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Finance Multiple Choices - Which of the following could explain why a business might choose to organize as a corporation rather than as a sole proprietorship or a partnership?

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Dear Tutor,
I don't trust myself so I would like to get a second opinion on these. Please answer the multiple choice questions and show any work you needed to do to obtain a given answer, if needed. Thank you

____ 1. Which of the following could explain why a business might choose to organize as a corporation rather than as a sole proprietorship or a partnership?
a. Corporations generally face fewer regulations.
b. Corporations generally face lower taxes.
c. Corporations generally find it easier to raise capital.
d. Corporations enjoy unlimited liability.
e. Statements c and d are correct.

____ 2. Given the following data, find the expected rate of inflation during the next year.

r* = real risk-free rate = 3%.

Maturity risk premium on 10-year T-bonds = 2%. It is zero on 1-year bonds, and a linear relationship exists.

Default risk premium on 10-year, A-rated bonds = 1.5%.

Liquidity premium = 0%.

Going interest rate on 1-year T-bonds = 8.5%.
a. 3.5%
b. 4.5%
c. 5.5%
d. 6.5%
e. 7.5%

____ 3. You deposit $2,000 in a savings account that pays 10 percent interest, compounded annually. How much will your account be worth in 15 years?
a. $2,030.21
b. $5,000.00
c. $8,091.12
d. $8,354.50
e. $9,020.10

____ 4. You can earn 8 percent interest, compounded annually. How much must you deposit today to withdraw $10,000 in 6 years?
a. $5,402.69
b. $6,301.70
c. $6,756.76
d. $8,432.10
e. $9,259.26

____ 5. Holmes Aircraft recently announced an increase in its net income, yet its net cash flow declined relative to last year. Which of the following could explain this performance?
a. The company's interest expense increased.
b. The company's depreciation expense declined.
c. The company's operating income declined.
d. All of the statements above are correct.
e. None of the statements above is correct.

____ 6. A company has the following balance sheet. What is its net operating working capital?

Cash $ 10 Accounts payable $ 30
Short-term investments 30 Accruals 10
Accounts receivable 50 Notes payable 50
Inventory 40 Current liabilities 90
Current assets 130 Long-term debt 60
Net fixed assets 100 Common equity 30
Retained earnings 50
Total assets $230 Total liab. & equity $230

a. $ 40
b. $ 60
c. $100
d. $130
e. $230

____ 7. Which of the following actions will increase a company's quick ratio?
a. Reduce inventories and use the proceeds to reduce long-term debt.
b. Reduce inventories and use the proceeds to reduce current liabilities.
c. Issue short-term debt and use the proceeds to purchase inventory.
d. Issue long-term debt and use the proceeds to purchase fixed assets.
e. Issue equity and use the proceeds to purchase inventory.

____ 8. Thomas Corp. has the following simplified balance sheet:

Cash $ 50,000 Current liabilities $125,000
Inventory 150,000
Accounts receivable 100,000 Long-term debt 175,000
Net fixed assets 200,000 Common equity 200,000
Total $500,000 Total $500,000

Sales for the year totaled $600,000. The company president believes the company carries excess inventory. She would like the inventory turnover ratio to be 8 and would use the freed up cash to reduce current liabilities. If the company follows the president's recommendation and sales remain the same, the new quick ratio would be:
a. 2.4
b. 4.0
c. 4.5
d. 1.2
e. 3.0

____ 9. In a portfolio of three different stocks, which of the following could not be true?
a. The riskiness of the portfolio is less than the riskiness of each of the stocks if they were held in isolation.
b. The riskiness of the portfolio is greater than the riskiness of one or two of the stocks.
c. The beta of the portfolio is less than the beta of each of the individual stocks.
d. The beta of the portfolio is greater than the beta of one or two of the individual stocks' betas.
e. None of the above (that is, they all could be true, but not necessarily at the same time).

