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Multiple Choice

Identify the choice that best completes the statement or answers the question.

____ 1. What would the future value of $100 be after 5 years at 10% compound interest?

a. $161.05

b. $134.54

c. $127.84

d. $151.29

e. $143.65

____ 2. Suppose a U.S. government bond promises to pay $2,249.73 three years from now. If the going interest rate

on 3-year government bonds is 6%, how much is the bond worth today?

a. $2,011.87

b. $2,591.45

c. $2,324.89

d. $1,888.92

e. $2,854.13

____ 3. Sims Inc. earned $1.00 per share in 2000. Five years later, in 2005, it earned $2.00. What was the growth rate

in Sims' earnings per share (EPS) over the 5-year period?

a. 10.82%

b. 14.87%

c. 13.61%

d. 14.28%

e. 12.17%

____ 4. Addico Corp's 2005 earnings per share were $2, and its growth rate during the prior 5 years was 11.0% per

year. If that growth rate were maintained, how long would it take for Addico's EPS to double?

a. 6.64 years

b. 6.81 years

c. 6.99 years

d. 7.13 years

e. 7.28 years

____ 5. What is the PV of an annuity due with 5 payments of $1,000 at an interest rate of 5%?

a. $11,110.34

b. $13,637.85

c. $12,513.68

d. $14,976.84

e. $15,349.15

____ 6. Your father has $500,000 invested at 8%, and he now wants to retire. He wants to withdraw $50,000 at the

beginning of each year, beginning immediately. How many years will it take to exhaust his funds, i.e., run the

account down to zero?

a. 11.34 years

b. 18.49 years

c. 17.54 years

d. 13.91 years

e. 15.27 years

____ 7. What's the present value of a 6-year ordinary annuity of $1,000 per year plus an additional $1,500 at the end

of Year 6 if the interest rate is 6%?

a. $5,324.89

b. $5,591.45

c. $5,974.77

d. $6,011.87

e. $4,854.13

____ 8. If a bank pays a 6% nominal rate, with monthly compounding, on deposits, what effective annual rate does

the bank pay?

a. 6.17%

b. 6.71%

c. 5.10%

d. 6.59%

e. 5.91%

____ 9. You are buying your first house for $220,000, and are paying $30,000 as a down payment. You have arranged

to finance the remaining $190,000 30-year mortgage with a 7% nominal interest rate and monthly payments.

What are the equal monthly payments you must make?

a. $1,513

b. $1,110

c. $1,264

d. $1,976

e. $1,349

____ 10. Companies generate income from their "regular" operations and from things like interest on securities they

hold, which is called non-operating income. Mitel Metals recently reported $9,000 of sales, $6,000 of

operating costs other than depreciation, and $1,500 of depreciation. The company had no amortization

charges and no non-operating income. It had issued $4,000 of bonds that carry a 7% interest rate, and its

federal-plus-state income tax rate was 40%. What was the firm's operating income, or EBIT?

a. $1,100

b. $1,200

c. $1,300

d. $1,400

e. $1,500

____ 11. Madison Metals recently reported $9,000 of sales, $6,000 of operating costs other than depreciation, and

$1,500 of depreciation. The company had no amortization charges and no non-operating income. It had issued

$4,000 of bonds that carry a 7% interest rate, and its federal-plus-state income tax rate was 40%. What was

the firm's taxable, or pre-tax, income?

a. $1,180

b. $1,220

c. $1,260

d. $1,300

e. $1,340

____ 12. Fine Breads Inc. paid out $26,000 common dividends during 2005, and it ended the year with $150,000 of

retained earnings. The prior year's retained earnings were $145,500. What was the firm's 2005 net income?

a. $30,000

b. $31,000

c. $32,000

d. $33,000

e. $34,000

____ 13. Cox Corporation reported EBITDA of $22.5 million and $5.4 million of net income. The company has a $6

million interest expense and its corporate tax rate is 35%. What was Cox's depreciation and amortization

expense?

a. $ 4,333,650

b. $ 8,192,308

c. $ 9,427,973

d. $11,567,981

e. $14,307,692

____ 14. Garfield Inc. is expanding throughout the Southeast United States, and it expects sales to increase by $1

million and operating costs (excluding depr and amort) by $700,000. Depreciation and amortization expenses

will rise by $50,000 and interest expense by $150,000, while the company's tax rate will remain at 40%. If the

company's forecast is correct, how much will net income change, as a result of the expansion?

a. No change

b. $ 40,000 increase

c. $ 60,000 increase

d. $100,000 increase

e. $180,000 increase

____ 15. Hebner Housing Corporation has forecast the following numbers for the upcoming year:

• Sales = $1,000,000.

