Practice Final

1. Mr. Dubofsky just won a Name That Tune contest with a grand prize of
$250,000. However, the contest stipulates that the winner will receive $100,000
immediately, and $15,000 at the end of each of the next 10 years. Assuming that
he can earn 5% on his money, how much has he actually won? PV = 215,826.02
2. Suppose a firm had equity of $12,000 at the beginning of the year. Net income
for the year was a loss of $200, dividends paid totaled $400, and the firm raised
$1,000 from the sale of new equity. What is the year-end equity value?
12,000+1,000-200-400=12,400
3. Which of the following is/are considered a benefit of the corporate form of
organization?
I. Ease of the transfer of ownership
II. Limited life
III. Double taxation
Answer (I)
4. What is the effective annual rate of 12% compounded monthly? 12.68%
5. What is the cost of equity for a firm for which the required return on assets (RA) is
14%, the cost of debt is 11%, and a target debt/equity ratio of .50? Ignore taxes.
RE=0.14+.5(.14-.11)=15.5%
6. BDJ, Inc. has 31,000 shares of stock outstanding with a market price of $15 per
share. If net income for the year is $155,000 and the dividend per share is $2.00,
what is the retention ratio for BDJ, Inc.? 93,000/155,000=60%
7. You are considering an investment with the following cash flows. Your required
return is 10%, you require a payback of 3 years and a discounted payback of 4
years. If your objective is to maximize your wealth, should you take this
investment? No NPV is negative. IRR=6.88%, Payback = 2.5years, Discounted
payback = 3.02years.
Year Cash Flow
0 -$100,000
1 40,000
2 40,000
3 40,000
4 40,000
5 -50,000
8. ToysRYou plans to raise $8 million in a rights offering. If management sets the
subscription price at $2 and the current market price is $2.50, how many shares
need to be sold in the rights offering? 8,000,000/2=4,000,000
9. A firms stock has a required return of 10%. The stocks dividend yield is 6%.
What is the dividend the firm just paid if the current stock price is $40?
D/P=6%; D=2.4
10. KCE Corporation is currently operating at its target capital structure with market
values of $110,000,000 in equity and $175,000,000 in debt outstanding. KCE
plans to finance a new $32 million project using the same relative weights of debt
and equity. Ignoring flotation costs, how much new debt must be issued to fund
the project? 175/(110+175)=.614 debt*32 million = 19,649,123
11. IBM announces that earnings per share for the current quarter are $1.25; this
figure is barely half of what investors and analysts expected. In an efficient
market, the price of IBM stock will (a)
a. Change immediately to reflect changes in investor expectations
b. Gradually fall over several days as investors assimilate the new
information
c. First fall, reflecting investors surprise; then rise back somewhat
as investors assimilate the new information
d. Probably not change at all
e. Fall only if there is additional unfavorable news about IBM
announced at the same time
12. If the underwriter wishes to have the option to make additional profits if an IPO is
oversubscribed, they may ask that the underwriting contract contain a _________.
Green shoe option
Use the following information to answer the questions below. Suppose you purchase
100 shares at a price of $45 per share. One period later, the shares are selling for $47
per share. In addition, a dividend of $4 per share is paid at the end of the period.
13. What is the percentage return on the investment? (47-45+4)/45=13.3%
14. What is the capital gains yield? (47-45)/45=4.44%
15. If a firm is allowed to miss a payment on a bond in a year in which it reports an
operating loss, the bond is likely a/an _________ bond. Income bond.
16. Your firm sells a machine it purchased two years ago. The selling price was
approximately 50% less than the book value of the machine. As a result of this
transaction, your firm has a tax benefit in the amount of the tax rate multiplied by
a. The difference between the selling price and the original
purchase price.
b. The difference between the original purchase price and the book
value.
c. The difference between the selling price and the current market
value.
d. The difference between the selling price and the book value.
e. The difference between the original purchase price and the
current market value.
17. You have a portfolio consisting of equal amounts of IBM stock and Treasury bills.
If you replace half of the Treasury bills with more shares of IBM stock, the
variance of the expected portfolio returns will ____________, all else equal.
increase
18. Treasury bills currently have a return of 3.5% and the market risk premium is 8%.
If a firm has a beta of 1.6, what is its cost of equity? RE=3.5+1.6(8)=16.3%
19. When choosing a capital structure, the objective of the firm should be to
a. Choose the one that maximizes the current value of the firms
bonds.
b. Choose the one that minimizes the value of the firm.
c. Choose the one that minimizes the firms WACC.
d. Choose the one that results in the largest interest tax shield.
 e. Choose any capital structure since capital structure is always
irrelevant.
