest answer.)

A) 10.4% B) 9.5% C) 8.4% D) 7.5% Ans: C Feedback: Years to maturity = n = 7 Coupon rate = C = 7% Annual coupon = $1,000 × (0.07) = $70 Yield to maturity = i Present value of bond = PB = $927.23 Use the trial-and-error approach to solve for YTM. Since the bond is selling at a discount, we know that the yield to maturity is higher than the coupon rate. Try YTM = 8%:

𝑃𝐵=C(𝑃𝑉𝐼𝐹𝐴𝑖,𝑛)+F(𝑃𝑉𝐼𝐹𝑖,𝑛) 1

1− (1+0.08)7

$927.23 = $70 * [

0.08

]+

$1,000 (1.08)7

= $364.45 + 583.49 ≠ $947.94 Try a higher rate, say YTM = 8.5%:

𝑃𝐵=C(𝑃𝑉𝐼𝐹𝐴𝑖,𝑛)+F(𝑃𝑉𝐼𝐹𝑖,𝑛) 1

1− (1+0.085)7

$927.23 = $70 * [

0.085

]+

$1,000 (1.085)7

= $358.30 + 564.93 = $923.22 Try a lower rate, say YTM = 8.4%: The YTM is approximately 8.4 percent. Using a financial calculator provided an exact YTM of 8.42 percent.

N = 7 PMT = $70

PV = –$927.23

FV = $1,000

CPT I/Y gives the interest rate as 8.42 percent.

.

8-30

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 56. Jane Almeda is interested in a 10-year bond issued by Roberts Corp. that pays a coupon of 10 percent annually. The current price of this bond is $1,174.45. What is the yield that Jane would earn by buying it at this price and holding it to maturity? (Round to the closest answer.)

A) 7.1% B) 7.5% C) 8.9% D) 8.5% Ans: B Feedback: Years to maturity = n = 10 Coupon rate = C = 10% Annual coupon = $1,000 × (0.10) = $100 Yield to maturity = i Present value of bond = PB = $1,174.45 Use the trial-and-error approach to solve for YTM. Since the bond is selling at a premium, we know that the yield to maturity is lower than the coupon rate. Try YTM = 8%:

𝑃𝐵=C(𝑃𝑉𝐼𝐹𝐴𝑖,𝑛)+F(𝑃𝑉𝐼𝐹𝑖,𝑛) 1

1− (1+0.08)10

$1,174.45 = $100 * [

0.08

]+

$1,000 (1.08)10

= $671.01 + 463.19 ≠ $1,134.20 Try a lower rate, say YTM = 7.5%: 𝑃𝐵 =𝐶(𝑃𝑉𝐼𝐹𝐴𝑖,𝑛)+𝐹(𝑃𝑉𝐼𝐹𝑖,𝑛) 1

$1,174.45=$100∗ [

1− ( 1+0.075)10 0.075

$1,000 ] + (1.075)10

= $686.41 + 485.19 ≅$1,171.60 The YTM is approximately 7.5 percent. Using a financial calculator provided an exact YTM of 7.46 percent.

N = 10 PMT = $100 PV = −$1,174.45 FV = $1,000 CPT I/Y gives the interest rate as 7.46 percent.

.

8-31

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 57. Shawna Carter wants to invest her recent bonus in a four-year bond that pays a coupon of 11 percent semiannually. The bonds are selling at $962.13 today. If she buys this bond and holds it to maturity, what would be her yield? (Round to the closest answer.)

A) 11.5% B) 11.8% C) 12.5% D) 12.2% Ans: D Feedback: Years to maturity = n = 4 Coupon rate = C = 11% Semiannual coupon = $1,000 × (0.11/2) = $55 Yield to maturity = i Present value of bond = PB = $962.13 Use the trial-and-error approach to solve for YTM. Since the bond is selling at a discount, we know that the yield to maturity is higher than the coupon rate. Try YTM = 12%:

 1−   $962.13= C   2 

1   1  2n 1− (1.06)8+ i  +  F   $1,000 = $55  2n i   0.06  (1.06)8 1+ i 2  2 

(1+2)

(

)

= $341.54+ $627.41 $968.95

Try a higher rate, say YTM = 12.2%:

 1−   $962.13= C   2 

1   1  2n 1− (1.061)8+ i  +  F   $1,000 = $55  2n i   0.061  (1.061)8 1+ i 2  2 

(1+2)

(

)

= $340.19+ $622.70 $962.89

The YTM is approximately 12.2 percent. Using a financial calculator provided an exact YTM of 12.22 percent (2 × 6.11%).

N=8 PMT = $55 PV = −$962.13 FV = $1,000 CPT I/Y gives the semiannual interest rate as 6.11 percent.

.

8-32

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 58. Alice Trang is planning to buy a six-year bond that pays a coupon of 10 percent semiannually.

Given the current price of $878.21, what is the yield to maturity on these bonds? (Round to the closest answer.)

A) 11% B) 12% C) 13% D) 14% Ans: C Feedback: Years to maturity = n = 6 Coupon rate = C = 10% Semiannual coupon = $1,000 × (0.10/2) = $50.00 Yield to maturity = i Present value of bond = PB = $878.21 Use the trial-and-error approach to solve for YTM. Since the bond is selling at a discount, we know that the yield to maturity is higher than the coupon rate. Try YTM = 12%:

 1−   $878.21= C   2 

1   1  2n i  + 1− 12 + F (1.06)  $1,000    = $50 2n i   0.06  (1.06)12 i + 1 2  2 

(1+2)

(

)

= $419.19+ $496.97 $916.16

Try a higher rate, say YTM = 13%:

 1−  $878.21= C  2  

1    1 2n i  + 1− 12 + F  = $50   (1.065)  $1,000 2n i   0.065  (1.065)12 1+ i 2  2 

(1+2)

(

)

= $407.94+ $469.68 $877.62

The YTM is approximately 13 percent. Using a financial calculator provided an exact YTM of 12.98 percent (2 × 6.49%).

N = 12 PMT = $50 PV = −$878.21 FV = $1,000 CPT I/Y gives the semiannual interest rate as 6.49 percent.

.

8-33

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 59. John Wong purchased a five-year bond today at $1,034.66. The bond pays 6.5 percent semiannually. What will be his yield to maturity? (Round to the closest answer.)

A) 6.7% B) 6.2% C) 3.25% D) 5.7% Ans: D Feedback: Years to maturity = n = 5 Coupon rate = C = 6.5% Semiannual coupon = $1,000 × (0.065/2) = $32.50 Yield to maturity = i Present value of bond = PB = $1,034.66 Use the trial-and-error approach to solve for YTM. Since the bond is selling at a premium, we know that the yield to maturity is lower than the coupon rate. Try YTM = 6%:

 1−   $1,034.66= C   2 

1   1  2n i  + 1− 10 + F (1.03)  $1,000    = $32.50 2n i   0.03  (1.03)10 1+ i 2  2 

(1+2)

(

)

= $277.23+ $744.09 $1, 021.33

Try a lower rate, say YTM = 5.7%:

  1   1 2n 1− +  1− 10 + F i $1,000  = $32.50  (1.0285)  $1,034.66= C   2n 10 2  + i  0.0285  (1.0285) + i  1 2  2      = $279.37+ $755.02 $1, 034.38

(1 2)

(

)

The YTM is approximately 5.7 percent. Using a financial calculator provided an exact YTM of 5.69 percent (2 × 2.847%).

N = 10 PMT = 32.50 PV = −$1,034.66 FV = $1,000 CPT I/Y gives the semiannual interest rate as 2.847 percent.

.

8-34

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 60. Huan Zhang bought a 10-year bond that pays 8.25 percent semiannually for $911.10. What is the yield to maturity on this bond? (Round your percentage answer to two decimal places.)

A) 7.60% B) 8.68% C) 9.66% D) 10.67% Ans: C Feedback: Years to maturity = n = 10 Coupon rate = C = 8.25% Semiannual coupon = $1,000 × (0.0825/2) = $41.25 Yield to maturity = i Present value of bond = PB = $911.10 Use the trial-and-error approach to solve for YTM. Since the bond is selling at a discount, we know that the yield to maturity is higher than the coupon rate. Try YTM = 9.4%:

 1−   $911.10= C   2 

1    1 2n i  + 1− 20 + F  = $41.25  (1.047)  $1,000 2n i   0.047  (1.047)20 1+ i 2  2 

(1+2)

)

(

= $527.40+ $399.09 $926.48

Try a higher rate, say YTM = 9.6%: $911.1= 𝐶⁄ 2 ×[

1−

1 (1+ 𝑖⁄ 2𝑛 2)

𝑖⁄

2

] +

1

𝐹 (1+ 𝑖⁄2)

2𝑛

=$41.25 × [

1− (1.048)20 0.048

]+

$1,000 (1.048) 20

= 522.90 + $391.54≈ $𝟗𝟏𝟒.𝟒𝟑 The YTM is approximately 9.66 percent. Using a financial calculator provided an exact YTM of 9.656 percent (2 × 4.828%).

N = 20 PMT = $41.25 PV = −$911.10 FV = $1,000 CPT I/Y gives the semiannual interest rate as 4.828 percent.

.

8-35

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 61. Five years ago, Shirley Harper bought a 10-year bond that pays 8 percent semiannually for $981.10. Today, she sold it for $1,067.22. What is the realized yield on her investment? (Round to the nearest percent.)

A) 7% B) 8% C) 11% D) 10% Ans: D Feedback:

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Fundamentals of Corporate Finance 3e

Test Bank

Purchase price of bond = $981.10 Years investment held = n = 5 Coupon rate = C = 8% Frequency of payment = m = 2 Semiannual coupon = $1,000 × (0.08/2) = $40 Realized Yield = i Selling price of bond = PB = $1,067.22 To compute the realized return, either the trial-and-error approach or the financial calculator can be used. Since the price has increased, market rates must have decreased. So, the realized return is going to be greater than the bond's coupon. Try rates higher than the coupon rate.

Try i = 10%, or i/2 = 5%:

  1 1− (1+ i mn  )  C FV 2 + PB =    mn i 2   (1+ i 2) 2    1  1− (1.05)10  $1,067.22  $981.10= $40  0.05  +  (1.05)10    = $308.87+ $655.18 $964.05

Try a lower rate, i = 9.6% or i/2 = 4.8%:

 1 i (1+ )mn C  FV 2 PB =   + mn i  (1+ i 2) 2  2      1   $1,067.22 1− (1.048)10 $981.10= $40    +  0.048  (1.048)10   = $311.89+ $667.79 $979.68  1−

9.6 percent rounded to 10% The realized rate of return is approximately . Using a financial calculator provided an exact yield of 9.56 percent.

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 62. Rachel McGovern bought a 10-year bond for $921.77 seven years ago. The bond pays a coupon of 15 percent semiannually. Today, the bond is priced at $961.22. If she sold the bond today, what would be her realized yield? (Round to the nearest percent.)

A) 17% B) 18% C) 9% D) 10% Ans: A Feedback:

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Fundamentals of Corporate Finance 3e

Test Bank

Purchase price of bond = $921.77 Years investment held = n = 7 Coupon rate = C = 15% Frequency of payment = m = 2 Annual coupon = $1,000 × (0. 15/2) = $75.00 Realized Yield = i Selling price of bond = PB = $961.22 To compute the realized return, either the trial-and-error approach or the financial calculator can be used. Since the price has increased, market rates must have decreased. So, the realized return is going to be greater than the bond's coupon. Try rates higher than the coupon rate.

Try i = 17%, or i/2 = 8.5%:

  1 1−  mn (1+ i )  C FV 2 + PB =    mn i 2   (1+ i 2) 2      1  1− (1.085)14 $961.22 $921.77= $75   +  0.085  (1.085)14   = $600.76+ $306.77 $907.52 Try a lower rate, i = 16.6% or i/2 = 8.3%:   1 1−  mn i C   (1+ 2)  FV + PB =  mn  i 2  (1+ i 2)  2     1   $961.22 1− (1.083)14 $921.77= $75   +  0.083  (1.083)14   = $607.69+ $314.79 $922.50 The realized rate of return is approximately 16.6 percent. Using a financial calculator provided an exact yield of 16.625 percent.

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 63. Jorge Cabrera paid $980 for a 15-year bond 10 years ago. The bond pays a coupon of 10 percent semiannually. Today, the bond is priced at $1,054.36. If he sells the bond today, what will be his realized yield? (Round to the nearest percent.)

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Fundamentals of Corporate Finance 3e

A) 12% B) 8% C) 11% D) 9% Ans: C Feedback: Purchase price of bond = $980 Years investment held = n = 10 Coupon rate = C = 10% Frequency of payment = m = 2 Annual coupon = $1,000 × (0. 10/2) = $50.00 Realized Yield = i Selling price of bond = PB = $1,054.36 To compute the realized return, either the trial-and-error approach or the financial calculator can be used. Since the price has increased, market rates must have decreased. So, the realized return is going to be greater than the bond's coupon. Try rates higher than the coupon rate.