____ 10. You are an investor in common stock, and you currently hold a well-diversified portfolio which has an expected return of 12 percent, a beta of 1.2, and a total value of $9,000. You plan to increase your portfolio by buying 100 shares of AT&E at $10 a share. AT&E has an expected return of 20 percent with a beta of 2.0. What will be the expected return and the beta of your portfolio after you purchase the new stock?
a. = 20.0%; bp = 2.00
b. = 12.8%; bp = 1.28
c. = 12.0%; bp = 1.20
d. = 13.2%; bp = 1.40
e. = 14.0%; bp = 1.32

____ 11. If interest rates fall from 8 percent to 7 percent, which of the following bonds will have the largest percentage increase in its value?
a. A 10-year zero coupon bond.
b. A 10-year bond with a 10 percent semiannual coupon.
c. A 10-year bond with a 10 percent annual coupon.
d. A 5-year zero coupon bond.
e. A 5-year bond with a 12 percent annual coupon.

____ 12. Assume that you wish to purchase a bond with a 30-year maturity, an annual coupon rate of 10 percent, a face value of $1,000, and semiannual interest payments. If you require a 9 percent nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?
a. $ 905.35
b. $1,102.74
c. $1,103.19
d. $1,106.76
e. $1,149.63

____ 13. The preemptive right is important to shareholders because it
a. Allows management to sell additional shares below the current market price.
b. Protects the current shareholders against dilution of ownership interests.
c. Is included in every corporate charter.
d. Will result in higher dividends per share.
e. The preemptive right is not important to shareholders.

____ 14. The expected rate of return on the common stock of Northwest Corporation is 14 percent. The stock's dividend is expected to grow at a constant rate of 8 percent a year. The stock currently sells for $50 a share. Which of the following statements is most correct?
a. The stock's dividend yield is 8 percent.
b. The stock's dividend yield is 7 percent.
c. The current dividend per share is $4.00.
d. The stock price is expected to be $54 a share in one year.
e. The stock price is expected to be $57 a share in one year.

____ 15. Warnes Motors' stock is trading at $20 a share. Call options that expire in three months with an exercise price of $20 have a price of $1.50. Which of the following will occur if the stock price increases 10 percent to $22 a share?
a. The price of the call option will increase by $2.
b. The price of the call option will increase by more than $2.
c. The price of the call option will increase by less than $2, and the percentage increase in price will be less than 10 percent.
d. The price of the call option will increase by less than $2, but the percentage increase in price will be more than 10 percent.
e. The price of the call option will increase by more than $2, but the percentage increase in price will be less than 10 percent.

____ 16. The current price of a stock is $50 and the annual risk-free rate is 6 percent. A call option with an exercise price of $55 and one year until expiration has a current value of $7.20. What is the value of a put option (to the nearest dollar) written on the stock with the same exercise price and expiration date as the call option?
a. $5.00.
b. $6.00.
c. $7.00.
d. $8.00.
e. $9.00.

____ 17. Which of the following statements about the cost of capital is incorrect?
a. A company's target capital structure affects its weighted average cost of capital.
b. Weighted average cost of capital calculations should be based on the after-tax-costs of all the individual capital components.
c. If a company's tax rate increases, then, all else equal, its weighted average cost of capital will increase.
d. The cost of retained earnings is equal to the return stockholders could earn on alternative investments of equal risk.
e. Flotation costs can increase the cost of preferred stock.

____ 18. A company's balance sheets show a total of $30 million long-term debt with a coupon rate of 9 percent. The yield to maturity on this debt is 11.11 percent, and the debt has a total current market value of $25 million. The balance sheets also show that that the company has 10 million shares of stock; the total of common stock and retained earnings is $30 million. The current stock price is $7.5 per share. The current return required by stockholders, rS, is 12 percent. The company has a target capital structure of 40 percent debt and 60 percent equity. The tax rate is 40%. What weighted average cost of capital should you use to evaluate potential projects?
a. 8.55%
b. 9.33%
c. 9.36%
d. 9.87%
e. 10.67%

____ 19. A company estimates that its weighted average cost of capital (WACC) is 10 percent. Which of the following independent projects should the company accept?
a. Project A requires an up-front expenditure of $1,000,000 and generates a net present value of $3,200.
b. Project B has a modified internal rate of return of 9.5 percent.
c. Project C requires an up-front expenditure of $1,000,000 and generates a positive internal rate of return of 9.7 percent.
d. Project D has an internal rate of return of 9.5 percent.
e. None of the projects above should be accepted.