• Cost of goods sold = 600,000.

• Interest expense = 100,000.

• Net income = 180,000.

The company is in the 40% tax bracket, and its cost of goods sold always represents 60% of its sales.

The company's CEO is unhappy with the forecast and wants the firm to achieve a net income equal to

$240,000. Assuming interest expense is unchanged, what level of sales will the company have to achieve?

a. $ 400,000

b. $ 500,000

c. $ 750,000

d. $1,000,000

e. $1,250,000

____ 16. Swann Systems has forecast this income statement for the upcoming year:

Sales $5,000,000

Operating costs (excluding depr and amort) 3,000,000

EBITDA $2,000,000

Depreciation and amortization 500,000

EBIT $1,500,000

Interest 500,000

EBT $1,000,000

Taxes (40%) 400,000

Net income $ 600,000

The company's president is unsatisfied with the forecast and wants to see higher sales and a forecasted net

income of $2,000,000.

Assume that operating costs are always 60% of sales, and that depreciation and amortization, interest expense,

and the company's tax rate (40%), will remain the same even if sales change. How much in sales would

Swann have to obtain to generate $2,000,000 in net income?

a. $ 5,800,000

b. $ 6,000,000

c. $ 7,200,000

d. $ 8,300,000

e. $10,833,333

____ 17. A real estate investment has the following expected cash flows:

1 $10,000

2 25,000

3 50,000

4 35,000

a. $103,799

b. $ 96,110

c. $ 95,353

d. $120,000

e. $ 77,592

____ 18. An investment pays $100 every six months (semiannually) over the next 2.5 years. Interest, however, is

compounded quarterly, at a nominal rate of 8%. What is the future value of the investment after 2.5 years?

a. $520.61

b. $541.63

c. $542.07

d. $543.98

e. $547.49

____ 19. The Wilson Corporation has the following results:

Return on assets (ROA) 4.0%

Return on equity (ROE) 6.0%

a. 2%; 0.33

b. 4%; 0.33

c. 4%; 0.67

d. 2%; 0.67

e. 4%; 0.50

____ 20. Cleveland Corporation has 100,000 shares of common stock outstanding, its net income is $750,000, and its

P/E is 8. What is the company's stock price?

a. $20.00

b. $30.00

c. $40.00

d. $50.00

e. $60.00

____ 21. Humphrey Hotels' operating income (EBIT) is $40 million. The company's times interest earned (TIE) ratio is

8.0, its tax rate is 40%, and its basic earning power (BEP) ratio is 10%. What is the company's return on

assets (ROA)?

a. 6.45%

b. 5.97%

c. 4.33%

d. 8.56%

e. 5.25%

____ 22. Assume Meyer Corporation is 100% equity financed. Calculate the return on equity (ROE), given the

following information:

Sales $5,000

Dividend payout ratio 60%

Total assets turnover 2.0

Tax rate 30%

a. 25%

b. 30%

c. 35%

d. 42%

e. 50%

____ 23. Moss Motors has $8 billion in assets, and its tax rate is 40%. The company's basic earning power (BEP) ratio

is 12%, and its return on assets (ROA) is 3%. What is Moss' times interest earned (TIE) ratio?

a. 2.25

b. 1.71

c. 1.00

d. 1.33

e. 2.50

____ 24. Last year, Kansas Office Supply had $400,000 of net income on $24,000,000 of sales, its total assets turnover

was 6.0, and the company's ROE was 15%. If the company only finances with debt and equity, what is the

company's debt ratio?

a. 0.20

b. 0.30

c. 0.33

d. 0.60

e. 0.66

____ 25. Aaron Aviation recently reported the following information:

ROA 10%

Interest expense $200,000

The company's average tax rate is 40%. What is the company's basic earning power (BEP)?

a. 14.12%

b. 16.67%

c. 17.33%

d. 20.67%

e. 22.50%

____ 26. Suppose the interest rate on a 1-year T-bond is 5.0% and that on a 2-year T-bill is 6.0%. Assuming the pure

expectations theory is correct, what is the market's forecast for 1-year rates 1 year from now?