Try i = 10.5%, or i/2 = 5.25%:

  1  1− (1+ i mn  C FV 2)  PB =   +  i 2  (1+ i ) mn 2 2  

 1 20  (1.0525)  + $1,054.36 $980= $50   0.0525  (1.0525)20   = $610.11+ $378.92 $989.03  1−

Try a higher rate, i = 10.7% or i/2 = 5.35%:

𝑃𝐵=

C 2

1−

× [

$908 = $50[

1

(1+ 𝑖⁄ 2)

𝑖⁄

𝑚𝑥𝑛

2

]+

𝐹𝑉 𝑚𝑥𝑛 (1+ 𝑖⁄ 2)

]+

$1 ,054.36

2

1− (1.0535)20 0.0535

(1.0535)20

= $605.03 + $371.70 ≅ $976.82 The realized rate of return is approximately 10.7 percent . Using a financial calculator provided an exact yield of 10.648 percent.

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 64. Suppose an investor earned a semiannual yield of 6.4 percent on a bond paying coupons twice a year. What is the effective annual yield (EAY) on this investment? (Round to two decimal places.)

A) 12.80% B) 6.40% C) 6.50% D) 13.21%.

Ans: D Feedback: Semiannual yield = 6.4% The effective annual yield can be computed as:

EAY = (1+

0.128 2 2

)−1

= 13.21%

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 65. Which of the following statements is true?

A) Long-term bonds have lower price volatility than short-term bonds of similar risk.

B) As interest rates decline, the prices of bonds rise; and as interest rates rise, the prices of C) bonds decline.

D) All other things being equal, short-term bonds are riskier than long-term bonds.

Interest rate risk decreases as maturity increases.

Ans: B

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 66. Which one of the following statements is NOT true?

A) Interest rate risk is the risk that bond prices will change as interest rates change.

B) Interest rate changes and bond prices are inversely related.

C) As interest rates increase, bond prices increase.

D) Long-term bonds are more price volatile than short-term bonds of similar risk.

Ans C : Format: Multiple Choice Learning Objective: LO 4, LO 6 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 67. Which of the following statements is true?

A) The longer the maturity of a security, the greater its interest rate risk.

B) If investors believe inflation will be subsiding in the future, the prevailing yield will be C) upward sloping.

D) An The real rate of interest varies with the business cycle, with the lowest rates seen at the s end of a period of business expansion and the highest at the bottom of a recession. : The interest rate risk premium always adds a downward bias to the slope of the yield curve.

A

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 68. Which of the following statements is true?

A) For a given change in market interest rates, the prices of higher-coupon bonds change more than the prices of lower-coupon bonds.

B) If market interest rates rise, a 1-year bond will fall in value more than a 10-year bond.

C) If interest rates rise, bond prices will rise.

D) If market interest rates rise, a 10-year bond will fall in value more than a 1-year bond.

Ans: D Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 69. Stanley Hart invested in a municipal bond that promised an annual yield of 6.7 percent. The bond pays coupons twice a year. What is the effective annual yield (EAY) on this investment?

(Round percentage to two decimal places.)

A) 13.4% B) 6.81% C) 6.70% D) None of the above Ans: B Feedback: Annual yield = 6.7% The effective annual yield can be computed as:

EAY = 0.06812 or 6.81%

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 70. Marketability is the ability of an investor A) to sell a security quickly, at a low transaction cost, and at a price close to its fair market value.

B) to sell at a profit under all circumstances.

C) to sell the security above its par value.

D) None of the above Ans: A

71.

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement Which of the following statements is true?

72.

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement Which of the following statements is NOT true?

A) B) C) D)

The lower the transaction costs are, the greater a security's marketability.

The interest rate, or yield, on a security varies with its degree of marketability.

U.S. Treasury bills have the largest and most active secondary market and are considered to be the most marketable of all securities.

All of the above are true.

Ans: D

A) The risk that the lender may not receive payments as promised is called default risk.

B) Investors must pay a premium to purchase a security that exposes them to default risk.

C) U.S. Treasury securities are the best proxy measure for the risk-free rate.

D) All of the above are true statements.

Ans: B Format: Multiple Choice Learning Objective: LO 6

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Fundamentals of Corporate Finance 3e

73.

D)

74.

Test Bank

Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement Downward-slopping yield curves are observed A) when the economy is growing.

B) when the economy is stagnant.

C) before the beginning of a recession.

None of the above.

Ans: C Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement Which one of the following statements is NOT true?

A) B) C) D)

The relationship between yield to maturity and marketability is known as the term structure of interest rates.

The shape of the yield curve is not constant over time.

As the general level of interest rises and falls over time, the yield curve shifts up and down and has different slopes.

Yield curves show graphically how market yields vary as term to maturity changes.

Ans: A Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 75. The three economic factors that affect the shape of the yield curve are: A) the real rate of interest, the expected rate of inflation, and marketability.

B) the real rate of interest, the expected rate of inflation, and interest rate risk.

C) the nominal rate of interest, the expected rate of inflation, and default risk.

D) the real rate of interest, the nominal rate of interest, and currency risk.

Ans: B

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 76. Which of the following statements is true?

A) Investment grade bonds are those rated single B and higher.

B) Federal laws typically allow insurance companies and pension funds to purchase noninvestment grade bonds.

C) Because investors are risk averse, they require a premium to purchase a security that D) exposes them to default risk.

All else equal, the higher a bond’s rating the higher the coupon rate.

Ans: C Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 77. Which of the following statements is true?

A) Downward sloping yield curves typically appear in the early to mid-period of a business expansion.

B) Interest rate risk premium always adds an upward bias to the slope of the yield curve.

C) D) If investors believe that inflation will be increasing in the near future, the yield curve will be downward sloping.

Downward-sloping yield curve is the yield curve most commonly observed.

Ans: B

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Fundamentals of Corporate Finance 3e

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Format: Essay Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 78. What is the marketability risk premium? Why should an issuing firm consider paying this premium?

Ans: Marketability is the ability of an investor to sell a security quickly at a low transaction cost and at its fair market value. The difference in interest rates or yields between the most marketable security and a less marketable security is known as the marketability risk premium. Investors would prefer more marketable securities. Investors prefer securities that can be easily converted to cash without a loss in value. The lower the marketability of a particular bond, the higher the compensation that would be demanded by investors. In order for investors to buy securities that are less marketable, issuing companies have to pay a marketability risk premium (MRP).

Format: Essay Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 79. Why does the default risk premium vary over the business cycle?

Ans: Default risk premiums vary over the business cycle. Larger premiums are required during recessionary times, while economic expansions reduce such premiums. During periods of economic expansion, investors are willing to hold bonds with low credit ratings in their portfolios because there is little chance of default and these bonds normally have higher yields. During such times, investors tend to seek out the highestyielding investments. On the other hand, during a recession, the prime concern of investors becomes safety. We call this the flight to quality. Since firms have a higher probability of failing during an economic downturn, investors are more concerned about default risk and will demand a higher default risk premium.

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Fundamentals of Corporate Finance 3e

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Format: Essay Learning Objective: LO 6 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 80. What economic factors affect the level and the shape of the yield curve? Explain.

Ans: Three economic factors affect the shape of the yield curve: (1) the real rate of interest; (2) the expected rate of inflation; and (3) the interest rate risk.

As an economy grows, the real rate of interest will increase, causing the yield curve to have an upward slope. Similarly, if investors think that inflation will increase in the future, they will require a higher inflation premium, again forcing an upward tilt to the yield curve. Since the observed or nominal interest rate is a combination of these two factors, the slope of the yield curve will shift upward. The opposite will happen during an economic downturn. The third factor, the interest rate risk, will cause longer term securities to have a higher yield than shorter term securities, again giving the yield curve an upward bias.

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Fundamentals of Corporate Finance 3e

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Chapter 9: Stock Valuation Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 1.

Equity securities are certificates of ownership of a corporation.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

2.

The stocks owned by households represent about 35% of the total value of all corporate equity.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

3.

A large number of investors in equities actually own through pension or retirement funds.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 4.

A) B) .

Companies raise capital in secondary markets by issuing new securities.

True False 9-1

Fundamentals of Corporate Finance 3e

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Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 5.

A) B)

An active secondary market for debt or equity securities makes raising new capital less expensive for firms.

True False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 6.

A) B)

For investors, the function of secondary markets is to provide marketability for the securities they own at a fair price.

True False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 7.

A) B)

Secondary market transactions in the United States mostly take place over the counter and not in exchanges.

True False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance .

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Fundamentals of Corporate Finance 3e

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AICPA: Industry/Sector Perspective 8.

A) B)

In terms of market capitalization (total stock value) of the firms listed, the NYSE is the largest in the world and NASDAQ is the second largest.

True False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Medium

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective

9.

Direct search markets provide the best price information.

A) True B) False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective

10. Direct search is the least efficient type of secondary market.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 11.

A) B)

For a commission fee less than the cost of direct search, brokers give investors an incentive to make use of the information by hiring them.

True False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy .

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Fundamentals of Corporate Finance 3e

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Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 12.

A) B)

A broker market eliminates the need for time-consuming search for a fair deal by buying and selling immediately from its inventory of securities.

True False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective

13. NASDAQ is the best-known example of a direct market.

A) True B) False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective

14. In an auction market, buyers and sellers confront each other directly and bargain over price.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective

15. The New York Stock Exchange is the best-known example of an auction market.

A) True B) False Ans: A

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective

16. The common stockholders of a company have unlimited liability.

A) True B) False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 17.

A) B)

Preferred stockholders are not guaranteed any dividend payments and have the lowest-priority claim on the firm’s assets in the event of bankruptcy.

True False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy

Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 18.

A) B)

Preferred dividend payments are fixed obligations of the firm, similar to the interest payments on corporate bonds.

True False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 19.

A) .

The market considers preferred stock to be a debt security because the dividend payment is a fixed contractual obligation and has credit ratings like bonds.

True 9-5

Fundamentals of Corporate Finance 3e

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B) False Ans: B Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 20.

A) B)

Valuation of common and preferred stock is done using a different valuation formula than that used for bonds.

True False Ans: A Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium

Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 21.

A) B)

In the general dividend-valuation model, the price of a share of stock is the present value of all expected future dividends.

True False Ans: A Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy

Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

22. For a company that has no growth, dividends stay constant over time.

A) True B) False Ans: A Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance .

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AICPA: Measurement

23. A fast growing company will pay constant dividends over a period of time.

A) True B) False Ans: B Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy

Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

24. The constant-growth stock has dividends growing at a constant rate over time.

A) True B) False Ans: A Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 25.

A) B)

The constant-growth dividend model tells us that the current price of a share of stock is the next period dividend divided by the difference between the discount rate and the dividend growth rate.

True False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

26. Whenever the constant-growth rate for dividends exceeds the required rate of return on the common stock, the constant-growth model provides invalid solutions.

True A) False B) Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium .

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Fundamentals of Corporate Finance 3e

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Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 27.

A) B)

The value of a supernormal growth stock is the present value of the mixed growth dividend payments and the present value of the constant-growth dividend payments.

True False Ans: A Format: True/False Learning Objective: LO 6 Level of Difficulty: Easy

Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective

28. Failure to pay a preferred dividend signals to the market that the firm is in serious financial trouble.

A) True B) False Ans: A Format: True/False Learning Objective: LO 6 Level of Difficulty: Easy

Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

29. Preferred stock with no fixed maturity can be valued as a perpetuity.

A) True B) False Ans: A Format: True/False Learning Objective: LO 6 Level of Difficulty: Easy

Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

30. The bond valuation model can be used to value perpetual preferred stocks.

A) True B) False Ans: B

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Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium

Bloomcode: Knowledge AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

31. The stocks owned by ––––– represent about 35 percent of the total value of all corporate equity.

A) mutual funds.

B) pension funds.

C) foreign investors.

D) households.

Ans: D Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective

32. Which of the following statements is true about secondary markets?

A) In secondary markets, outstanding shares of stock are bought and sold among investors.

Most secondary market transactions directly affect the capital of the firm that issues the securities.

B) An active secondary market causes firms to sell their new debt or equity issues at a higher C) transaction cost of funds.

All of the above statements are true D) Ans: A Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective

33. Which of the following statements is true about secondary markets in the United States?

A) In terms of market capitalization (total stock value) of the firms listed, the NASDAQ is the largest B) in the world and the NYSE is the second largest.

C) NASDAQ is an OTC (over-the-counter) market.

Firms listed on the NASDAQ tend to be, on average, larger in size, and their shares trade D) more Ans: Bfrequently than those traded on NYSE. In the United States, most secondary market transactions are done over the counter.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy .

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Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 34.

A)

B) C) D)

Which of the following statements is NOT true about secondary markets?

In terms of market capitalization (total stock value) of the firms listed, the NASDAQ is the largest in the world and the NYSE is the second largest.

NASDAQ is the second-largest stock market in the United States.

Firms listed on the NYSE tend to be, on average, larger in size and their shares trade more frequently than those traded on NASDAQ. In the United States, most secondary market transactions are done on one of the many stock exchanges.