____ 20. As the director of capital budgeting for Denver Corporation, you are evaluating two mutually exclusive projects with the following net cash flows:

Year Project XCash Flow Project ZCash Flow
0 -$100,000 -$100,000
1 50,000 10,000
2 40,000 30,000
3 30,000 40,000
4 10,000 60,000

If Denver's cost of capital is 15 percent, which project would you choose?
a. Neither project.
b. Project X, since it has the higher IRR.
c. Project Z, since it has the higher NPV.
d. Project X, since it has the higher NPV.
e. Project Z, since it has the higher IRR.

____ 21. Sanford & Son Inc. is thinking about expanding their business by opening another shop on property they purchased 10 years ago. Which of the following items should be included in the analysis of this endeavor?
a. The property was cleared of trees and brush 5 years ago at a cost of $5,000.
b. The new shop is expected to affect the profitability of the existing shop since some current customers will transfer their business to the new shop. Sanford and Son estimate that profits at the existing shop will decrease by 10 percent.
c. Sanford & Son can lease the entire property to another company (that wants to grow flowers on the lot) for $5,000 per year.
d. Both statements b and c should be included in the analysis.
e. All of the statements above should be included in the analysis.

____ 22. Stanton Inc. is considering the purchase of a new machine which will reduce manufacturing costs by $5,000 annually and increase earnings before depreciation and taxes by $6,000 annually. Stanton will use the MACRS method to depreciate the machine, and it expects to sell the machine at the end of its 5-year operating life for $10,000 before taxes. Stanton's marginal tax rate is 40 percent, and it uses a 9 percent cost of capital to evaluate projects of this type. If the machine's cost is $40,000, what is the project's NPV?
a. $1,014
b. $2,292
c. $7,550
d. $ 817
e. $5,040

____ 23. Kenney Corporation reported the following income statement for the most recent year(numbers are in millions of dollars):

Sales $7,000
Total operating costs 3,000
EBIT $4,000
Interest 200
Earnings before tax (EBT) $3,800
Taxes (40%) 1,520
Net income available to
common shareholders $2,280

The company forecasts that its sales will increase by 10 percent in the next year and its operating costs will increase in proportion to sales. The company's interest expense is expected to remain at $200 million, and the tax rate will remain at 40 percent. The company plans to pay out 50 percent of its net income as dividends, the other 50 percent will be additions to retained earnings. What is the forecasted addition to retained earnings for the next year?
a. $1,140
b. $1,260
c. $1,440
d. $1,790
e. $1,810

____ 24. Using the AFN formula approach, calculate the total assets of Harmon Photo Company given the following information: Sales this year = $3,000; increase in sales projected for next year = 20 percent; net income this year = $250; dividend payout ratio = 40 percent; projected excess funds available next year = $100; accounts payable = $600; notes payable = $100; and accrued wages and taxes = $200. Except for the accounts noted, there were no other current liabilities. Assume that the firm's profit margin remains constant and that the company is operating at full capacity.
a. $3,000
b. $2,200
c. $2,000
d. $1,200
e. $1,000

____ 25. Which of the following is not a barrier to a hostile takeover?
a. Nonpecuniary benefits.
b. Targeted share repurchases.
c. Shareholder rights provision.
d. Restricted voting rights.
e. Poison pill.

____ 26. Using the corporate valuation model, the value of a company's operations is $750 million. The company's balance sheet shows $50 million in short-term investments that are unrelated to operations. The balance sheet also shows $100 million in accounts payable, $100 million in notes payable, $200 million in long-term debt, $40 million in common stock (par plus paid-in-capital), and $160 million in retained earnings. What is your best estimate for the market value of equity?
a. $200 million
b. $300 million
c. $400 million
d. $500 million
e. $600 million

____ 27. If debt financing is used, which of the following is true?
a. The percentage change in net operating income is greater than a given percentage change in net income.
b. The percentage change in net operating income is equal to a given percentage change in net income.
c. The percentage change in net income relative to the percentage change in net operating income depends on the interest rate charged on debt.
d. The percentage change in net operating income is less than the percentage change in net income.
e. The degree of operating leverage is greater than 1.

