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# Review Assessment: Final Exam

User Submitted Name Status Score Aaron M Courtright 2/20/10 12:09 AM Final Exam Needs Grading 215 out of 250 points

Time Elapsed 4 hours, 1 minutes, and 24 seconds out of 4 hours and 0 minutes allowed. Instructions Question 1 0 out of 5 points McCue Inc.'s bonds currently sell for \$1,100. They pay a \$90 annual coupon, have a 25-year maturity, and a \$1,000 par value, but they can be called in 5 years at \$1,050. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. What is the difference between this bond's YTM and its YTC? (Subtract the YTC from the YTM; it is possible to get a negative answer.) Selected Answer: Correct Answer: Feedback: 0.64% 0.66% If called in 5 years: 25 N = Call 5

If held to maturity:

N= Maturity Price = \$1,100 PV \$1,100 PV PMT \$90 PMT \$90 FV = Par \$1,000 FV = Call \$1,050 Price I/YR = 8.06% I/YR = 7.40% YTM YTC Difference: YTM - YTC = 0.66% Question 2 Which of the following statements is CORRECT? Selected Answer: Correct Answer: Question 3 Using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a projects forecasted NPV. Using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a projects forecasted NPV. 5 out of 5 points

0 out of 5 points A firm wants to strengthen its financial position. Which of the following actions would INCREASE its current ratio? Selected Use cash to increase inventory holdings.

Answer: Correct Answer: Question 4 Issue new stock, then use some of the proceeds to purchase additional inventory and hold the remainder as cash.

5 out of 5 points Zero Corp's total common equity at the end of last year was \$430,000 and its net income was \$70,000. What was its ROE? Selected Answer: Correct Answer: 16.28% 16.28% \$430,000 \$70,000 16.28%

## Feedback: Common equity Net income ROE = NI/Equity = Question 5

5 out of 5 points Which of the following investments would have the highest future value at the end of 10 years? Assume that the effective annual rate for all investments is the same and is greater than zero. Selected Answer: Correct Answer: Investment A pays \$250 at the beginning of every year for the next 10 years (a total of 10 payments). Investment A pays \$250 at the beginning of every year for the next 10 years (a total of 10 payments).

Feedback: A dominates B because it provides the same total amount, but it comes faster, hence it can earn more interest over the 10 years. A also dominates C and E for the same reason, and it dominates D because with D no interest whatever is earned. We could also do these calculations to answer the question: A \$4,382.79 Largest EFF% 10.00% 10 250 B \$4,081.59 NOM% 9.76% 125 C \$4,280.81 125 D \$2,500.00 2500 E \$3,984.36 250 Question 6 Which of the following is a primary market transaction? Selected Answer: Correct Answer: Question 7 Which of the following statements is CORRECT? Selected Answer: Correct Answer: A good example of a sunk cost is money that a banking corporation spent last year to investigate the site for a new office, then expensed that cost for tax purposes, and now is deciding whether to go forward with the project. A good example of a sunk cost is money that a banking corporation spent last year to investigate the site for a new office, then expensed that cost for tax purposes, and now is deciding whether to go forward with the project. IBM issues 2,000,000 shares of new stock and sells them to the public through an investment banker. IBM issues 2,000,000 shares of new stock and sells them to the public through an investment banker. 5 out of 5 points 5 out of 5 points

Question 8

5 out of 5 points Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows. Selected Answer: Correct Answer: To find a projects IRR, we must solve for the discount rate that causes the PV of the inflows to equal the PV of the projects costs. To find a projects IRR, we must solve for the discount rate that causes the PV of the inflows to equal the PV of the projects costs. 0 out of 5 points Which of the following statements is CORRECT? Selected Answer: Correct Answer: The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price. The optimal capital structure simultaneously maximizes the stock price and minimizes the WACC. 5 out of 5 points Which of the following statements is CORRECT? Selected Answer: Correct Answer: Increasing a company's debt ratio will typically increase the marginal costs of both debt and equity financing. However, this action still may lower the company's WACC. Increasing a company's debt ratio will typically increase the marginal costs of both debt and equity financing. However, this action still may lower the company's WACC.

