Starting to invest early for retirement increases the benefits of compound interest.
Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?
A. Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit.
B. The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity.
C. If an investment pays 10% interest, compounded annually, its effective annual rate will be less than 10%.
D. A bank loan’s nominal interest rate will always be equal to or less than its effective annual rate.
E. A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage.
If a firm raises capital by selling new bonds, it is called the “issuing firm,” and the coupon rate is generally set equal to the required rate on bonds of equal risk.
Which of the following statements is CORRECT?
A. An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank’s other offices to increase.
B. An externality is a situation where a project would have an adverse effect on some other part of the firm’s overall operations. If the project would have a favorable effect on other operations, then this is not an externality.
C. Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified. However, the payback method does not.
D. The NPV method automatically deals correctly with externalities, even if the externalities are not specifically identified, but the IRR method does not. This is another reason to favor the NPV.
E. Identifying an externality can never lead to an increase in the calculated NPV.
Amram Company’s current ratio is 1.9. Considered alone, which of the following actions would reduce the company’s current ratio?
A. Borrow using short-term notes payable and use the proceeds to reduce accruals.
B. Use cash to reduce short-term notes payable.
C. Use cash to reduce accounts payable.
D. Use cash to reduce accruals.
E. Borrow using short-term notes payable and use the proceeds to reduce long-term debt.
An option is a contract that gives its holder the right to buy or sell an asset at a predetermined price within a specified period of time.
As a firm’s sales grow, its current assets also tend to increase. For instance, as sales increase, the firm’s inventories generally increase, and purchases of inventories result in more accounts payable. Thus, spontaneous liabilities that reduce AFN arise from transactions brought on by sales increases.
The cash flows associated with common stock are more difficult to estimate than those related to bonds because stock has a residual claim against the company versus a contractual obligation for a bond.
Which of the following statements is most CORRECT?
A. The coupon rate on convertible debt is normally set below the coupon rate that would be set on otherwise similar straight debt even though investing in convertibles is more risky than investing in straight debt.
B. One important difference between warrants and convertibles is that convertibles bring in additional funds when they are converted, but exercising warrants does not bring in any additional funds.
C. Warrants have an option feature but convertibles do not.
D. Warrants can sometimes be detached and traded separately from the debt with which they were issued, but this is unusual.
E. The value of a warrant to buy a safe, stable stock should exceed the value of a warrant to buy a risky, volatile stock, other things held constant.
The “preferred” feature of preferred stock means that it normally will provide a higher expected return than will common stock.
If a firm’s goal is to maximize its earnings per share, this is the best way to maximize the price of the common stock and thus shareholders’ wealth.
If an investment project would make use of land which the firm currently owns, the project should be charged with the opportunity cost of the land.
Which of the following could explain why a business might choose to operate as a corporation rather than as a sole proprietorship or a partnership?
A. Corporate shareholders escape liability for the firm’s debts, but this factor may be offset by the tax disadvantages of the corporate form of organization.
B. Less of a corporation’s income is generally subjected to taxes than would be true if the firm were a partnership.
C. Corporations generally find it relatively difficult to raise large amounts of capital.
D. Corporate investors are exposed to unlimited liability.
E. Corporations generally face relatively few regulations.
Which of the following statements is CORRECT?
A. A portfolio with a large number of randomly selected stocks would have less market risk than a single stock that has a beta of 0.5.
B. If a stock has a negative beta, its expected return must be negative.
C. If the returns on two stocks are perfectly positively correlated (i.e., the correlation coefficient is +1.0) and these stocks have identical standard deviations, an equally weighted portfolio of the two stocks will have a standard deviation that is less than that of the individual stocks.
D. According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns.
E. A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock’s beta was correctly calculated and is stable.
A firm’s AFN must come from external sources. Typical sources include short-term bank loans, long-term bonds, preferred stock, and common stock.
To finance the construction of a new plant, Pietersen Corporation must raise an additional $10,000,000 of equity capital through the sale of common stock. The firm currently has an EPS of $5.40 and a P/E ratio of 10, with 1,200,000 shares outstanding. If the firm wants its ex-rights price to be $50, what subscription price must it set on the new shares?
A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate of return is rs = 10.5%, and the expected constant growth rate is g = 6.4%. What is the stock’s current price?
The cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt.
If the current price of a stock is below the strike price, then an option to buy the stock is worthless and will have a zero value.
Which of the following statements is CORRECT?
A. Dividends do not show up in the statement of cash flows because dividends are considered to be a financing activity, not an operating activity.
B. In the statement of cash flows, a decrease in inventories is reported as a use of cash.
C. In the statement of cash flows, a decrease in accounts receivable is reported as a use of cash.
D. In the statement of cash flows, a decrease in accounts payable is reported as a use of cash.
E. In the statement of cash flows, depreciation charges are reported as a use of cash.
“Capital” is sometimes defined as funds supplied to a firm by investors.
Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.
The annual report contains four basic financial statements: the income statement, balance sheet, statement of cash flows, and statement of stockholders’ equity.
Two important issues in corporate governance are (1) the rules that cover the board’s ability to fire the CEO and (2) the rules that cover the CEO’s ability to remove members of the board.