a. 6.65%

b. 6.74%

c. 6.83%

d. 6.92%

e. 7.01%

____ 27. The real risk-free rate is 3%. Inflation is expected to be 4% this coming year, jump to 5% next year, and

increase to 6% the year after. According to the expectations theory, what should be the interest rate on 3-year,

risk-free securities today?

a. 18%

b. 12%

c. 6%

d. 8%

e. 10%

____ 28. One-year Treasury securities yield 5%, 2-year Treasury securities yield 5.5%, and 3-year Treasury securities

yield 6%. Assume that the expectations theory holds. What does the market expect will be the yield on 1-year

Treasury securities two years from now?

a. 6.01%

b. 6.51%

c. 7.01%

d. 7.51%

e. 8.01%

____ 29. Given the following data, find the expected rate of inflation during the next year. Disregard cross-product

terms, i.e., if averaging is required, use the arithmetic average.

• 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%

____ 30. The real risk-free rate is expected to remain constant at 3%. Inflation is expected to be 2% a year for the next

3 years, and then 4% a year thereafter. The maturity risk premium is 0.1%(t − 1), where t equals the maturity

of the bond. A 5-year corporate bond has a yield of 8.4%. What is the yield on a 7-year corporate bond that

has the same default risk and liquidity premiums as the 5-year corporate bond? Disregard cross-product terms,

i.e., if averaging is required, use the arithmetic average.

a. 8.73%

b. 8.94%

c. 8.65%

d. 7.98%

e. 9.24%

____ 31. Three-year Treasury securities currently yield 6%, while 4-year Treasury securities currently yield 6.5%.

Assume that the expectations theory holds. What does the market believe the rate will be on 1-year Treasury

securities three years from now?

a. 8.01%

b. 8.51%

c. 9.01%

d. 9.51%

e. 10.01%

____ 32. The real risk-free rate is 3%. The market expects that inflation of 3% for each of the next 5 years, and 5% a

year thereafter. The maturity risk premium is estimated to be MRPt = 0.1%(t − 1). What is the yield on a

Treasury bond that matures in 12 years? Disregard cross-product terms, i.e., if averaging is required, use the

arithmetic average.

a. 8.10%

b. 8.27%

c. 8.45%

d. 8.53%

e. 8.68%

____ 33. Brown Enterprises' bonds currently sell for $1,025. They have a 9-year maturity, an annual coupon of $80,

and a par value of $1,000. What is their yield to maturity?

a. 6.87%

b. 7.03%

c. 7.21%

d. 7.45%

e. 7.61%

____ 34. Brown Enterprises' bonds currently sell for $1,025. They have a 9-year maturity, an annual coupon of $80,

and a par value of $1,000. What is their current yield?

a. 7.80%

b. 7.90%

c. 9.00%

d. 9.10%

e. 9.20%

____ 35. Yest Corporation's bonds have a 15-year maturity, a 7% semiannual coupon, and a par value of $1,000. The

going interest rate (rd) is 6%, based on semiannual compounding. What is the bond's price?

a. $1,008.65

b. $1,024.67

c. $1,051.34

d. $1,098.00

e. $1,105.78

____ 36. Moussawi Ltd's outstanding bonds have a $1,000 par value, and they mature in 5 years. Their yield to

maturity is 9%, based on semiannual compounding, and the current market price is $853.61. What is the

bond's annual coupon interest rate?

a. 5.10%

b. 5.20%

c. 5.30%

d. 5.40%

e. 5.50%

____ 37. Walker Industries has a bond outstanding with 12 years to maturity, a 9% coupon paid semiannually, and a

$1,000 par value. The bond has a 7% nominal yield to maturity, but it can be called in 3 years at a price of

$1,045. What is the bond's nominal yield to call?

a. 4.43%

b. 4.62%

c. 4.82%

d. 4.91%

e. 4.99%

____ 38. You just purchased a $1,000 par value, 9-year, 7% semiannual coupon bond. The bond sells for $920. What is

the nominal yield to maturity?

a. 7.28%

b. 8.28%

c. 9.60%

d. 8.67%

e. 4.13%

____ 39. A 10-year, $1,000 face value bond sells for $1,075. The bond has a 9% semiannual coupon and is callable in

5 years and a call price is $1,035. What is the bond's nominal yield to call?