Question 9

Question 10

Question 11

5 out of 5 points To help finance a major expansion, Castro Chemical Company sold a noncallable bond several years ago that now has 20 years to maturity. This bond has a 9.25% annual coupon, paid semiannually, sells at a price of \$875, and has a par value of \$1,000. If the firm's tax rate is 40%, what is the component cost of debt for use in the WACC calculation? Selected Answer: Correct Answer: 6.47% 6.47% 9.25% 2 20 \$875.00 \$1,000 40%

Feedback: Coupon rate Periods/year Maturity (yr) Bond price Par value Tax rate Calculator inputs: N = 2 x 20 PV = Bond's price

40 \$875.00 PMT = Coupon rate Par / 2 \$46.25 FV = Par = Maturity value \$1,000 Calculator output: I/YR, semiannual rate 5.39% Annual rate = 2 (I/YR) = Before-tax cost of debt 10.79% = After-tax cost (A-T rd) for use in WACC 6.47%

Question 12

5 out of 5 points

Suppose the yield on a 10-year T-bond is currently 5.05% and that on a 10-year Treasury Inflation Protected Security (TIPS) is 2.85%. Suppose further that the MRP on a 10-year Tbond is 0.90%, that no MRP is required on a TIPS, and that no liquidity premium is required on any T-bond. Given this information, what is the expected rate of inflation over the next 10 years? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. Selected Answer: Correct Answer: 1.30% 1.30% 5.05% 2.85% 0.90% 1.30%

Feedback: 10-year T-bond yield 10-year TIPS yield = r* MRP, 10-year Tbond only Expected inflation = rT10 r* - MRP Question 13

0 out of 5 points Harry's Inc. is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that if a project's projected NPV is negative, it should be rejected. WACC: 14.75% Year 0 Cash flows -\$1,000 Selected Answer: Correct Answer: Feedback:

2 \$300

3 \$300

4 \$300

5 \$300

## WACC: 14.75% Year 0 1 Cash -\$1,000 \$300 flows NPV = \$11.63

2 \$300

3 \$300

4 \$300

5 \$300

Question 14

5 out of 5 points Which of the following statements is CORRECT, assuming stocks are in equilibrium? Selected Answer: Correct Answer: The dividend yield on a constant growth stock must equal its expected total return minus its expected capital gains yield. The dividend yield on a constant growth stock must equal its expected total return minus its expected capital gains yield.

Question 15

5 out of 5 points You have the following data on three stocks shown below. You decide to use the data on these stocks to form an index, and you want to find the average earned rate of return for 2008 on your index. If you follow the averaging procedure used to calculate the S&P 500 Index return, what would your index's rate of return be? Hints: Rates of return are based on beginning-of-year prices, and the S&P Index is weighted by market values of the companies in the index.

Stock A B C

## Dividend \$ 1.50 \$ 2.00 \$ 0.75

Beginning Price Ending Price \$ 30.00 \$ 28.50 \$ 20.00 \$ 32.00 \$ 27.00 \$ 24.00

## Shares Outstanding (millions) 5.00 4.50 19.50

16.82 % 16.82 % Ending Price \$ 32.00 \$ 27.00 \$ 24.00 Change Shares Total Outstanding Market (millions) Value \$ 2.00 5.00 \$ 150.00 - \$ 1.50 4.50 \$ 128.25 \$ 4.00 19.50 \$ 390.00 \$ 668.25 Weight

Stock Dividend Beginning Price A B C \$ 1.50 \$ 2.00 \$ 0.75 \$ 30.00 \$ 28.50 \$ 20.00

## 22.45% 19.19% 58.36% 100.00%

Stock Div Yield Cap Gain Total Weight Weighted Return Yield Return A 5.00 % 6.67 % 11.67 % 0.2245 0.0262 B 7.02 % -5.26 % 1.75 % 0.1919 0.0034 C 3.75 % 20.00 % 23.75 % 0.5836 0.1386 0.1682 Index return = 16.82% Question 16 5 out of 5 points As a member of UA Corporation's financial staff, you must estimate the Year 1 cash flow for a proposed project with the following data. What is the Year 1 cash flow? Sales revenues, each year \$40,500 Depreciation \$10,000 Other operating costs \$17,000 Interest expense \$4,000 Tax rate 35.0% Selected Answer: Correct Answer: \$18,775 \$18,775