____ 28. The Congress Company has identified two methods for producing playing cards. One method involves using a machine having a fixed cost of $10,000 and variable costs of $1.00 per deck of cards. The other method would use a less expensive machine (fixed cost = $5,000), but it would require greater variable costs ($1.50 per deck of cards). If the selling price per deck of cards will be the same under each method, at what level of output will the two methods produce the same net operating income?
a. 5,000 decks
b. 10,000 decks
c. 15,000 decks
d. 20,000 decks
e. 25,000 decks

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____ 1. Which of the following could explain why a business might choose to organize as a corporation rather than as a sole proprietorship or a partnership?
a. Corporations generally face fewer regulations.
b. Corporations generally face lower taxes.
c. Corporations generally find it easier to raise capital.
d. Corporations enjoy unlimited liability.
e. Statements c and d are correct.

Answer: C

____ 2. Given the following data, find the expected rate of inflation during the next year.

r* = real risk-free rate = 3%.

Maturity risk premium on 10-year T-bonds = 2%. It is zero on 1-year bonds, and a linear relationship exists.

Default risk premium on 10-year, A-rated bonds = 1.5%.

Liquidity premium = 0%.

Going interest rate on 1-year T-bonds = 8.5%.
a. 3.5%
b. 4.5%
c. 5.5%
d. 6.5%
e. 7.5%
Answer: C
r = r* + IP + DRP + MRP + LP
8.5% = 3% + IP + 0% + 0% + 0%
IP = 5.5%
r* = real risk-free rate of return
IP = inflation premium. This is the annual average expected inflation over the life of the bond
DRP = default risk premium
MRP = maturity risk premium
LP = liquidity premium
____ 3. You deposit $2,000 in a savings account that pays 10 percent interest, compounded annually. How much will your account be worth in 15 years?
a. $2,030.21
b. $5,000.00
c. $8,091.12
d. $8,354.50
e. $9,020.10

Answer: D

FV = 2,000(1 + 0.10)15

____ 4. You can earn 8 percent interest, compounded annually. How much must you deposit today to withdraw $10,000 in 6 years?
a. $5,402.69
b. $6,301.70
c. $6,756.76
d. $8,432.10
e. $9,259.26

Answer: B

PV = 10,000/(1 + 0.08)6

____ 5. Holmes Aircraft recently announced an increase in its net income, yet its net cash flow declined relative to last year. Which of the following could explain this performance?
a. The company's interest expense increased.
b. The company's depreciation expense declined.
c. The company's operating income declined.
d. All of the statements above are correct.
e. None of the statements above is correct.

Answer: D

____ 6. A company has the following balance sheet. What is its net operating working capital?

Cash $ 10 Accounts payable $30
Short-term investments 30 Accruals 10
Accounts receivable 50 Notes payable 50
Inventory 40 Current liabilities 90
Current assets 130 Long-term debt 60
Net fixed assets 100 Common equity 30
Retained earnings 50
Total assets $230 Total liab. & equity $230

a. $ 40
b. $ 60
c. $100
d. $130
e. $230

Answer: B

Net operating working capital = Cash + A/R + Inventory - A/P - Accruals
= 10 + 50 + 40 - 30 - 10 =

____ 7. Which of the following actions will increase a company's quick ratio?
a. Reduce inventories and use the proceeds to reduce long-term debt.
b. Reduce inventories and use the proceeds to reduce current liabilities.
c. Issue short-term debt and use the proceeds to purchase inventory.
d. Issue long-term debt and use the proceeds to purchase fixed assets.
e. Issue equity and use the proceeds to purchase inventory.

Answer: B

____ 8. Thomas Corp. has the following simplified balance sheet:

Cash $ 50,000 Current liabilities $125,000
Inventory 150,000
Accounts receivable 100,000 Long-term debt 175,000
Net fixed assets 200,000 Common equity 200,000
Total $500,000 Total $500,000

Sales for the year totaled $600,000. The company president believes the company carries excess inventory. She would like the inventory turnover ratio to be 8 and would use the freed up cash to reduce current liabilities. If the company follows the president's recommendation and sales remain the same, the new quick ratio would be:
a. 2.4
b. 4.0
c. 4.5
d. 1.2
e. 3.0

Answer: E

Inventory turnover ratio = Sales/Inventory = 600,000/150,000 = 4
8 = Sales/Inventory
8 = 600,000/Inventory
Inventory = 75,000

Quick ratio = Current assets - Inventory
Current Liabilities
= 150,000 + 75,000 - 75,000
125,000 - 75,000

____ 9. In a portfolio of three different stocks, which of the following could not be true?
a. The riskiness of the portfolio is less than the riskiness of each of the ...

