Analysis for Financial Management 12Th Edition BY Robert Higgins – Test Bank

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Description Analysis for Financial Management 12Th Edition BY Robert Higgins – Test Bank Sample Questions Instant Download With Answers Chapter 03 Test Bank

1.

The percent-of-sales approach to financial forecasting works well for forecasting the income statement but is not useful for forecasting the balance sheet.

FALSE Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic

2.

An advantage of the percent-of-sales approach to financial forecasting is that effective forecasts can be prepared without consulting historical financial statements.

FALSE Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic

3.

The forecast for retained earnings on the 2019 balance sheet can be determined as 2018 retained earnings plus projected 2019 after-tax earnings less projected 2019 dividends.

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4.

An annual financial forecast for 2017 showing no external funding required assures a company that no cash shortfalls are likely to occur during 2017.

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5.

All else equal, increasing the assumed payables period in a financial forecast will decrease external funding required.

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6.

All else equal, increasing the assumed collection period in a financial forecast will decrease external funding required.

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7.

Given the same assumptions, cash flow forecasts and pro forma projections will yield the same need for external funding.

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8.

A drawback of forecasting using spreadsheets is that typical spreadsheet programs are not equipped to deal with the circularity involving interest expense and debt.

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9.

Scenario analysis involves changing one input to a financial forecast, whereas sensitivity analysis involves changing multiple inputs.

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10.

Cash flow forecasts are less informative than pro forma financial statements.

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11.

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6.

You are estimating your company’s external financing needs for the next year. At the end of next year, you expect that owners’ equity will be $80 million, total assets will amount to $170 million, and total liabilities will be $70 million. How much will your firm need to borrow, or otherwise acquire, from outside sources during the next year?

$20 million $70 million $150 million $160 million $180 million None of the options are correct.

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12.You are estimating your company’s external financing needs for the next year. Your first-pass pro forma financial statements showed a large financing deficit for next year. Which of the following changes to your company’s operating plan would reduce the financing deficit if incorporated in revised pro forma financial statements?

1.

2.

3.

4.

5.

Increase the sales growth rate Increase cost of goods sold as a percentage of sales Reduce the collection period Increase the dividend payout ratio None of the options are correct.

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13.

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5.

6.

To estimate Missed Places, Inc.’s (MP) external financing needs, the CFO needs to figure out how much equity her firm will have at the end of next year. At the end of the most recent fiscal year, MP’s retained earnings were $158,000. The Controller has estimated that over the next year, gross profits will be $360,700, earnings after tax will total $23,400, and MP will pay $12,400 in dividends. What are the estimated retained earnings at the end of next year?

$169,000 $170,400 $181,400 $506,300 $518,700 None of the options are correct.

158,000 + 23,400 − 12,400 = $169,000

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14.

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5.

6.

The most common approach to developing pro forma financial statements is called the

cash budget method. financial planning method. seasonality approach. percent-of-sales method. market-oriented approach.

None of the options are correct.

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15.

Which of the following are viable techniques to cope with the uncertainty inherent in realistic financial projections?

16.

Simulation 17.

Ad hoc adjustments III. Scenario analysis 1.

Sensitivity analysis

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II and IV only III and IV only II, III, and IV only I, II, and III only I, III, and IV only I, II, III, and IV

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16.

1.

2.

Which one of the following statements is correct concerning the cash balance of a firm?

Most firms attempt to maintain a zero cash balance at all times.

The cumulative cash surplus shown on a cash budget is equal to the ending cash balance plus the minimum desired cash balance.

3.

Most firms attempt to maximize the cash balance at all times.

4.

A cumulative cash deficit on a cash budget indicates the need to acquire additional funds.

5.

The ending cash balance must equal the minimum desired cash balance.

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Assume each month has 30 days and AmDocs has a 60-day accounts receivable period. During the second calendar quarter of the year (April, May, and June), AmDocs will collect payment for the sales it made during which of the months listed below?

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2.

3.

4.

5.

October, November, and December November, December, and January December, January, and February January, February, and March February, March, and April

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18.

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The Limited collects 25 percent of sales in the month of sale, 60 percent of sales in the month following the month of sale, and 15 percent of sales in the second month following the month of sale. During the month of April, the firm will collect

60 15 60 15 25

percent percent percent percent percent

of of of of of

February sales.

April sales.

March sales.

March sales.

February sales.

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19.

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2.

Steve has estimated the cash inflows and outflows for his sporting goods store for next year. The report that he has prepared summarizing these cash flows is called a

pro forma income statement. sales projection.

3.

4.

5.

6.

cash budget. receivables analysis. credit analysis.

None of the options are correct.

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20.

You are developing a financial plan for a corporation. Which of the following questions will be considered as you develop this plan?