a. 7.19%

b. 7.75%

c. 7.90%

d. 8.00%

e. 8.13%

____ 40. T. Martell Inc.'s stock has a 50% chance of producing a 30% return, a 25% chance of producing a 9% return,

and a 25% chance of producing a -25% return. What is Martell's expected return?

a. 14.4%

b. 15.2%

c. 16.0%

d. 16.8%

e. 17.6%

____ 41. Tom Skinner has $45,000 invested in a stock with a beta of 0.8 and another $55,000 invested in a stock with a

beta of 1.4. These are the only two investments in his portfolio. What is his portfolio's beta?

a. 0.93

b. 0.98

c. 1.03

d. 1.08

e. 1.13

____ 42. Magee Company's stock has a beta of 1.20, the risk-free rate is 4.50%, and the market risk premium is 5.00%.

What is Magee's required return?

a. 10.25%

b. 10.50%

c. 10.75%

d. 11.00%

e. 11.25%

____ 43. Niendorf Corporation's stock has a required return of 13.00%, the risk-free rate is 7.00%, and the market risk

premium is 4.00%. Now suppose there is a shift in investor risk aversion, and the market risk premium

increases by 2.00%. What is Niendorf's new required return?

a. 14.00%

b. 15.00%

c. 16.00%

d. 17.00%

e. 18.00%

____ 44. Apex Roofing's stock has a beta of 1.50, its required return is 14.00%, and the risk-free rate is 5.00%. What is

the required rate of return on the stock market? (Hint: First find the market risk premium.)

a. 10.50%

b. 11.00%

c. 11.50%

d. 12.00%

e. 12.50%

____ 45. Suppose you hold a diversified portfolio consisting of $10,000 invested equally in each of 10 different

common stocks. The portfolio's beta is 1.120. Now suppose you decided to sell one of your stocks that has a

beta of 1.000 and to use the proceeds to buy a replacement stock with a beta of 1.750. What would the

portfolio's new beta be?

a. 0.982

b. 1.017

c. 1.195

d. 1.246

e. 1.519

____ 46. Assume the risk-free rate is 5% and that the market risk premium is 7%. If a stock has a required rate of return

of 13.75%, what is its beta?

a. 1.25

b. 1.35

c. 1.37

d. 1.60

e. 1.96

____ 47. An investor is forming a portfolio by investing $50,000 in stock A that has a beta of 1.50, and $25,000 in

stock B that has a beta of 0.90. The market risk premium is equal to 2% and Treasury bonds have a yield of

4%. What is the required rate of return on the investor's portfolio?

a. 6.6%

b. 6.8%

c. 5.8%

d. 7.0%

e. 7.5%

____ 48. Given the following probability distribution, what are the expected return and the standard deviation of

returns for Security J?

State Pi kJ

1 0.2 10%

2 0.6 15

3 0.2 20

a. 15%; 6.50%

b. 12%; 5.18%

c. 15%; 3.16%

d. 15%; 10.00%

e. 20%; 5.00%

____ 49. If D1 = $2.00, g (which is constant) = 6%, and P0 = $40, what is the stock's expected total return for the

coming year?

a. 10.8%

b. 11.0%

c. 11.2%

d. 11.4%

e. 11.6%

____ 50. A stock is expected to pay a dividend of $1 at the end of the year. The required rate of return is rs = 11%, and

the expected constant growth rate is 5%. What is the current stock price?

a. $16.67

b. $18.83

c. $20.00

d. $21.67

e. $23.33

____ 51. Hahn Manufacturing is expected to pay a dividend of $1.00 per share at the end of the year (D1 = $1.00). The

stock sells for $40 per share, and its required rate of return is 11%. The dividend is expected to grow at a

constant rate, g, forever. What is Hahn's expected growth rate?

a. 8.00%

b. 8.50%

c. 9.00%

d. 9.50%

e. 10.00%

____ 52. P. Daves Inc's stock is currently sells for $45 per share. The stock's dividend is projected to increase at a

constant rate of 4% per year. The required rate of return on the stock, rs, is 12%. What is Daves' expected

price 6 years from now?

a. $52.68

b. $53.71

c. $54.41

d. $55.12

e. $56.94

____ 53. The Lashgari Company is expected to pay a dividend of $1 per share at the end of the year, and that dividend

is expected to grow at a constant rate of 5% per year in the future. The company's beta is 1.2, the market risk

premium is 5%, and the risk-free rate is 3%. What is the company's current stock price?