Ans: A Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective

In comparison to the NYSE, NASDAQ has less company listed. total share volume is lower on the NASDAQ. firms listed on the NASDAQ tend to be smaller.

NASDAQ firms exceed NYSE listed firms in total capitalization.

Ans: C 35.

A) B) C) D)

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective

Direct search markets are characterized by: A) complete price information.

B) extensive broker and dealer participation.

C) private placement transactions and sale of common stock of small private companies.

D) a high level of efficiency.

Ans: C 36.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium

Bloomcode: Comprehension AASCB: Analytic .

9-10

Fundamentals of Corporate Finance 3e

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IMA: Corporate Finance AICPA: Industry/Sector Perspective

The least efficient of all the different types of secondary markets is the: auction market. direct search market. dealer market. broker market.

Ans: B 37.

A) B) C) D)

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective

38. Which of the following statements is NOT true about broker markets?

A) Brokers bring buyers and sellers together to earn a fee, called a commission.

B) Brokers’ extensive contacts provide them with a pool of price information that individual investors C) could not economically duplicate themselves.

D) Investors have an incentive to hire a broker because what they charge as a commission is less than the cost of direct search.

Brokers can guarantee an order because they have an inventory of securities.

Ans: D Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective

In brokered markets: A) the commission charged by brokers is a lower cost to buyers and sellers than the cost of direct search.

B) buyers and sellers are brought together for a commission.

C) brokers build a pool of price information through their extensive contacts.

D) All of the above are true of broker markets.

Ans: D 39.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 40. .

Which of the following statements is true about dealer markets?

9-11

Fundamentals of Corporate Finance 3e

A) B) C) D)

Test Bank

NYSE is the best-known example of a dealer market.

A dealer market involves time-consuming search for a fair deal.

The advantage of a dealer over a brokered market is that brokers cannot guarantee that an order will be executed promptly, while dealers can, because they have an inventory of securities.

All of the above are true of dealer markets.

Ans: C Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective

Dealer markets are characterized by: A) no time-consuming search for a fair deal.

B) a guarantee of order fulfillment because the dealer holds an inventory of securities.

C) improved market efficiency because dealers provide continuous bid and ask prices for securities.

D) All of the above characterize dealer markets.

Ans: D 41.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective 42.

Which of the following statements is NOT true about auction markets?

A) B) C) D)

In an auction market, buyers and sellers confront each other directly and bargain over price.

The participants can only communicate orally in auction markets.

The New York Stock Exchange is the best-known example of an auction market.

The auctioneer in an auction market is the specialist, who is designated by the exchange to represent orders placed by public customers.

Ans: B Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 43.

A)

B) .

Which of the following statements is NOT true about common stock?

Common-stock holders have the right to vote on the election of the board of directors of their company.

Common stock is considered to have no fixed maturity.

9-12

Fundamentals of Corporate Finance 3e

Test Bank

C) D)

Owners of common stock are guaranteed dividend payments by the firm.

Common-stock holders have limited liability toward the obligations of the corporation.

Ans: C Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

Which of the following statements is true about common stock?

A) Common stock is considered to have a fixed maturity.

B) Owners of common stock are guaranteed dividend payment by the firm.

C) Owners of common stock have the lowest-priority claim on the firm’s assets in the event of bankruptcy.

D) Common-stock holders have unlimited liability toward the obligations of the corporation.

Ans: C 44.

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective

45.

A

Which of the following is NOT a widely known stock market index?

The Dow Jones Industrial Average

B

The OTQ Composite Index

C

The New York Stock Exchange Index

D) The Standard and Poor’s 500 Index Ans: B Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 46.

A) B) C) D) .

Which of the following statements is NOT true about preferred stock?

Preferred stock represents ownership in the firm.

Preferred stockholders are not eligible for guaranteed dividend payments by the firm.

Preferred stock dividends are paid by the issuer with after-tax dollars.

Preferred stock holders have limited voting privileges relative to common-stock owners.

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Fundamentals of Corporate Finance 3e

Test Bank

Ans: B Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

47. Which of the following statements is NOT true about preferred stock?

A) Preferred dividend payments are paid by the issuer with after-tax dollars.

Preferred dividends are tax deductible just like the interest on bonds.

B) Preferred stock holders have limited voting privileges relative to common-stock owners.

C) Preferred stocks are generally viewed as perpetuities because they have no fixed maturity.

D) Ans: B Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 48.

A) B) C)

Owners of preferred stock: have limited voting rights. usually receive fixed dividend payments. are given priority treatment over common stock with respect to dividends payments, and the claims against the firm’s assets in the event of bankruptcy or liquidation.

All of the above statements are true.

D) D Ans: Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 49.

Preferred stock is sometimes treated like a debt security because: legally preferred stock is a debt security.

A) preferred dividend payments are similar to bond interest payments and are fixed in nature B) regardless of the firm’s earnings.

C) preferred dividends are deductible from taxable income just like interest payments on bonds. preferred stock holders receive a residual value and not a stated value.

D) Ans: B

.

9-14

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

50.

A) B) C) D) An s

Which of the following statements is true?

Preferred stockholders are considered to be the true owners of public corporations.

Dividends paid to preferred stockholders are not fixed.

Preferred stockholders do not typically have voting rights.

Preferred stock can never be converted to common stock.

C

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 51.

A) B) C) D)

Applying the valuation procedure to common stocks is more difficult than applying it to bonds because: the size and timing of the dividend cash flows are less certain than the coupon payments for bonds. common stocks have no final maturity date. unlike the rate of return, or yield, on bonds, the rate of return on common stock is not directly observable.

All of the above are true.

Ans: D

.

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium

52.

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

Assume that you are considering the purchase of a stock which will pay dividends of $4.50 during the next year. Further assume that you will be able to sell the stock for $85.00 one year from today and that your required rate of return is 15 percent.

How much would you be willing to pay for the stock today? (Round off to the nearest A) $89.5 $0.01) B) 0 C) $65.3 D) 7 Ans: D$94.1 0 Feedback: $77.8P1 $4.50+$85.00 D1+ $89.50 = = P0= 3 =$77.82 1+0.15

1+R

1.15

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

53. Which of the following statements is NOT true about the general dividend valuation model?

A) The model does not assume any specific pattern for future dividends, such as a constant growth rate.

B) It makes a specific assumption about when the share of stock is going to be sold in the future.

C) The model calls for forecasting an infinite number of dividends for a stock.

D) The price of a share of stock is the present value of all expected future dividends.

Ans: B

.

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium

54.

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

Which of the following statements is true about the general dividend valuation model?

A) It implies that the underlying value of a share of stock is determined by the market’s B) expectations of the future dividends that the firm will generate.

C) It implies that the value of a firm’s common stock can be determined only if the expected D) future dividends are infinite.

It implies that the value of a growth stock can be determined by forecasting the future price of the stock.

The model cannot be used to calculate the value of a common stock unless the dividends exceed the firm’s expected growth rate.

Ans: A

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

55. Which of the following statements is true about growth stocks?

A) These are stocks of firms that grow their sales at above-average rates and are expected to do so for a length of time.

B) These are stocks of firms that grow their earnings at above-average rates and are expected to do so for a length of time.

C) They generally pay dividends during their fast growth phase.

None of the above.

D) Ans: B Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 56.

A) B) C) .

Which of the following are the three simplifying assumptions that cover most stock growth patterns?

Dividends remain constant over time, dividends grow at a constant rate, and dividends are equal to zero.

Dividends have a zero-growth rate, dividends grow at a varying rate, and dividends are equal to zero.

Dividends remain constant over time, dividends grow at a constant rate, and dividends have a mixed growth pattern.

9-17

Fundamentals of Corporate Finance 3e

Test Bank

D)

None of the above.

Ans: C Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 57.

A) B) C) D)

Which of the following statements is NOT true about zero-growth stocks?

Dividend payment pattern remains constant over time.

The cash flow pattern resembles a perpetuity with a constant cash flow.

Dividend pattern for common stock of a company shows growth over time.

There is no growth in dividends over time.

Ans: C Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

Which of the following statements is NOT true about constant-growth stocks?

Cash dividend remains constant over time.

Mature companies with a history of stable growth show this pattern.

Dividends grow at a constant rate from one period to the next forever.

Far distant-dividends have a very small present value and add little to the stock’s price.

Ans: A 58.

A) B) C) D)

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

The constant-growth dividend model will provide invalid solutions when: A) the growth rate of the stock exceeds the required rate of return for the stock.

B) the growth rate of the stock is less than the required rate of return for the stock.

C) the growth rate of the stock is equal to the risk-free rate.

D) None of the above.

Ans: A 59.

.

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 60.

A) B) C) D)

Cortez, Inc., is expecting to pay out a dividend of $2.50 next year. After that it expects its dividend to grow at 7 percent for the next four years. What is the present value of dividends over the next five-year period if the required rate of return is 10 percent? (Do not round intermediate calculations. Round final answer to two decimal places.) $10.76 $9.80 $11.88 $11.50

Ans: A Feedback: Expected dividends for Cortez, Inc., and their present value: D2 = D1(1 + g) = $2.50(1 + 0.07) = $2.675 D3 = D2(1 + g) = $2.675(1.07) = $2.862 D4 = D3(1 + g) = $2.862(1.07) = $3.063 D5 = D4(1 + g) = $3.063(1.07) = $3.277 Present value of the dividends = PV(D1) + PV(D2) + PV(D3) + PV(D4) + PV(D5)

$2.50 $2.675 $2.862 $3.063 $3.277 = (1.10) + (1.10)2+ (1.10)3+ + (1.10)5 (1.10)4 = $2.27+$2.21+$2.15+$2.09+$2.03 = $10.76

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 61.

A) B) C) D)

Next year Jenkins Traders will pay a dividend of $3.00. It expects to increase its dividend by $0.25 in each of the following three years. If their required rate of return is 14 percent, what is the present value of their dividends over the next four years? (Do not round intermediate calculations. Round final answer to two decimal places) $13.50 $9.72 $12.50 $11.63

Ans: B Feedback: Expected dividends for Jenkins Traders and their present value: D1 = $3.00; D2 = $3.25; D3 = $3.50; D4 = $3.75 Present value of the dividends = PV(D1) + PV(D2) + PV(D3) + PV(D4) .

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Fundamentals of Corporate Finance 3e

Test Bank

$3.00 $3.25 $3.50 $3.75 = (1.14) + + + (1.14)2 (1.14)3 (1.14)4 = $2.63+$2.50+$2.36+$2.22 = $9.72 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 62.

A) B) C) D)

Kleine Toymakers is introducing a new line of robotic toys, which it expects to grow their earnings at a much faster rate than normal over the next three years. After paying a dividend of $2.00 last year, it does not expect to pay a dividend for the next three years. After that Kleine plans to pay a dividend of $4.00 in year 4 and then increase the dividend at a rate of 10 percent in years 5 and 6.

What is the present value of the dividends to be paid out over the next six years if the required rate of return is 15 percent?(Do not round intermediate calculations. Round final answer to two decimal places.) $13.24 $12.00 $6.57 $10.24

Ans: C Feedback: Expected dividends for Kleine Toymakers and their present value: D0 = $2.00; D1 = D2 = D3 = $0 D4 = $4.00 D5 = D4(1 + g) = $4.00(1.10) = $4.40 D6 = D5(1 + g) = $4.40(1.10) = $4.84 Present value of the dividends = PV(D1) + PV(D2) +…………+ PV(D6)

$4.00 + $4.40 + $4.84 = $ + $ + $ + (1.15)4 (1.15)6 (1.15)5 = 0 + 0 + 0 + 2.29+$2.19+$2.09 = $6.57 $ $ $

0 0Multiple 0 Format: Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 63.

.

Givens, Inc., is a fast growing technology company that paid a $1.25 dividend last week. The company’s expected dividend growth rates over the next four years are as follows: 25 percent, 30 percent 35 percent, and 30 percent. The company then expects to settle down to a constant-growth rate of 8 percent annually. If the required rate of return is 12 percent, what is the present value of 9-20

Fundamentals of Corporate Finance 3e

Test Bank

the dividends over the fast growth phase? (Do not round intermediate calculations.

Round final answer to two decimal places.)

A) B) C) D)

$1.25 $6.46 $8.37 $7.23

Ans: D Feedback: Expected dividends for Givens, Inc., and their present value: D0 = $1.25 D1 = D0(1 + g) = $1.25(1.25) = $1.563 D2 = D1(1 + g) = $1.563(1.30) = $2.031 D3 = D2(1 + g) = $2.031(1.35) = $2.742 D4 = D3(1 + g) = $2.742(1.30) = $3.565 Present value of the dividends = PV(D1) + PV(D2) + PV(D3) + PV(D4)

$2.742+ $3.565 = $1.563+ $2.031+ (1.12)3 (1.12)4 (1.12) (1.12)2 = $1.40+$1.62+$1.95+$2.27 = $7.23

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 64.