Feedback: Sales revenues \$40,500 17,000 Operating costs (excl. depr.) Depreciation 10,000 Operating \$13,500 income (EBIT) 35% 4,725 Taxes rate = After-tax EBIT \$8,775 + 10,000 Depreciation Cash flow, \$18,775

Year 1 Question 17 5 out of 5 points Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 6.80%. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. Selected Answer: Correct Answer: 10.30% 10.30%

Feedback: Real 3.50% riskfree rate, r* Inflation 6.80% Yield 10.30% on 1year Tbond Question 18 5 out of 5 points A 10-year corporate bond has an annual coupon of 9%. The bond is currently selling at par (\$1,000). Which of the following statements is CORRECT? Selected Answer: Correct Answer: Question 19 The bonds expected capital gains yield is zero. The bonds expected capital gains yield is zero.

5 out of 5 points Suppose you have \$1,425 and plan to purchase a 5-year certificate of deposit (CD) that pays 3.5% interest, compounded annually. How much will you have when the CD matures? Selected Answer: Correct Answer: \$1,692.45 \$1,692.45

Feedback: N 5 I/YR 3.5% \$1,425 PV PMT \$0 FV \$1,692.45 Question 20 5 out of 5 points Your company, CSUS Inc., is considering a new project whose data are shown below. The required equipment has a 3-year tax life, and the accelerated rates for such property are 33%, 45%, 15%, and 7% for Years 1 through 4. Revenues and other operating costs are expected to be constant over the project's 10-year expected operating life. What is the project's Year 4 cash flow? Equipment cost (depreciable basis) \$70,000 Sales revenues, each year \$41,000 Operating costs (excl. depr.) \$25,000 Tax rate 35.0% Selected Answer: \$12,115

## \$12,115 \$70,000 7.0% \$41,000 25,000

Feedback: Equipment cost Depreciation rate, Year 4 Sales revenues Operating costs (excl. depr.)

4,900 Depreciation Operating \$11,100 income (EBIT) rate 35% 3,885 Taxes = After-tax EBIT \$7,215 + 4,900 Depreciation Cash flow, \$12,115 Year 4 Question 21 5 out of 5 points Southwest U's campus book store sells course packs for \$15 each, the variable cost per pack is \$9, fixed costs to produce the packs are \$200,000, and expected annual sales are 49,000 packs. What are the pre-tax profits from sales of course packs? Selected Answer: Correct Answer: \$94,000 \$94,000

Feedback: Sales price per unit (P) \$15.00 Variable costs per unit \$9.00 (V) 49,000 Annual sales (Q) Fixed costs (F) \$200,000 Profit = PQ VQ F = EBIT = \$735,000 - \$441,000 - \$200,000 = \$94,000 Question 22 5 out of 5 points Bill Dukes has \$100,000 invested in a 2-stock portfolio. \$75,000 is invested in Stock X and the remainder is invested in Stock Y. X's beta is 1.50 and Y's beta is 0.70. What is the portfolio's beta? Selected Answer: Correct Answer: 1.30 1.30

Feedback: CompanyInvestmentWeightBetaWeight x beta \$75,000 0.75 1.50 1.13 X Y \$25,000 0.25 0.70 0.18 1.30* \$100,000 1.00 * Portfolio beta Question 23 Which of the following statements is CORRECT? 5 out of 5 points

The balance sheet gives us a picture of the firms financial position at a point in time. The balance sheet gives us a picture of the firms financial position at a point in time.

5 out of 5 points Other things held constant, which of the following actions would increase the amount of cash on a companys balance sheet? Selected Answer: Correct Answer: The company issues new common stock. The company issues new common stock. 5 out of 5 points Which of the following statements is CORRECT? Selected Answer: Correct Answer: The regular payback is useful as an indicator of a projects liquidity because it gives managers an idea of how long it will take to recover the funds invested in a project. The regular payback is useful as an indicator of a projects liquidity because it gives managers an idea of how long it will take to recover the funds invested in a project.

Question 25

Feedback: Statement d is true. The payback does indicate how long it should take to recover the investment; hence, it is a measure of liquidity. Question 26 5 out of 5 points A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter? Selected Answer: Correct Answer: Stock B. Stock B.

