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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.