1.

How much will our sales grow?

2.

Will additional fixed assets be required?

III. Will dividends be paid to shareholders?

1.

How much new debt must be obtained?

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2.

3.

4.

5.

I and IV only II and III only I, III, and IV only II, III, and IV only I, II, III, and IV

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21.Ruff Wear expects sales of $560, $650, $670, and $610 for the months of May through August, respectively. The firm collects 20 percent of sales in the month of sale, 70 percent in the month following the month of sale, and 8 percent in the second month following the month of sale. The remaining 2 percent of sales is never collected. How much money does the firm expect to collect in the month of August?

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2.

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5.

$621 $628 $633 $639 $643

August collections = 0.20($610) + 0.70($670) + 0.08($650) = $643

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22.

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5.

On May 1, Vaya Corp. had a beginning cash balance of $175. Vaya’s sales for April were $430, and May sales were $480. During May, the firm had cash expenses of $110 and made payments on accounts payable of $290. Vaya’s accounts receivable period is 30 days. What is the firm’s beginning cash balance on June 1?

$145 $155 $205 $215 $265

Cash balance = $175 − $110 − $290 + $430 = $205

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23.

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4.

You are preparing pro forma financial statements for 2017 using the percent-ofsales method. Sales were $100,000 in 2016 and are projected to be $120,000 in 2017. Net income was $5,000 in 2016 and is projected to be $6,000 in 2017. Equity was $45,000 at year-end 2015 and $50,000 at year-end 2016. Assuming that this company never issues new equity, never repurchases equity, and never changes its dividend payout ratio, what would be projected for equity at year-end 2017?

$55,000 $56,000 $60,000 Insufficient information is provided to project equity in 2017.

All of net income was added to equity in 2016, so all of net income will be added to equity in 2017. $50,000 + $6,000 = $56,000.

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[The following information applies to the questions displayed below.]

Oscar’s Incredible Eatery ($ thousands) Income Statement for the year ending Dec. 31, 2017 Net sales Cost of goods sold Depreciation Earnings before interest and taxes Interest expense Earnings before tax Tax Earnings after tax Dividends

Oscar’s Incredible Eatery ($ thousands) Balance Sheet as of Dec. 31, 2017

24.

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Cash

350

Accounts payable

Accounts receivable

940

Long-term debt

Inventory

2,360

Common stock

Total current assets

3,650

Retained earnings

Net fixed assets

10,850

Total assets

14,500

Total liab. & equity

Please refer to Oscar’s financial statements above. What was Oscar’s increase in retained earnings during 2017?

$450 $1,380 $1,830 $2,280 None of the options are correct.

1,830 − 450 = 1,380

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25.

Please refer to Oscar’s financial statements above. Sales are projected to increase by 3 percent next year. The profit margin and the dividend payout ratio are projected to remain constant. What is the projected addition to retained earnings for next year?

309.

310.

311.

312.

313.

314.

$1,309.19 $1,421.40 $1,884.90 $2,667.78 $3,001.40 None of the options are correct.

Projected addition to retained earnings = $1,380 × (1 + 0.03) = $1,421.40

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26.

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Please refer to Oscar’s financial statements above. All of Oscar’s costs and current asset accounts vary directly with sales. Sales are projected to increase by 10 percent. What is the pro forma accounts receivable balance for next year?

$949 $1,034 $1,113 $1,730 $2,670 None of the options are correct.

Pro forma accounts receivable = $940 × (1 + 0.10) = $1,034

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27.

Please refer to Oscar’s financial statements above. Assume a constant profit margin and dividend payout ratio, and further assume all of Oscar’s assets and current liabilities vary directly with sales. Assume long-term debt and common stock remain unchanged. Sales are projected to increase by 10 percent. What is Oscar’s external financing need for next year?

1.

2.

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5.

6.

-$410 -$260 $235 $1,320 $7,240 None of the options are correct.

Projected total assets = $14,500 × 1.10 = $15,950 Projected total liabilities = $1,920 × 1.10 + $3,500 = $5,612 Projected total equity = $7,500 + ($1,580 + $1,380 × 1.1) = $10,598 External financing needed = $15,950 − ($5,612 + $10,598) = −$260

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28.

Please refer to Oscar’s financial statements above. Assume a constant debtequity ratio, net profit margin, and dividend payout ratio, and further assume all of Oscar’s expenses, assets, and current liabilities vary directly with sales. What is the pro forma net fixed asset value for next year if sales are projected to increase by 7.5 percent?

857.

858.

859.

860.

861.

862.

$10,857.50 $10,931.38 $11,663.75 $15,587.50 $18,987.50 None of the options are correct.

Pro forma net fixed assets = $10,850 × (1 + 0.075) = $11,663.75

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[The following information applies to the questions displayed below.]