a. $15.00

b. $20.00

c. $25.00

d. $30.00

e. $35.00

____ 54. Mack Industries just paid a dividend of $1.00 per share (D0 = $1.00). Analysts expect the company's dividend

to grow 20% this year (D1 = $1.20) and 15% next year. After two years the dividend is expected to grow at a

constant rate of 5%. The required rate of return on the company's stock is 12%. What should be the company's

current stock price?

a. $12.33

b. $16.65

c. $16.91

d. $18.67

e. $19.67

____ 55. Klieman Company's perpetual preferred stock sells for $90 per share and pays a $7.50 annual dividend per

share. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the price

paid by investors. What is the company's cost of preferred stock?

a. 7.50%

b. 7.79%

c. 8.21%

d. 8.57%

e. 8.77%

____ 56. Assume that you are a consultant to Thornton Inc., and you have been provided with the following data: rRF =

5.5%; RPM = 6.0%; and b = 0.8. What is the cost of equity from retained earnings based on the CAPM

approach?

a. 9.65%

b. 9.91%

c. 10.08%

d. 10.30%

e. 10.49%

____ 57. Assume that you are a consultant to Morton Inc., and you have been provided with the following data: D1 =

$1.00; P0 = $25.00; and g = 6% (constant). What is the cost of equity from retained earnings based on the

DCF approach?

a. 9.79%

b. 9.86%

c. 10.00%

d. 10.20%

e. 10.33%

____ 58. You were hired as a consultant to Keys Company, and you were provided with the following data: Target

capital structure: 40% debt, 10% preferred, and 50% common equity. The after-tax cost of debt is 4.00%, the

cost of preferred is 7.50%, and the cost of retained earnings is 11.50%. The firm will not be issuing any new

stock. What is the firm's WACC?

a. 7.55%

b. 7.73%

c. 7.94%

d. 8.10%

e. 8.32%

____ 59. Wagner Lumber Company hired you to help them estimate their cost of capital. You were provided with the

following data: D1 = $1.25; P0 = $40; g = 6% (constant); and F = 5%. The firm must issue new stock; what is

the cost of equity raised by selling new common stock?

a. 9.29%

b. 9.40%

c. 9.62%

d. 9.85%

e. 9.99%

____ 60. Hamilton Company has 20-year, 8% quarterly coupon bonds that currently sell for $686.86. The company's

tax rate is 40%. What is the firm's nominal component cost of debt?

a. 3.05%

b. 7.32%

c. 7.36%

d. 12.20%

e. 12.26%

comprehensive exam question bank

Answer Section

MULTIPLE CHOICE

1. ANS: A

TOP: FV of a lump sum

2. ANS: D

TOP: PV of a lump sum

3. ANS: B

TOP: Simple growth rate

4. ANS: A

TOP: Number of periods

5. ANS: B

TOP: PV of an annuity due

6. ANS: C

TOP: Years to deplete an annuity due

7. ANS: C

TOP: PV of an ordinary annuity plus an ending payment

8. ANS: A

TOP: Nominal vs. effective annual rate

9. ANS: C

TOP: Mortgage payments

10. ANS: E

TOP: Income statement: EBIT

11. ANS: B

PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems

TOP: Income statement: Taxable income

12. ANS: B

TOP: Dividends, retained earnings

13. ANS: B

TOP: Income statement

14. ANS: C

Set up an income statement:

Sales $1,000,000

Operating costs 700,000

EBITDA $ 300,000

Depreciation and amortization 50,000

EBIT $ 250,000

Interest 150,000

EBT $ 100,000

Taxes (40%) 40,000 Taxes = 0.4($100,000) = $40,000.

Net income $ 60,000

TOP: Calculating change in net income

15. ANS: E

This question requires working backwards through the income statement from net income to sales. The

income statement will look like this:

CGS (60%) 750,000 $1,250,000 × 0.6

EBIT $ 500,000 $100,000 + $400,000

Interest 100,000 (Given)

EBT $ 400,000 $240,000/(1 − 0.4)

Tax (40%) 160,000

NI $ 240,000

TOP: Sales level

16. ANS: E

Working up the income statement you calculate the new sales level should be $10,833,333.

