1.

Holding other factors constant, for a given change in a bonds yield to maturity, the
__________ the time to maturity, the _________ the change in the bonds price.
a.
b.
c.
d.
e.

longer; smaller.
shorter; larger.
longer; greater.
shorter; smaller.
Answers c and d are correct.

2. Shareholder wealth is typically measured as:

a.
b.
c.
d.

the number of shares outstanding times market price per share.

the total cash held by a firm.
the book value of equity.
the book value of a firms assets.

3. Assume that a firm is calculates the NPV of a proposed (independent) project. How should
the firm use this information when making the investment decision?
a. The investment should be accepted if, and only if, the NPV is exactly equal to zero.
b. The investment should be rejected if the NPV is positive (or equal to zero) and
accepted if it is negative.
c. The investment should be accepted if the NPV is positive (or equal to zero) and
rejected if it is negative.
d. The investment should be accepted if the NPV is greater than or equal to the projects
IRR.
e. The NPV is not relevant to the investment decision.

4. If the discount rate is zero

a.
b.
c.
d.

the present value of an amount will equal its future value.

the present value of an amount will be greater than its future value.
the present value of an amount will be less than its future value.
the cash flow stream must be a perpetuity.

5. Holding everything else constant, which of the following is a source of cash?

a.
b.
c.
d.

A decrease in inventories.
An increase in accounts receivable.
An increase in gross fixed assets.
A decrease in accounts payable.

6. Thames Inc.s expected dividend next year is $2.54 per share (i.e., D1 = $2.54). The dividend
is expected to grow at a rate of 6 percent per year. The risk-free rate is 5 percent and the
return on the market is 9 percent. If the companys beta is 1.3, what is the price of the stock
today?
a.
b.
c.
d.
e.

$72.14
$57.14
$40.00
$68.06
$60.47

7. In 2002 Clanton, Inc. had a gross profit of $27,000 on sales of $110,000. Clanton's operating
expenses for 2002 were $13,000, and its net profit margin was .0585. Clanton had no interest
expense in 2002. What was Clanton's gross profit margin for 2002?
a.
b.
c.
d.

0.127
0.325
0.245
0.364

8. What annual rate of interest do you need to earn in order to have saved $200,000 in 10 years
if you deposit $1,000 per month into a savings account starting one month from today?
a.
b.
c.
d.

4.81%
6.37%
9.58%
10.25%

9. Given the following probability distribution, what is the expected return and the standard
deviation of returns for Security J?
State
_____
1
2
3
a.
b.
c.
d.
e.

15%; 6.50%
12%; 5.18%
15%; 3.16%
15%; 10.00%
20%; 5.00%

Pi
____
0.2
0.6
0.2

kJ
____
10%
15
20

10. How much would you have to invest today at 9% compounded annually to have $35,000
available for the purchase of a car five years from now?
a.
b.
c.
d.
e.

$20,267.26
$22,747.60
$24,147.25
$26,370.10
$28,149.57

11. What is the IRR of an investment that costs $25,000 and pays $6,000 a year for 6 years? If
the required return is 10%, should a firm make this investment if it is an independent
project?
a.
b.
c.
d.
e.

IRR = 11.5%. The firm should only make this investment if the IRR is higher than the
IRRs of all other independent projects.
IRR = 24%. The firm should only make this investment if the IRR is higher than the
IRRs of all other independent projects.
IRR = 10%. The firm is indifferent to the project because the NPV = $0.
IRR = 11.5%. The firm should make this investment because the NPV > 0.
IRR = 24%. The firm should make this investment because the NPV > 0.

12. The _________ value of a bond is also called its face value. Bonds which sell at less than face
value are priced at a _________, while bonds which sell at greater than face value sell at a
_________.
a.
b.
c.
d.

discount; par; premium

premium; discount; par
par; discount; premium
coupon; premium; discount

13. You are interested in investing your money in a bank account. Which of the following banks
provides you with the highest effective rate of interest?
a.
b.
c.
d.
e.

Bank 1; 8 percent with monthly compounding.

Bank 2; 8 percent with annual compounding.
Bank 3; 8 percent with quarterly compounding.
Bank 4; 7.8 percent with annual compounding.
You are indifferent between Banks 1, 2, and 3. You should pick the one that is within
walking distance of your home.

