What is the present value of an annuity of $120

Unit 2 Multiple Choice Questions (Enter your answers on the enclosed
answer sheet)
1. What is the present value of an annuity of $120 received at the end of each
year for 11 years? Assume a discount rate of 7%. The rst payment will be
received one year from today (round to nearest $1).
a. $570 b. $250 c. $400 d. $900
2. You bought a racehorse that has had a winning streak for six years, bringing in
$250,000 at the end of each year before dying of a heart attack. If you paid
$1,155,720 for the horse 4 years ago, what was your annual return over this
4-year period?
a. 12% b. 8% c. 18% d. 33%
3. How much money do I need to place into a bank account that pays a 1.08%
rate in order to have $500 at the end of 7 years?
a. $751.81 b. $463.78 c. $629.51 d. $332.54
4. Your daughter is born today and you want her to be a millionaire by the time
she is 40 years old. You open an investment account that promises to pay
11.5% per year. How much money must you deposit today so your daughter
will have $1,000,000 by her 35th birthday?
a. $20,100 b. $18,940 c. $28,575 d. $22,150
5. If you want to have $3,575 in 29 months, how much money must you put in a
savings account today? Assume that the savings account pays 12% and it is
compounded monthly (round to nearest $1).
a. $2,438 b. $2,679 c. $3,147 d. $3,008 Unit 2 Examination
BAM 313 Introduction to Financial Management
6. U.S. Savings Bonds are sold at a discount. The face value of the bond
represents its value on its future maturity date. Therefore:
1. The current price of a $50 face value bond that matures in 10 years
will be greater than the current price of a $50 face value bond that
matures in 5 years.
2. The current prices of all $50 face value bonds will be the same,
regardless of their maturity dates because they will all be worth $50 in
the future. 3. The current price of a $50 face value bond will be higher if interest
rates increase.
4. The current price of a $50 face value bond that matures in 10 years
will be less than the
current price of a $50 face value bond that matures on 5 years.
7. Stock A has the following returns for various states of the economy:
State of the Economy
Recession Below Average Average
Above Average Boom
Probability Stock A’s Return 9% -72% 16% -15%
51% 16% 14% 35% 10% 85% Unit 2 Examination
97 Stock A’s expected return is
a. 9.9%. b. 13.8% c. 12.7%. d. 16.5%.
8. Beginning with an investment in one company’s securities, as we add securities of
other companies to our portfolio, which type of risk declines?
1. unsystematic risk
2. market risk
3. systematic risk
4. non-diversi able risk
BAM 313 Introduction to Financial Management Unit 2 Examination Project 1 Probabilit Retu Standard
y
rn
Deviation Bet
a 50%
chance 22% 12% 50%
chance - 4% 1.1 Project 2 Probabilit Retu Standard
y
rn
Deviation Bet
a 30%
chance 36% 19.5% 0.8 40%
chance 10.5
% 30%
chance 20% Project 3 Probabilit Retu Standard
y
rn
Deviation Bet
a 10%
chance 28% 12% 2.0 70%
chance 18% 20%
chance - 8% 98 9. Assume the risk-free rate of return is 2% and the market risk premium is 8%.
If you are a risk averse investor, which project should you choose?
1. Project 3
2. Project 2
3. Project 1
4. Either Project 2 or Project 3 because the higher expected return on
project 3 offsets its
higher risk.
10. Stock A has a beta of 1.2 and a standard deviation of returns of 14%. Stock B
has a beta of 1.8 and a standard deviation of returns of 18%. If the risk-free
rate of return increases and the market risk premium remains constant, then:
1. the required returns on stocks A and B will not change
2. the required returns on stocks A and B will both increase by the same
amount
3. the required return on stock A will increase more than the required
return on stock B
4. the required return on stock B will increase more than the required
return on stock A
BAM 313 Introduction to Financial Management
99 11. Suppose interest rates have been at historically low levels the past two years.
A reasonable strategy for bond investors during this time period would be to:
1. buy only junk bonds which have higher interest rates
2. invest in long-term bonds to reduce interest rate risk
3. invest in short-term bonds to reduce interest rate risk
4. invest in long-term bonds to lock in a bond position for when interest
rates increase in the
future
12. Fred and Ethel are both considering buying a corporate bond with a coupon
rate of 8%, a face value of $1,000, and a maturity date of January 1, 2025.
Which of the following statements is MOST correct? 1. Fred and Ethel will only buy the bonds if the bonds are rated BBB or
above.
2. Because both Fred and Ethel will receive the same cash ows if they
each buy a bond,
they both must assign the same value to the bond.