Which of the following statements is CORRECT?
A. If a coupon bond is selling at par, its current yield equals its yield to maturity.
B. If interest rates increase, the price of a 10-year coupon bond will decline by a greater percentage than the price of a 10-year zero coupon bond.
C. If a bond’s yield to maturity exceeds its annual coupon, then the bond will trade at a premium.
D. If a coupon bond is selling at a premium, its current yield equals its yield to maturity.
E. If a coupon bond is selling at a discount, its price will continue to decline until it reaches its par value at maturity.
The owner of a convertible bond owns, in effect, both a bond and a call option.
On the balance sheet, total assets must always equal total liabilities and equity.
The optimal distribution policy strikes that balance between current dividends and capital gains that maximizes the firm’s stock price.
A proxy is a document giving one party the authority to act for another party, including the power to vote shares of common stock. Proxies can be important tools relating to control of firms.
The common stock of Southern Airlines currently sells for $33, and its 8% convertible debentures (issued at par, or $1,000) sell for $850. Each debenture can be converted into 25 shares of common stock at any time before 2025. What is the conversion value of the bond?
Taylor Inc. estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and C) should the company accept?
A. All of the projects should be accepted.
B. None of the projects should be accepted.
C. Project A, which is of average risk and has a return of 9%.
D. Project B, which is of below-average risk and has a return of 8.5%.
E. Project C, which is of above-average risk and has a return of 11%.
A firm should never accept a project if its acceptance would lead to an increase in the firm’s cost of capital (its WACC).
Time lines can be constructed in situations where some of the cash flows occur annually but others occur quarterly.
ESOPs were originally designed to help improve worker productivity, but today they are also used to help prevent hostile takeovers.
Many leases written today combine the features of operating and financial leases. Such leases are often called “combination leases.”
Operating leases help to shift the risk of obsolescence from the user to the lessor.
The form of organization for a business is not an important issue, as this decision has very little effect on the income and wealth of the firm’s owners.
A warrant is an option, and as such it cannot be used as a “sweetener.”
Projects S and L are equally risky, mutually exclusive, and have normal cash flows. Project S has an IRR of 15%, while Project L’s IRR is 12%. The two projects have the same NPV when the WACC is 7%. Which of the following statements is CORRECT?
A. If the WACC is 10%, both projects will have positive NPVs.
B. Project S’s NPV is more sensitive to changes in WACC than Project L’s.
C. If the WACC is 10%, both projects will have a negative NPV.
D. If the WACC is 6%, Project S will have the higher NPV.
E. If the WACC is 13%, Project S will have the lower NPV.
High current and quick ratios always indicate that a firm is managing its liquidity position well.
Other things held constant, an increase in the cost of capital will result in a decrease in a project’s IRR.
The desire for floating-rate bonds, and consequently their increased usage, arose out of the experience of the early 1980s, when inflation pushed interest rates up to very high levels and thus caused sharp declines in the prices of outstanding bonds.
Convertible debentures for Kulik Corporation were issued at their $1,000 par value in 2012. At any time prior to maturity on February 1, 2032, a debenture holder can exchange a bond for 25 shares of common stock. What is the conversion price, Pc?
BLW Corporation is considering the terms to be set on the options it plans to issue to its executives. Which of the following actions would decrease the value of the options, other things held constant?
A. BLW’s stock price becomes more risky (higher variance).
B. The exercise price of the option is increased.
C. The Federal Reserve takes actions that increase the risk-free rate.
D. The life of the option is increased, i.e., the time until it expires is lengthened.
E. BLW’s stock price suddenly increases.
In the lease versus buy decision, leasing is often preferable
A. because lease obligations do not affect the firm’s risk as seen by investors.
B. because it has no effect on the firm’s ability to borrow to make other investments.
C. because the lessee owns the property at the end of the least term.
D. because, generally, no down payment is required, and there are no indirect interest costs.
E. because the lessee may have greater flexibility in abandoning the project in which the leased property is used than if the lessee bought and owned the asset.
Because of improvements in forecasting techniques, estimating the cash flows associated with a project has become the easiest step in the capital budgeting process.
Ratio analysis involves analyzing financial statements in order to appraise a firm’s financial position and strength.
The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.
Heavy use of off-balance sheet lease financing will tend to
A. affect a company’s cash flows but not its degree of risk.
B. make a company appear more risky than it actually is because its stated debt ratio will be increased.
C. have no effect on either cash flows or risk because the cash flows are already reflected in the income statement.
D. make a company appear less risky than it actually is because its stated debt ratio will appear lower.
E. affect the lessee’s cash flows but only due to tax effects.
The term “additional funds needed (AFN)” is generally defined as follows:
A. The amount of assets required per dollar of sales.
B. The amount of internally generated cash in a given year minus the amount of cash needed to ac quire the new assets needed to support growth.
C. Funds that a firm must raise externally from non-spontaneous sources, i.e., by borrowing or by selling new stock to support operations.
D. Funds that are obtained automatically from routine business transactions.
E. A forecasting approach in which the forecasted percentage of sales for each balance sheet account is held constant.
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