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26. Which of the following is true?
a. Two points on the Characteristic Line are the T-bill and the market portfolio.
b. All securities have a beta between 0 and 1.
c. Most of the unsystematic risk is removed by the time a portfolio contains 30 stocks.
d. The greater the total risk of an asset, the greater the expected return.
27. Which of the following is NOT a definition of yield to maturity?
a. return that an investor will earn if they buy the bond for its market price and hold it until
maturity
b. discount rate that equates present value of future cash flows with a bond’s price
c. investors’ required rate of return on a bond investment
d. discount rate that equates present value of future cash flows with a bond’s face value
28. Charlie Corporation has two bonds outstanding. Both bonds mature in 10 years, have a face
value of $1,000, and have a yield to maturity of 8%. One bond is a zero coupon bond and
the other bond has a coupon rate of 8%. Which of the following statements is true?
a. Both bonds must sell for the same price if markets are in equilibrium.
b. The zero coupon bond must have a higher price because of its greater capital gain
potential.
c. All rational investors will prefer the 8% bond because it pays more interest.
d. The zero coupon bond must sell for a lower price than the bond with an 8% coupon rate.
29. GPR Corporation just issued $1,000 par 20-year bonds. The bonds sold for $936 and pay
interest semiannually. Investors require a rate of 7.00% on the bonds. What is the amount of
the semiannual interest payment on the bonds?
a. $55.00
b. $21.75
c. $32.00
d. $64.50
30. Two investors are considering the purchase of Corporation LMQ bonds. The bonds are selling
at their par value of $1,000 with a coupon rate of 9%. Investor A decides to buy the bonds
and Investor B does not buy the bonds. Why?
a. The yield to maturity for Investor A must be higher than the yield to maturity for
Investor B.
b. Investor A must have a required return less than or equal to 9%.
c. Investor A must have a required return higher than the bond’s yield to maturity.
d. Investor B must have required return lower than the bond’s yield to maturity.
31. The yield to maturity on a bond:
a. is lower for higher risk bonds
b. is fixed in the indenture
c. is generally below the coupon interest rate
d. is the required rate of return on the bond
32. Crandle’s common stock is currently selling for $79.00. It just paid a dividend of $4.60 and
dividends are expected to grow at a rate of 5% indefinitely. What is the required rate of
return on Crandle’s stock?
a. 11.11%
b. 14.21%
c. 12.2%
d. 11.76%
33. If a shareholder cannot attend the corporation’s annual meeting, the shares may still be
voted using:
a. the preemptive right
b. majority voting rules
c. the cumulative voting right
d. a proxy
34. Asymmetric Frames Corp had a return on equity of 15%. The corporation’s earnings per share
was $6.00, its dividend payout ratio was 40% and its profit-retention rate was 60%. If these
relationships continue, what will be United Financial Corp’s internal growth rate?
a. 9.0%
b. 6.0%
c. 15.6%
d. 8.6%
35. Bensen Co. paid a dividend of $5.25 on its common stock yesterday. The company’s
dividends are expected to grow at a constant rate of 8.5% indefinitely. The required rate of
return on this stock is 15.5%. You observe a market price of $78.50 for the stock. Should
you purchase this stock?
a. No, the market price is above the intrinsic value of the stock.
b. Yes, but only if you can keep the stock for at least 5 years.
c. Yes, the market price is below the intrinsic value of the stock.
d. No, the growth rate in dividends is too far below the required return.
36. Preferred stock differs from common stock in that:
a. Common stock investors have a required return and preferred stock investors do not.
b. Preferred stock dividends are fixed.
c. Preferred stock investors have a higher required return than common stock investors.
d. Preferred stock usually has a maturity date.
Texas Transport has five possible investment projects for the coming year. Each project is
indivisible. They are:
Project Investment (million) IRR
A $ 6 18%
B $10 15%
C $ 9 20%
D $ 4 12%
E $ 3 24%
37. The firm’s weighted marginal cost of capital schedule is 12 percent for up to $6 million of
investment; 16 percent for between $6 million and $18 million of investment; and above
$18 million the weighted cost of capital is 18 percent. The optimal capital budget is
a. $23 million
b. $28 million
c. $12 million
d. $18 million
38. A corporate bond has a face value of $1,000 and a coupon rate of 5%. The bond matures in
15 years and has a current market price of $925. If the corporation sells more bonds it will
incur flotation costs of $25 per bond. If the corporate tax rate is 35%, what is the after-tax
cost of debt capital?
a. 3.74%
b. 5.29%
c. 4.45%
d. 6.78%
39. Sentry Manufacturing paid a dividend yesterday of $5 per share (D0 = $4). The dividend is
expected to grow at a constant rate of 8% per year. The price of Sentry Manufacturing’s
stock today is $29 per share. If Sentry Manufacturing decides to issue new common stock,
flotation costs will equal $2.50 per share. Sentry Manufacturing’s marginal tax rate is 35%.
Based on the above information, the cost of retained earnings is
a. 24.12%
b. 31.40%
c. 28.38%
d. 26.62%
40. Given the following information on S & G Inc.’s capital structure, compute the company’s
weighted average cost of capital.