3. If Fred decides to buy the bond, then Ethel will also decide to buy the
bond if markets are
ef cient.
4. Fred may determine a different value for a bond than Ethel because
each investor may
have a different level of risk aversion, and hence a different required
return.
13. Which of the following statements is true?
1. Short-term bonds have greater interest rate risk than do long-term
bonds.
2. Long-term bonds have greater interest rate risk than do short-term
bonds.
3. Interest rate risk is highest during periods of high interest rates.
4. All bonds have equal interest rate risk.
14. 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% inde nitely. What
is the required rate of return on Crandle’s stock?
a. 11.76% b. 11.11% c. 12.2% d. 14.21%
15. An example of the growth factor in common stock is:
1. retaining pro ts in order to reinvest into the rm
2. two strong companies merging together to increase their economies of
scale
3. acquiring a loan to fund an investment in Asia
4. issuing new stock to provide capital for future growth Unit 2 Examination
BAM 313 Introduction to Financial Management 100 16. Waterfront Solutions, Inc. paid a dividend of $5.00 per share on its common
stock yesterday. Dividends are expected to grow at a constant rate of 4% for
the next two years, at which point the stock is expected to sell for $56.00. If
investors require a rate of return on Waterfront’s common stock of 18%, what
should the stock sell for today?
a. $40.22 b. $50.22 c. $44.76 d. $48.51
17. Andre’s parents established a college savings plan for him when he was born.
They deposited $50 into the account on the last day of each month. The
account has earned 10.9% compounded monthly, tax-free. How much can
they withdraw on his 18th birthday to spend on his education?
a. $33,307 b. $30,028 c. $43,730 d. $27,560
18. Charlie wants to retire in 15 years, and he wants to have an annuity of
$50,000 a year for
20 years after retirement. Charlie wants to receive the rst annuity payment
the day he retires. Using an interest rate of 8%, how much must Charlie invest
today in order to have his retirement annuity (round to nearest $10).
a. $167,130 b. $315,240 c. $256,890 d. $200,450
An investor currently holds the following portfolio:
4,000 shares of Stock H 7,500 shares of Stock I 12,500 shares of Stock J
19. The beta for the portfolio is:
a. 1.45 b. 1.27 c. 1.99 d. 1.77
Amount
Invested
$8,000 Beta = 1.3 $24,000 Beta = 1.8 $48,000 Beta = 2.2 Unit 2 Examination
BAM 313 Introduction to Financial Management
101 20. Which of the following will cause the value of a bond to increase, if other
things held the same?
1. interest rates decrease
2. the company’s debt rating drops from AAA to BBB
3. investors’ required rate of return increases 4. the bond is callable
21. A small biotechnology research corporation has been experiencing losses for
the rst three years of its existence, and thus has a negative balance in
retained earnings. The corporation’s stock price, however, is $1 per share.
Which of the following statements is MOST correct?
1. The required return on the stock will be small because the company
has very few assets.
2. Investors believe the stock is worth $1 per share because future
earnings (and cash ows)
are expected to be positive.
3. The corporation’s accountants must have made a mistake because
retained earnings may
not be negative.
4. Investors are irrational to pay $1 per share when earnings per share
have been negative for
three years.
22. How much money must be put into a bank account yielding 6.42%
(compounded annually) in order to have $1,671 at the end of 11 years?
(round to nearest $1)
a. $798 b. $886 c. $921 d. $843
23. Wendy purchased 800 shares of Robotics Stock at $3 per share on 1/1/09.
Wendy sold the shares on 12/31/09 for $3.45. Genetics stock has a beta of
1.3, the risk-free rate of return is 3%, and the market risk premium is 8%. The
required return on Genetics Stock is:
a. 21.1% b. 13.4% c. 16.5% d. 17.6% Unit 2 Examination
BAM 313 Introduction to Financial Management
102 24. Bart’s Moving Company bonds have a 11% coupon rate. Interest is paid
semiannually. The bonds have a par value of $1,000 and will mature 8 years
from now. Compute the value of Bart’s Moving Company bonds if investors’
required rate of return is 9.5%.
a. $1,133.05 b. $1,098.99 c. $1,082.75 d. $1,197.27 25. Jackson Corp. common stock paid $2.50 in dividends last year (D0). Dividends
are expected to grow at a 12-percent annual rate forever. If Jackson’s current
market price is $40.00, what is the stock’s expected rate of return? (nearest .
