Expert Answers - The uncertainty that relates

Expert Answers - The uncertainty that relates

1. The uncertainty that relates to future cash flows is referred to as

A. friction.
B. risk.
C. liability.
D. the agency problem.

2. Cash flows for a foreign project will be in the foreign currency while the discount rate is usually evaluated from the domestic currency perspective. Which one of the following is a method for resolving the problem?

A. Engage in arbitrage to make up for any potential foreign exchange losses
B. Convert all cash flows from the foreign currency in question to another foreign currency
C. Use purchasing power parity to determine the discount rate
D. Convert the domestic discount rate to an equivalent in the foreign currency

3. You’re taking a cruise to Australia and want to have $3,000 Australian in spending money for the trip. If $1.0320 Australian buys $1 U.S. and $0.9310 Swiss francs buys $1 U.S., how many Swiss francs will you need to convert into $3,000 Australian for your trip?

A. 2,684
B. 3,124
C. 2,843
D. 2,706

4. Which of the following best explains why minimizing costs has potentially serious shortcomings as a means of maximizing owners’ equity?

A. Spending lavishly can impress potential customers.
B. Minimizing costs allows for the payment of larger dividends to company owners.
C. It’s difficult to maximize market share without increasing spending.
D. Without spending money on R&D to improve its products, a firm won’t survive long in the constantly evolving economy.

5. If the direct quote for converting Canadian dollars to euros is 0.7488 and the cross rate for Canadian dollar-euro is 0.7479, what three simultaneous trades could you make to profit from the arbitrage opportunity created by this pricing differential?

A. Trade euros for U.S. dollars, trade U.S. dollars for Canadian dollars, and trade Canadian dollars for euros.
B. Trade Canadian dollars for U.S. dollars, trade U.S. dollars for euros, and trade euros for Canadian dollars.
C. Trade U.S. dollars for Canadian dollars, trade Canadian dollars for euros, and trade the euros for U.S. dollars.
D. Trade U.S. dollars for euros, trade euros for Canadian dollars, and trade Canadian dollars for U.S. dollars.

6. What type of business organization would give your investors limited liability but you, as the owner and operator, unlimited liability?

A. Limited liability corporation (LLC)
B. Corporation
C. General partnership
D. Limited partnership (LP)

7. A business structure designed to pass through income and avoid the double taxation associated with corporations while still offering limited liability is known as a

A. sole proprietorship.
B. partnership.
C. hybrid organization.
D. corporation.

8. Adam Smith attributed his belief that individuals pursuing their own economic self-interest would result in the greatest good for society over the long term to

A. securitization.
B. the time value of money (TVM).
C. the invisible hand.
D. economies of scale.

9. Helping money flow from individuals who want to improve their financial future to businesses that want to expand the scale or scope of their operations relies on the successful application of

A. economies of scale.

B. financial theories.

C. financial management.
D. the time value of money (TVM).

10. Why do fiduciary relationships create ethical dilemmas for financial professionals?

A. They’re subject to monitoring by their firms.
B. They manage other people’s money.
C. They’re regulated by the government.
D. Financial management requires them to analyze investments.

11. What type of strategies do financial managers implement to reduce exchange rate risks?

A. Hedging
B. Discounting
C. Arbitrage
D. Currency conversion

12. Which one of the following is used in restructuring a firm’s debt?

A. Assignment
B. Hedging
C. Composition
D. Liquidation

13. A situation in which the best interests of a company don’t necessarily align with the best interests of its managers is called

A. double taxation.
B. the agency problem.
C. unlimited liability.
D. corporate governance.

14. The study of applying specific value to things we own, services we use, and decisions we make is called

A. investments.
B. financial management.
C. finance.

D. time value of money (TVM).

15. Using a linear probability model that uses the following formula: PD1 = 0.6 (Debt/Equity) – 0.12 (Sales/Total Assets), calculate the percentage chance of bankruptcy/default of a firm you’re thinking of investing in that has a debt-to-equity ratio of 25 percent and a sales-to-assets ratio of 1.1.

A. 1.8 percent
B. 3.0 percent
C. 4.3 percent
D. 1.2 percent

16. Firm A from the table below is considering a merger with a competitor in its industry. However, the firm wishes to avoid proposing a merger with the competitor if it’s likely to be challenged by the Department of Justice (DOJ) on the grounds that it exceeds guidelines for acceptable changes.