20. What is the accounting break-even? Price = $100 per unit; variable cost = $24 per
unit; fixed cots = $40,000 per year; depreciation = $10,000 per year. Assume a
discount rate of 10%, project initial outlay of $100,000, project life of 10 years,
and ignore taxes. Q=(40,000+10,000)/(100-24)=1,842.11
21. A firm has an ROA of 7%, sales of $100, and total assets of $75. What is its
profit margin? ROA=NI/TA=.07; NI=5.25, PM=5.25/100=5.25%
22. An increase in the financial leverage of a firm as a result of an increase in
outstanding debt _____________the potential reward to stockholders while
______________the risk of financial distress or bankruptcy. Increases, increasing
23. Given the following information and assuming straight-line depreciation to zero,
what is the NPV of this project? Initial investment = $400,000; life = 5 years;
cost savings = $150,000 per year; salvage = $30,000 in year 5; tax rate = 34%;
discount rate = 14%. OCF=(150,000)(1-.34)+80,000(.34)=126,200;
CV(SV)=30,000-(30,000-0)(.34)=19,800; NPV = 43,538.32
24. A cash payment to shareholders that is truly unusual and wont be repeated is
called __________________. Special Dividend
25. A project that has an IRR equal to _____ just breaks even on a financial basis.
The required return, the cost of capital.
26. TGIF Sportswear is considering expanding its T-shirt line. The project would last
3 years and have an initial investment of $200,000. The after-tax cash flows are
estimated at $60,000 for year one, $120,000 for year 2, and $135,000 for year 3.
The firm has a target debt-to-equity ratio of 1.2. The project cost of equity is 14%
and its cost of debt is 9%. The tax rate is 34%. What is the NPV of this project?
D/E=1.2=6/5; D/V=6/11;E/V=5/11; WACC=(5/11)(14)+(6/11)(9)(1-.34)=9.6%
27. Suppose you have a portfolio comprised of two securities. You have 40 shares of
the first security, at a price of $15 per share, and 200 shares of the second security
at a cost of $2 per share. What is the market value weight of the first security in
the portfolio? 40*$15=$600; 200*$2=$400; weight=600/1000=60%
28. ABC Companys preferred stock is selling for $25 a share. It is expected that the
company will pay its constant preferred dividend in perpetuity. If the required
return is 12%, what will be the dividend two years from now? R=D/P=.12;D=3
29. Net present value________________________. b
a. Is equal to the initial investment in a project.
b. Compares project cost to the present value of the project benefits
c. Is equal to zero when the discount rate used is less than the IRR
d. Is simplified by the fact that future cash flows are easy to
estimate.
e. Requires the firm set an arbitrary cutoff point for determining
whether an investment is a good one or not.
30. Given the following cash flows, what is the present value if the discount rate is
8%? PV=1,947.23
Year Cash Flow
1 $200
2 $350
3 $800
4 $1125
31. What is the expected return for the following stock?
E (R)=.55*.2+.20*.1+.25*(-.2)=8%
State Probability E(Ri)
Average .55 .20
Recession .20 .10
Depression .25 -.20
32. An assets undiversifiable risk is measured by its e
a. total return
b. expected return
c. variance of returns
d. unexpected component of returns
e. beta coefficient
33. The Wrangler Co. has expected EBIT of $9,250, debt with a face and market
value of $14,000 paying a 9% annual coupon, and an unlevered cost of capital of
12%. If the tax rate is 39%, what is the value of the firm?
VL=VU+T*D; VU=EBIT(1-T)/RU=9250(1-.39)/.12; VL=52,480.83
34. You hear on the news that an underwriter is participating in an equity issue on a
standby basis. You know the type of offer must be a(n) __________________.
Rights offer.
35. Given the following returns, what is the variance? Year 1=15%; year 2=3%; year
3=-29%; and year 4 = -1%. Average=-3%; VAR= 346.67
36. Of the following, only _______will likely affect the three equity accounts of
common stock, retained earnings, and additional paid in capital. b
a. The payment of a regular cash dividend.
b. The payment of a stock dividend.
c. The payment of a cash liquidating dividend.
d. The payment of a special cash dividend.
e. A stock split.
37. At the end of each year for the next ten years you will receive cash flows of $50.
The initial investment is $320. What rate of return are you expecting from this
investment? 9.06%
38. The current price of ABC Corporation stock is $50. Dividends are expected to
grow at 7% indefinitely and the most recent dividend was $1. What is the
required rate of return on ABCs stock? 9.14%
39. You earn 5% real return. If the inflation rate is 4%, what is your nominal return?
9.2%
40. Stansfield, Inc. currently has 400,000 shares of stock outstanding, each with a
market price of $20 and a par value of $2. The firm would prefer to have its stock
trade at a value of between $30 and $35 per share. Of the following choices,
which would allow the firm to achieve its objective? C price would go to $30
a. The firm should execute a 2-for-1 stock split
b. The firm should execute a 50% stock dividend
c. The firm should execute a 2-for-3 reverse stock split
d. The firm should execute a 1-for-2 reverse stock split
e. The firm should pay a $2 per share cash dividend.