01 percent)
a. 18.25% b. 5.50% c. 11.00% d. 19.00%
Unit 3: Multiple Choice Questions (Enter your answers on the enclosed answer sheet) 1. The DEF Company is planning a $64 million expansion. The expansion is to be
nanced by selling $25.6 million in new debt and $38.4 million in new common stock.
The before-tax required rate of return on debt is 9 percent and the required rate of
return on equity is 14 percent. If the company is in the 35 percent tax bracket, what
is the rm’s cost of capital?
a. 8.92% b. 10.74% c. 11.50% d. 9.89%
Valley Flights, Inc. has a capital structure made up of 40% debt and 60% equity and a
tax rate of 30%. A new issue of $1,000 par bonds maturing in 20 years can be issued
with a coupon of 9% at a price of $1,098.18 with no otation costs. The rm has no
internal equity available for investment at this time, but can issue new common stock
at a price of $45. The next expected dividend on the stock is $2.70. The dividend for
the rm is expected to grow at constant annual rate of 5% per year inde nitely.
Flotation costs on new equity will be $7.00 per share. The company has the following
independent investment projects available:
Project
Initial Outlay IRR
1. 1 $100,000 10% 2. 2 $10,000 8.5% 3. 3 $50,000 12.5% 2. Which of the above projects should the company take on?
1. Project 3 only
2. Projects 1, 2 and 3
3. Projects 1 and 3
4. Projects 1 and 2
3. PrimaCare has a capital structure that consists of $7 million of debt, $2 million
of preferred stock, and $11 million of common equity, based upon current
market values. The rm’s yield to maturity on its bonds is 7.4%, and investors
require an 8% return on the rm’s preferred stock and a 14% return on
PrimaCare’s common stock. If the tax rate is 35%, what is PrimaCare’s WACC? a. 7.21% b. 10.18% c. 12.25% d. 8.12% Unit 3 Examination
BAM 313 Introduction to Financial Management
136 4. JPR Company is nanced 75 percent by equity and 25 percent by debt. If the rm
expects to earn $30 million in net income next year and retain 40% of it, how
large can the capital budget be before common stock must be sold?
1. $15.5 million
2. $7.5 million
3. $16.0 million
4. $12.0 million
5. All else equal, an increase in beta results in:
1. an increase in the cost of retained earnings
2. an increase in the cost of common equity, whether or not the funds
come from retained
earnings or newly issued common stock
3. an increase in the cost of newly issued common stock
4. an increase in the after-tax cost of debt
6. Haroldson Inc. common stock is selling for $22 per share. The last dividend
was $1.20, and dividends are expected to grow at a 6% annual rate. Flotation
costs on new stock sales are 5% of the selling price. What is the cost of
Haroldson’s retained earnings?
a. 12.09% b. 11.78% c. 11.45% d. 5.73%
7. A company has preferred stock that can be sold for $21 per share. The
preferred stock pays an annual dividend of 3.5% based on a par value of
$100. Flotation costs associated with the sale of preferred stock equal $1.25
per share. The company’s marginal tax rate is 35%. Therefore, the cost of
preferred stock is:
a. 14.26% b. 12.94% c. 18.87% d. 17.72%
8. Which of the following should NOT be considered when calculating a rm’s
WACC? 1. after-tax YTM on a rm’s bonds
2. cost of newly issued preferred stock
3. after-tax cost of accounts payable
4. cost of newly issued common stock Unit 3 Examination
BAM 313 Introduction to Financial Management
137 9. Your rm is considering an investment that will cost $920,000 today. The
investment will produce cash ows of $450,000 in year 1, $270,000 in years 2
through 4, and $200,000 in year 5. The discount rate that your rm uses for
projects of this type is 11.25%. What is the investment’s pro tability index?
a. 1.26 b. 1.69 c. 1.21 d. 1.43
10. Your rm is considering investing in one of two mutually exclusive projects.
Project A requires an initial outlay of $3,500 with expected future cash ows of
$2,000 per year for the next three years. Project B requires an initial outlay of
$2,500 with expected future cash ows of $1,500 per year for the next two
years. The appropriate discount rate for your rm is 12% and it is not subject to
capital rationing. Assuming both projects can be replaced with a similar
investment at the end of their respective lives, compute the NPV of the two
chain cycle for Project A and three chain cycle for Project B.