Jacob Suppliers has not paid out any dividend in the last three years. It does not expect to pay dividends in the next two years either as it recovers from an economic slowdown.

Three years from now it expects to pay a dividend of $2.50 and then $3.00 in the following two years. What is the present value of the dividends to be received over the next five years if the discount rate is 15 percent?( Do not round intermediate calculations. Round final answer to two decimal places.) $4.85 $5.37 $5.50 $6.14

A) B) C) D) Ans: A Feedback: Expected dividends for Jacobs Suppliers and their present value: D0 = D1 = D2 = $0; D3 = $2.50; D4 = $3.00; D5 = $3.00 Present value of the dividends = PV(D1) + PV(D2) +…………+ PV(D5)

$2.50 + $3.00 + $3.00 = $ + $ + (1.15)3 (1.15)4 (1.15)5 = 0 + 0 + $1.64+$1.72+$1.49 = $4.85 $ $

.

0

0

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 65.

A) B) C) D)

Xinhua Manufacturing Company has been generating stable revenues but sees no growth in it for the foreseeable future. The company’s last dividend was $3.25, and it is unlikely to change the amount paid out. If the required rate of return is 12 percent, what is the stock worth today? (Round the final answer to two decimal places.) $39.00 $3.69 $27.08 $21.23

Ans: C Feedback: D0 = $3.25;

g = 0; R = 12%

D $3.25 P0= R = 0.12 =$27.08

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 66.

A) B) C) D)

Zephyr Electricals is a company with no growth potential. Its last dividend payment was $4.50, and it expects no change in future dividends. What is the current price of the company’s stock given a discount rate of 9 percent? $40.50 $50.00 $45.00 $500.00

Ans: B Feedback: D0 = $4.50;

g = 0; R = 9%

D $4.50 P0= R = 0.09 =$50.00

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance .

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Fundamentals of Corporate Finance 3e

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AICPA: Measurement 67.

A) B) C) D)

Metasteel Limited Co. has a stable sales track record, but does not expect to grow in the next several years. Its last annual dividend was $5.75. If the required rate of return on similar investments is 18 percent, what is the current stock price? (Round the answer to two decimal places.) $103.50 $13.50 $39.30 $31.94

Ans: D Feedback: D0 = $5.75;

g = 0; R = 18%

D $5.75 P0= R = 0.18 =$31.94

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 68.

A) B) C) D)

Ambassador Corp. sells household cleaners producing a revenue stream that has remained unchanged in the last few years. The firm does not expect any change in its sales or earnings in the next several years. The stock is currently selling at $46.88. If the required rate of return is 16 percent, what is the dividend paid by this company? (Round the answer to two decimal places.) $2.93 $4.65 $6.89 $7.50

Ans: D Feedback: P0 = $46.88; g = 0; R = 16%

D D P0 = = 0 = $46.88 R 0.16 D 0 =$46.880.16=$7.50

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 69.

.

A communications company pays annual dividends of $8.50 with no possibility of it changing in the next several years. If the firm’s stock is currently selling at $60.71, what is the required rate of return? (Round to nearest whole number.)

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Fundamentals of Corporate Finance 3e

A) B) C) D)

14% 16% 13% 15% Ans: A Feedback: P0 = $60.71; g = 0; D0 = $8.50

D $8.5 0 P0 =$60.71= = R R $8.5 0 = 14% R= $6 0.7 1

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 70.

A) B) C) D)

You are interested in investing in a company that expects to grow steadily at an annual rate of 6 percent for the foreseeable future. The firm paid a dividend of $2.30 last year.

If your required rate of return is 10 percent, what is the most you would be willing to pay for this stock? (Round to the nearest dollar.) $58 $61 $23 $24

Ans: B Feedback: D0 = $2.30;

g = 6%;

D1 D0(1+ g) R − =g R − g $2.30(1.06) = 0.10−0.06 = $2.438= $60.95 0.04

R = 10%

P0 =

=$61.00

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 71.

A) B) .

Johnson Corporation has just paid a dividend of $4.45. The company has forecasted a growth rate of 8 percent for the next several years. If the appropriate discount rate is 14 percent, what is the current price of this stock? (Round to the nearest dollar.) $74 $32 9-24

Fundamentals of Corporate Finance 3e

Test Bank

C) D)

$80 $60 Ans: C Feedback: D0 = $4.45;

g = 8%; R = 14%

D0(1+ g) D1 P0 = R − g = R − g

= $4.45(1.08)= $4.806= $80.10 0.14−0.08 0.06

=$80.00

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 72.

Ryder Supplies has its stock currently selling at $63.25. The company is expected to grow at a constant rate of 7 percent. If the appropriate discount rate is 17 percent, what is the expected dividend, a year from now? (Round the answer to two decimal places.)

A) $4.43 B) $3.25 C) $10.75 D) $6.33 Ans: D Feedback: P0 = $63.25; g = 7%; R = 17%

P0 =

D1 R−g

D 1 =P0(R − g) =$63.25(0.17− 0.0 7)= $6.325 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 73.

A) B) C) .

Prior, Inc., is expected to grow at a constant rate of 9 percent. If the company’s next dividend is $2.75 and its current price is $37.35, what is the required rate of return on this stock? (Do not round intermediate calculations. Round final answer to the nearest percent.)

13% 16% 20% 9-25

Fundamentals of Corporate Finance 3e

Test Bank

D)

21% Ans: B Feedback: D1 = $2.75;

P0 = $37.35; g = 9%

D1 R−g $2.7 5 $3 7.3 5= R − 0.09 $37.35(R−0.09)= $2.7 5 −3.3615−2.75 = −37.35R R= 6.1115= 16.4% 3 7.3 5 P0 =

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 74.

A) B) C) D)

A company is growing at a constant rate of 8 percent. Last week it paid a dividend of $3.00. If the required rate of return is 15 percent, what is the price of the stock three years from now? (Do not round intermediate calculations. Round final answer to two decimal places.) $58.31 $46.29 $51.02 $42.83

Ans: A Feedback: R = 15%;

P3= =

.

D0 = $3.00;

D(1 + g ) D4 = 0 R−g R−g 3.00(1.08)4 0.15−0.08

g= 8% 4

= $58.31

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

75.

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

Which of the following is the most typical example of a zero-growth dividend stock?

A) The common stock of a firm in the biotechnology industry.

B) The preferred stock of a utility company.

C) The common stock of a firm in the health care industry.

D) The common stock of a firm in the information technology industry.

Ans: B Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

76.

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

The constant growth dividend model would be useful to determine the value of all, but which of the following firms?

A) A firm whose earnings and dividends are declining at a fairly steady rate.

B) A firm whose sales, profits, and dividends are growing at an annual average compound C) rate of 5 percent.

D) A firm whose earnings and dividends are growing at a fairly steady rate.

A firm whose expected sales, profits, and dividends are flat.

Ans: D

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Hard

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 77.

A) B) C) D)

Starskeep, Inc., is a fast growing technology company. The firm projects a rapid growth of 40 percent for the next two years and then a growth rate of 20 percent for the following two years.

After that, the firm expects a constant-growth rate of 8 percent. The firm expects to pay its first dividend of $1.25 a year from now. If your required rate of return on such stocks is 20 percent, what is the current price of the stock? (Do not round intermediate calculations. Round final answer to two decimal places.) $15.63 $4.70 $30.30 $22.68

Ans: A Feedback: .

9-27

Fundamentals of Corporate Finance 3e

Test Bank

g1 = g2 = 40%, g3 = g4 = 20%, g = 8%, D1 = $1.25, R = 20% D1 = $1.25, D2 = $1.25(1.40) = $1.75, D3 = $1.75(1.20) = $2.10 D4 = $2.10(1.20) = $2.52, D5 = $2.52(1.08) = $2.722

D5 $2.7 2 2 = =$22.68 − g 0.20− 0.08 R D1 D3 D2 D4 P4 + + + + P0 = (1+ R)1 (1+ R)2 (1+ R)3 (1+ R)4 (1+ R)4 $1.25 $1.75 $2.10 ($2.52+22.68) + + + P0 = (1.20)4 1.20 (1.20)2 (1.20)3 P0 =$1.04+$1.22+$1.22+12.15

P4 =

P0 =$15.63 Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Hard

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 78.

A) B) C) D)

BioSci, Inc., a biotech firm has forecast the following growth rates for the next three years: 30 percent, 25 percent, and 20 percent. The company then expects to grow at a constant rate of 7 percent for the next several years. The company paid a dividend of $2.00 last week. If the required rate of return is 16 percent, what is the market value of this stock? (Do not round intermediate calculations. Round final answer to two decimal places.) $51.03 $36.86 $56.12 $46.37

Ans: B Feedback: g1 = 30%; g2 = 25%, g4 = 20%, g = 7%, D0 = $2.00, R = 16% D1 = $2.00(1.30) = $2.60, D2 = $2.60(1.25) = $3.25, D3 = $3.25(1.20) = $3.90 D4 = $3.90(1.07) = $4.173;

D4 $4.1 7 3 = =$46.37 R − g 0.16− 0.07 D3 D1 D2 P3 + + + P0 = 2 1 +R (1+ R (1+ R)3 (1+ R)3 ) (1 ) $2.60 $3.25 ($3.90+46.37) + + P0 = (1.16)3 1.16 (1.16)2

P= 3

P0 =$2.24+ $2.42+ $32.20 P0 =$36.86

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Hard

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 79.

A) B) C) D)

Grant, Inc., is a fast growth stock and expects to grow at a rate of 25 percent for the next four years.

It will then settle to a constant-growth rate of 10 percent. The first dividend will be paid out in year 3 and will be equal to $5.00. If the required rate of return is 18 percent, what is the current price of the stock? (Do not round intermediate calculations. Round final answer to two decimal places.) $85.94 $97.19 $50.59 $65.68

Ans: C Feedback: g1-4 = 25%; g = 10%; D3 = $5.00; R = 18% D4 = D3 (1.25) = $5.00(1.25) = $6.25; D5 = $6.25(1.10) =$6.875

P4 =

D5 $6.8 7 5 = =$85.94 R − g 0.18− 0.10 D3 D1 + D2 D 4+ P4 P0 = (1+ R)2+ (1+ R)3+ (1+ R)4 (1+R) $5.00 ($6.25+$85.94) + P0 =0 + 0 + (1.18)3 (1.18)4 P0 = $3.04+ $47.55=$50.59

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Hard

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 80.

A) B) C) D)

Stag Corp. will pay dividends of $4.75, $5.25, $5.75, and $7 for the next four years.

Thereafter, the company expects its growth rate to be at a constant rate of 7 percent. If the required rate of return is 15 percent, what is the current market price of the stock?

(Do not round intermediate calculations. Round final answer to two decimal places.) $69.41 $93.63 $57.54 $80.29

Ans: A Feedback: D1 = $4.75; D2 = $5.25; D3 = $5.75; D4 = $7; g = 7%;

P= 4 .

D5 $7(1.07) = =$93.63 R − g 0.15− 0.07

R = 15%

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Fundamentals of Corporate Finance 3e

P0 =

Test Bank

D3 D2 D4 P4 D1 + + + + 2 3 R (1+ R) (1+ R) (1+ R) (1+ )4 (1+ R)4

$4.75+ $5.25 + $5.75 + ($7 + $93.63) (1.15)4 1.15 (1.15)2 (1.15)3 P0 = $4.13+ $3.97+ $3.78+$57.53= $69.41 P0 =

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Hard

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 81.

A) B) C) D)

Lincoln, Inc. expects to pay no dividends for the next four years. It has projected a growth rate of 35 percent for the next four years. After four years, the firm will grow at a constant rate of 6 percent. Its first dividend to be paid in year 5 will be worth $4.25. If your required rate of return is 20 percent, what is the stock worth today? (Do not round intermediate calculations. Round final answer to two decimal places.) $14.64 $32.18 $36.43 $21.82

Ans: A Feedback: gconstant = 6%; R = 20%; D5 = $4.25; D1 – D4 = 0 PV (D1) + PV(D2) + PV(D3) + PV(D4) = 0

P= 4

.

D5 = $4.2 5 =$30.36 R − g 0.20− 0.06 P4 $30.36 $30.36 =0+ = 2.0736= $14.64 P0 =PV of dividends+ (1+ R)4 (1.20)4

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Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium

82.

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

Suppose a firm’s expected dividends for the next three years are as follows: D1 = $1.10, D2 = $1.20, and D3 = $1.30. After three years, the firm’s dividends are expected to grow at 5.00 percent per year. What should the current price of the firm’s stock (P0) be today if investors require a rate of return of 12.00 percent on the stock? (Do not round intermediate calculations. Round off final answer to the nearest $0.01) A) $61.30 B) $10.10 C) $16.74 D) $24.12 Ans: C Feedback:

D1 D2 D3 Dt $1.20 $1.30 $19.50 + + + = $1.10+ + + P0= 1 2 3 t = (1 + R)+ (1+ R) 1.12 (1.12)2 (1.12)3 (1.12)3 (1+ R) (+ 1 R) P 0 $0.9 8 $0.9 6+ $0.9 3+ $1 3.8 8= $1 6.7 4 =$16.74

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium

83.