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Financial Management - 40 Multiple Choice Questions in Finance

1. Which of the following could explain why a business might choose to organize as a corporation rather than as a sole proprietorship or a partnership?

a. Corporations generally face fewer regulations.
b. Corporations generally face lower taxes.
c. Corporations generally find it easier to raise capital.
d. Corporations enjoy unlimited liability.
e. Statements c and d are correct.

2. Which of the following statements is most correct?

a. Due to limited liability, unlimited lives, and ease of ownership transfer, the vast majority of U.S. businesses (in terms of number of businesses) are organized as corporations.
b. Most businesses (by number and total dollar sales) are organized as proprietorships or partnerships because it is easier to set up and operate in one of these forms rather than
as a corporation. However, if the business gets very large, it becomes advantageous to convert to a corporation, primarily because corporations have important tax advantages over
proprietorships and partnerships.
c. Due to legal considerations related to ownership transfers and limited liability, most business (measured by dollar sales) is conducted by corporations.
d. Statements a, b, and c are correct.
e. All of the statements are false.

3. Harmeling Enterprises experienced a decline in net operating profit after taxes (NOPAT). Which of the following definitely cannot help explain this decline?

a. Sales revenues decreased.
b. Costs of goods sold increased.
c. Depreciation increased.
d. Interest expense increased.
e. Taxes increased.

4. Which of the following statements is most correct?

a. Cash flows and accounting profit are not at all related since no common elements are used in the calculation of either individual measure.
b. Accounting profits are more important than free cash flow.
c. High inflation can seriously distort firms' balance sheets, and
since inflation also affects depreciation and inventory costs, profits can also be affected.
d. When an action is taken at one point in time, but its full effects cannot be accurately measured until later, this has the potential to affect the firm's financial statements. However, as long as the firm keeps the same standard accounting period this timing problem can be avoided.
e. None of the statements above is correct.

5. Which of the following alternatives could potentially result in a net increase in a company's free cash flow for the current year?
a. Reducing the days-sales-outstanding ratio.
b. Increasing the number of years over which fixed assets are depreciated.
c. Decreasing the accounts payable balance.
d. All of the answers above are correct.
e. Answers a and b are correct.

6. You observe that a firm's profit margin is below the industry average, its debt ratio is below the industry average, and its return on equity exceeds the industry average. What can you conclude?

a. Return on assets is above the industry average.
b. Total assets turnover is above the industry average.
c. Total assets turnover is below the industry average.
d. Both statements a and b are correct.
e. None of the statements above is correct.

7. The percentage of sales method produces accurate results unless which of the following conditions is (are) present?

a. Fixed assets are "lumpy."
b. Strong economies of scale are present.
c. Excess capacity exists because of a temporary recession.
d. Answers a, b, and c all make the percentage of sales methodinaccurate.
e. Answers a and c make the percentage of sales method inaccurate, but, as the text explains, the assumption of increasing economies of scale is built into the percentage of sales method.

8. A firm has the following balance sheet:

Cash $ 20 Accounts payable $ 20
Accounts receivable 20 Notes payable 40
Inventory 20 Long-term debt 80
Fixed assets 180 Common stock 80
Retained earnings 20
Total liabilities
Total assets $240 and equity $240
Sales for the year just ended were $400, and fixed assets were used at 80 percent of capacity, but its current assets were at optimal levels. Sales are expected to grow by 5 percent next year, the profit margin is 5 percent, and the dividend payout ratio is 60 percent.

How much additional funds (AFN) will be needed?
a. $4.6
b. -$6.4 (Surplus)
c. $2.4
d. -$4.6 (Surplus)
e. $0.8

9. Which of the following statements is correct?
a. The New York Stock Exchange is an organized auction market.
b. Money markets include markets for consumer automobile loans.
c. If an investor sells shares of stock through a broker, then it would be a primary market ransaction.
d. Capital market transactions involve only the purchase and sale of equity securities.
e. None of the answers above is correct.