Operating costs

(excl. depr. and amort.)(60%) 6,500,000 $10,833,333 × 0.6

EBITDA $ 4,333,333 $3,833,333 + $500,000

Depreciation and amortization 500,000

EBIT $ 3,833,333 $3,333,333 + $500,000

Interest 500,000

EBT $ 3,333,333 $2,000,000/0.6

Taxes (40%) 1,333,333

Net income $ 2,000,000

TOP: Sales level

17. ANS: B

NPV = $10,000/1.08 + $25,000/(1.08)2 + $50,000/(1.08)3 + $35,000/(1.08)4

= $9,259.26 + $21,433.47 + $39,691.61 + $25,726.04

= $96,110.38 ≈ $96,110.

Inputs: CF0 = 0; CF1 = 10000; CF2 = 25000; CF3 = 50000; CF4 = 35000; I/YR = 8.

Output: NPV = $96,110.39 ≈ $96,110.

TOP: PV of an uneven CF stream

18. ANS: C

The effective rate is given by:

NOM% = 8; P/YR = 4; and solve for EFF% = 8.2432%.

EFF% = 8.2432; P/YR = 2; and solve for NOM% = 8.08%.

N = 2.5 × 2 = 5; I/YR = 8.08/2 = 4.04; PV = 0; PMT = -100; and solve for FV = $542.07.

TOP: FV under quarterly compounding

19. ANS: A

First, calculate the profit margin, which equals NI/Sales:

ROA = NI/TA = 0.04.

Sales/TA = S/TA = 2.

PM = (NI/TA)(TA/S) = 0.04(0.5) = 0.02. [TA/S = 1/2 = 0.5.]

E/TA = (E/NI)(NI/TA). [ROE = NI/E and ROA = NI/TA.]

E/TA = (1/ROE)(ROA) = (1/0.06)(0.04) = 0.667, or 66.7% equity.

Therefore, D/TA must be 0.333 = 33.3%.

TOP: Du Pont equation

20. ANS: E

EPS = $750,000/100,000 = $7.50.

P/E = Price/EPS = 8.

Thus, Price = 8 × $7.50 = $60.00.

TOP: P/E ratio and stock price

21. ANS: E

Step 1: We must find TA. We are given BEP and EBIT.

and .

Therefore, TA = $40,000,000/0.1, or $400 million.

Step 2: NI/TA = ROA, so now we need to find net income. Net income is found by working

through the income statement (in millions):

EBIT $40

Interest 5 (from TIE ratio: 8 = EBIT/Int)

EBT $35

Taxes (40%) 14

NI $21

TOP: ROA

22. ANS: D

Profit margin = ($1,500(1 − 0.3))/$5,000 = 21%.

Equity multiplier = 1.0 since firm is 100% equity financed.

= (21%)(2.0)(1.0) = 42%.

PTS: 1 DIF: Medium OBJ: Part II TYPE: Problems

TOP: ROE

23. ANS: B

TA = $8,000,000,000; T = 40%; EBIT/TA = 12%; ROA = 3%; TIE ?

= $960,000,000

= $240,000,000

Now use the income statement format to determine interest so you can calculate the firm's TIE ratio.

TIE = EBIT/INT

= $960,000,000/$560,000,000

= 1.7143 ≈ 1.71.

TOP: TIE ratio

24. ANS: C

Debt ratio = Debt/Total assets.

Sales/Total assets = 6

Total assets = $24,000,000/6 = $4,000,000.

ROE = NI/Equity

Equity = NI/ROE = $400,000/0.15 = $2,666,667.

TOP: Debt ratio

25. ANS: D

Given ROA = 10% and net income of $500,000, total assets must be $5,000,000.

ROA =

10% =

TA = $5,000,000.

To calculate BEP, we still need EBIT. To calculate EBIT construct a partial income statement:

Interest 200,000 (Given)

EBT $ 833,333 $500,000/0.6

Taxes (40%) 333,333

NI $ 500,000

BEP =

=

= 0.2067 = 20.67%.

TOP: Basic earning power (BEP)

26. ANS: E

TOP: Estimating the 1-year forward rate

27. ANS: D

Average inflation = .

rRF = r* + IP = 3% + 5% = 8%.

TOP: Expected interest rates

28. ANS: C

r2 = 2 year rate today

r3 = 3 year rate today

2r 1 = 1 year rate, two years from now

(1.06)3= (1.055)2(1 + 2r1)

2r1= 7.01%

TOP: Expectations theory

29. ANS: C

rNom = r* + IP + DRP + LP + MRP

8.5% = 3% + IP + 0 + 0 + 0

IP = 5.5%.

