2) A Perpetuity pays $85 per year and costs $950. What is the rate of return?
A)
8.95%: PV=PMT/I I= PMT/PV 85/950= 0.0894
The greater the number of compounding periods within a year, then (1) the greater the future value of a lump sum investment at Time 0 and (2) the smaller the present value of a given lump sum to be received at some future date. (T/F)
True PV= (FVn)/ (1+I)^n
A stock's beta measures its diversifiable risk relative to the diversifiable risks of other firms (T/F)
False. A stocks beta measures the stocks volatility in relation to the market. Market has beta of 1. Beta over 1= more volatility, but could have higher returns.
A firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions. (T/F)
TRUE
A call provision gives bondholders the right to demand, or "call for," repayment of a bond. Typically, calls are exercised if interest rates rise, because when rates rise the bondholder can get the principal amount back and reinvest it elsewhere at higher
False.
Call provisions provides "Issuers" of the bond the right to call the bond and have it redeemed prior to maturity. If interest rates have declined since the company first issued the bond, the company is likely to want to refinance this debt at the l
There is an inverse relationship between bonds' quality ratings and their required rates of return. Thus, the required return is lowest for AAA-rated bonds, and required returns increase as the ratings get lower. (T/F)
True.
Lower rated bonds, are a bit riskier, but can hold higher returns.
The required rate of return (RRR) is the minimum annual percentage earned by an investment that will induce individuals or companies to put money into a particular security or projec
A bond has a $1,000 par value, makes annual interest payments of $100, has 5 years to maturity, cannot be called, and is not expected to default. The bond should sell at a premium if interest rates are below 10% and at a discount if interest rates are gre
True. If a bond's coupon rate is less than its YTM, the bond is selling a a discount rate. If coupon rate is more then YTM, then bond is selling at premium. If Coupon rate = YTM, than bond is selling at par. Premium Bond (Bond priced above its par value)
Assume that all interest rates in the economy decline from 10% to 9%. Which of the following bonds would have the largest percentage increase in price?
a. A 1-year bond with a 15% coupon.
b. A 3-year bond with a 10% coupon.
c. A 10-year zero coupon bond.
C. Zero coupon bond is paid at discount price but owner receives bonds face value. No interest effect. Interest goes down and older Bond's become more valuable w/ a higher coupon rate.
Below is the common equity section (in millions) of Fethe Industries' last two year-end balance sheets:
2015 2014
Common stock $2,000 $1,000
Retained earnings 2,000 2,340
Total common equity $4,000 $3,340
The company has never paid a dividend to its commo
B
11. Rao Corporation has the following balance sheet. How much net operating working capital does the firm have?
Cash $ 10 Accounts payable $ 20
Short-term investments 30 Accruals 20
Accounts receivable 50 Notes payable 50
Inventory 40 Current liabilities
ANSWER: b
RATIONALE: Net operating working capital = Operating current assets ? Operating current liabilities NOWC = $100.00 ? $40.00 NOWC = $60.00
12. A firm wants to strengthen its financial position. Which of the following actions would increase its quick ratio?
a. Issue new common stock and use the proceeds to acquire additional fixed assets.
b. Offer price reductions along with generous credit t
B.
Inventory is less Liquid asset. Quick ratio measures the $ amount of liquid assets available for each $ amount of current Liabilities.
13. If a bank loan officer were considering a company's request for a loan, which of the following statements would you consider to be CORRECT?
a. Other things held constant, the lower the current ratio, the lower the interest rate the bank would charge t
D
14. Which of the following would indicate an improvement in a company's financial position, holding other things constant?
a. The current and quick ratios both increase.
b. The inventory and total assets turnover ratios both decline.
c. The debt ratio inc
A
15) Companies Heidee and Leaudy have the same tax rate, sales, total assets, and basic earning power. Both companies have positive net incomes. Company Heidee has a higher debt ratio and, therefore, a higher interest expense. Which of the following statem
ANSWER: a
RATIONALE: Heidee has higher interest charges. Basic earning power equals EBIT/Assets, and since assets are equal, EBIT must also be equal. TIE = EBIT/Interest. Therefore, Heidee higher interest charges means that its TIE must be lower. Thus, a
16. The Jameson Company just paid a dividend of $0.75 per share, and that dividend is expected to grow at a constant rate of 5.50% per year in the future. The company's beta is 1.15, the market risk premium is 5.00%, and the risk-free rate is 4.00%. What
ANSWER: a
RATIONALE: D0 $0.75
b 1.15
rRF 4.0%
RPM 5.0%
g 5.5%
D1 = D0(1 + g) = $0.7913
rs = rRF + b(RPM) = 9.75%
P0 = D1/(rs ? g) $18.62
17. Justus Motor Co.has a WACC of 11.50%, and its value of operations is $25.00 million. Justus's free cash flow is expected to grow at a constant rate of 7.00%. What was the last free cash flow, FCF0 in millions?
a. $0.95
b. $1.05
c. $1.16
d. $1.27
e. $1
ANSWER: b
RATIONALE: Value of operations $25.00
Required return 11.50%
Growth rate 7.00%
Vops = FCF1/(WACC ? g), so FCF1 = Vops(WACC ? g) = $1.1250
Last FCF = FCF0 = FCF1/(1 + g) $1.05
18. Gere Furniture forecasts a free cash flow of $40 million in Year 3, i.e., at t = 3, and it expects FCF to grow at a constant rate of 5% thereafter. If the weighted average cost of capital is 10% and the cost of equity is 15%, what is the horizon value
ANSWER: a
RATIONALE: FCF3: $40
g: 5%
WACC: 10%
HV3 = FCF4/(WACC ? g) = FCF3(1 + g)/(WACC ? g)
= $40(1 + 0.05)/(0.10 ? 0.05) = $42/0.05 = $840
19. The value of Broadway-Brooks Inc.'s operations is $900 million, based on the free cash flow valuation model. Its balance sheet shows $70 million in accounts receivable, $50 million in inventory, $30 million in short-term investments that are unrelated
ANSWER: c
RATIONALE: Value of operations: $900
Short-term investments: $30
Notes payable: $110
Long-term debt: $90
Preferred stock $20
Shares outstanding: 25
Assuming that the book value of debt is close to its market value, the total market value of the
Two important issues in corporate governance are (1) the rules that cover the board's ability to fire the CEO and (2) the rules that cover the CEO's ability to remove members of the board.