Financial Statements for Royal Corporation Actual 2016 and Pro Forma 2017 ($ millions) Income Statement

Balance Sheet

Net sales

2016 $

47,616

2017 $

Cash & securities

52,378

Cost of goods sold

40,718

44,790

Accounts receivable

Other expenses

5,171

5,688

Inventories

Depreciation expense

1,000

1,100

EBIT

727

800

Interest expense

215

215

Earnings before tax

512

585

Bank loan (short-term

Tax

154

176

Accounts payable

Net income Dividends paid

$

359 90

$

409 102

Net fixed assets Total assets

Long-term debt Total liabilities

Shareholders’ eq

Add. to retained earnings

29.

1.

2.

3.

4.

$

269

Total liabilities &

In the above financial statements, Royal Corporation has prepared (incomplete) pro forma financial statements for 2017 based on actual financial statements for 2016. Royal Corp. used the percent-of-sales method, assuming a sales growth rate of 10% for 2017. If capital expenditures are planned to be $1,615 in 2017, then what would be the appropriate projection for net fixed assets in 2017?

$4,453 $4,563 $4,663 $5,663

4,048 + 1,615 − 1,100 = $4,563

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30.

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4.

Please refer to the pro forma financial statements for Royal Corporation above. If Royal Corporation plans to issue $100 in new equity in 2017, what should be the projection for shareholders’ equity for 2017?

$5,349 $5,436 $5,451 $5,536

4,942 + 307 + 100 = $5,349

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31.

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4.

Please refer to the pro forma financial statements for Royal Corporation above.

Assume that net fixed assets are projected to be $5,000 for 2017 and that shareholders’ equity is projected to be $5,500 for 2017. If long-term debt is the plug figure, what should be the projection for long-term debt for Royal Corporation in 2017?

$2,206 $2,363 $2,455 $2,847

Total assets would be 1,046 + 6,233 + 4,660 + 5,000 = $16,939 Total liabilities and equity, without long-term debt, would be 431 + 8,161 + 5,500 = $14,092 Longterm debt must make up the difference = 16,939 − 14,092 = $2,847

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[The following information applies to the questions displayed below.]

Selected assumptions for 2018 Sales growth rate Cost of goods sold/Sales Dividends/Net income

Income Statement

Sales

Balance Shee Actual

Forecast

2017

2018 1,000

Cash

Cost of goods sold

600

Accounts rec

Operating expense

200

Inventory

Depreciation expense

100

EBIT

100

Interest expense

35

Total Assets

Pre-tax income

65

Accounts pay

Tax

26

Bank loan

39

Total Current

Net Income

$

$

Total Current Net PP&E

Long-Term De

Shareholders

Total Liabilitie

32.

Please refer to the spreadsheet above. Selected assumptions are given for preparing pro forma financial statements for 2018. Which of the following formulas would correctly give the forecast for sales in cell C8?

1.

2.

3.

4.

5.

= B8 × B2 = B8 + B8 × B2 = (1 + B8) × B2 = (1/B2) × B8 None of the options are correct.

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33.

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4.

5.

Please refer to the spreadsheet above. Selected assumptions are given for preparing pro forma financial statements for 2018. When the pro formas are completed, which of the following formulas would correctly give the forecast for cost of goods sold in cell C9?

= B9 × B3 = B9 + B9 × B3 = B8 × B3 = B9 × B2 None of the options are correct.

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34.

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5.

Please refer to the spreadsheet above. Selected assumptions are given for preparing pro forma financial statements for 2018. Assume that no new equity will be issued in 2018. When the pro formas are completed, which of the following formulas would correctly give the forecast for shareholders’ equity in cell G19?

= F19 × B2 = F19 × (1 + B2) = F19 + (1 − B4) × C16 = F19 + B4 × C16 None of the options are correct.

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35.

1.

2.

Which of the following statements is correct if a firm’s pro forma financial statements project net income of $12,000 and external financing required of $5,000?

Total assets cannot grow by more than $10,000.

Dividends cannot exceed $10,000.

3.

4.

Retained earnings cannot grow by more than $12,000.

Long-term debt cannot grow by more than $5,000.

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36.

Pro forma financial statements, by definition, are predictions of a company’s financial statements at a future point in time. So, why is it important to analyze the historical performance of the company before constructing pro forma financial statements?

Historical analysis helps decide for which financial statement items a percent-of-sales forecast might be appropriate. For example, a stable trend in the collection period would tell you that, unless you expect changes in the management of the accounts receivable, future collection periods should continue along this trend.

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37.

Edna’s Laundry Services just completed pro forma statements using the percentage-of-sales approach. The pro forma shows a projected external financing need of -$5,500. Interpret this figure. What are the firm’s options in this case?

