CHAPTER 1
Which of the following statements is CORRECT?
a.Bondholders are generally more willing than stockholders to have managers invest in risky projects with high potential returns as opposed to safer projects with lower expected returns.
b.There is no good reason to expect a firm's bondholders and stockholders to react differently to the types of new asset investments a firm makes.
c.Stockholders are generally more willing than bondholders to have managers invest in risky projects with high potential returns as opposed to safer projects with lower expected returns.
d.One disadvantage of operating as a corporation rather than as a partnership is that corporate shareholders are exposed to more personal liability than partners.
e.Relative to sole proprietorships, corporations generally face fewer regulations, which makes raising capital easier for corporations.
What is C: Stockholders are generally more willing than bondholders to have managers invest in risky projects with high potential returns as opposed to safer projects with lower expected returns.
Analysts following Armstrong Products recently noted that the company's operating net cash flow increased over the prior year, yet cash as reported on the balance sheet decreased. Which of the following factors could explain this situation?
a. The company issued new common stock.
b.The company issued new long-term debt.
c.The company sold a division and received cash in return.
d.The company cut its dividend.
e.The company made a large investment in a profitable new plant.
What is A: The company issued new common stock.
Under normal conditions, which of the following would be most likely to increase the coupon rate required to enable a bond to be issued at par?
a.Adding additional restrictive covenants that limit management's actions.
b.Adding a sinking fund.
c.The rating agencies change the bond's rating from Baa to Aaa.
d.Making the bond a first mortgage bond rather than a debenture.
e.Adding a call provision.
What is E: Adding a call provision.
Bloome Co.'s stock has a 25% chance of producing a 30% 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?
a.8.12%
b.7.72%
c.9.00%
d.8.55%
e.9.50%
What is C: 9.00%
You, in analyzing a stock, find that its expected return exceeds its required return. This suggests that you think
a.the stock is a good buy.
b.the stock is experiencing supernormal growth.
c.the stock should be sold.
d.management is probably not trying to maximize the price per share.
e.dividends are not likely to be declared.
What is A: the stock is a good buy.
Which of the following statements is CORRECT?
a.In a regular partnership, liability for the firm's debts is limited to the amount a particular partner has invested in the business.
b.Corporations are at a disadvantage relative to partnerships because they have to file more reports to state and federal agencies, including the Securities and Exchange Administration, even if they are not publicly owned.
c.A fast-growth company would be more likely to set up as a partnership for its business organization than would a slow-growth company.
d.Partnerships have difficulty attracting capital in part because of their unlimited liability, the lack of impermanence of the organization, and difficulty in transferring ownership.
e.A major disadvantage of a partnership relative to a corporation as a form of business organization is the high cost and practical difficulty of its formation.
What is D: Partnerships have difficulty attracting capital in part because of their unlimited liability, the lack of impermanence of the organization, and difficulty in transferring ownership.
Olivia Hardison, CFO of Impact United Athletic Designs, plans to have the company issue $500 million of new common stock and use the proceeds to pay off some of its outstanding bonds. Assume that the company, which does not pay any dividends, takes this action, and that total assets, operating income (EBIT), and its tax rate all remain constant. Which of the following would occur?
a.The company would have less common equity than before.
b.The company's interest expense would remain constant.
c.The company's taxable income would fall.
d.The company's net income would increase.
e.The company would have to pay less taxes.
What is D:The company's net income would increase.
Which of the following statements is CORRECT?
a.If a bond is selling at a premium, this implies that its yield to maturity exceeds its coupon rate.
b.If rates fall rapidly, a zero coupon bond's expected appreciation could become negative.
c.If a firm moves from a position of strength toward financial distress, its bonds' yield to maturity would probably decline.
d.If a coupon bond is selling at par, its current yield equals its yield to maturity.
e.If rates fall after its issue, a zero coupon bond could trade at a price above its par value.
What is D: If a coupon bond is selling at par, its current yield equals its yield to maturity.
If you randomly select stocks and add them to your portfolio, which of the following statements best describes what you should expect?
A) Adding more such stocks will increase the portfolio's expected rate of return.
B) Adding more such stocks will reduce the portfolio's beta coefficient and thus its systematic risk.
C) Adding more such stocks will have no effect on the portfolio's risk.
D) Adding more such stocks will reduce the portfolio's market risk but not its unsystematic risk.
E) Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk.
What is E: Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk.
Dyer Furniture is expected to pay a dividend of D1 = $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 1.15, the market risk premium is 5.50%, and the risk-free rate is 4.00%. What is Dyer's current stock price?
a.$31.12
b.$31.90
c.$28.90
d.$30.36
e.$29.62
What is C: $28.90
One drawback of switching from a partnership to the corporate form of organization is the following:
a.It makes it more difficult for the firm's investors to transfer their ownership interests.
b.It cannot affect the amount of the firm's operating income that goes to taxes.
c.It subjects the firm to additional regulations.
d.It makes it more difficult for the firm to raise additional capital.
e.It makes the firm's investors subject to greater potential personal liabilities.
What is C: It subjects the firm to additional regulations.
Bae Inc. has the following income statement. How much net operating profit after taxes (NOPAT) does the firm have?