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

Which of the following statements is true?

A) In order for the constant growth dividend model to properly value a firm’s common B) stock, R must be greater than g.

From a practical perspective, the growth rate in the constant growth dividend model must be greater than the sum of the long-term rate of inflation and the long-term real growth rate of the economy.

C) In order for the constant growth dividend model to properly value a firm’s common D) stock, g must be greater than R. The constant growth dividend model can be used effectively to value the common shares of a mixed growth stock.

Ans: A

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement .

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Fundamentals of Corporate Finance 3e

84.

A) B) C) D)

Ajax Company has issued perpetual preferred stock with a par of $100 and a dividend of 5.5 percent. If the required rate of return is 7.75 percent, what is the stock’s current market price? (Round off to the two decimal places.) $12.90 $70.97 $53.27 $62.14

Ans: B Feedback: D = 5.5% ($100) = $5.50;

D R

Test Bank

P0=

R = 7.75%

$5.50 = 0.0775=$70.97

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 85.

A) B) C) D)

The National Bank of Columbia has issued perpetual preferred stock with a $100 par value. The bank pays a quarterly dividend of $1.40 on this stock. What is the current price of this preferred stock given a required rate of return of 8.5 percent? (Round off to two decimal places.) $23.06 $65.88 $37.57 $43.25

Ans: B Feedback: Quarterly dividend = $1.40 Required rate of return = R = 8.5%

(1.40  4) P0= 0.0 8 5 =$65.88

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 86.

A) B) C) D) .

The preferred stock of Acme International is selling currently at $110.35. If your required rate of return is 9.75 percent, what is the dividend paid by this stock? (Round off to the two decimal places.) $9.75 $11.32 $10.76 $8.53

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Fundamentals of Corporate Finance 3e

Test Bank

Ans: C Feedback: P0 = $110.35;

R = 9.75%

D D = 0.0975 R D = $110.350.0975 = $10.76

P0 =$110.35=

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Hard

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 87.

Each quarter, Transam, Inc., pays a dividend on its perpetual preferred stock. Today, the stock is selling at $83.45. If the required rate of return for such stocks is 10.5 percent, what is the quarterly dividend paid by the firm? (Do not round intermediate calculations. Round final answer to two decimal places.) $8.76 $10.50 $2.19 $2.63

A) B) C) D)

Ans: C Feedback: P0 = $83.45;

R = 10.5%

D D P0 = $83.45 = = 0.105 R D=$83.450.105 =$8.76

Annual dividend = $8.76, Quarterly dividend = $8.76$2.19 /4 = Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Hard

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement 88.

A) B) C) .

The Columbia Consumer Products Co. has issued perpetual preferred stock with a $100 par value. The firm pays a quarterly dividend of $2.60 on this stock. What is the current price of this preferred stock given a required rate of return of 12.5 percent? $47.25 $80.00 $20.80 9-33

Fundamentals of Corporate Finance 3e

Test Bank

D)

$83.20 Ans: D Feedback: Quarterly dividend = $2.60 Required rate of return = R = 12.5%

(2.604) P0= 0.125 =$83.20

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium

89.

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

Which of the following statements about preferred stock is FALSE? A) Preferred stock has a higher-priority claim on the firm’s assets than the common stock.

B) Failure to pay dividends on preferred stocks will result in a default.

C) Preferred stock has a lower-priority claim on the firm’s assets than the firm’s creditors in D) the event of default.

Preferred stock typically pays a fixed dividend.

Ans: B Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium

90.

Bloomcode: Application AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

Durango Water Works has an outstanding issue of preferred stock that has a par (maturity value) of $75.00. The stock, which pays a quarterly dividend of $1.10, will be retired by the firm in 20 years. If the preferred stock is currently selling for $68.00, what is the preferred stock’s yield-to-maturity? (Round off to the nearest 0.01%) A) 6.72% B) 5.64% C) 4.28% D) 7.73% Ans: A Feedback: N = 20 × 4 = 80 PV = –$68.00 PMT = $ 1.10 FV = $75.00 Solve for i = 1.68% × 4 = 6.72%

Format: Essay .

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Fundamentals of Corporate Finance 3e

Test Bank

Learning Objective: LO 1 Level of Difficulty: Medium

Bloomcode: Comprehension AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective

91. Discuss the significance of an active secondary market to both issuers of securities and to investors.

Ans: Most secondary market transactions do not directly affect the firm which issues the securities. The presence of a secondary market does, however, affect the issuer indirectly. Simply put, investors will pay a premium price for primary securities that have an active secondary market because most investors do not hold securities forever. Thus, the marketability provided by secondary markets is an important service to the issuers. Financial managers are well aware of the importance of secondary markets for the sale of their firm’s primary securities, and as a result, they encourage investment banking firms to establish secondary markets for their securities. The presence of an active secondary market allows firms to sell their new debt or equity issues at a lower funding cost than firms selling similar securities that have no secondary market. From an investor’s perspective, the function of secondary markets is to provide marketability for the shares of securities they own at a fair price.

Format: Essay Learning Objective: LO 1 Level of Difficulty: Medium

Bloomcode: Analysis AASCB: Analytic IMA: Corporate Finance AICPA: Industry/Sector Perspective

92. How do the secondary markets for securities differ across the four types of markets?

Ans: The direct search markets are the farthest from our ideal of complete price information and are those markets in which buyer and seller must seek each other out directly. Securities are bought and sold so infrequently that no third party, such as a broker or dealer, has an incentive to serve the market. The sale of common stock of small private companies and private placement transactions are good examples of direct search markets. This is the least efficient type of secondary market.

In broker markets, brokers bring buyers and sellers together to earn a fee, called a commission. Brokers have extensive contacts, who provide them with a pool of price information that individual investors could not economically duplicate themselves. Investors have an incentive to make use of the information by hiring brokers because what brokers charge them as a commission is less than the cost of direct search.

In dealer markets, market efficiency is improved by dealers providing continuous bidding (selling or buying) for the security with the help of an inventory of securities that they hold and use to make a profit. The advantage of a dealer over a brokered market is that brokers cannot guarantee that an order will be executed promptly, while dealers can because they have an inventory of securities. NASDAQ is the best-known example of a dealer the United States.

In an market auction in market, buyers and sellers confront each other directly and bargain over price. The New York Stock Exchange is the best-known example of an auction market and is also the most efficient equity market in the United States. In the NYSE, the auction for a security takes place at a specific location on the floor of the exchange, called a post. The auctioneer in this case is the specialist, who is designated by the exchange to represent orders placed by public customers.

Format: Essay Learning Objective: LO 1 .

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Fundamentals of Corporate Finance 3e

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Level of Difficulty: Medium

Bloomcode: Analysis AASCB: Analytic IMA: Corporate Finance AICPA: Measurement

93. Differentiate the characteristics of common and preferred stocks.

Ans: Characteristic Common Stock Preferred Stock Ownership of firm Represents basic ownership claim inRepresents a ownership interest in the corporation. corporation.

Common stockholders can vote on all important matters that affect the life of the company, such as to The preferred stockholders have no elect the board of directors, approve the capital budget, or voting privileges in those vote on a proposed merger or matters affecting day-to-day Voting rights running the firm. acquisition.

Common stockholders enjoy limited liability that is their losses are Liability of owners limited to the original value of Limited their investment in the firm.

Preferred stock holders are given priority treatment over common stockholders with Have the lowest-priority claim on the respect to dividends payments Claim on assets firm’s assets in the event of and the claims against the bankruptcy. firm’s assets in the event of bankruptcy or liquidation.

Owners of common stock are not Preferred dividend payments take Dividends guaranteed any dividend precedence over common payments dividends.

Preferred stocks are legally classified Common stocks are perpetuities in the as perpetuities because they Maturity sense that they have no maturity. have no maturity. Although some type of preferred stock might have a maturity date.

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Chapter 10: The Fundamentals of Capital Budgeting Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 1. The goal of the capital budgeting decisions is to select capital projects that will decrease the value of the firm.

A) True B) False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 2. Capital budgeting decisions, once made, are not easy to reverse because of the huge investments involved.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 3. The basis on which capital budgeting plans are made is a firm's three- to five-year strategic plan.

A) True B) False Ans: A

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10-1

Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 4. Most of the information required to make capital budgeting decisions are internally generated, beginning with the sales force.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 5. All capital budgeting projects are independent projects.

A) True B) False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 6. When two projects have cash flows that are tied to each other, the projects may be classified as independent.

A) True B) False Ans: B

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 7. Projects are classified as independent when their cash flows are unrelated.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 8. When two projects are independent, accepting one project implicitly eliminates the other.

A) True B) False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 9. When two projects are mutually exclusive, accepting one project implicitly eliminates the other.

A) True B) False Ans: A

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 10. Projects that are classified as contingent could be mandatory or optional projects.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 11. All contingent projects are mandatory projects.

A) True B) False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 12. The cost of capital is the maximum return a project can earn.

A) True B) False Ans: B

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 13. Capital rationing refers to the limiting of capital resources to underperforming divisions.

A) True B) False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 14. The net present value technique is an approach that goes against the goal of shareholder wealth maximization.

A) True B) False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 15. The NPV method determines how much the present value of cash inflows exceeds the present value of costs.

A) True B) False Ans: A

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 16. Accepting a positive-NPV project decreases shareholder wealth.

A) True B) False Ans: B Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 17. Accepting a positive-NPV project increases shareholder wealth.

A) True B) False Ans: A Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 18. Accepting a negative-NPV project increases shareholder wealth.

A) True B) False Ans: B

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 19. The discount rate used to determine the present value of future cash flows is the cost of capital.

A) True B) False Ans: A Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 20. The payback method is a discounted cash flow technique.

A) True B) False Ans: B Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 21. If the payback period for a project exceeds the firm's threshold period, then the project is accepted.

A) True B) False Ans: B

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 22. The payback method is consistent with the goal of shareholder wealth maximization.

A) True B) False Ans: B Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 23. The discounted payback period calculation calls for the future cash flows to be discounted by a firm's cost of capital.

A) True B) False Ans: A Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 24. Unlike the regular payback method, the discounted payback method does not ignore cash flows beyond a firm's threshold period.

A) True B) False Ans: B

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10-8

Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 25. The accounting rate of return is not a true return because it simply utilizes some average figures from a firm's balance sheet and income statement.

A) True B) False Ans: A Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 26. The decision criterion for the accounting rate of return is consistent with the goal of shareholder wealth maximization.

A) True B) False Ans: B Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 27. The IRR and NPV decisions are consistent with each other when a project's cash flows follow a conventional pattern.

A) True B) False Ans: A

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10-9

Fundamentals of Corporate Finance 3e

Test Bank

Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 28. Unconventional cash flow patterns could lead to conflicting decisions by NPV and IRR. A) True B) False Ans: A Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 29. When mutually exclusive projects are considered, both NPV and IRR will always produce the same acceptance decision.

A) True B) False Ans: B Format: True/False Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 30. When evaluating two projects that require different outlays, the IRR does not recognize the difference in the size of the investments.

A) True B) False Ans: A

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Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 31. Which of the following is NOT true about capital budgeting?

A) It involves identifying projects that will add to a firm's value.

B) It involves investing large capital.

C) It allows a firm to reverse the decision of large capital investments at any time.

D) It allows a firm's management to analyze potential business opportunities and decide on which ones to undertake.

Ans: C Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 32. Which of the following is an aspect of independent projects?

A) The cash flows are related.

B) The cash flows are unrelated.

C) Selecting one would automatically eliminate accepting the other.

D) None of the above Ans: B Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 33. Two projects are considered to be independent if A) selecting one would have no bearing on accepting the other.

B) their cash flows are unrelated.

C) Both a and b D) None of the above Ans: C

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Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 34. Two projects are considered to be mutually exclusive if A) the projects perform the same function.

B) selecting one would automatically eliminate accepting the other.

C) Both a and b D) None of the above Ans: C Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 35. Two projects are considered to be contingent projects if A) selecting one would automatically eliminate accepting the other.

B) the acceptance of one project is dependent on the acceptance of the other.

C) rejection of one project does not eliminate the selection of the other.

D) None of the above Ans: B Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 36. Contingent projects would imply that A) the acceptance of one project is dependent on the acceptance of the other.

B) the projects can be either mandatory or optional.

C) Both a and b.

D) None of the above Ans: C

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Fundamentals of Corporate Finance 3e

Test Bank

Reference 10-1: Use the following to answer questions 37-38: A construction firm is evaluating two value-adding projects. The first project deals with building access roads to a new terminal at the local airport. The second project is to build a parking garage on a piece of land that the firm owns adjacent to the airport.

Reference: Ref 10-1 Format: Multiple Choice Learning Objective: LO 1 Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective Level of Difficulty: Medium 37. The firm's decision will be to A) accept both projects because they are independent projects.

B) accept both projects because they are contingent projects.

C) pick the one that adds the most value because they are mutually exclusive projects.