A negative value implies that the company has excess cash above its desired minimum. With a negative external financing need, the firm has a surplus of funds that it can use to reduce current liabilities, reduce long-term debt, buy back common stock, or increase dividends. If acceptable opportunities exist, the firm might also use the extra funds to purchase fixed assets, thereby increasing its potential growth, should that action be warranted.

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38.

Preston Fencing Company’s sales, half of which are for cash and the other half sold on credit, over the past three months were: 39.

Estimate Preston’s cash receipts in October if the company’s collection period is 30 days.

40.

Estimate Preston’s cash receipts in October if the company’s collection period is 45 days.

41.

What would be Preston’s accounts receivable balance at the end of October if the company’s collection period is 30 days? 45 days?

1.

If the collection period is 30 days, October cash receipts from September sales will equal half of September sales or $60,000. In addition, the company will receive cash from half of October sales, which were for cash of $40,000. The total is $100,000.

2.

With a 45–day collection period, cash collected during the first half of October is from credit sales made from the middle until the end of August; and collections during the second half of October are from credit sales made from the beginning until the middle of September. Therefore, cash receipts from credit sales (which are half of total sales) are from the period mid-August through mid–September, or (70,000/2 + 120,000/2)/2 = $47,500. Adding sales for cash of $40,000 in October, the total is $87,500.

3.

If the collection period is 30 days, then the October accounts receivable balance should be the last 30 days” worth of credit sales. October credit sales were $40,000, thus the accounts receivable balance would be $40,000. If the collection period is 45 days, then the balance would be October”s credit sales and half of September”s credit sales, or 40,000 + 60,000/2 = $70,000.

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39.

Suppose your colleague constructed a pro forma balance sheet and a cash budget for your company for the same time period, and the external financing required from the pro forma forecast exceeded the cash deficit estimated on the cash budget. How would you interpret this result?

This would tell you that your colleague had erred in constructing one or both of the forecasts. Using the same assumptions and avoiding accounting and arithmetic errors, estimated external financing required should equal estimated cash surplus or deficit for the same date.

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40.

Complete the following pro forma financial statements for XYZ Corporation. Use the percent-of-sales method and use long-term debt as the plug figure (balancing item). Assume the following: 20% sales growth, capital expenditures of $200 in 2018, no equity issues or repurchases in 2018, no sale or disposal of fixed assets in 2018, and a 50% dividend payout ratio. Round figures to the nearest whole dollar.

XYZ Corporation Financial Statements Actual 2017 and Pro Forma 2018

Income Statement 2017 sales

$

1,000

2018 Current assets

COGS

700

Net fixed assets

Operating expense

100

Total assets

Depreciation expense

100

EBIT

100

Interest expense

25

Pre-tax income

75

Equity

Tax

25

Total liabilities & equi

Net income

$

130 Current liabilities 20

Long-term debt

50

XYZ Corporation Financial Statements Actual 2017 and Pro Forma 2018

Income Statement 2017 sales

$

1,000

2018 $

1,200

Current assets

COGS

700

840

Net fixed assets

Operating expense

100

120

Total assets

Depreciation expense

100

130

EBIT

100

110

Current liabilities

Interest expense

25

20

Long-term debt

Pre-tax income

75

90

Equity

Tax

25

30

Total liabilities & equ

Net income

$

Notes: Net fixed assets = 500 + 200 − 130 = 570 Equity = 200 + 0.5 × 60 = 230

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Chapter 03 Test BankSummary

50

$

60

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Chapter 05 Test Bank 1.

In the steps a company takes to prepare for an IPO, the “road show” precedes the “bake-off”.

FALSE Accessibility: Keyboard Navigation Difficulty: 2 Medium Gradable: automatic

2.

The only reason why the price would fall on a corporate bond is if market interest rates increase.

FALSE Accessibility: Keyboard Navigation Difficulty: 1 Easy Gradable: automatic

3.

After issue, the market price of a fixed-rate bond can differ substantially from its par value.

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4.

Bond investors should be more concerned with real returns than with nominal returns.

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5.

Investment–grade bonds are usually defined as bonds with ratings of BBB– or higher.

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6.

Private equity firms comprise a relatively insignificant portion of the American economy.

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7.

Shelf registration is possible for both debt and equity issues.

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8.

In a strong-form efficient market, insider trading is not profitable.

TRUE Accessibility: Keyboard Navigation Difficulty: 2 Medium

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9.

Principal is exchanged in interest rate swaps but not in currency swaps.

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10.

Valuing a call option requires an accurate estimate of the future value of the underlying asset.

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11.

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2.

3.

4.

5.

Which one of the following statements is false?

Financial executives must design financial securities to meet the needs of the firm and its investors.