1. $2,865 and $94
2. $3,528 and $136
3. $5,000 and $1,500
4. $2,232 and $85
11. The capital budgeting manager for XYZ Corporation, a very pro table high
technology company, completed her analysis of Project A assuming 5-year
depreciation. Her accountant reviews the analysis and changes the
depreciation method to 3-year depreciation. This change will:
1. increase the present value of the NCFs
2. have no effect on the NCFs because depreciation is a non-cash
expense
3. only change the NCFs if the useful life of the depreciable asset is
greater than 5 years 4. decrease the present value of the NCFs
12. 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 modi
ed internal rate of return for Project B is:
a. 18.52% b. 22.80% c. 19.75% d. 17.84% Unit 3 Examination
BAM 313 Introduction to Financial Management
138 13. A capital budgeting project has a net present value of $30,000 and a modi ed
internal rate of return of 15%. The project’s required rate of return is 13%. The
internal rate of return is:
1. greater than $30,000
2. greater than 15%
3. between 13% and 15%
4. less than 13%
14. A new project is expected to generate $800,000 in revenues, $250,000 in
cash operating expenses, and depreciation expense of $150,000 in each year
of its 10-year life. The corporation’s tax rate is 35%. The project will require an
increase in net working capital of $85,000 in year one and a decrease in net
working capital of $75,000 in year ten. What is the free cash ow from the
project in year one?
a. $410,000 b. $375,000 c. $380,000 d. $298,000
15. A local restaurant owner is considering expanding into another rural area. The
expansion project will be nanced through a line of credit with City Bank. The
administrative costs of obtaining the line of credit are $500, and the interest
payments are expected to be $1,000 per month. The new restaurant will
occupy an existing building that can be rented for $2,500 per month. The
incremental cash ows for the new restaurant include:
1. $2,500 per month rent
2. $500 administrative costs, $1,000 per month interest payments,
$2,500 per month rent
3. $1,000 per month interest payments, $2,500 per month rent 4. $500 administrative costs, $2,500 per month rent
16. Which of the following should be included in the initial outlay?
1. increased investment in inventory and accounts receivable
2. preexisting rm overhead reallocated to the new project
3. rst year depreciation expense on any new equipment purchased
4. taxable gain on the sale of old equipment being replaced Unit 3 Examination
BAM 313 Introduction to Financial Management
139 17. QRW Corp. needs to replace an old lathe with a new, more ef cient model. The
old lathe was purchased for $50,000 nine years ago and has a current book
value of $5,000. (The old machine is being depreciated on a straight-line basis
over a ten-year useful life.) The new machine costs $100,000. It will cost the
company $10,000 to get the new lathe to the factory and get it installed. The
old machine will be sold as scrap metal for $2,000. The new machine is also
being depreciated on a straight-line basis over ten years. Sales are expected
to increase by $8,000 per year while operating expenses are expected to
decrease by $12,000 per year. QRW’s marginal tax rate is 40%. Additional
working capital of $3,000 is required to maintain the new machine and higher
sales level. The new lathe is expected to be sold for $5,000 at the end of the
project’s ten-year life. What is the incremental free cash ow during year 1 of
the project?
1. $11,400
2. $15,200
3. $12,800
4. $14,400
18. The cost of retained earnings is less than the cost of new common stock
because:
1. dividends are not tax deductible
2. otation costs are incurred when new stock is issued
3. accounting rules allow a deduction when using retained earnings
4. marginal tax brackets increase 19. Beauty Inc. plans to maintain its optimal capital structure of 40 percent debt,
10 percent preferred stock, and 50 percent common equity inde nitely. The
required return on each component source of capital is as follows: debt--8
percent; preferred stock--12 percent; common equity--16 percent. Assuming a
40 percent marginal tax rate, what after-tax rate of return must the rm earn
on its investments if the value of the rm is to remain unchanged?
1. 12.00 percent
2. 11.12 percent
3. 12.40 percent
4. 10.64 percent
20. Your rm is considering an investment that will cost $920,000 today. The
investment will produce cash ows of $450,000 in year 1, $270,000 in years 2
through 4, and $200,000 in year 5. The discount rate that your rm uses for
projects of this type is 11.25%. What is the investment’s internal rate of
return?
a. 15.98% b. 27.28% c. 20.53% d. 21.26% Unit 3 Examination
BAM 313 Introduction to Financial Management
140 21. The advantages of NPV are all of the following EXCEPT:
1. it provides the amount by which positive NPV projects will increase the
value of the rm
2. it allows the comparison of bene ts and costs in a logical manner
through the use of time
value of money principles
3. it recognizes the timing of the bene ts resulting from the project
4. it can be used as a rough screening device to eliminate those projects
whose returns do
not materialize until later years
22. Which of the following are included in the terminal cash ow?
1. recapture of any working capital increase included in the initial outlay
2. the expected salvage value of the asset 3. any tax payments or receipts associated with the salvage value of the
asset
4. all of the above
23. Which of the following differentiates the cost of retained earnings from the
cost of newly issued common stock?