D) pick neither project.

Ans: A Reference: Ref 10-1 Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 38. If both projects are positive-NPV projects, then the firm should A) accept both projects because they are independent projects.

B) select the higher NPV project because they are mutually exclusive.

C) accept both projects because they are contingent projects.

D) Not enough information is given to make a decision.

Ans: A

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 39. The cost of capital is A) the minimum return that a capital project must earn to be accepted.

B) the maximum return a project can earn.

C) the return that a previous project for the firm had earned.

D) None of the above Ans: A Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 40. Capital rationing implies that A) a firm has constraint to fund all of the available projects.

B) funding needs is equal to funding resources.

C) the available capital will be allocated equally to all available projects.

D) None of the above Ans: A Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 41. Capital rationing implies that A) funding resources exceed funding needs.

B) funding needs exceed funding resources.

C) funding needs equal funding resources.

D) None of the above Ans: B

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10-14

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 42. Which one of the following statements is NOT true?

A) Accepting a positive-NPV project increases shareholder wealth.

B) Accepting a negative-NPV project has no impact on shareholder wealth.

C) Accepting a negative-NPV project decreases shareholder wealth.

D) Managers are indifferent about accepting or rejecting a zero NPV project.

Ans: B Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 43. Which one of the following statements is NOT true?

A) Accepting a positive-NPV project increases shareholder wealth.

B) Accepting a negative-NPV project decreases shareholder wealth.

C) Accepting a zero NPV project has a negative impact on shareholder wealth.

D) Managers are indifferent about accepting or rejecting a zero NPV project.

Ans: C Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective NOT 44. In computing the NPV of a capital budgeting project, one should A) estimate the cost of the project.

B) discount the future cash flows over the project's expected life.

C) ignore the salvage value.

D) make a decision based on the project's NPV. Ans: C

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10-15

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 45. The net present value A) uses the discounted cash flow valuation technique.

B) will provide a direct measure of how much a firm’s value will change because of the C) capital project.

D) is consistent with shareholder wealth maximization goal.

All of the above Ans: D Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 46. To accept a capital project when using NPV, A) the project NPV should be less than zero.

B) the project NPV should be greater than zero.

C) Both a and b D) None of the above Ans: B

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10-16

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 47. The Cyclone Golf Resorts is redoing its golf course at a cost of $2,744,320. It expects to generate cash flows of $1,223,445, $2,007,812, and $3,147,890 over the next three years. If the appropriate discount rate for the firm is 13 percent, what is the NPV of this project? (Do not round intermediate computations. Round final answer to nearest dollar.)

A) $7,581,072 B) $2,092,432 C) $4,836,752 D) $3,112,459 Ans: B Feedback: Initial investment = $2,744,320 Length of project = n = 3 years Required rate of return = k = 13% Net present value = NPV

NCFt $1,223,445$2,007,812 $3,147, 890 + + =−$2,744,320+ 1 (1.13)2 (1.13)3 1 ) (1.13) t0 (+kt = −$2, 744, 320 + $1, 082, 695 + $1, 572, 411 + $2,181, 646 = $2, 092, 432 n

NPV = =

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10-17

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 48. Cortez Art Gallery is adding to its existing buildings at a cost of $2 million. The gallery expects to bring in additional cash flows of $520,000, $700,000, and $1,000,000 over the next three years. Given a required rate of return of 10 percent, what is the NPV of this project? (Do not round intermediate computations. Round final answer to nearest dollar.)

A) $1,802,554 B) $197,446 C) –$1,802,554 D) –$197,446 Ans: D Feedback: Initial investment = $2,000,000 Length of project = n = 3 years Required rate of return = k = 10% Net present value = NPV

NCF $520,000+ $700,000+ $1, 000, 000 t = −$2000,000+ (1.10)2 (1.10)1 (1.10)3 t= 0 (1+ k)t + $578, 512 + $751, 315 = −$2, 000, 000 + $472, 727 = −$197, 446 n

NPV = 

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10-18

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 49. Johnson Entertainment Systems is setting up to manufacture a new line of video game consoles.

The cost of the manufacturing equipment is $1,750,000. Expected cash flows over the next four years are $725,000, $850,000, $1,200,000, and $1,500,000. Given the company's required rate of return of 15 percent, what is the NPV of this project? (Do not round intermediate computations. Round final answer to nearest dollar.)

A) $1,169,806 B) $2,919,806 C) $4,669,806 D) $3,122, 607 Ans: A Feedback: Initial investment = 1,750,000 Length of project = n = 4 years Required rate of return = k = 15% Net present value = NPV

NCF t $725,000$850,000$1,200,000 $1, 500, 000 + + + =−$1,750,000+ 1 2 3 (1.15)4 (1.15) (1.15) (1.15) t= 0 (1+kt) = −$1, 750, 000 + $630, 435 + $642, 722 + $789, 019 + $857, 630 = $1, 169, 806 n

NPV = 

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10-19

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 50. Gao Enterprises plans to build a new plant at a cost of $3,250,000. The plant is expected to generate annual cash flows of $1,225,000 for the next five years. If the firm's required rate of return is 18 percent, what is the NPV of this project? (Do not round intermediate computations.

Round final answer to nearest dollar.)

A) $2,875,000 B) $3,830,785 C) $580,785 D) $2, 225,875 Ans: C Feedback: Initial investment = $3,250,000 Annual cash flows = $1,225,000 Length of project = n = 5 years Required rate of return = k = 18% Net present value = NPV

 1  − 1 (1.18)5   n FCF   NPV =  tt = −$3,250,000+ $1,225,000  0.18  1 k) = (+ t0   = −$3, 250, 000 + $3, 830, 785  = $580, 785 Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 51. Jenkins Corporation is investing in a new piece of equipment at a cost of $6 million. The project is expected to generate annual cash flows of $1,850,000 over the next six years. The firm's cost of capital is 20 percent. What is the project's NPV? (Do not round intermediate computations. Round final answer to nearest dollar.)

A) $722,604 B) $351,097 C) $152,194 D) $261,008 Ans: C Feedback: Initial investment = $6,000,000

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10-20

Fundamentals of Corporate Finance 3e

Test Bank

Annual cash flows = $1,850,000 Length of project = n = 6 years Required rate of return = k = 20% Net present value = NPV

 1  1− (1.20)6  FCF   NPV =  t = −$6,000,000+ $1,850,000  0.20  1 k) t = (+ t0   = −$6, 000, 000 + $6,152,194  = $152, 194 n

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 52. Turnbull Corp. is in the process of constructing a new plant at a cost of $30 million. It expects the project to generate cash flows of $13,000,000, $23,000,000, and 29,000,000 over the next three years. The cost of capital is 20 percent. What is the net present value of this project? (Do not round intermediate computations. Round final answer to nearest million dollars.)

A) $10 million B) $12 million C) $14 million D) $16 million Ans: C Feedback: Initial investment = $30,000,000 Length of investment = n = 3 years Required rate of return = k = 20% Net present value = NPV n NCFt $13,000,000$23,000,000$29,000,000 + + NPV =  =−$30,000,000+ +kt) (1.20)1 (1.20)2 (1.20)3 t0(1 = = −$30, 000, 000 + $10, 833, 333 + $15, 972, 222 + $16, 782, 407 = $13, 587, 963

= 14 million (rounded)

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10-21

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 53. Jamaica Corp. is adding a new assembly line at a cost of $8.5 million. The firm expects the project to generate cash flows of $2 million, $3 million, $4 million, and $5 million over the next four years. Its cost of capital is 16 percent. What is the net present value of this project?

(Do not round intermediate computations. Round final answer to nearest dollar.)

A) $645,366 B) $1,213,909 C) $905,888 D) $777,713 Ans: D Feedback: Initial investment = $8,500,000 Length of investment = n = 4 years Required rate of return = k = 16% Net present value = –$8,500,000 + [$2,000,000 / 1.16] + [3,000,000 / (1.16)2] + [$4,000,000 / (1.16)3] + [$5,000,000 / (1.16)4] = $777,713

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10-22

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 54. Strange Manufacturing Company is purchasing a production facility at a cost of $21 million.

The firm expects the project to generate annual cash flows of $7 million over the next five years. Its cost of capital is 18 percent. What is the net present value of this project? (Do not round intermediate computations. Round final answer to nearest dollar.)

A) $890,197 B) $1,213,909 C) $905,888 D) $777,713 Ans: A Feedback: Initial investment = $21,000,000 Length of investment = n = 5 years Annual cash flows = $7,000,000 Required rate of return = k = 18% Net present value = NPV

 1  1− (1.18)5  FCF   NPV =  tt = −$21,000,000 + $7,000,000  0.18  1 k) = (+ t0   = −$21,000,000+$21,890,197  = $890, 197 n

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 55. Which of the following is true about the Net Present Value method?

A) The NPV does not utilize time value of money concepts.

B) The NPV assumes that all cash flows are reinvested at the firm’s discount rate.

C) The NPV allows projects to be ranked by rate of return.

D) The NPV is a rate of return that is acceptable to the firm.

Ans: B

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10-23

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Comrpehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 56. Which of the following statements about the payback method is true?

A) The payback method is consistent with the goal of shareholder wealth maximization B) The payback method represents the number of years it takes a project to recover its initial C) investment plus a required rate of return.

D) There is no economic rational that links the payback method to shareholder wealth maximization.

None of the above statements are true.

Ans: C Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 57. Which one of the following statements about the discounted payback method is NOT true?

A) The discounted payback method represents the number of years it takes a project to recover its initial investment.

B) The discounted payback method calls for a project to be accepted if the payback period is C) greater than a target period.

D) The discount payback method is a risk indicator.

The expected cash flows from a project are discounted at the cost of capital.

Ans: B Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 58. Which of the following is an advantage of the payback method?

A) The technique is simple for managers to compute and interpret.

B) It is a good measure of liquidity risk.

C) Both a and b D) None of the above Ans: C

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10-24

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 59. Which of the following is a disadvantage of the payback method?

A) It ignores the time value of money.

B) It is inconsistent with the goal of maximizing shareholder wealth.

C) It ignores cash flows beyond the payback period.

D) All of the above.

Ans: D Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 60. Binder Corp. has invested in new machinery at a cost of $1,450,000. This investment is expected to produce cash flows of $640,000, $715,250, $823,330, and $907,125 over the next four years. What is the payback period for this project? (Round your answer to two decimal places.)

A) 2.12 years B) 1.88 years C) 4.00 years D) 3.00 years.

Ans: A Feedback: Binder Corp.

CF Cumulative CF Year 0 $(1,450,000) $(1,450,000) 1 640,000 (810,000) 2 715,250 (94,750) 3 823,330 728,580 4 907,125 1,635,705 PB = Years before cost recovery + (Remaining cost to recover/ Cash flow during the year) = 2 + ($94,750 / $823,330) = 2.12 years

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10-25

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 61. Elmer Sporting Goods is getting ready to produce a new line of golf clubs by investing $1.85 million. The investment will result in additional cash flows of $525,000, $812,500, and 1,200,000 over the next three years. What is the payback period for this project? (Round your answer to two decimal places.)

A) 3.55 years B) 2.43 years C) 1.57 years D) More than 3 years Ans: B Feedback: Elmer Sporting Goods CF Cumulative CF Year 0 $(1,850,000) $(1,850,000) 1 525,000 (1,325,000) 2 812,500 (512,500) 3 1,200,000 687,500 PB = Years before cost recovery + (Remaining cost to recover/ Cash flow during the year) = 2 + ($512,500 / $1,200,000) = 2.43 years

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10-26

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard Bloomcode: Analysis AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 62. Creighton, Inc. has invested $2,165,800 on equipment. The firm uses payback period criteria of not accepting any project that takes more than four years to recover costs. The company anticipates cash flows of $424,386, $512,178, $561,755, $764,997, $816,500, and $825,375 over the next six years. What is the payback period, and does this investment meet the firm's payback criteria? (Round your answer to two decimal places.)

A) 4.13 years; no B) 4.13 years; yes C) 3.87 years; yes D) 3.87 years; no Ans: C Feedback: Creighton Inc. CF Cumulative CF Year 0 $(2,165,800) $(2,165,800) 1 424,386 (1,741,414) 2 512,178 (1,229,236) 3 561,755 (667,481) 4 764,997 97,516 5 816,500 914,016 6 825,375 1,739,391 PB = Years before cost recovery + (Remaining cost to recover/ Cash flow during the year) = 3 + ($667,481 / $764,997) = 3.87 years Since the payback period of 3.87 years is less than the decision criteria of 4 years, this project should be accepted.

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10-27

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard Bloomcode: Analysis AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 63. Kathleen Dancewear Co. has bought some new machinery at a cost of $1,250,000. The impact of the new machinery will be felt in the additional annual cash flows of $375,000 over the next five years. What is the payback period for this project? If its acceptance period is three years, will this project be accepted? (Round your answer to two decimal places.)