Given this, which of firm A’s competitors has the largest percentage market share it could merge with while staying within DOJ guidelines?

A. D
B. F
C. G
D. C

17. The process of valuing things from the perspective of a company or firm is called

A. investment management.
B. financial management.
C. finance.
D. corporate governance.

18. Calculate the change in HHI following a merger between firm B and firm D in an industry with the following market share levels:

A. 814
B. 721
C. 498
D. 685

19. Tax _______ is commonly a tax consideration motivating a merger.

A. losses from surplus funds
B. gains from increased operating income
C. gains from unused debt capacity
D. gains from paying down debt

20. Using the table below for spot and forward exchange rates, what should the six-month forward rate be for the Swiss franc if U.S. six-month interest rates are 0.22 percent and Swiss six-month rates are 0.18 percent?

A. 0.9784
B. 1.0743
C. 1.0723
D. 1.0842

21. Which of these is a factor that encourages managers to finance projects with debt financing rather than selling more stock?

A. Interest payments are deducted from operating income for taxable purposes, but dividends paid by corporations to shareholders aren’t.
B. Taking on debt is riskier than raising funds by selling equity.
C. A firm’s marginal tax rate is the amount of additional taxes a firm must pay out for every additional dollar of taxable income it earns.
D. Stockholders are entitled to a company’s residual cash flows.

22. How is interest paid to municipal bondholders treated differently than interest paid to corporate bondholders?

A. It isn’t taxed at the federal level or by any state in the country.
B. It’s taxed by the state for which the bond is issued but not by the federal government.
C. It isn’t taxed at the federal level or by the state for which the bond is issued.
D. It isn’t taxed by the state for which the bond is issued.

23. What characteristic of a bond determines the dollar amount of interest paid to bondholders?

A. Bid
B. Coupon rate
C. Par value
D. Yield to maturity

24. You have a portfolio with a beta of 1.46. What will the new portfolio beta be if you keep 75 percent of your money in the old portfolio and 25 percent in a stock with a beta of 0.6?

A. 1.31
B. 1.14
C. 1.67
D. 1.25

25. To analyze performance meaningfully, what must ratio results be interpreted against?

A. The discount rate
B. ROE
C. A standard or benchmark
D. The time value of money (TVM)

26. What’s the difference between APR and EAR?

A. EAR loans use compounding interest, and APR loans don’t.
B. EAR is a more accurate representation of what you’ll actually pay in interest on a loan than APR.
C. Lenders are legally required to show borrowers the EAR on any loan offered.
D. EAR computes interest on a loan from the first day of the loan, while APR computes interest from the end of the first month of the loan.

27. You’re thinking about buying a car. You can afford $800 in monthly payments for 3 years. If interest rates are 7 percent APR, what price of car can you afford?

A. $28,621.18
B. $25,909.17
C. $29,541.23
D. $26,452.82

28. If the risk-free rate is 5 percent and the risk premium is 7 percent, what’s the required return?

A. 12 percent
B. –2 percent
C. 15 percent
D. 2 percent

29. The applicability of beta depends on a firm’s

A. growth rate.
B. future plans.
C. standard deviation.
D. historical returns.

30. Suppose a firm has an EBIT of $1,400,000 and finances its assets with $6,000,000 of debt at 6 percent interest and 300,000 shares of stock selling at $12.50 a share. To lessen the risk associated with this financial leverage, the firm is thinking about reducing its debt by $3,000,000 by selling more stock. The firm is in the 35 percent tax bracket. The change in the capital structure won’t have any effect on the firm’s operations, thus EBIT will remain at $1,400,000. What’s the change in the firm’s EPS from this change in capital structure?

A. EPS rises by $0.54 per share
B. EPS falls by $0.36 per share
C. EPS rises by $0.28 per share
D. EPS falls by $0.48 per share

31. A company has earnings per share of $2.89 and a P/E ratio of 16.54. What’s the price of the company’s stock?

A. $8.77
B. $56.70
C. $47.80
D. $33.08

32. An 8 percent corporate coupon bond is callable in seven years for a call premium of one year of coupon payments. Assuming a par value of $1,000, what’s the price paid to the bondholder if the issuer calls the bond?