Financial instruments are subject to full disclosure requirements.

The design of financial instruments is greatly constrained by law and regulation.

Financial instruments are claims against a company’s cash flows and assets.

None of the options are correct.

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12.

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2.

3.

4.

Which of the following securities has a purely fixed claim against a firm’s cash flows? bonds options common stock None of the options are correct.

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13.

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2.

3.

4.

5.

Which of the following securities has a purely residual claim against a firm’s cash flows?

preferred stock callable bonds common stock non-callable bonds None of the options are correct.

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14.

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3.

4.

5.

6.

Mike just purchased a bond which pays $40 every six months in interest. The $40 interest payment is also called the coupon. par value. discount. call premium. yield.

None of the options are correct.

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15.

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3.

4.

5.

6.

A $1,000 par value bond with a fixed 10% rate of interest pays coupons semiannually. What amount will the bondholder receive on the bond’s maturity date?

$50 $100 $500 $1,000 $1,050 $1,100

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16.

Zack owns a bond that will pay him $35 each year in interest plus a $1,000 principal payment at maturity. The $1,000 principal payment is called the

1.

2.

3.

4.

5.

6.

coupon. par value. discount. yield. call premium.

None of the options are correct.

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17.

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2.

3.

4.

5.

6.

Which one of the following statements is true?

Debt instruments offer residual claims to future cash payouts.

Bonds with call provisions will have lower coupon rates than otherwise identical bonds.

Bondholders enjoy a direct voice in company decisions.

Bonds are low-risk investments that do well in inflationary periods.

Preferred shareholders are the first investors to be repaid in bankruptcy liquidation.

None of the options are correct.

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18.

Which one of the following accurately orders the rate of return on financial securities from highest to lowest over most of recorded market history (the 19282016 period)?

1.

Short-term government bills, long-term corporate bonds, long-term government bonds, common stocks Long-term corporate bonds, long-term government bonds, common stocks, shortterm government bills Common stocks, long-term government bonds, long-term corporate bonds, shortterm government bills Common stocks, long-term corporate bonds, long-term government bonds, shortterm government bills Long-term corporate bonds, common stocks, short-term government bills, longterm government bonds None of the options are correct.

2.

3.

4.

5.

6.

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19.

1.

2.

3.

4.

5.

6.

Which one of the following statements is true?

Equity securities offer fixed claims on future cash payouts.

Unlike bondholders, for their returns, shareholders rely entirely on price appreciation.

In theory, common shareholders exercise very little control over company decisions.

Historically, common shareholders have earned a risk premium as compensation for risk borne in excess of government bonds.

Preferred shareholders are the first investors to be repaid in bankruptcy liquidation.

None of the options are correct.

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20.

1.

2.

3.

4.

5.

6.

You bought a yen-denominated corporate bond at the beginning of the year for ¥100,000. The bond paid 3 percent annual interest and was trading for ¥110,000 at year-end. What holding period return, measured in yen, did you earn on the bond?

3% 7% 10% 13% 30% None of the options are correct.

The holding period return in yen was (3% × 100,000 + 10,000)/100,000 = 13%.

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21.

18.

19.

20.

21.

22.

23.

You bought a yen–denominated corporate bond at the beginning of the year for ¥100,000. The bond paid 3 percent annual interest and was trading for ¥110,000 at year-end. The exchange rate was $1 = ¥100 at the beginning of the year and $1 = ¥122 at year-end. What holding period return, measured in U.S. dollars, did you earn on the bond?

−18.03% −7.38% −5.03% 3.0% 10.0% None of the options are correct.

You paid $1,000 for the bond (¥100,000/100). At the end of the year, you had interest income and a yen bond worth a total of $926.23 (¥113,000/122). Your dollar return was ($926.23 − $1,000)/$1,000 = −7.38 percent.

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22.

You bought a yen-denominated corporate bond at the beginning of the year for ¥100,000. The bond paid 3 percent annual interest and was trading for ¥110,000 at year-end. The exchange rate was $1 = ¥100 at the beginning of the year and $1 = ¥97 at year-end. What holding period return, measured in U.S. dollars, did you earn on the bond?

3.

4.

5.

6.

7.

8.

3.09% 6.09% 13% 16.49% 30% None of the options are correct.

You paid $1,000 for the bond (¥100,000/100). At the end of the year, you had interest income and a yen bond worth a total of $1,164.95 (¥113,000/97). The U.S. dollar holding period return would be ($1,164.95 − $1,000)/$1,000 = 16.49%.

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23.

11.

12.

13.

14.

What is the holding period return for the year on a bond with a par value of $1,000 and a coupon rate of 8.5% if its price at the beginning of the year was $1,215 and its price at the end of the year was $1,020? Assume interest is paid annually.