Type of Percent of Before-Tax
Capital Capital Structure Component Cost
Bonds 40% 7.5%
Preferred Stock 5% 11%
Common Stock 55% 15%
(Internal Only)
The company’s marginal tax rate is 40%.
a. 10.6%
b. 10%
c. 7.1%
d. 13.3%
41. Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs
$95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project
B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two,
$56,000 in year three, and $45,000 in year four. Lithium, Inc.’s required rate of return for
these projects is 10%.The modified internal rate of return for Project A is
a. 19.19%
b. 26.89%
c. 29.63%
d. 24.18%
42. Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs
$95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project
B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two,
$56,000 in year three, and $45,000 in year four. Lithium, Inc.’s required rate of return for
these projects is 10%. The equivalent annual annuity amount for project A is
a. $13,357
b. $18,532
c. $15,024
d. $12,989
43. A machine that costs $1,500,000 has a 3-year life. It will generate after tax annual cash
flows of $700,000 at the end of each year. It will be salvaged for $200,000 at the end of
year 3. If your required rate of return for the project is 13%, what is the NPV of this
investment?
a. $291,417
b. $338,395
c. $600,000
d. $400,000
Interstate Appliance Inc. is considering the following 3 mutually exclusive projects. Projected
cash flows for these ventures are as follows:
Plan A Plan B Plan C
Initial Outlay=$3,600,000 Initial Outlay=$6,000,000 Initial Outlay=$3,500,000
Cash Flow: Cash Flow: Cash Flow:
Yr 1=$ -0- Yr 1=$4,000,000 Yr 1=$2,000,000
Yr 2= -0- Yr 2= 3,000,000 Yr 2= -0-
Yr 3= -0- Yr 3= 2,000,000 Yr 3=2,000,000
Yr 4= -0- Yr 4= -0- Yr 4=2,000,000
Yr 5=$7,000,000 Yr 5= -0- Yr 5=2,000,000
44. If Interstate Appliance has a 12% cost of capital, what decision should be made regarding
the projects above?
a. accept plan A
b. accept plan B
c. accept plan C
d. accept Plans A, B and C
45. AFB Systems is considering a new marketing campaign that will require the addition of a
new computer programmer and new software. The programmer will occupy an office in AFB’s
current building and will be paid $8,000 per month. The software license costs $1,000 per
month. The rent for the building is $4,000 per month. AFB’s computer system is always on,
so running the new software will not change the current monthly electric bill of $900. The
incremental expenses for the new marketing campaign are:
a. $8,000 per month
b. $9,000 per month
c. $13,000 per month
d. $13,900 per month
46. Tillamook Farms invests in a new kind of frozen dessert called polar cream that becomes very
popular. So many new customers come to the store that the sales of existing ice cream
products are increased. The extra sales revenue:
a. should be included in the analysis, but not the cost of the ice cream that is sold as that
is a recurring expense
b. should not be counted as incremental revenue for the polar cream project because the
sales come from existing products
c. are cannibalized sales that should be excluded from the analysis
d. are synergistic effects that should be counted as incremental revenues for the polar
cream project
47. AFB, Inc. requires an investment in equipment of $600,000 to replace existing equipment.
The existing equipment will produce after-tax salvage value of $70,000. Net working capital
requirements are increased by $50,000. What is the total cash outflow at time zero?
a. $580,000
b. $530,000
c. $650,000
d. $720,000
48. An asset with an original cost of $100,000 and a current book value of $20,000 is sold for
$50,000 as part of a capital budgeting project. The company has a tax rate of 30%. This
transaction will have what impact on the project’s initial outlay?
a. reduce it by $6,000
b. reduce it by $15,000
c. reduce it by $20,000
d. reduce it by $50,000
49. Which of the following would be considered a fixed cost in a manufacturing setting?
a. sales commissions
b. direct labor
c. direct materials
d. depreciation
50. Operating leverage has to do with:
a. using preferred stock to increase sales volume
b. the incurrence of fixed operating costs in the firm’s income stream
c. borrowing money to finance a firm’s growth
d. financing with fixed cost sources of capital
51. Optimal capital structure is:
a. the mix of funds that will maximize the firm’s interest tax shield
b. the mix of permanent sources of funds used by the firm in a manner that will maximize
the company’s common stock price
c. the mix of funds that will minimize the firm’s cost of equity capital
d. the mix of all items that appear on the right-hand side of the company’s balance sheet
52. Which of the following statements about operating leverage is true?
a. Operating leverage is the responsiveness of the firm’s EBIT to fluctuations in sales.
b. Operating leverage involves the usage of fixed cost financial securities in the operation of
a business.
c. Operating leverage is the responsiveness of the firm’s EPS to fluctuations in sales.
d. Operating leverage reduces a firm’s risk.
53. The dividend irrelevance hypothesis is based on all of the following assumptions EXCEPT:
a. perfect capital markets.
b. borrowing decisions will not be altered by the amount of dividend payments.
c. investment decisions will not be altered by the amount of dividend payments.
d. investors do not need cash dividends to supplement their current income.
54. Concentric Corporation has 10 million shares of stock outstanding. Concentric’s after-tax
profits are $140 million and the corporation’s stock is selling at a price-earnings multiple of
18, for a stock price of $252 per share. Concentric’s management issues a 40% stock
dividend. What is the effect on an investor who owns 100 shares of Concentric before the
dividend if Concentric’s price-earnings multiple remains the same after the dividend is paid?
a. The investor will own 100 shares worth $35,280.
b. The investor will own 100 shares worth $25,200.
c. The investor will own 140 shares worth $25,200.
d. The investor will own 140 shares worth $35,280.
55. Which of the following is true if dividend policy is irrelevant?
a. Perfect capital markets exist.
b. The information effect exists.
c. Tax deferral on capital gains exists.
d. The clientele effect exists.
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