A. $1,040
B. $1,080
C. $920
D. $1,160

33. A company has a beta of 2.86. If the market return is expected to be 9 percent and the risk-free rate is 4 percent, what’s the company’s required return?

A. 34.3 percent
B. 18.4 percent
C. 28.5 percent
D. 29.2 percent

34. Why is the declining price of bonds in response to rising interest rates greater for bonds with lower coupons?

A. Default risk
B. Market risk
C. Reinvestment rate risk
D. Interest rate risk

35. One-year Treasury bills currently yield 2.43 percent. You expect that one year from now, one-year Treasury bill rates will increase to 2.83 percent, and two years from now, one-year Treasury bill rates will increase to 3.04 percent. The liquidity premium on two-year securities is 0.08 percent and on three-year securities, 0.14 percent. If the liquidity premium theory is correct, what should the current rate be on three-year Treasury securities?

A. 3.26 percent
B. 1.94 percent
C. 2.84 percent
D. 2.68 percent

36. What’s another name commonly used for junk bonds?

A. Mortgage bonds
B. Equipment trust certificates
C. High-yield bonds
D. Debentures

37. What’s the present value of a $150 payment made every year forever at an interest rate of 7.3 percent?

A. $2,175
B. $1,984
C. $2,227
D. $2,055

38. In 2015, Camilla’s Pet Stores, Inc., reported an ROA of 9.24 percent, ROE of 15.8 percent, and profit margin of 21.2 percent. The firm had total assets equal to $12.8 million at the end of 2015. What’s common stockholders’ equity as of year-end 2015 for Camilla’s Pet Stores, Inc.?

A. $9.3 million
B. $8.1 million
C. $7.5 million
D. $6.7 million

39. What happens when a firm issues debt to finance its assets?

A. Debt holders are entitled to receive the same amount of dividends as stockholders.
B. The firm’s capital structure doesn’t change.
C. Stockholders surrender their rights to dividends but not capital gains.
D. It gives the debt holders first claim to a fixed amount of its cash flows.

40. A treasury bond bought at the beginning of the year for $1,064 pays $48 in interest payments during the year, ending the year valued at $1,095. What was the percent return?

A. 7.42
B. 4.88
C. 8.44
D. 6.86

41. A common criticism of the payback (PB) benchmark is that it doesn’t

A. consider a project’s IRR.
B. account for the time value of money (TVM).
C. take into account NPV.
D. receive complementing information from discount payback (DPB).

42. Happy Clowns, Inc., has a cash balance of $445,000, accounts payable of $234,000, inventory of $144,000, accounts receivable of $411,000, notes payable of $124,000, and accrued wages and taxes of $88,000. How much net working capital does the company need to fund?

A. $387,000
B. $554,000
C. $446,000
D. $614,000

43. Sterling Candy Shops, Inc., has a net income of $840,000 and retained earnings necessary to fund positive NPV projects of $500,000. If the company has 2,000,000 shares outstanding, how much in dividends per share should the company pay out according to the residual dividend model?

A. $0.27
B. $0.17
C. $0.24
D. $0.15

44. Credit analysis relating to a borrower generally involves examining which one of the following?

A. The “two C’s”
B. The “four C’s”
C. The “five C’s”
D. The “three C’s”

45. Super Fun Toys, Inc., has the following balance sheet:

Suppose Super Fun Toys, Inc., has sales of $8.9 million for the year just ended, the profit margin of the firm is 16 percent with a retention rate of 28 percent, and the firm expects sales of $10.8 million next year. If fixed assets will have to grow by $800,000 to support the sales growth, with current assets and current liabilities expected to grow with sales, what amount of additional funds will Super Fun Toys need from external sources to fund the expected growth?

A. $622,314
B. $482,562
C. $824,511
D. $550,991

46. The preliminary version of the prospectus for a public offering is known as

A. a shelf registration.
B. an indenture instrument.
C. the red herring prospectus.
D. the statement of information.

47. The tendency of stockholders in firms where the equity is close to being worthless to gamble by investing in an arguably bad project is known as the

A. overinvestment problem.
B. capital structure irrelevance hypothesis.
C. underinvestment problem.
D. clientele effect.

48. You’re evaluating the proposed acquisition of a new machining tool for $88,000 by your company. The tool falls into the MACRS three-year class, and it will be fully depreciated after three years and sold at that time for $26,000. Use of the tool requires an increase in NWC (spare parts inventory) of $3,500. The tool will have no effect on revenues, but it’s expected to save the firm $24,000 per year in before-tax operating costs, mostly labor. The firm’s marginal tax rate is 38 percent. What will be the adjusted total cash flow (ATCF) from the sale of the machining tool?