A) 2.67 years; yes B) 2.67 years; no C) 3.33 years; yes D) 3.33 years; no Ans: D Feedback: Kathleen Dancewear Inc. CF Cumulative CF Year 0 $(1,250,000) $(1,250,000) 1 375,000 (875,000) 2 375,000 (500,000) 3 375,000 (125,000) 4 375,000 250,000 5 375,000 625,000 PB = Years before cost recovery + (Remaining cost to recover/ Cash flow during the year) = 3 + ($125,000 / $375,000) = 3.33 years Since the payback period of 3.33 years exceeds the decision criteria of 3 years, this project should be rejected.

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10-28

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard Bloomcode: Analysis AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 64. Carmen Electronics bought new machinery for $5 million. This is expected to result in additional cash flows of $1.2 million over the next seven years. What is the payback period for this project? If its acceptance period is five years, will this project be accepted? (Round your answer to two decimal places.)

A) 4.17 years; yes B) 4.17 years; no C) 3.83 years; yes D) 3.83 years; no Ans: A Feedback: Carmen Electronics CF Cumulative CF Year 0 $(5,000,000) $(5,000,000) 1 1,200,000 (3,800,000) 2 1,200,000 (2,600,000) 3 1,200,000 (1,400,000) 4 1,200,000 (200,000) 5 1,200,000 1,000,000 6 1,200,000 2,200,000 7 1,200,000 3,400,000 PB = Years before cost recovery + (Remaining cost to recover/ Cash flow during the year) = 4 + ($200,000 / $1,200,000) = 4.17 years Since the payback period of 4.17 years is less than the decision criteria of 5 years, this project should be accepted.

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10-29

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 65. Roswell Energy Company is installing new equipment at a cost of $10 million. Expected cash flows from this project over the next five years will be $1,045,000, $2,550,000, $4,125,000, $6,326,750, and $7,000,000. The company's discount rate for such projects is 14 percent. What is the project's discounted payback period? (Do not round intermediate computations. Round your answer to one decimal place.)

A) 4.2 years B) 4.4 years C) 4.8 years D) 5.0 years Ans: A Feedback: i = 14%

Roswell Energy

Cumulative PVCF CF PVCF Year 0 $(10,000,000) $(10,000,000) $(10,000,000) 1 1,045,000 916,667 (9,083,333) 2 2,550,000 1,962,142 (7,121,191) 3 4,125,000 2,784,258 (4,336,934) 4 6,326,750 3,745,944 (590,990) 5 7,000,000 3,635,581 3,044,591 Discounted PB = Years before cost recovery + (Remaining cost to recover/ Present value of Cash flow during the year) = 4 + ($590,990/ $3,635,581) = 4.16 years or 4.2 years

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10-30

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard Bloomcode: Analysis AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 66. Carmen Electronics bought new machinery for $5 million. This is expected to result in additional cash flows of $1.2 million over the next seven years. The firm's cost of capital is 12 percent. What is the discounted payback period for this project? If the firm's acceptance period is five years, will this project be accepted? (Do not round intermediate computations. Round your answer to one decimal place.)

A) 5.4 years; no B) 6.1 years; no C) 6.1 years; yes D) 4.2 years; yes Ans: B Feedback: i = 12% Year 0 1 2 3 4 5 6 7

Carmen Electronics CF $(5,000,000) 1,200,00 0 1,200,00 0 1,200,00 0 1,200,00 0

PVCF $(5,000,000) 1,071,429 956,633 854,136 762,622 680,912

Cumulative PVCF $(5,000,000) (3,928,571) (2,971,939) (2,117,802) (1,355,181) (674,269)

607,957 542,819

(66,311) 476,508 1,200,00 Discounted PB = Years before cost recovery + (Remaining cost to recover/ Present value of Cash flow during the year) 0 = 6 + ($66,311 / $542,819) = 6.12 years 1,200,00 Since the payback period of 6.12 years exceeds the decision criteria of 5 years, this project should be rejected.

0 1,200,00 0

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10-31

Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Hard Bloomcode: Analysis AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 67. Kathleen Dancewear Co. has bought some new machinery at a cost of $1,250,000. The impact of the new machinery will be felt in the additional annual cash flows of $375,000 over the next five years. The firm's cost of capital is 10 percent. What is the discounted payback period for this project? If its acceptance period is three years, will this project be accepted? (Do not round intermediate computations. Round your answer to one decimal place.)

A) 2.7 years; yes B) 4.7 years; no C) 2.3 years; yes D) 4.3 years; no Ans: D Feedback: i = 10%

Kathleen Dancewear Inc.

Cumulative PVCF Year CF PVCF 0 $(1,250,000) $(1,250,000) $(1,250,000) 1 340,909 (909,091) 375,00 2 309,917 (599,174) 0 3 281,743 (317,431) 375,00 4 256,130 (61,300) 0 5 232,845 171,545 375,00 0 Discounted PB = Years before cost recovery + (Remaining cost to recover/ Present value of 375,00 Cash flow during the year) 0 = 4 + ($61,300 / $232,845) 375,00 = 4.26 years Since the payback period of 4.30 years exceeds the decision criteria of 3 years, this project should be rejected.

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10-32

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 68. Turnbull Corp. is in the process of constructing a new plant at a cost of $30 million. It expects the project to generate cash flows of $13,000,000, $23,000,000, and 29,000,000 over the next three years. The cost of capital is 20 percent. What is the payback period for this project?

(Round your answer to one decimal place.)

A) 1.7 years B) 2.2 years C) 1.2 years D) 2.7 years Ans: A Feedback: Initial investment = $30,000,000 Length of investment = n = 3 years Turnbull Corp. i = 20.00% Year CF Cumulative CF 0 $(30,000,000 $(30,000,000) 1 ) 13,000,000 (17,000,000) 2 23,000,000 6,000,000 3 29,000,000 35,000,000 PB = Years before cost recovery + (Remaining cost to recover/ Cash flow during the year) = 1 + ($17,000,000 / $23,000,000) = 1.74 years or 1.7 years

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10-33

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 69. Jamaica Corp. is adding a new assembly line at a cost of $8.5 million. The firm expects the project to generate cash flows of $2 million, $3 million, $4 million, and $5 million over the next four years. Its cost of capital is 16 percent. What is the payback period for this project?

(Round your answer to one decimal place.)

A) 2.7 years B) 2.9 years C) 3.1 years D) 3.4 years Ans: B Feedback: Initial investment = $8,500,000 Length of investment = n = 4 years Jamaica Inc. i = 16.00% Year CF Cumulative CF 0 $(8,500,000) $(8,500,000) 1 (6,500,000) 2,000,00 2 (3,500,000) 0 3 500,000 3,000,00 4,000,000 4 0 5,000,000 5,500,000 PB = Years before cost recovery + (Remaining cost to recover/ Cash flow during the year) = 2 + ($3,500,000/ $4,000,000) = 2.88 years or 2.9 years Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 70. Strange Manufacturing Company is purchasing a production facility at a cost of $21 million.

The firm expects the project to generate annual cash flows of $7 million over the next five years. Its cost of capital is 18 percent.

What is the payback period for this project?

A) 2.8 years B) 3.0 years C) 3.2 years D) 3.4 years Ans: B Feedback: Initial investment = $21,000,000

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10-34

Fundamentals of Corporate Finance 3e

Test Bank

Length of investment = n = 5 years Annual cash flows = $7,000,000 Strange Manufacturing i = 18.00% Year 0 1 2 3 4 5 PB CF Cumulative CF $(21,000,000 $(21,000,000) ) 7,000,000 (14,000,000) (7,000,000) 7,000,000 -7,000,000 7,000,000 7,000,000 14,000,000 7,000,000 = Years before cost recovery + (Remaining cost to recover/ Cash flow during the year = 3 + ($0 / $7,000,000) = 3.0 years

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10-35

Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 71. You have been asked to analyze an investment project. The project’s cost is $180,000. Cash inflows are projected to be: year 1 = $55,000, year 2 = $65,000; year 3 = $75,000; year 4 = $85,500; year 5 = $95,000.

What is the investment project’s payback? (Round off to the nearest 0.1 years) A) 4.1 years B) 1.6 years C) 3.5 years D) 2.8 years Ans: D Feedback:

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MethodPayback Cumulative Estimated Year Cash Flows Cash Flows 0 ($180,000) (180,000) 1 55,000 (125,000) 2 65,000 (60,000) 3 75,000 15,000 4 85,500 100, 500 5 95,000 195, 500 = 2.80 Years

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Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 72. LaGrange Corp. has forecasted that over the next four years the average annual after-tax income will be $45,731. The average book value of the manufacturing equipment that is used is $167,095. What is the accounting rate of return? (Round your answer to one decimal place.)

A) 33.3% B) 27.4% C) 29.8% D) 22.3% Ans: B Feedback: Annual after-tax income = $45,731 Average after-tax income = ($45,731+$45,731 + $45,731+$45,731) / 4 = $45,731 Average book value of equipment = $167,095

after-tax income = Average Accounting rate of return Average book value = $45, 731 = 27.4% $167, 095 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 73. Stump Storage Co. is expecting to generate after-tax income of $155,708, $159,312, and $161,112 for each of the next three years. The equipment used will have an average book value of $251,575 over that period. What is the ARR? (Do not round intermediate computations.

Round final answer to one decimal place.)

A) 65.7% B) 69.4% C) 63.1% D) 66.8% Ans: C Feedback: Average after-tax income = ($155,708+$159,312 +$161,112) / 3 = $158,711 Average book value of equipment = $251,575

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Test Bank

Fundamentals of Corporate Finance 3e

= Accounting rate of return

Average after-tax income Average book value

= $158, 711= 63.1% $251, 575 Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Hard Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 74. Which of the following statements about IRR is NOT true?

A) The IRR is the discount rate that makes the NPV greater than zero.

B) The IRR is a discounted cash flow method.

C) The IRR is an expected rate of return.

D) None of the above Ans: A Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 75. The internal rate of return is A) the discount rate that makes the NPV greater than zero.

B) the discount rate that makes the NPV equal to zero.

C) the discount rate that makes the NPV less than zero.

D) Both a and c are correct.

Ans: B

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 76. When evaluating capital projects, the decisions using the NPV method and the IRR method will agree if A) the projects are independent.

B) the cash flow pattern is conventional.

C) the projects are mutually exclusive.

D) Both a and b are correct.

Ans: D Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 77. In evaluating capital projects, the decisions using the NPV method and the IRR method may disagree if A) the projects are independent.

B) the cash flows pattern is unconventional.

C) the projects are mutually exclusive.

D) Both b and c are correct.

Ans: D Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Hard Bloomcode: Analysis AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 78. Which of the following cash flow patterns is NOT an unconventional cash flow pattern?

A) A positive initial cash flow is followed by negative future cash flows.

B) A cash flow pattern in which there are alternate inflows and outflows.

C) A negative initial cash flow is followed by positive future cash flows.

D) A cash flow stream looks similar to a conventional cash flow stream except for a final negative cash flow.

Ans: C

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 79. Quick Sale Real Estate Company is planning to invest in a new development. The cost of the project will be $23 million and is expected to generate cash flows of $14,000,000, $11,750,000, and $6,350,000 over the next three years. The company's cost of capital is 20 percent. What is the internal rate of return on this project? (Do not round intermediate computations. Round final answer to the nearest percent.)

A) 22% B) 20% C) 24% D) 28% Ans: A Feedback: Initial investment = $23,000,000 Length of project = n = 3 years Required rate of return = k = 20% To determine the IRR, the trial-and-error approach can be used. Set NPV = 0.

Try IRR = 21.6%. 𝑛

𝐹𝐶𝐹𝑡 𝑡=0 (1 +𝐼𝑅𝑅)

𝑁𝑃𝑉 =0 = ∑

𝑡 $14,000,000 $11,750,000 $6,350,000 + (1.216)2 + (1.216)3

0 = -$23,000,000 + (1.216)2

= $23,000 + $11,513,158 + $7,946,405 + $3,531,612 = -$8,825≅0

The IRR of the project is 21.6 percent . Using a financial calculator, we find that the IRR is 21.572 percent.

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Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 80. Modern Federal Bank is setting up a brand new branch. The cost of the project will be $1.2 million. The branch will create additional cash flows of $235,000, $412,300, $665,000 and $875,000 over the next four years. The firm's cost of capital is 12 percent. What is the internal rate of return on this branch expansion? (Do not round intermediate computations. Round final answer to the nearest percent.)

A) 20% B) 23% C) 25% D) 27% Ans: B Feedback: Initial investment = $1,200,000 Length of project = n = 4 years To determine the IRR, the trial-and-error approach can be used. Set NPV = 0.

Try IRR =23.1%. 𝑛

𝐹𝐶𝐹𝑡 𝑁𝑃𝑉 =0 = ∑ (1 +𝐼𝑅𝑅)𝑡 𝑡=0

$665,000 $875,000 + + 0 = -$1,200,000 +$235,000 $412,300 + (1.231)1

(1.231)2

(1.231)3

(1.231)4

= $1,200,000 + $190,902 + $272,080 + $356,490 + $381,045 = $517 ≅0 The IRR of the project is 23.1 percent . Using a financial calculator, we find that the IRR is 23.119 percent.