14. Your company had net sales of $70,000 over the past year. During that time, average
receivables were $10,000. What was the average collection period?
a.
b.
c.
d.
e.

7 days
12 days
30 days
43 days
52 days

15. MJs Medical Supply Co. currently pays no dividends. The firm plans to begin paying
dividends 4 years from today. The first dividend will be $4.00, and it will remain at that level
forever. Given a required return of 7%, what would you pay for the stock today?
a.
b.
c.
d.
e

$36.09
$43.38
$46.64
$51.85
$57.14

16. What is the future value of a 5-year ordinary annuity with annual payments of $200, evaluated
at a 15 percent interest rate?
a.
b.
c.
d.
e.

$ 670.44
$ 842.91
$1,169.56
$1,522.64
$1,348.48

17. A major disadvantage of the payback period method is that it

a.
b.
c.
d.
e.

Is useless as a measure of risk & project liquidity.

Ignores cash flows beyond the payback period.
Does not directly account for the time value of money.
All of the answers above are disadvantages.
Only answers b and c are disadvantages.

18. Asset-specific risk is also known as

a.
b.
c.
d.
e.

total
market
systematic
diversifiable
beta

risk.

19. Procon preferred stock currently sells for $35.53. You believe that the stock will pay a
perpetual dividend of $1.76 per share and your required return is 5.5%. Should you purchase
this stock for $35.53 (and why)?
a. The stock is fairly priced because the market is in equilibrium. Thus, you are
indifferent between purchasing and not purchasing the stock.
b. You should buy the stock for $35.53 because its market value is greater than what you
think it is worth.
c. You should not purchase the stock because you think it is worth less than it currently
costs.
d. You should purchase the stock because the stock will pay you (or your heirs) an infinite
amount of money (the dividends last forever!).

20. If a 5-year ordinary annuity has a present value of $1,000, and if the interest rate is 10
percent, what is the amount of each annuity payment?
a.
b.
c.
d.
e.

$240.42
$263.80
$300.20
$315.38
$346.87

21. Assume Illogicom is operating at full capacity. Last year the firm had sales of $300 million,
and its total asset turnover ratio was 0.75. What amount of total assets would be required to
support a sales increase of 10%? Assume costs, current liabilities and assets vary directly
with sales, and that the dividend payout ratio remains unchanged.
a.
b.
c.
d.
e.

$225.0 million
$231.6 million
$246.7 million
$330.5 million
$440.0 million

22. Asset A has a required return of 10%. The expected market return is 14% and the risk-free
rate is 5%. What is asset As beta?
a.
b.
c.
d.
e.

0.33
0.55
0.67
0.88
1.15

23. Craigs Manufacturing Company is considering the purchase of a new machine for a cost of
$220,000. The new machine will have a 5-year useful life and will be depreciated to an
expected salvage value of zero using the straight-line method. The machine will allow the
firm to produce a new product, which is expected to generate new sales of $350,000 per year.
To produce these sales, the firm must incur an additional $275,000 in annual labor, materials,
and other costs. Tonys income tax rate is 34%. What is the projected operating cash flow of
the machine in each of years 1 to 5?
a.
b.
c.
d.
e.

$93,500
$74,640
$64,460
$49,500
$44,000

24. The annual coupon payment that a bond may promise is calculated as:
a.
b.
c.
d.

the coupon rate * the face value of the bond.

the yield-to-maturity * the face value of the bond.
the coupon rate * the bond price.
the yield-to-maturity * the bond price.

25. Protective covenants are typically included in a bond contract to protect

a.
b.
c.
d.

the interests of the firm's shareholders.

the jobs of company managers in highly competitive industries.
bondholders from managerial decisions that benefit only the firm's shareholders.
the IRS.

26. Protox Beta is 1.2. The risk free rate is 4.5% and the market risk premium is 3%. What is
Protox's required rate of return?
a.
b.
c.
d.

8.1%
7.9%
9.2%
9.9%

27. Which of the following is likely to increase the level of interest rates in the economy?
a.
b.
c.
d.
e.

Households start saving a larger percentage of their income.

Corporations increase their demand for capital.
Expected inflation decreases.
The government budget deficit decreases.
Answers a and c are correct.

28. The length of time required for an investment to generate cash flows sufficient to recover its
initial cost is the:
a.
b.
c.
d.
e.

time to maturity.
net present value.
internal rate of return.
payback period.
planning horizon.

