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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?

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

Solution Preview

____ 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 ...

Solution Summary

This solution is comprised of a detailed explanation to answer finance multiple choices.

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