- In a competitive marketplace, if managers deviate too far from making decisions that are consistent with stockholder wealth maximization, they risk being disciplined by the market. Part of this discipline involves the threat of being taken over by groups who are more aligned with stockholder interests.
True / False
- If a bond is callable, and if interest rates in the economy decline, then the company can sell a new issue of low-interest-rate bonds and use the proceeds to “call” the old bonds in and have effectively refinanced at a lower rate.
True / False
- Preferred stock is a hybrid–a sort of cross between a common stock and a bond–in the sense that it pays dividends that normally increase annually like a stock, but its payments are contractually guaranteed like interest on a bond.
True / False
- All else equal, a dollar received sooner is worth more than a dollar received at some later date, because the sooner the dollar is received the more quickly it can be invested to earn a positive return.
True / False
- Current cash flow from existing assets is highly relevant to the investor. However, the value of the firm depends primarily upon its growth opportunities. As a result, profit projections from those opportunities are the only relevant future flows with which investors are concerned.
True / False
- Determining whether a firm’s financial position is improving or deteriorating requires analysis of more than one set of financial statements. Trend analysis is one method of measuring a firm’s performance over time.
True / False
- A firm’s net income reported on its income statement must equal the operating cash flows on the statement of cash flows.
True / False
- The Securities Exchange Commission is the U.S. government agency that regulates the issuance and trading of stocks and bonds.
True / False
- Compounding is the process of converting today’s values, which are termed present value, to future value.
True / False
- Risk really should not be a significant factor when making financial decision because all business decisions involve predictions about the future, which is unknown. As a result, all decisions automatically include some consideration of risk.
True / False
- Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and it will have a beta which is greater than 1.0.
True / False
- A firm cannot change its beta through any managerial decision because betas are completely market determined.
True / False
- From an investor’s perspective, a firm’s preferred stock is generally considered to be less risky than its common stock but riskier than its bonds. However, from a corporate issuer’s standpoint, these risk relationships are reversed: bonds are the riskiest for the firm, preferred is next, and common is least risky.
- True / False
- The difference between the PV of an annuity due and the PV of an ordinary annuity is that each of the payments of the annuity due is discounted by one more year.
True / False
- A publicly owned corporation is simply a company whose shares are held by the investing public, which may include other corporations and institutions.
True / False
- The preemptive right gives current stockholders the right to purchase, on a pro rata basis, any new shares issued by the firm. This right helps protect current stockholders against both dilution of control and dilution of value.
True / False
- Because short-term interest rates are much more volatile than long-term rates, you would, in the real world, be subject to much more interest rate price risk if you purchased a 30-day bond than if you bought a 30-year bond.
True / False
- Although common stock represents a riskier investment to an individual than do bonds, in the sense of exposing the firm to the risk of bankruptcy, bonds represent a riskier method of financing to a corporation than does common stock.
True / False
- The longer the maturity of a bond, the more its price will change in response to a given change in interest rates; this is called interest rate price risk.
True / False
- The quick ratio and inventory turnover ratio can be used to help assess the liquidity of a firm. The quick ratio measures the relation of a firm’s quick assets to its current liabilities and the inventory turnover ratio measures how rapidly a firm turns its inventory back into a “quick” asset or cash.
True / False
- Other things held constant, P/E ratios are higher for firms with high growth prospects. At the same time, P/E’s are lower for riskier firms, other things held constant. These two factors, growth prospects and riskiness, may either be offsetting or reinforcing as P/E determinants.
True / False
- The book value per share is computed by taking the sum of common stock, additional paid in capital, and retained earnings and dividing the number by the number of shares outstanding.
True / False
- The effective annual interest rate is less than the simple interest rate when we have monthly compounding.
True / False
- Which of the following statements shows the portion of the firm’s earnings that has been saved rather than paid out as dividends?
| a. | balance sheet |
| b. | income statement |
| c. | statement of retained earnings |
| d. | statement of cash flows |
| e. | proxy statement |
- (3 Points) Henry currently has an investment portfolio that contains four stocks with a total value equal to $80,000. The portfolio has a beta (Beta) equal to 1.4. Henry wants to invest an additional $20,000 in a stock that has a Beta = 2.4. After Henry adds the new stock to his portfolio, what will be the portfolio’s beta?