29. Suppose you expect to receive $250 at the end of every month for the next 4 years. If the
discount rate is 4% (this is stated as an annual rate), what is the present value of this expected
cash flow stream?
a.
b.
c.
d.

$12,000
$11,715
$11,072
$10,443

30. Which of the following statements concerning diversification is FALSE? Assume that the
securities being considered for inclusion in a portfolio all have the same expected return
(10%) and standard deviation (15%), and that the correlations between the securities are all
less than +1, and greater than 0.
a. As more securities are added to the portfolio (holding the total investment constant),
the portfolio standard deviation decreases.
b. As more securities are added to the portfolio (holding the total investment constant),
the portfolio expected return does not change.
c. As more securities are added to the portfolio (holding the total investment constant),
the standard deviation of each security remains constant (at 15%).
d. As more securities are added to the portfolio (holding the total investment constant),
portfolio risk eventually approaches zero.
e. Both a and b are false.

31. Dizzy Corp. bonds bear a coupon rate of 12%, pay coupons semiannually, have 3 years
remaining to maturity, and are currently priced at $940 per bond. What is the yield to
maturity?
a.
b.
c.
d.
e.

12.00%
13.99%
14.54%
15.25%
15.57%

32. Which of the following statements is most correct? (Other things held constant.)
a. The "liquidity preference theory" would generally lead to an upward sloping yield
curve.
b. The "expectations theory" would generally lead to an upward sloping yield curve.
c. The yield curve under "normal" conditions should be horizontal (i.e., flat.)
d. A downward sloping yield curve would suggest that investors expect inflation to
increase in the future.

33. Frank Lewis has a 30-year, $100,000 mortgage with a fixed, nominal interest rate of 10
percent (per year) and monthly compounding. Which of the following statements regarding
his mortgage is most correct?
a. The monthly payments will decline over time.
b. The proportion of the monthly payment which represents interest will be lower for the
last payment than for the first payment on the loan (i.e., the monthly interest payment
decreases over the life of the loan).
c. The total dollar amount of principal being paid off each month gets larger as the loan
approaches maturity.
d. Statements a and c are correct.
e. Statements b and c are correct.

34. Stock A has a beta of 1.5 and Stock B has a beta of 0.5. According to the CAPM, which of
the following statements must be true about these securities?
a.
b.
c.
d.
e.

Stock A has a higher standard deviation than Stock B.

Stock B has a higher standard deviation than Stock A.
The required return on Stock A is greater than that on Stock B.
The required return on Stock B is greater than that on Stock A.
Stock A has higher operating cash flows than Stock B.

35. Comparison of the financial ratios for two firms may be difficult if:
I. The firms operate in different industries.
II. The firms use different accounting methodologies, such as FIFO and LIFO.
III. The firms financial statements are prepared using different fiscal year-ends.
a.
b.
c.
d.
e.

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

36. Which of the following statements about wealth maximization and ethical behavior is true?
a. No firm can take socially responsible actions in a competitive marketplace and expect
to make money because these actions will increase costs without creating offsetting
economic benefits.
b. A firm should offer products at a price all potential consumers can afford and should
compensate all employees with a living wage just so long as the firms shareholders
can still earn a return equal to the risk-free rate.
c. If a firm's managers want to maximize stock price, it is in their best interests to operate
efficient, low-cost plants; develop new and safe products that consumers want; and
maintain good relationships with employees, suppliers, creditors, and the communities
in which they operate.
d. Due to competitive pressures and the continuing need of firms to attract capital, most
socially beneficial (but cost-increasing) actions will have to be made mandatory by
government.

37. Bayberry $1,000 par bonds have a 4.6% coupon and come due in 7 years. Interest is paid
annually. If your required rate of return was 6.8%, what is the most you would be willing to
pay for this bond?
a.
b.
c.
d.

$1,132
$ 881
$ 982
$ 763

38. Albright Motors is expected to pay a year-end dividend of $3.00 a share (D1 = $3.00). The
stock currently sells for $30 a share. The required (and expected) rate of return on the stock
is 16 percent. If the dividend is expected to grow at a constant rate, g, what is g?
a. 13.00%
b. 10.05%
c. 6.00%
d. 5.33%
e. 7.00%

39. Which type of organization is best able to access capital markets to finance growth?
a.
b.
c.
d.

corporation.
sole proprietorship.
partnership.
all types of organization can raise capital with similar ease.