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Test Bank

Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 81. Signet Pipeline Co. is looking to install new equipment that will cost $2,750,000. The cash flows expected from the project are $612,335, $891,005, $1,132,000, and $1,412,500 for the next four years. What is Signet's internal rate of return? (Do not round intermediate computations. Round final answer to the nearest percent.)

A) 11% B) 13% C) 15% D) 17% Ans: C Feedback: Initial investment = $2,750,000 Length of project = n = 4 years To determine the IRR, the trial-and-error approach can be used. Set NPV = 0.

Try IRR =15.1%. 𝑛

𝐹𝐶𝐹𝑡 𝑡=0 (1 +𝐼𝑅𝑅) 𝑡

𝑁𝑃𝑉 =0 = ∑

$612, 335

$891,005 $1,132,000 $1,412,500 + (1.151)3 (1.151)4

0 = -$2,750,000 +(1.151)1 + (1.151)2 +

= -$2,750,000+ $532,003 + $672,558 + $742,370 + $804,799

= $1,729 ≅ 0 The IRR of the project is 15.1 percent . Using a financial calculator, we find that the IRR is 15.127 percent.

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 82. Casa Del Sol Property Development Company is refurbishing a 200-unit condominium complex at a cost of $1,875,000. It expects that this will lead to expected annual cash flows of $415,350 for the next seven years. What internal rate of return can the firm earn from this project? (Do not round intermediate computations. Round final answer to the nearest percent.)

A) 10% B) 12% C) 14% D) 16% Ans: B Feedback: Initial investment = $1,875,000 Annual cash flows = $415,350 Length of investment = n = 7 years To determine the IRR, the trial-and-error approach can be used. Set NPV = 0.

Try IRR =12.3%.

 1  1−  FCFt (1.123)7 =−$1,875,000+ $415, 350 NPV = 0 =  t=0 (1+IRR)t  0.123    0 = −$1, 875, 000$1, + 877, 660  = $2, 660 0 n

. Using a financial calculator, we find that the IRR is 12.3 percent The IRR of the project is 12.345 percent.

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Fundamentals of Corporate Finance 3e

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Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 83. Lowell Communications, Inc., has been installing a fiber-optic network at a cost of $18 million.

The firm expects annual cash flows of $3.7 million over the next 10 years. What is this project's internal rate of return? (Do not round intermediate computations. Round final answer to the nearest percent.)

A) 10% B) 12% C) 14% D) 16% Ans: D Feedback: Initial investment = $18,000,000 Annual cash flows = $3,700,000 Length of investment = n = 10 years To determine the IRR, the trial-and-error approach can be used. Set NPV = 0.

Try IRR =15.8%.

  1 1−  10 n FCF   (1.158)  NPV = 0 =  t =t −$18,000,000+ $3, 700, 000  0.158  = (1+ IRR) t0   0 = −$18, 000, 000 + $18, 016, 910  = $16, 910 0

. Using a financial calculator, we find that the IRR is 15.8 percent The IRR of the project is 15.825 percent.

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 84. Turnbull Corp. is in the process of constructing a new plant at a cost of $30 million. It expects the project to generate cash flows of $13,000,000, $23,000,000, and 29,000,000 over the next three years. The cost of capital is 20 percent. What is the internal rate of return that Turnbull can earn on this project? (Do not round intermediate computations. Round final answer to the nearest percent.)

A) 41% B) 42% C) 43% D) 44% Ans: D Feedback: Initial investment = $30,000,000 Length of investment = n = 3 years Since NPV > 0, try IRR > 20%. Try IRR = 43.6%.

𝑁𝑃𝑉 =0 = ∑𝑡=0

𝑛

𝑁𝐶𝐹𝑡 (1 +𝐼𝑅𝑅)𝑡

$13,000,000 $23,000,000 + (1436)2

= -$30,000,000 + (1.436)1

+

$29,000 ,000 (1.436) 3

= -$30,000,000 + $9,052,925 + $11,153,700 + $9,793,427 = $51 ≅ 0

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 85. Turnbull Corp. is in the process of constructing a new plant at a cost of $30 million. It expects the project to generate cash flows of $13,000,000, $23,000,000, and 29,000,000 over the next three years. The cost of capital is 20 percent. What is the MIRR on this project? (Do not round intermediate computations. Round final answer to the nearest percent.)

A) 36% B) 37% C) 38% D) 39% Ans: A Feedback: PV of costs = $30,000,000 Length of project = n = 3 years Cost of capital = k = 20%

+ k )n− 2+ TV = CF 1(1+ k )n− 1+CF2 (1

+ k )n− n +CFn(1

= $13,000,000(1.20)2+$23,000,000(1.20)1+$29,000,000(1.20)0 = $18, 720, 000 + $27, 600, 000 + $29, 000, 000 = $75, 320, 000 TV PVCosts = (1+ MIRR)t = $30, 000, 000

$75, 320, 000 (1+ MIRR)3

= $75, 320, 000 (1+ MIRR )3 = 2.5107 $30, 000, 000 (1+)MIRR = (2.5107) 3 = 1.3591 MIRR = 0.3591 = 35.9% 1

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 86. Jamaica Corp. is adding a new assembly line at a cost of $8.5 million. The firm expects the project to generate cash flows of $2 million, $3 million, $4 million, and $5 million over the next four years. Its cost of capital is 16 percent. What is the internal rate of return that Jamaica can earn on this project? (Do not round intermediate computations. Round final answer to the nearest percent.)

A) 18% B) 19% C) 20% D) 21% Ans: C Feedback: Initial investment = $8,500,000 Length of investment = n = 4 years Since NPV > 0, try IRR > 16%. Try IRR = 19.9%.

Net present value = –$8,500,000 + [$2,000,000 / 1.199] + [3,000,000 / (1.199)2] + [$4,000,000 / (1.199)3] + [$5,000,000 / (1.199)4] = -5,202 The IRR of the project is 19.9 percent. Using a financial calculator, we find that the IRR is 19.872 percent.

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 87. Jamaica Corp. is adding a new assembly line at a cost of $8.5 million. The firm expects the project to generate cash flows of $2 million, $3 million, $4 million, and $5 million over the next four years. Its cost of capital is 16 percent. What is the MIRR on this project? (Round to the nearest percent.)

A) 18% B) 19% C) 20% D) 21% Ans: B Feedback: Initial investment = $8,500,000 Length of investment = n = 4 years Cost of capital = k = 16% − TV = CF1( 1+ k)n−1+CF2 + (1k )n 2+

− + CFn (1+ k)n n

= $2, 000, 000(1.16)3 + $3, 000, 000(1.16)2 + $4, 000, 000(1.16)1 + $5, 000, 000(1.16)0 = $3,121, 792 + $4, 036, 800 + $4, 640, 000 + $5, 000, 000 = $16, 798, 592 TV PVCosts = (1+ MIRR)t = $8, 500, 000

$16, 798, 592 (1+ MIRR)4

= $16, 798, 592 (1+ MIRR )4 = 1.9763 $8, 500, 000 (1+)MIRR = (1.9763) 4 =1.1857 MIRR = 0.1857 = 18.6% 1

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Fundamentals of Corporate Finance 3e

Test Bank

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 88. Strange Manufacturing Company is purchasing a production facility at a cost of $21 million.

The firm expects the project to generate annual cash flows of $7 million over the next five years. Its cost of capital is 18 percent. What is the internal rate of return on this project? (Do not round intermediate computations. Round final answer to the nearest percent.)

A) 17% B) 18% C) 19% D) 20% Ans: D Feedback: Initial investment = $8,500,000 Length of investment = n = 4 years Since NPV > 0, try IRR > 18%. Try IRR = 19.9%.

  1 1− (1.199)5  FCF   NPV =  t = −$21,000,000 + $7,000,000  0.199  1 k) t = (+ t0   = −$21, 000, 000 + $20, 980, 433  = −$19, 567 0 n

The IRR of the project is 19.9 percent. Using a financial calculator, we find that the IRR is 19.858 percent.

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Fundamentals of Corporate Finance 3e

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Format: Essay Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 89. What difficulties are associated with valuing real assets compared to financial assets?

Ans: The valuation of real assets is less straightforward than the valuation of financial assets for several reasons: • First, in many cases, cash flows for financial assets are well documented in a legal contract. If they are not, we are at least able to make some reasonable assumptions about what they are. For real assets, no such information exists.

Specialists within the firm, usually from the finance, marketing, and production groups, prepare estimates of future cash flows for the capital project.

• Second, many financial securities are traded in public markets, and these markets are reasonably efficient. Thus, market data on rates of return are accessible. For real assets, no such markets exist. As a result, we must look at investors' opportunity cost, the rate of return they give up when they invest in real assets rather than financial assets. We must estimate required rates of return on real assets from market data on financial assets, which can be difficult to do.

Format: Essay Learning Objective: LO 2 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 90. What are the advantages of the net present value technique?

Ans: 1. Uses the discounted cash flow valuation technique to adjust for the time value of money.

2. Provides a direct measure of how much a capital project will increase the value of the firm.

3. Consistent with the goal of maximizing stockholder value.

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Fundamentals of Corporate Finance 3e

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Format: Essay Learning Objective: LO 5 Level of difficulty: Medium Bloomcode: Analysis AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 91. Explain under what circumstances the NPV and IRR could provide different decisions.

Ans: The IRR and NPV methods can produce different accept/reject decisions: • If a project either has unconventional cash flows or the projects are mutually exclusive. Unconventional cash flows could follow several different patterns. It could be a positive initial cash flow followed by negative future cash flows, or both positive and negative cash flows, or, a cash flow stream that looks similar to a conventional cash flow stream except for a final negative cash flow.

• When you are comparing two mutually exclusive projects, the NPVs of the two projects will equal each other at a certain discount rate. This point at which the NPVs intersect is called the crossover point. Depending on whether the required rate of return is above or below this cross-over point, the ranking of the projects will be different. While it is easy to identify the superior project based on the NPV, one cannot do so based on the IRR. Thus, ranking conflicts can arise.

• A second situation involves comparison of projects with different costs. While IRR gives you a return based on the dollar invested, it does not recognize the difference in the size of the investments. NPV does!

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Fundamentals of Corporate Finance 3e

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Difficult Bloomcode: Application AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 92. Crossover Point/Rate:Packard Electronics Corp. is evaluating the two mutually exclusive projects shown below.

Boundless Corp. Project A Project B Period Cash Flows Cash Flows $ (100,000) $ (150,000) 0 50,000 15,000 1 40,000 30,000 2 30,000 50,000 3 20,000 70,000 4 10,000 80,000 5 What is the “crossover rate” of the two projects? (Round off to the nearest (0.01%)) A) 10.82% B) 8.24% C) 13.76% D) 16.38% Ans: A Feedback: Boundless Corp.

Period 0

Project A Project B Project Project Cash Cash A B Flows Flows WACC NPV NPV $(100,000) $(150,000)

0.0% 5.0%

1

50,00

15,000

2

0

30,000 10.0%

3

40,00

50,000 12.5%

4

0

70,000 15.0%

5

30,00

80,000 17.5%

0 20,00

Diff in CF's A vs. B

50,000

95,000

50,000

34,105

54,960

35,000

20,921

23,480

10,000

15,155

10,249

(20,000)

9,856

(1,600)

(50,000)

4,976 (12,240)

(70,000)

IRR

IRR =

IRR

20.27% 14.65%

10.82 %

0 10,00 0 .

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Fundamentals of Corporate Finance 3e

Test Bank

Chapter 11: Cash Flows and Capital Budgeting

Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy

Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 1. The term incremental in the context of incremental after-tax free cash flows refers to the fact that the firm's total after-tax free cash flows will change if the new project is adopted.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 2. Conceptually, free cash flows are what is left over for distribution to creditors and stockholders after the firm has made the necessary investments in working capital and long-term assets.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 3. Incremental cash flow from operations is the cash flow from a project that is expected to be generated after all operating expenses and taxes have been paid.

A) True B) False Ans: A

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 4. The purchase of a factory building for a prospective project is an example of an incremental addition to working capital.

A) True B) False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Medium Bloomcode: Comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 5. If a firm expects to increase its investment in inventory due to a prospective project, then this is an example of an incremental capital expenditure.

A) True B) False Ans: B Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 6. The stand-alone principle says that we can treat a project as if it were a stand-alone firm that has its own revenue, expenses, and investment requirements.

A) True B) False Ans: A

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Fundamentals of Corporate Finance 3e

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Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: comprehension AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 7. If you start with incremental net operating profits after tax (NOPAT) and add depreciation and amortization to it, then you will obtain incremental cash flow from operations.

A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 8. Free cash flow equals cash flow from operations minus required investments.

A) True B) False Ans: A Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy Bloomcode: Knowledge AASCB: Analytic IMA: Investment Decisions AICPA: Industry/Sector Perspective 9. Increases in working capital are considered cash flows associated with investments.

A) True B) False Ans: A

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