−11.00% −10.78% −9.05% 10.50%

(85 + 1,020 − 1,215)/1,215 = −0.0905

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24.

Which of the following statements regarding junk bonds is true?

1.

2.

3.

4.

Junk Junk Junk Junk higher.

bonds bonds bonds bonds

typically offer lower yields to maturity than investment-grade bonds. have higher priority in bankruptcy than preferred stock. offer no coupon payments to investors. are typically defined as bonds with default probabilities of 25% or

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25.

Which of the following statements regarding preferred stock is true?

1.

2.

Holders of preferred stock have the same voting rights as common stockholders.

Preferred stock dividend payments are a deductible expense for corporate tax purposes.

3.

Almost all public corporations are at least partly financed with preferred stock.

4.

None of the options are correct.

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26.

1.

2.

3.

4.

What would be the carried interest (at 20%) on a private equity portfolio with an initial value of $500 million that was subsequently liquidated for $750 million? $50 million $100 million $150 million $250 million

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27.

28.

29.

Which of the following statements are true?

Underwriters help private companies access public stock markets through IPOs. Shelf registrations and private placements are examples of seasoned security issues.

III. Issue costs for debt are typically greater than issue costs for equity.

1.

Bearer bonds make it easier for investors to avoid paying taxes on interest income.

1.

2.

3.

4.

5.

6.

I and II only I and III only I, II, and IV only I, III, and IV only I, II, III, and IV None of the options are correct.

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28.

4.

5.

6.

7.

Carbon8 Corporation wants to raise $120 million in a seasoned equity offering, net of all fees. Carbon8 stock currently sells for $28.00 per share. The underwriters will require a fee of $1.25 per share, and indicate that the issue must be underpriced by 7.5%. In addition to the underwriter’s fee, the firm will incur $785,000 in legal, administrative, and other costs. How many shares must Carbon8 sell in order to raise the desired amount of capital?

4.3 4.5 4.6 4.9

million million million million

The price will be set at 7.5% below the current price, or at 0.925 × 28.00 = $25.90. The underwriters will take $1.25 per share, leaving $24.65/share for Carbon8. Carbon8 needs to earn $120,785,000 at $24.65/share, so it must sell 120.785mil/24.65 = 4.9 million shares.

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29.

1.

2.

At the end of 2016, Crane Industries, Inc.’s stock price was $30.75. A year later, it was $34.88. Per share dividends over the year were $0.55, while earnings per share were $1.33. What rate of return did the common stockholders earn in fiscal year 2017?

1.79% 4.33%

3.

4.

5.

6.

13.43% 15.22% 17.76% None of the options are correct.

Rate of return = (34.88 + 0.55 − 30.75)/30.75 = 15.22%

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30.

1.

2.

3.

4.

5.

6.

At the end of 2016, Crane Industries, Inc.’s stock price was $30.75. A year later, it was $34.88. Per share dividends over the year were $0.55, while earnings per share were $1.33. What was the dividend yield in fiscal year 2017?

1.79% 4.33% 13.43% 15.22% 17.76% None of the options are correct. Dividend yield = 0.55/30.75 = 1.79%

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31.

At the end of 2016, Crane Industries, Inc.’s stock price was $30.75. A year later, it was $34.88. Per share dividends over the year were $0.55, while earnings per share were $1.33. What was the percentage change in the share price in fiscal year 2017?

1.

2.

3.

4.

5.

6.

1.79% 4.33% 13.43% 15.22% 17.76% None of the options are correct.

Percentage change in share price = (34.88 − 30.75)/30.75 = 4.13/30.75 = 13.43%.

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32.

1.

2.

3.

4.

5.

Which of the following would allow a corporation to issue a bond at a lower coupon rate, all else equal?

The addition of a call provision to the bond The removal of protective covenants from the bond A deterioration in the corporation’s credit quality An increase in the expected inflation rate None of the options are correct.

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33.

Which of the following statements related to market efficiency tend to be supported by current evidence?

1.

2.

Markets tend to respond quickly to new information.

It is difficult for the typical investor to earn above-average returns without taking above-average risks.

III. Short-run prices are difficult to predict accurately based on public information.

1.

Markets are most likely strong-form efficient.

1.

I and III only 2.

II and IV only 3.

I and IV only 4.

I, III, and IV only 5.

I, II, and III only 6.

None of the options are correct Accessibility: Keyboard Navigation Difficulty: 2 Medium

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34.

Individuals who continually monitor the financial markets seeking mispriced securities

1.

2.

3.

4.

5.

earn excess profits over the long term. make the markets increasingly more efficient. are never able to find a security that is temporarily mispriced. are overwhelmingly successful in earning abnormal profits. are always quite successful using only historical price information as their basis of evaluation.