FALSE
The cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt.
FALSE
22. Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting?
a. Accounts payable.
b. Common stock "raised" by reinvesting earnings.
c. Common stock raised by new issues.
d
A
23. The Lincoln Company sold a $1,000 par value, noncallable bond several years ago that now has 20 years to maturity and a 7.00% annual coupon that is paid semiannually. The bond currently sells for $925 and the company's tax rate is 40%. What is the com
C)
Coupon rate 7.00%
Periods/year 2
Maturity (yr) 20
Bond price $925.00
Par value $1,000
Tax rate 40%
Calculator inputs:
N = Periods/year � Maturity 40
PV = Bond's price ?$925.00
PMT = Coupon rate � Par/2 $35
FV = Par = Maturity value $1,000
I/YR 3.87%
Ti
24. The CEO of Harding Media Inc. as asked you to help estimate its cost of common equity. You have obtained the following data: D0 = $0.85; P0 = $22.00; and g = 6.00% (constant). The CEO thinks, however, that the stock price is temporarily depressed, and
C)
Old Price New Price
D0 $0.85 $0.85
P0 $22.00 $40.00
g 6.00% 6.00%
D1 = D0 � (1 + g) $0.901 $0.901
rs = D1/P0 + g 10.10% 8.25%
Difference, rs0 ? rs1 ?1.84%
25. Westbrook's Painting Co. plans to issue a $1,000 par value, 20-year noncallable bond with a 7.00% annual coupon, paid semiannually. The company's marginal tax rate is 40.00%, but Congress is considering a change in the corporate tax rate to 30.00%. By
C)
Old rate, 40% New rate
Coupon rate 7.00% 7.00%
Periods/year 2 2
Maturity (yr) 20 20
Bond price = Par value $1,000 $1,000
Old and New tax rates 40% 30%
Calculator inputs:
N = Periods/year � Maturity 40 40
PV = Bond's price ?$1,000 ?$1,000
PMT = Coupon r
26. Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.
a. The higher the WACC used to calculate the NPV, the lower the calculated NPV will be.
b.
A) The higher the WACC used to calculate the NPV, the lower the calculated NPV will be.
27. Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.
a. A project's regular IRR is found by discounting the cash inflows at the WACC to find the
C)
28. Which of the following statements is CORRECT?
a. If a project has "normal" cash flows, then its MIRR must be positive.
b. If a project has "normal" cash flows, then it will have exactly two real IRRs.
c. The definition of "normal" cash flows is that t
D
29. Which of the following statements is CORRECT?
a. Sunk costs must be considered if the IRR method is used but not if the firm relies on the NPV method.
b. A good example of a sunk cost is a situation where a bank opens a new office, and that new office
C
30. Which of the following statements is CORRECT?
a. Only incremental cash flows are relevant in project analysis, the proper incremental cash flows are the reported accounting profits, and thus reported accounting income should be used as the basis for i
C
31. The optimal capital structure has been achieved when the:
A. debt-equity ratio is equal to 1.
B. weight of equity is equal to the weight of debt.
C. cost of equity is maximized given a pre-tax cost of debt.
D. debt-equity ratio is such that the cost o
E
32. The proposition that a firm borrows up to the point where the marginal benefit of the interest tax shield derived from increased debt is just equal to the marginal expense of the resulting increase in financial distress costs is called:
A. the static
A
33. Bruce & Co. expects its EBIT to be $100,000 every year forever. The firm can borrow at 11 percent. Bruce currently has no debt, and its cost of equity is 18 percent. The tax rate is 31 percent. Bruce will borrow $61,000 and use the proceeds to repurch
C)
VU = $100,000(1 - 0.31)/0.18 = $383,333.33
VL = $383,333.33 + 0.31($61,000) = $402,243.33
RE = 0.18 + (0.18 - 0.11)($61,000/$402,243.33 - $61,000)(1 - 0.31) = 0.1886
WACC = 0.1886($402,243.33 - $61,000)/$402,243.33 + 0.11($61,000/$402,243.33) (1 - 0.31
34. LeCompte Learning Solutions is considering making a change to its capital structure in hopes of increasing its value. The company's capital structure consists of debt and common stock. In order to estimate the cost of debt, the company has produced th
D)
rRF = 5%; rM ? rRF = 6%. rs = rRF + (rM ? rRF)b. WACC = rd � wd � (1 ? T) + rs � wc. You need to use the D/E ratio given for each capital structure to find the levered beta using the Hamada equation. Then, use each of these betas with the CAPM to find
HW 35
35. Whitson Co. is looking for ways to shorten its cash conversion cycle. It has annual sales of $36,500,000, or $100,000 a day on a 365-day basis. The firm's cost of goods sold is 75% of sales. On average, the company has $9,000,000 in inventory an
?