10. Your company has the following balance sheet (in millions of dollars):
Current assets $4.0 Accounts payable $0.8
Net fixed assets 4.0 Notes payable 1.0
Accrued wages and taxes 0.2
Total current liabilities $2.0
Long-term debt 1.5
Common equity 1.5
Retained earnings 3.0
Total assets $8.0 Total liabilities and equity $8.0 You have determined the following facts: (1) last year's sales were $10 million; (2) the company will pay out 40 percent of earnings as dividends; (3) a profit margin of 3 percent is projected; (4) fixed assets were used to full capacity; and (5) all assets as well as spontaneous liabilities as shown on the balance sheet are expected to grow proportionally with sales. Further, your boss estimates she will need to raise $2 million externally by issuing new debt or common stock next year. If the above assumptions hold, what rate
of sales growth is your boss expecting? (Hint: You can use the AFN equation to help answer this problem.)

a. 12.50%
b. 15.25%
c. 18.00%
d. 23.15%
e. 31.96%

11. Which of the following statements is most correct?

a. The slope of the security market line is beta.
b. A stock with a negative beta must have a negative required rate of return.
c. If a stock's beta doubles its required rate of return must double.
d. If a stock has a beta equal to 1.0, its required rate of return will be unaffected by changes in the market risk premium.
e. None of the above statements is correct.

12. Inflation, recession, and high interest rates are economic events which are characterized as

a. Company-specific risk that can be diversified away.
b. Market risk.
c. Systematic risk that can be diversified away.
d. Diversifiable risk.
e. Unsystematic risk that can be diversified away.

13. Which of the following statements is most correct?

a. An efficient portfolio is one that provides the highest expected
rate of return for a given amount of risk.
b. An efficient portfolio is one that has the lowest amount of risk for a given expected rate of return.
c. The set of efficient portfolios is the same whether or not a risk free asset is considered.
d. Both a and b are correct.
e. Both a and c are correct.

14. Which of the following statements is most correct?

a. The Capital Market Line (CML) is a curved line that connects the risk-free rate and the market portfolio.
b. The slope of the CML is (�� k - k M RF)/ bM .
c. All portfolios that lie on the CML to the right of ΦM are inefficient.
d. All portfolios that lie on the CML to the left of ΦM are inefficient.
e. None of the above statements are correct.

15. Which of the following investments has the highest effective return (EAR)? (Assume that all CDs are of equal risk.)

a. A bank CD which pays 10 percent interest quarterly.
b. A bank CD which pays 10 percent monthly.
c. A bank CD which pays 10.2 percent annually.
d. A bank CD which pays 10 percent semiannually.
e. A bank CD which pays 9.6 percent daily (on a 365-day basis).

16. Assume you are to receive a 20-year annuity with annual payments of $50. The first payment will be received at the end of Year 1, and the last payment will be received at the end of Year 20. You will invest each payment in an account that pays 10 percent. What will be the value in your account at the end of Year 30?

a. $6,354.81
b. $7,427.83
c. $7,922.33
d. $8,591.00
e. $6,752.46

17. A 10-year corporate bond has an annual coupon payment of 9 percent. The bond is currently selling at par ($1,000). Which of the following statements is most correct?

a. The bond's yield to maturity is 9 percent.
b. The bond's current yield is 9 percent.
c. If the bond's yield to maturity remains constant, the bond's price will remain at par.
d. Both answers a and c are correct.
e. All of the answers above are correct.

18. Assume that all interest rates in the economy decline from 10 percent to 9 percent. Which of the following bonds will have the largest percentage increase in price?

a. A 10-year bond with a 10 percent coupon.
b. An 8-year bond with a 9 percent coupon.
c. A 10-year zero coupon bond.
d. A 1-year bond with a 15 percent coupon.
e. A 3-year bond with a 10 percent coupon.

19. Which of the following statements is most correct?
a. If a market is strong-form efficient this implies that the returns on bonds and stocks should be identical.
b. If a market is weak-form efficient this implies that all public information is rapidly incorporated into market prices.
c. If your uncle earns a return higher than the overall stock market, this means the stock market is inefficient.
d. Both answers a and b are correct.

e. None of the above answers is correct.