6.

None of the options are correct.

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35.

Which of the following are the most likely reasons for why a stock price might not react at all on the day that new information related to the stock issuer is released?

36.

Insiders knew the information prior to the announcement.

37.

Investors need time to digest the information prior to reacting.

III. The information has no bearing on the value of the firm.

1.

The information was anticipated.

1.

2.

3.

4.

5.

6.

I and II only I and III only II and III only II and IV only III and IV only None of the options are correct

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36.

1.

2.

3.

In March, with the spot price of wheat at $5.75 per bushel, Hollywood Bakery longs 100 July wheat futures contracts (5,000 bushels each) on the CBOE at a futures price of $5.90 per bushel. In June, Hollywood Bakery closes out its futures contracts when the futures price is $5.80 per bushel. What is Hollywood Bakery’s gain (or loss) on the futures contracts?

A gain of $50,000 A gain of $25,000 A loss of $25,000

4.

5.

A loss of $50,000 None of the options are correct.

Gain on futures = ($5.80 − $5.90) × 500,000 bushels = −$50,000

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37.

Which of the following variables does NOT affect the value of a stock option?

1.

2.

3.

4.

5.

The The The The The

predicted future price of the underlying stock current price of the underlying stock option’s time to maturity option’s strike price interest rate

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38.

1.

2.

3.

4.

What type of financial instrument is depicted in the position diagram shown below?

Forward sale Forward purchase Call option Put option

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39.

1.

2.

3.

4.

5.

The price of a call option tends to be lower when which of the following is higher (all else equal)?

The expected volatility of the underlying stock The price of the underlying stock The time to maturity The strike price None of the options are correct.

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40.

1.

2.

3.

4.

5.

Which of the following factors, when increased, will tend to cause the value of a put to decrease (all else equal)?

The expected volatility of the underlying stock The price of the underlying stock The time to maturity The strike price None of the options are correct.

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41.

1.

2.

3.

4.

5.

Suppose you purchase a call option on XYZ stock when the stock price is $81.

The option premium is $3, and the strike price is $85. What is your net profit on the call option if the stock price is $89 at maturity?

−$7 −$3 $1 $4 $5

The gain on the call is 89 − 85 = $4; less the option premium of $3 gives a net profit of $1.

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42.

1.

2.

3.

4.

5.

Suppose you purchase a put option on XYZ stock when the stock price is $40.

The option premium is $2, and the strike price is $39. What is your net profit on the put option if the stock price is $41 at maturity? −$2 −$1 $0 $1 $2

The put option is out of the money at maturity, so the net profit is −$2.

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43.

Principal amounts are usually exchanged

1.

2.

3.

4.

in in in in

currency swaps. interest rate swaps. both currency swaps and interest rate swaps. neither currency swaps nor interest rate swaps.

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44.

Chapter 5 presents evidence that the average annual rate of return on common stocks over many years has exceeded the return on government bonds in the United States, while returns on common stocks have also exhibited more volatility than returns on U.S. government bonds. Suppose that last year, the realized rate of return on government bonds exceeded the return on common stocks. Your colleague suggests that “last year shows us that investors are now willing to settle for lower returns on stocks than on bonds.” How would you interpret this result?

The fact that government bonds earned a higher rate of return than common stocks in one year is not evidence that investors are suddenly willing to settle for lower returns on stocks than bonds. It means that investors’ expectations were not met or, alternatively, that investors were surprised. To take on additional risk, risk-averse investors require additional expected return. But expected returns are not the same as realized returns. Because stocks and bonds are risky, their returns will fluctuate from year to year, and bonds will earn higher returns than stocks in some years. But the expected returns of common stocks should always be higher than the expected returns of government bonds.

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45.

Himmel Corp. wants to raise $100 million in a new stock issue. Its investment banker indicates that the sale of new stock will require 12 percent underpricing and a 7 percent spread.

1.

Assuming Himmel’s stock price does not change from its current price of $50 per share, how many shares must the company sell and at what price to the public?

2.

How much money will the investment banking syndicate earn on the sale?

3.

Is the 12 percent underpricing a cash flow? Is it a cost? If so, to whom?

a.Stock Price − 12% underpricing Issue price − 7% spread Net to company Desired revenue (millions) Number of shares (millions)

3.

4.

Investment bankers’ revenue = $3.08 × 2.444 million = $7.528 million.

Underpricing is not a cash flow. It is, however, an opportunity cost to current owners because it means that more shares must be sold to raise $100 million and each share will represent a smaller ownership interest in the company.

Accessibility: Keyboard Navigation Difficulty: 2 Medium Gradable: manual 46.

If the stock market in the United States is efficient, how do you explain the fact that some people make very high returns? Would it be more difficult to reconcile very high returns with efficient markets if the same people made extraordinary returns year after year?