Feedback: With only 4 stocks in the portfolio, unsystematic risk matters, and B has less. Question 27 5 out of 5 points In Japan, 90-day securities have a 4% annualized return and 180-day securities have a 5% annualized return. In the United States, 90-day securities have a 4% annualized return and 180-day securities have an annualized return of 4.5%. All securities are of equal risk, and Japanese securities are denominated in terms of the Japanese yen. Assuming that interest rate parity holds in all markets, which of the following statements is most CORRECT? Selected Answer: Correct Answer: Question 28 Which of the following statements is CORRECT? The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market. 5 out of 5 points

As they are generally defined, money market transactions involve debt securities with maturities of less than one year. As they are generally defined, money market transactions involve debt securities with maturities of less than one year.

5 out of 5 points Schalheim Sisters Inc. has always paid out all of its earnings as dividends, hence the firm has no retained earnings. This same situation is expected to persist in the future. The company uses the CAPM to calculate its cost of equity, its target capital structure consists of common stock, preferred stock, and debt. Which of the following events would REDUCE its WACC? Selected Answer: Correct Answer: The market risk premium declines. The market risk premium declines.

Question 30

0 out of 5 points Assume that inflation is expected to decline steadily in the future, but that the real risk-free rate, r*, will remain constant. Which of the following statements is CORRECT, other things held constant? Selected Answer: Correct Answer: The expectations theory cannot hold if inflation is decreasing. If the pure expectations theory holds, the Treasury yield curve must be downward sloping.

Question 31

5 out of 5 points Royce Corp's sales last year were \$260,000, and its net income was \$23,000. What was its profit margin? Selected Answer: Correct Answer: 8.85% 8.85% \$260,000 \$23,000 8.85%

## Feedback: Sales Net income Profit margin = NI/Sales = Question 32

5 out of 5 points Ryngaert Inc. recently issued noncallable bonds that mature in 15 years. They have a par value of \$1,000 and an annual coupon of 5.7%. If the current market interest rate is 9.7%, at what price should the bonds sell? Selected Answer: Correct Answer: \$690.48 \$690.48

Feedback: Coupon 5.70% rate PMT \$57.00 N 15 9.70% I/YR FV \$1,000 PV \$690.48 Question 33 0 out of 5 points

Companies can issue different classes of common stock. Which of the following statements concerning stock classes is CORRECT? Selected Answer: Correct Answer: Question 34 Which of the following statements is CORRECT? Selected Answer: Correct Answer: Question 35 Which of the following statements is CORRECT? Selected Answer: Correct Answer: Question 36 A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure. A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure. If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping. If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping. 5 out of 5 points All common stocks, regardless of class, must have the same voting rights. Some class or classes of common stock are entitled to more votes per share than other classes. 5 out of 5 points

5 out of 5 points If a typical U.S. company correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely Selected Answer: Correct Answer: become more risky and also have an increasing WACC. Its intrinsic value will not be maximized. become more risky and also have an increasing WACC. Its intrinsic value will not be maximized.

Question 37

5 out of 5 points Dothan Inc.'s stock has a 25% chance of producing a 17% return, a 50% chance of producing a 12% return, and a 25% chance of producing a -18% return. What is the firm's expected rate of return? Selected Answer: Correct Answer: 5.75% 5.75%

Feedback: ConditionsProb.Return Prob. x Return Good 0.25 17.0% 4.25% Average 0.50 12.0% 6.00% Poor 0.25 - -4.50% 18.0% 5.75%* 1.00 * Expected return

Question 38

5 out of 5 points Ten years ago, Lucas Inc. earned \$0.50 per share. Its earnings this year were \$6.20. What was the growth rate in earnings per share (EPS) over the 10-year period? Selected Answer: Correct Answer: 28.63% 28.63%

Feedback: N 10 PV \$0.50 PMT \$0 \$6.20 FV I/YR 28.63% Question 39 5 out of 5 points Warnock Inc. is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's projected NPV can be negative, in which case it will be rejected. WACC: 10.00% Year 0 1 2 3 Cash flows -\$825 \$500 \$400 \$300 Selected Answer: Correct Answer: \$185.52 \$185.52

Feedback: WACC: 10.00% Year 0 1 2 3 Cash -\$825 \$500 \$400 \$300 flows NPV = \$185.52 Question 40 5 out of 5 points You are considering two bonds. Bond A has a 9% annual coupon while Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity, and the YTM is expected to remain constant. Which of the following statements is CORRECT Selected Answer: Correct Answer: Question 41 Multinational financial management requires that Selected Answer: Correct Answer: Question 42 The effects of changing currency values be included in financial analyses. The effects of changing currency values be included in financial analyses. The price of Bond A will decrease over time, but the price of Bond B will increase over time. The price of Bond A will decrease over time, but the price of Bond B will increase over time. 5 out of 5 points

5 out of 5 points You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would lower the calculated value of the investment?