A. $16,120
B. $18,186
C. $12,820
D. $22,410

49. Which one of the following is not a capital-budgeting technique?

A. Net present value (NPV)
B. Modified internal rate of return (MIRR)
C. Payback (PB)
D. Modified payback (MPB)

50. Suppose that the common shares of Oceanic Luxury Vessels, Inc., is trading for $38 a share and that 5 million shares are outstanding. The company also has 75,000 bonds outstanding, which are selling at 102 percent of par. If Oceanic Luxury Vessels, Inc., was considering an active change to its capital structure so that the firm would have a D/E ratio of 1.6, which type of security (stocks or bonds) would it need to sell to accomplish this, and how much would it have to sell?

A. Stock: $445.2 million
B. Debt; $349.9 million
C. Stock; $289.4 million
D. Debt; $248.5 million

51. Up & Down Industries doesn’t have any taxes to pay and has $348 million in assets, currently financed only with equity. The equity is worth $11 per share with 8 million shares outstanding, and book value of equity is equal to market value of equity. Assume that the firm’s expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities as follows:

• State: Pessimistic; Probability = 45 percent; Expected EBIT in state = $15 million

• State: Optimistic; Probability = 55 percent; Expected EBIT in state = $19 million


The company is considering switching to a 60 percent debt capital structure and has determined that it would have to pay a 10-percent yield on perpetual debt in either event. What would the level of expected EPS in either scenario be if the firm switches to the proposed capital structure as compared to its current structure?

A. Pessimistic state: $0.35 EPS; Optimistic state: $0.88 EPS
B. Pessimistic state: $0.32 EPS; Optimistic state $0.82 EPS
C. Pessimistic state: $0.23 EPS; Optimistic state: $0.73 EPS
D. Pessimistic state: $0.27 EPS; Optimistic state: $0.77 EPS

52. A graph of a project’s NPV as a function of possible capital costs is called the _______ profile.

A. NPV
B. standard deviation
C. IRR
D. beta

53. What’s the appropriate tax rate to be used in WACC?

A. The highest applicable tax rate charged on the firm’s income
B. The weighted average of the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction
C. The simple average of the tax rates that would have been paid on the taxable income shielded by the interest deduction
D. The weighted average of the firm’s discounted current marginal tax rates

54. Suppose that a firm has a retention rate of 45 percent, net income of $18 million, and 88 million shares outstanding. What would be the dividend per share paid out on the company’s stock?

A. $.1125
B. $.1175
C. $.1315
D. $.1252

55. The fact that, in real life, investors don’t have identical desires about the taxability and timing of firm payments is known as the

A. bird-in-the-hand theory.
B. information effect.
C. dividend irrelevance theorem.
D. clientele effect.

56. The hypothesis that, with a well-functioning capital market, a firm’s capital budgeting decisions are separate from its capital structure decisions is called the

A. efficient market hypothesis.
B. Baumol theorem.
C. separation principle.
D. Modigliani-Miller theorem.

57. According to IRS Publication 946, which one of the following are included in the depreciable basis of real property?

A. Debt payments
B. Storage fees
C. Freight charges
D. Maintenance fees

58. When analyzing the risk of a new project, what can be used to provide a fairly accurate estimate of the new project’s beta?

A. Flotation costs
B. Proxy betas
C. The separation principle
D. The component cost of debt

59. Super Fun Toys, Inc., has the following balance sheet:

Suppose Super Fun Toys, Inc., has sales of $8.9 million for the year just ended, the profit margin of the firm is 16 percent with a retention rate of 28 percent, and the firm expects sales of $9.8 million next year. If all assets and current liabilities are expected to grow with sales, what amount of additional funds will Super Fun Toys need from external sources to fund the expected growth?

A. $689,500
B. $368,484
C. $552,800
D. $187,925

60. The Miller-Orr model is more realistic than the Baumol model because it

A. accounts for taxes.
B. deals with both cash inflows and outflows.
C. includes compensation balances.
D. assumes cash starts from a replenishment level.
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