Earning high returns in an efficient market is like winning at roulette. In any random process, there will be winners and losers, and some winners might win big. Earning consistently high returns over time is also possible in an efficient market, just like a gambler on a lucky streak might win repeatedly at roulette. The relevant question is whether the very high returns or the length of the winning streak is inconsistent with blind luck or not.

Accessibility: Keyboard Navigation Difficulty: 2 Medium Gradable: manual 47.

You believe interest rates will soon fall.

1.

Would you rather own a three-year, 6 percent coupon, fixed-rate bond or an equivalent-risk, three-year, floating-rate bond currently paying 6 percent interest?

2.

Would your answer to (a) change if you were contemplating issuing a bond rather than owning one? If so, how?

3.

Would your answer to (a) change if, as an investor, you believed interest rates would soon rise? If so, why?

1.

I would rather own a fixed-rate bond because the interest income I receive from a floating-rate bond will fall as interest rates decline. Equivalently, the market value of the fixed-rate bond will rise as rates fall, but that of the floating-rate bond will not.

(This presumes the fixed-rate bond is not callable.)

2.

My answer would change. I would rather issue a floating-rate bond now because future interest payments will fall as rates decline.

3.

My answer would change. As an investor, I would want to hold a floating-rate bond because interest income will rise as interest rates rise. Equivalently, the price of the fixed-income bond will fall as rates rise, while that of the floating-rate bond will not.

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48.

Houston Corp., an American company, has a payment of ¥500 million due to Osaka Corp. one year from today. At the prevailing spot rate of 100 ¥/$, this would cost Houston $5 million, but Houston faces the risk that the ¥/$ rate will fall in the coming year, so that it will end up paying a higher amount in dollar terms. To hedge this risk, Houston has two possible strategies. The first strategy is to buy ¥500 million forward today at a one-year forward rate of 98 ¥/$. The second strategy is to pay a premium of $100,000 for a one-year call option on ¥500 million at an exchange rate of 0.96 ¥/$.

1.

Suppose that in one year, the spot exchange rate is 95 ¥/$. What would be Houston’s net dollar cost for the payable under each strategy?

2.

Suppose that in one year, the spot exchange rate is 105 ¥/$. What would be Houston’s net dollar cost for the payable under each strategy?

3.

Which hedging strategy would you recommend to Houston Corp., if any? Why?

5.

In the first strategy, the net cost in dollars is ¥500 million/98 = $5.102 million. In the second strategy, Houston Corp. exercises its option to exchange at 96 ¥/$ for a cost of ¥500 million/96 = $5.208 million. Including the cost of the option, the net cost is $5.308 million.

6.

In the first strategy, the net cost in dollars is again ¥500 million/98 = $5.102 million. In the second strategy, Houston Corp. allows its option to expire and exchanges at the spot rate of 105 ¥/$ for a cost of ¥500 million/105 = $4.762 million.

Including the cost of the option, the net cost is $4.862 million.

7.

The first strategy allows Houston to lock in an exact cost without paying a premium up front. The second strategy requires a premium payment, but Houston retains the possibility of having a much lower net dollar cost if the dollar strengthens enough relative to the yen. The correct strategy for Houston depends on its risk tolerance, its expectations for exchange rate movements, and its cash availability.

Accessibility: Keyboard Navigation Difficulty: 3 Hard Gradable: manual 49.

ABC Corp. has an outstanding debt of $50 million on which it pays a 4 percent fixed interest rate annually. ABC just made its annual interest payment and has three years remaining until maturity. ABC wants to swap its fixed rate payments for floating rate payments. A bank offers ABC a three-year interest rate swap with annual payments in which ABC will pay LIBOR, currently at 4.2 percent, and receive a 3.8 percent fixed rate on $50 million notional principal. Suppose that LIBOR turns out to be 4.3 percent in one year, 4.4 percent in two years, and 4.5 percent in three years.

Including interest payments on ABC’s outstanding debt and payments on the swap, what will be ABC’s net interest payments for the next three years?

The table below shows ABC’s net interest payments for years 1 through 3. Negative signs indicate cash flows paid by ABC and positive signs indicate cash flows received by ABC, all in dollars.

Year

LIBOR Outstanding Fixed leg of Floating leg debt

0

4.2%

payment

swap

of

1

4.3%

-2,000,000

1,900,000

-2,

2

4.4%

-2,000,000

1,900,000

-2,

-2,000,000

1,900,000

-2,

3

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Chapter 05 Test Bank Summary Category Accessibility: Keyboard Navigation Difficulty: 1 Easy Difficulty: 2 Medium Difficulty: 3 Hard Gradable: automatic Gradable: manual