| a. | 1.6 |
| b. | 1.9 |
| c. | 2.2 |
| d. | Not enough information to determine the new beta |
- If in the opinion of a given investor a stock’s expected return exceeds its required return, this suggests that the investor thinks
| a. | the stock is experiencing supernormal growth. |
| b. | the stock should be sold. |
| c. | the stock is a good buy. |
| d. | management is probably not trying to maximize the price per share. |
- (3 Points) If a stock has a beta coefficient, Beta, equal to 1.20, the risk premium associated with the market is 9 percent, and the risk-free rate is 5 percent, application of the capital asset pricing model indicates the appropriate return should be __________.
| a. | 9.8% |
| b. | 14% |
| c. | 5% |
| d. | 15.8% |
- (4 Points) The Charleston Company is a relatively small, privately owned firm. Last year the company had after-tax income of $15,000, and 10,000 shares were outstanding. The owners were trying to determine the market value for the stock, prior to taking the company public. A similar firm which is publicly traded had a price/earnings ratio of 5.0. Using only the information given, estimate the market value of one share of Charleston’s stock.
| a. | $10.00 |
| b. | $7.50 |
| c. | $5.00 |
| d. | $2.50 |
| e. | $1.50 |
- (3 Points) Gray Manufacturing is expected to pay a dividend of $1.25 per share at the end of the year (D1 = $1.25). The stock sells for $27.50 per share, and its required total rate of return is 10.5%. The dividend is expected to grow at some constant rate, “g”, forever. What is the stock price’s expected growth rate?
| a. | 6.01% |
| b. | 5.54% |
| c. | 6.07% |
| d. | 5.95% |
- (4 Points) The Francis Company 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 1.70, the market risk premium is 5.50%, and the risk-free rate is 4.00%. What is the company’s current stock price?
| a. | $13.44 |
| b. | $17.01 |
| c. | $12.93 |
| d. | $21.89 |
- If you wanted to purchase previously issued shares of stock from another investor you would find the shares in the
| a. | primary market. |
| b. | debt market. |
| c. | IPO market. |
| d. | secondary market. |
| e. | SEO market. |
- (3 Points) A _______ option gives the _________ the right to _________ a fixed number of shares at a specified price for a certain amount of time.
| a. | call; bond issuer; repurchase |
| b. | put; bond holder; sell |
| c. | call; bond holder; repurchase |
| d. | put; bond issuer; sell |
- Which of the following statements is correct?
| a. | Other things held constant, an increase in the number of discounting periods per year increases the present value of a given annual annuity. |
| b. | Other things held constant, an increase in the number of discounting periods per year increases the present value of a lump sum to be received in the future. |
| c. | The payment made each period under an amortized loan is constant, and it consists of some interest and some principal. The later we are in the loan’s life, the smaller the interest portion of the payment. |
| d. | There is an inverse relationship between the present value interest factor of an annuity and the future value interest factor of an annuity, (i.e., one is the reciprocal of the other). |
- All else equal, if you expect to receive a certain amount in the future, say, $500 in ten (10) years, the present value of that future amount will be lowest if the interest earned on such investments is compounded
| a. | daily |
| b. | weekly |
| c. | monthly |
| d. | quarterly |
| e. | annually |
- (3 Points) 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. | $1,171 |
| b. | $1,126 |
| c. | $1,082 |
| d. | $1,163 |
| e. | $1,008 |
- Your uncle would like to restrict his interest rate risk and his default risk, but he still would like to invest in corporate bonds. Which of the possible bonds listed below best satisfies your uncle’s criteria?
| a. | BBB bond with 10 years to maturity. |
| b. | BBB perpetual bond. |
| c. | AAA bond with 5 years to maturity. |
| d. | AAA bond with 10 years to maturity. |
| e. | BBB bond with 5 years to maturity. |
- Which of the following is not one of the four fundamental factors that affect the cost of money?
| a. | production opportunities |
| b. | time preferences for consumption |
| c. | risk |
| d. | liquidity |
| e. | inflation |
- (3 Points) You read in The Wall Street Journal that 30-day T-bills currently are yielding 8 percent. Your brother-in-law, a broker at Kyoto Securities, has given you the following estimates of current interest rate premiums:
| Inflation premium | 5% |
| Liquidity premium | 1% |
| Maturity risk premium | 2% |
| Default risk premium | 2% |
Based on these data, the real risk-free rate of return is
| a. | 0% |
| b. | 1% |
| c. | 2% |
| d. | 3% |
| e. | 4% |
- A contract negotiated directly with a bank in which the borrower agrees to make a series of interest and principal payments on specific dates to the bank is called
| a. | Preferred stock. |
| b. | commercial paper. |
| c. | convertible debt. |
| d. | a term loan. |
| e. | a bond issue. |
- A bond differs from term in loans in that
| a. | a bond issue is generally advertised. |
| b. | a bond is sold to many investors. |
| c. | a bond is offered to the public. |
| d. | All of the above. |
| e. | None of the above. |
- Which of the following events would make it less likely that a company would choose to call its outstanding callable bonds?