The discount rate increases. The discount rate increases. 5 out of 5 points

Which of the following statements is CORRECT? Selected Answer: Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of -0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period. Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of -0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period.

Question 44

5 out of 5 points Confu Inc. expects to have the following data during the coming year. What is the firm's expected ROE? Assets Debt/Assets, book value EBIT Selected Answer: Correct Answer: Feedback: Assets D/A EBIT Interest rate Tax rate Debt = (D/A) A Equity = Assets Debt 17.06% 17.06% \$165,000 65% \$25,000 8% 40% \$107,250 \$57,750 EBIT \$25,000 8,580 \$165,000 65% \$25,000 Interest rate Tax rate 8% 40%

-Interest = rate debt = Earnings before taxes \$16,420 -Taxes 6,568 Net income \$9,852 NI / Equity = ROE = 17.06%

Question 45

5 out of 5 points Brown Office Supplies recently reported \$18,500 of sales, \$8,250 of operating costs other than depreciation, and \$1,750 of depreciation. It had \$9,000 of bonds outstanding that carry a 7.0% interest rate, and its federal-plus-state income tax rate was 40%. How much was the firm's earnings before taxes (EBT)? Selected Answer: Correct Answer: \$7,870 \$7,870

Feedback: Bonds \$9,000.00 Interest rate 7.00% \$18,500.00 Sales Operating costs \$8,250.00 excluding depr'n

Depreciation \$1,750.00 Operating \$8,500.00 income (EBIT) Interest charges -\$630.00 EBT = Taxable income \$7,870 Question 46 Which of the following statements is NOT CORRECT? Selected Answer: Correct Answer: Question 47 "Going public" establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares. "Going public" establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares. 5 out of 5 points

5 out of 5 points Your corporation has the following cash flows: If the applicable income tax rate is 40% (federal and state combined), and if 70% of dividends received are exempt from taxes, what is the corporation's tax liability? Operating income Interest received Interest paid Dividends received Dividends paid Selected Answer: Correct Answer: \$87,800 \$87,800 \$250,000 \$10,000 \$45,000 \$15,000 \$50,000

Feedback: Operating income \$250,000 Interest received \$10,000 Interest paid \$45,000 \$15,000 Dividends received Divdend exclusion % 70% Dividends paid \$50,000 Tax rate (T) 40% Taxable income = Oper. income + Interest received Interest paid + Taxable dividends received Taxable income = Oper. income + Interest received Interest paid + dividends received (1 Div exclusion %) Taxable income = \$219,500 Taxes paid = Taxable income Tax rate Taxes paid = \$87,800 Question 48 If D = \$1.25, g (which is constant) = 4.7%, and P dividend yield for the coming year? Selected Answer: Correct Answer: Feedback: D1 g P0 5.30% 4.31% \$1.25 4.7% \$29.00 0 out of 5 points = \$29.00, what is the stocks expected

Dividend yield = D1/P0 = 4.31% Question 49 5 out of 5 points The Francis Company is expected to pay a dividend of D = \$1.25 per share at the end of the year, and that dividend is expected to grow at a constant rate of 6.00% per year in the future. The company's beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is 4.00%. What is the company's current stock price? Selected Answer: Correct Answer: Feedback: D1 \$1.25 1.20 b rRF 4.00% RPM5.50% g 6.00% rs = rRF + b(RPM) = 10.60% P0 = D1/(rs - g) Question 50 \$27.17 \$27.17 \$27.17

5 out of 5 points Scanlon Inc.'s CFO hired you as a consultant to help her estimate the cost of capital. You have been provided with the following data: rRF = 4.10%; RPM = 5.25%; and b = 1.15. Based on the CAPM approach, what is the cost of equity from retained earnings? Selected Answer: Correct Answer: Feedback: rRF 4.10% RPM5.25% 1.15 b rs = rRF + (RPM b) 10.138% 10.14% 10.14%