Sales $2,000.00
Costs 1,200.00
Depreciation 100.00
EBIT $ 700.00
Interest expense 200.00
EBT $ 500.00
Taxes (35%) 175.00
Net income $ 325.00
a.$390.11
b.$432.25
c.$370.60
d.$455.00
e.$410.64
What is D. $455.00
Haswell Enterprises' bonds have a 10-year maturity, a 6.25% semiannual coupon, and a par value of $1,000. The going interest rate (rd) is 4.75%, based on semiannual compounding. What is the bond's price?
a.1,063.09
b.1,118.31
c.1,090.35
d.1,174.93
e.1,146.27
What is B: 1,118.31
Recession, inflation, and high interest rates are economic events that are best characterized as being
A) company-specific risk factors that can be diversified away.
B) among the factors that are responsible for market risk.
C) risks that are beyond the control of investors and thus should not be considered by security analysts or portfolio managers.
D) irrelevant except to governmental authorities like the Federal Reserve.
E) systematic risk factors that can be diversified away.
What is B: among the factors that are responsible for market risk.
Which of the following statements is CORRECT, assuming stocks are in equilibrium?
a.Assume that the required return on a given stock is 13%. If the stock's dividend is growing at a constant rate of 5%, its expected dividend yield is 5% as well.
b.The dividend yield on a constant growth stock must equal its expected total return minus its expected capital gains yield.
c.A required condition for one to use the constant growth model is that the stock's expected growth rate exceeds its required rate of return.
d.A stock's dividend yield can never exceed its expected growth rate.
e. Other things held constant, the higher a company's beta coefficient, the lower its required rate of return.
What is B: The dividend yield on a constant growth stock must equal its expected total return minus its expected capital gains yield.
You recently sold 200 shares of Apple stock to your brother. The transfer was made through a broker, and the trade occurred on the NYSE. This is an example of:
a.A primary market transaction.
b.A secondary market transaction.
c.An over-the-counter market transaction.
d. A money market transaction.
e.A futures market transaction.
What is B: A secondary market transaction.
Cordelion Communications is considering issuing new common stock and using the proceeds to reduce its outstanding debt. The stock issue would have no effect on total assets, the interest rate Cordelion pays, EBIT, or the tax rate. Which of the following is likely to occur if the company goes ahead with the stock issue?
a.Taxable income will decrease.
b.The times interest earned ratio will decrease.
c.The ROA will decline.
d.Net income will decrease.
e.The tax bill will increase.
What is E: The tax bill will increase.
Suppose your credit card issuer states that it charges a 15.00% nominal annual rate, but you must make monthly payments, which amounts to monthly compounding. What is the effective annual rate?
a.17.72%
b.15.27%
c.18.61%
d.16.88%
e.16.08%
What is E: 16.08%
If markets are in equilibrium, which of the following conditions will exist?
A) Each stock's expected return should equal its required return as seen by the marginal investor.
B) All stocks should have the same expected return as seen by the marginal investor.
C) The expected and required returns on stocks and bonds should be equal.
D) All stocks should have the same realized return during the coming year.
E) Each stock's expected return should equal its realized return as seen by the marginal investor.
What is A: Each stock's expected return should equal its required return as seen by the marginal investor.
Huxley Building Supplies' last free cash flow was $1.75 million. Its free cash flow growth rate is expected to be constant at 25% for 2 years, after which free cash flows are expected to grow at a rate of 6% forever. Its weighted average cost of capital WACC is 12%. Huxley has $5 million in short-term investments and $7 million in debt and has 1 million shares outstanding. What is the best estimate of the current intrinsic stock price?
a.$42.80
b.$44.92
c.$40.64
d.$41.71
e.$39.58
What is C: $40.64
Which of the following statements is NOT CORRECT?
a.When a corporation's shares are owned by a few individuals and are not traded on public markets, we say that the firm is "closely, or privately, held."
b. "Going public" establishes a firm's true intrinsic value, and it also insures that a highly liquid market will always exist for the firm's shares.
c.When stock in a closely held corporation is offered to the public for the first time, the transaction is called "going public," and the market for such stock is called the new issue market.
d.Publicly owned companies have shares owned by investors who are not associated with management, and public companies must register with and report to a regulatory agency such as the SEC.
e.It is possible for a firm to go public and yet not raise any additional new capital at the time.
What is B: "Going public" establishes a firm's true intrinsic value, and it also insures that a highly liquid market will always exist for the firm's shares.
Which of the following statements is CORRECT?
a.A reduction in accounts receivable would have no effect on the current ratio, but it would lead to an increase in the quick ratio.
b.If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding will decline.
c.If a security analyst saw that a firm's days' sales outstanding (DSO) was higher than the industry average and was also increasing and trending still higher, this would be interpreted as a sign of strength.
d.If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding (DSO) will increase.
e.There is no relationship between the days' sales outstanding (DSO) and the average collection period (ACP). These ratios measure entirely different things.
What is B: If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding will decline.
How much would $20,000 due in 50 years be worth today if the discount rate were 7.5%?
a.$461.08
b.$510.89
c.$485.35
d.$537.78
e.$438.03
What is D: $537.78
Because your mother is about to retire, she wants to buy an annuity that will provide her with $75,000 of income a year for 20 years, with the first payment coming immediately. The going rate on such annuities is 5.25%. How much would it cost her to buy the annuity today?
a.$963,213
b.$1,011,374
c.$869,300
d.$915,052
What is A: $963,213
TRUE OR FALSE From an investor's perspective, a firm's preferred stock is generally considered to be less risky than its common stock but more risky than its bonds. However, from a corporate issuer's standpoint, these risk relationships are reversed: Bonds are the most risky for the firm, preferred is next, and common is least risky.
What is TRUE