| a. | Increase in interest rates. |
| b. | Decrease in interest rates. |
| c. | Increase in price of outstanding convertible bonds. |
| d. | A decrease in call premium. |
| e. | Answers b and c only. |
- __________ are high-risk, high-yield bonds used to finance mergers, leveraged buyouts, and troubled companies.
| a. | Callable bonds |
| b. | Junk bonds |
| c. | Convertible bonds |
| d. | Floating rate bonds |
| e. | Putable bonds |
- Which of the following securities is the riskiest to investors?
| a. | Floating rate notes. |
| b. | Income bonds. |
| c. | Treasury bills. |
| d. | First mortgage bonds. |
| e. | Common stock. |
- Shareholders exert control of the management of the firm by
| a. | electing board members who can replace management. |
| b. | directly replacing management with themselves. |
| c. | buying shares in an IPO at a discounted price. |
| d. | running the daily operations of the firm. |
| e. | None of the above. |
- (3 Points) Henderson Company has 20,000,000 shares of common stock authorized, but to date, has only 12,000,000 shares outstanding, each with a $1.00 par value. The company has $24,000,000 in additional paid-in capital and retained earnings are $96,000,000. What is Henderson’s current book value per share?
| a. | $1.00 |
| b. | $3.00 |
| c. | $11.00 |
| d. | $6.60 |
| e. | $9.00 |
- (3 Points) A share of perpetual preferred stock pays an annual dividend of $6 per share. If investors require a 12 percent rate of return, what should be the price of this preferred stock?
| a. | $57.25 |
| b. | $50.00 |
| c. | $62.38 |
| d. | $46.75 |
| e. | $41.64 |
- When constructing a Statement of Cash Flows, which of the following actions would be considered a source of funds?
| a. | increase in the cash account |
| b. | decrease in accounts payable |
| c. | increase in inventory |
| d. | increase in long-term bonds |
| e. | increase in fixed assets |
- Which of the following statements is correct as it relates to Annual Reports?
| a. | The annual report contains four basic financial statements: the income statement; balance sheet; statement of cash flows; and statement of changes in long-term financing. |
| b. | Although the annual report is geared toward the average stockholder, it represents financial analysts’ most complete source of financial information about the firm. |
| c. | The key importance of annual report information is that it is used by investors when they form their expectations about the firm’s future earnings and dividends and the riskiness of those cash flows. |
| d. | The annual report provides no relevant information for use by financial analysts or by the investing public. |
- (3 Points) A firm has a profit margin of 15 percent on sales of $20,000,000. If the firm has debt of $7,500,000, total assets of $22,500,000, and an after-tax interest cost on total debt of 5 percent, what is the firm’s ROA?
| a. | 8.4% |
| b. | 10.9% |
| c. | 12.0% |
| d. | 13.3% |
| e. | 15.1% |
- (3 Points) Alpha’s preferred stock currently has a market price equal to $80 per share. If the dividend paid on this stock is $6 per share, what is the required rate of return investors are demanding from Alpha’s preferred stock?
| a. | 7.5% |
| b. | 13.3% |
| c. | 6.0% |
| d. | $6.00 |
| e. | None of the above is a correct answer.
|
- Which of the following are generally considered advantages of term loans over publicly issued bonds?
| a. | Lower flotation costs. |
| b. | Speed, or how long it takes to bring the issue to market. |
| c. | Flexibility, or the ability to adjust the bond’s terms after it has been issued. |
| d. | All of the above. |
- (2 Points) The net income that firm earns can either be paid out to shareholders as __________ or can be reinvested in the company as __________.
| a. | interest; additional paid-in capital |
| b. | dividends; retained earnings |
| c. | shares; capital stock. |
| d. | capital gains; additional paid-in capital |
| e. | interest; retained earnings |