20. Which of the following statements is false?

a. When a corporation's shares are owned by a few individuals who are associated with or are the firm's management, we say that the firm is "closely held."
b. A publicly owned corporation is simply a company whose shares are held by the investing public, which may include other corporations and institutions as well as individuals.
c. Going public establishes a true market value for the firm and ensures that a liquid market will always exist for the firm's shares.
d. 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.
e. It is possible for a firm to go public, and yet not raise any additional new capital.

21. Which of the following is not considered a capital component for the purpose of calculating the weighted average cost of capital as it applies to capital budgeting?

a. Long-term debt.
b. Common stock.
c. Short-term debt used to finance seasonal current assets.
d. Preferred stock.
e. All of the above are considered capital components for WACC and capital budgeting purposes.

22. In applying the CAPM to estimate the cost of equity capital, which of the following elements is not subject to dispute or controversy?

a. The expected rate of return on the market, kM.
b. The stock's beta coefficient, bi.
c. The risk-free rate, kRF.
d. The market risk premium (RPM).
e. All of the above are subject to dispute.

23. Which of the following is not a barrier to a hostile takeover?

a. Nonpecuniary benefits.
b. Targeted share repurchases.
c. Shareholder rights provision.
d. Restricted voting rights.
e. Poison pill.

24. A company forecasts free cash flow of $40 million in three years. It expects the free cash flow to grow at a constant rate of 5 percent thereafter. If the weighted average cost of capital is 10 percent and the cost of equity is 15 percent, what is the horizon value, to the nearest million?

a. $280 million
b. $400 million
c. $420 million
d. $800 million
e. $840 million

25. Which of the following statements is most correct?
a. The NPV method assumes that cash flows will be reinvested at the cost of capital while the IRR method assumes reinvestment at the IRR.
b. The NPV method assumes that cash flows will be reinvested at the risk-free rate while the IRR method assumes reinvestment at the IRR.
c. The NPV method assumes that cash flows will be reinvested at the cost of capital while the IRR method assumes reinvestment at the risk-free rate.
d. The NPV method does not consider the inflation premium.
e. The IRR method does not consider all relevant cash flows, and particularly cash flows beyond the payback period.

26. Using the corporate valuation model, the value of a company's operations is $750 million. The company's balance sheet shows $50 million in short-term investments that are unrelated to operations. The balance sheet also shows $100 million in accounts payable, $100 million in notes payable, $200 million in long-term debt, $40 million in common stock (par plus paid-in-capital), and $160 million in retained earnings. What is your best estimate for the market value
of equity?

a. $200 million
b. $300 million
c. $400 million
d. $500 million
e. $600 million

27. When evaluating a new project, the firm should consider all of the following factors except:

a. Changes in working capital attributable to the project.
b. Previous expenditures associated with a market test to
determine the feasibility of the project, if the expenditures have been expensed for tax purposes.
c. The current market value of any equipment to be replaced.
d. The resulting difference in depreciation expense if the project involves replacement.
e. All of the statements above should be considered.

28. Which of the following statements is most correct?
a. The MIRR method will always arrive at the same conclusion as the NPV method.
b. The MIRR method can overcome the multiple IRR problem, while the NPV method cannot.
c. The MIRR method uses a more reasonable assumption about reinvestment rates than the IRR method.
d. Statements a and c are correct.
e. All of the above statements are correct.

29. The value of an option depends on the stock's price, the risk-free rate, and the

a. Exercise price.
b. Variability of the stock price.
c. Option's time to maturity.
d. All of the above.
e. None of the above.

30. Warnes Motors' stock is trading at $20 a share. Call options that expire in three months with an exercise price of $20 have a price of $1.50. Which of the following will occur if the stock price increases 10 percent to $22 a share?

a. The price of the call option will increase by $2.
b. The price of the call option will increase by more than $2.
c. The price of the call option will increase by less than $2, and the percentage increase in price will be less than 10 percent.
d. The price of the call option will increase by less than $2, but the percentage increase in price will be more than 10 percent.
e. The price of the call option will increase by more than $2, but the percentage increase in price will be less than 10 percent.