1. the larger dividends paid to the new common stockholders
2. the otation costs incurred when issuing new securities
3. the cost of the pre-emptive rights held by existing shareholders
4. the greater marginal tax rate faced by the now-larger rm
24. 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 pro
tability index for Project B is:
a. 1.55 b. 1.39 c. 1.33 d. 1.48
25. When terminating a project for capital budgeting purposes, the working
capital outlay required
at the initiation of the project will:
1. increase the cash ow because it is recaptured
2. decrease the cash ow because it is an outlay
3. not affect the cash ow
4. decrease the cash ow because it is a historical cost Unit 4:
Multiple Choice Questions (Enter your answers on the enclosed
answer sheet)
1. A high degree of variability in a rm’s earnings before interest and taxes refers
to:
a. business risk
b. nancial leverage c. operating leverage d. nancial risk
2. If a rm has no operating leverage and no nancial leverage, then a 10%
increase in sales will have what effect on EPS? 1. EPS will increase by 10%
2. EPS will remain the same
3. EPS will increase by less than 10%
4. EPS will decrease by 10%
3. According to the moderate view of capital costs and nancial leverage, as the
use of debt nancing increases:
1. the cost of capital continuously increases
2. there is an optimal level of debt nancing
3. the cost of capital remains constant
4. the cost of capital continuously decreases
4. The primary weakness of EBIT-EPS analysis is that:
1. it double counts the cost of debt nancing
2. it applies only to rms with large amounts of debt in their capital
structure
3. it may only be used by rms that are pro table this year
4. it ignores the implicit cost of debt nancing
5. Potential applications of the break-even model include:
1. optimizing the cash-marketable securities position of a rm
2. replacement for time-adjusted capital budgeting techniques
3. pricing policy
4. All of the above. Unit 4 Examination
BAM 313 Introduction to Financial Management
191 6. The Modigliani and Miller hypothesis does NOT work in the “real world”
because: 1. interest expense is tax deductible, providing an advantage to debt
nancing
2. higher levels of debt increase the likelihood of bankruptcy, and
bankruptcy has real costs
for any corporation
3. both a and b
4. dividend payments are xed and tax deductible for the corporation
7. A corporation with very high growth prospects and many positive NPV projects
to fund may want to increase its dividend based on the:
1. very low agency costs of the corporation
2. information effect
3. tax bias against capital gains
4. residual dividend theory
8. Which of the following strategies may be used to alter a rm’s capital structure
toward a higher percentage of debt compared to equity?
1. stock split
2. stock repurchase
3. stock dividend
4. maintain a low dividend payout ratio
9. AFB, Inc.’s dividend policy is to maintain a constant payout ratio. This year
AFB, Inc. paid out a total of $2 million in dividends. Next year, AFB, Inc.’s sales
and earnings per share are expected to increase. Dividend payments are
expected to:
1. increase above $2 million only if the company issues additional shares
of common stock
2. decrease below $2 million
3. increase above $2 million
4. remain at $2 million
10. Which of the following is true? 1. In industries with volatile earnings, the residual dividend policy results
in the most consistent dividend stream.
2. If the clientele effect is correct, rms should follow a constant dividend
payout ratio policy.
3. In general, the higher the number of positive NPV investment
opportunities for a rm, the
lower the dividend payout ratio.
4. According to the informational content of dividends, an increase in
dividends is always a
positive signal. Unit 4 Examination
BAM 313 Introduction to Financial Management
192 11. Which of the following is always a non-cash expense?
1. salaries
2. depreciation
3. income taxes
4. None of the above.
12. Which of the following is a limitation of the “percent of sales method” of
preparing pro forma nancial statements?
1. Inventory levels are seldom affected by changes in sales volume.
2. A rm’s investment in accounts receivable is seldom related to sales
volume.
3. Not all assets and liabilities increase or decrease as a constant percent
of sales.
4. The dividend payout ratio may change from one year to the next.
13. Spontaneous sources of funds refer to all of the below EXCEPT:
1. accounts payable
2. accruals 3. common stock
4. a bank loan
14. Selection of a source of short-term nancing should include all of the following
EXCEPT:
1. the effect of the use of credit from a particular source on the cost and
availability of other sources of credit
2. the oatation costs for debentures
3. the effective cost of credit
4. the availability of nancing in the amount and for t...