40. You deposited $1,000 in a savings account that pays 8 percent interest, compounded
quarterly, planning to use it to finish your last year in college. Eighteen months later, you
decide to go to the Rocky Mountains to become a ski instructor rather than continue in
school, so you close out your account. How much money will you receive?
a.
b.
c.
d.
e.

$1,171
$1,126
$1,082
$1,163
$1,008

41. If the expected rate of return on a stock exceeds the required rate,
a.
b.
c.
d.
e.

Managers are engaging in unethical behavior.

The stock should be sold.
The company is probably not trying to maximize its stock price.
The stock is a good buy.
Dividends are not being declared

42. Hawkball Inc. is planning to introduce a new "long-yardage" golf ball for the 2006. The
typical life cycle for a golf ball is four years. The total investment cost of the new golf ball is
$50,000. The estimated after tax cash flow is $10,000 in year one; $15,000 in year two;
$25,000 in year three; and $35,000 in year four. If the required return is 12%, what is the Net
Present Value of this project?
a.
b.
c.
d.

$12,577
$ 8,721
$10,924
$ 6,003

43. You have the opportunity to buy a perpetuity which pays $1,000 annually. Your required rate
of return on this investment is 15 percent. What is the most you should pay for this
investment?
a.
b.
c.
d.
e.

$5,000.00
$6,000.00
$6,666.67
$7,500.00
$8,728.50

44. Adams Audio is considering whether to make an investment in a new type of technology.
Which of the following factors should the company consider when it decides whether to
undertake the investment?
a. The company has already spent $3 million researching the technology.
b. The new technology will affect the cash flows produced by its other operations.
c. If the investment is not made, then the company will be able to sell one of its
laboratories for $2 million.
d. All of the factors above should be considered.
e. Factors b and c should be considered.

45. In the CAPM, the risk premium depends primarily on

a.
b.
c.
d.
e.

risk.

total
systematic
diversifiable
firm-specific
net present value

46. Assume a project has normal cash flows (i.e., the initial cash flow is negative, and all other
cash flows are positive). Which of the following statements is most correct?
a.
b.
c.
d.
e.

All else equal, the project's IRR increases as the required return declines.
All else equal, the project's NPV increases as the required return declines.
All else equal, the project's payback period increases as the required return declines.
Answers a and b are correct.
Answers b and c are correct.

47. Inflation, recession, and high interest rates are economic events which are:
a.
b.
c.
d.
e.

company-specific risks that can be diversified away.

microeconomic risks that can be diversified away.
systematic risks that can be diversified away.
macroeconomic risks that cannot be diversified away..
unsystematic risks that cannot be diversified away.

48. In words, what does a net profit margin of 10 percent mean?

a.
b.
c.
d.
e.

For each $1 of sales generated by the firm it incurs 10 cents in operating expenses.
For each $1 of sales generated by the firm it earns 10 cents in net income.
For each $1 of profits generated by the firm before taxes, it keeps 10 cents after taxes.
For each $1 of net income generated, 10 cents in sales are required.
The firm completely sells off its production level 10 times on average during the year.

49. You are going to withdraw $5,000 at the end of each year for the next four years from an
account that pays interest at a rate of 9% compounded annually. How much must there be in
the account today in order for the account balance to be zero after the last withdrawal?
a.
b.
c.
d.
e.

$14,793.83
$16,198.60
$18,602.29
$19,713.75
$20,000.00

50. Hawkball Inc. is planning to introduce a new "long-yardage" golf ball for the 2006. The
typical life cycle for a golf ball is four years. The total investment cost of the new golf ball is
$50,000. The estimated after tax cash flow is $10,000 in year one; $15,000 in year two;
$25,000 in year three; and $35,000 in year four. What is the Payback Period of this project in
months?
a.
b.
c.
d.

32 months
28 months
43 months
36 months

Answers:
1
2
3
4
5
6
7
8
9
10

e
a
c
a
a
e
c
c
c
b

11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50

d
c
a
e
c
e
e
d
c
b
e
b
c
a
c
a
b
d
c
d
c
a
e
c
e
c
b
c
a
b
d
c
c
e
b
b
d
b
b
d