31. Which of the following would increase the likelihood that a company would increase its debt ratio in its capital structure?

a. An increase in costs incurred when filing for bankruptcy.
b. An increase in the corporate tax rate.
c. An increase in the personal tax rate.
d. A decrease in the firm's business risk.
e. Statements b and d are correct.

32. Company A and Company B have the same total assets, operating income (EBIT), tax rate, and business risk. Company A, however, has a much higher debt ratio than Company B. Company A's basic earning power (BEP) exceeds its cost of debt financing (kd). Which of
the following statements is most correct?

a. Company A has a higher return on assets (ROA) than Company B.
b. Company A has a higher times interest earned (TIE) ratio than Company B.
c. Company A has a higher return on equity (ROE) than Company B, and its risk, as measured by the standard deviation of ROE, is also higher than Company B's.
d. Statements b and c are correct.
e. All of the statements above are correct.

33. The trade-off theory provides several insights to financial managers concerning optimal capital structure. Which of the following insights is false?

a. Other things equal, firms with large amounts of marketable fixed assets should use more debt financing than firms whose value stems mostly from intangible assets.
b. Other things equal, firms with high corporate tax rates should use less debt financing than firms with low tax rates.
c. Other things equal, firms with high business risk should use less debt financing than firms with low business risk.

The following information applies to the next problem.
The Kimberly Corporation is a zero growth firm with an expected EBIT of $100,000 and a corporate tax rate of 30 percent. Kimberly uses $500,000 of 12.0 percent debt financing, and the cost of equity to an unlevered firm in the same risk class is 16.0 percent.

34. What is the value of the firm according to MM with corporate taxes?

a. $400,000
b. $437,500
c. $587,500
d. $625,000
e. $775,000

35. Which of the following would not have an influence on the optimal dividend policy?

a. The possibility of accelerating or delaying investment projects.
b. A strong shareholders' preference for current income versus capital gains.
c. Bond indenture constraints.
d. The costs associated with selling new common stock.
e. All of the statements above can have an effect on dividend policy.

36. Which of the following is not an advantage of going public?
a. It allows a firm's founders to diversify their holdings.
b. It increases the liquidity of the stock.
c. It establishes a value for the firm.
d. It makes it easier to raise new equity capital in the future.
e. All of the above are advantages of going public.

37. McGwire Company's pension fund projected that a significant number of its employees would take advantage of an early retirement program the company plans to offer in five years.
Anticipating the need to fund these pensions, the firm bought zero coupon U.S. Treasury Trust Certificates maturing in five years. When these instruments were originally issued, they were 12
percent coupon, 30-year U.S. Treasury bonds. The stripped Treasuries are currently priced to yield 10 percent. Their total maturity value is $6,000,000. What is their total cost (price) to
McGwire today?

a. $ 553,776
b. $5,142,600
c. $3,404,561
d. $4,042,040
e. $3,725,528

38. Reading Railroad's common stock is currently priced at $30, and its 8 percent convertible debentures (issued at par, or $1,000) are priced at $850. Each debenture can be converted into 25 shares of common stock at any time before 2005. What is the conversion price, CP, and
the conversion value of the bond?

a. $25.00; $1,000
b. $25.00; $ 750
c. $40.00; $ 750
d. $40.00; $ 850
e. $40.00; $1,000

39. Which of the following is typically part of the cash budget?
a. Payments lag.
b. Payment for plant construction.
c. Cumulative cash.
d. All of the above.
e. Only answers a and c above.

40. Assume that Sunshine Products Inc. has an agreement with Shady Finance Company to factor its receivables. Shady charges a flat commission of 2 percent of the receivables factored, plus 6 percent a year interest on the outstanding balance. It also deducts a reserve of 10 percent for returned and damaged materials. Interest and commission are paid in advance. No interest is charged on the reserve or the commission. If the average level of outstanding receivables is $700,000, and if they are turned over 4 times a year (hence the commission is paid 4 times a year), then what is the effective quarterly interest rate charged by Shady for this arrangement?

a. 6.05%
b. 3.83%
c. 7.52%
d. 9.31%
e. 10.56%

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