TOP: Inflation rate

30. ANS: B

The return on the 5-year corporate bond is calculated as follows:

r5 = r* + IP + MRP + DRP + LP

8.4% = 3% + [(2% × 3) + (4% × 2)]/5 + 0.4% + DRP + LP

DRP + LP = 2.2%.

= 3% + 3.1429% + 0.6% + 2.2% = 8.9429% ≈ 8.94%.

TOP: Expected interest rates

31. ANS: A

r3 = 3 year rate today

3r 1 = 1 year rate, three years from now

r4 = 4 year rate today

(1.065)4= (1.06)3(1 + 3r1)

3r1= 8.01%

TOP: Expected interest rates

32. ANS: B

r = r* + IP + MRP; DRP = LP = 0.

IP = [(3%)5 + (5%)7]/12 = 4.1667%.

MRP = 0.1%(12 − 1) = 1.1%.

TOP: Expected interest rates

33. ANS: E

TOP: Yield to maturity

34. ANS: A

PTS: 1 DIF: Easy/Medium OBJ: Part I TYPE: Problems

TOP: Current yield

35. ANS: D

TOP: Bond valuation--semiannual coupons

36. ANS: C

TOP: Determining the coupon rate

37. ANS: B

PTS: 1 DIF: Medium/Hard OBJ: Part I TYPE: Problems

TOP: Yields to maturity and call

38. ANS: B

Enter the following input data in the calculator:

N = 18; PV = -920; PMT = 35; FV = 1000; and then solve for I/YR = 4.1391%. Convert this semiannual

periodic rate to a nominal annual rate, 4.1391% × 2 = 8.2782% ≈ 8.28%.

TOP: Yield to maturity--semiannual bond

39. ANS: B

Enter the following data as inputs in your calculator:

N = 2 × 5 = 10; PV = -1075; PMT = 0.09/2 × 1,000 = 45; FV = 1035; and then solve for I/YR = rd/2 =

3.8743%.

Since this is a 6-month rate, just multiply by 2 to solve for the nominal yield to call. I/YR = rd = 2 × 3.8743%

= 7.7486% ≈ 7.75%.

TOP: Yield to call--semiannual bond

40. ANS: A

TOP: Expected return

41. ANS: E

TOP: Portfolio beta

42. ANS: B

TOP: CAPM

43. ANS: C

PTS: 1 DIF: Medium OBJ: Part I TYPE: Problems

TOP: CAPM

44. ANS: B

TOP: CAPM

45. ANS: C

TOP: Portfolio beta

46. ANS: A

13.75% = 5% + 7%(b)

8.75% = 7%(b)

b = 1.25.

TOP: Beta coefficient

47. ANS: A

The portfolio's beta is a weighted average of the individual security betas as follows:

($50,000/$75,000)1.5 + ($25,000/$75,000)0.9 = 1.3. The required rate of return is then simply: 4% + 2%(1.3)

= 6.6%.

TOP: Portfolio return

48. ANS: C

J = (0.2)(0.10) + (0.6)(0.15) + (0.2)(0.20) = 0.15 = 15.0%.

Expected return = 15.0%.

Standard deviation = = 0.0316 = 3.16%.

TOP: Expected return

49. ANS: B

TOP: Expected total return

50. ANS: A

TOP: Constant growth valuation

51. ANS: B

TOP: Constant growth rate

52. ANS: E

TOP: Future price of a constant growth stock

53. ANS: C

PTS: 1 DIF: Medium OBJ: Part I TYPE: Problems

TOP: Constant growth valuation; CAPM

54. ANS: D

First, find the stock price after two years:

D1 = $1.20.

D2 = $1.20 × 1.15 = $1.38.

D3 = $1.38 × 1.05 = $1.449.

= D3/(rs − g)

= $1.449/(0.12 − 0.05)

= $20.70.

D1 = $1.00 × 1.2 = $1.20.

D2 = $1.20 × 1.15 = $1.38.

Numerical solution:

Enter in CFLO register CF0 = 0, CF1 = 1.20, and CF2 = 22.08. Then enter I/YR = 12, and press NPV to get

NPV = P0 = $18.67.

TOP: Nonconstant growth stock

55. ANS: E

TOP: Component cost of preferred stock

56. ANS: D

PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems

TOP: Component cost of retained earnings: CAPM

57. ANS: C

TOP: Component cost of retained earnings: DCF, D

58. ANS: D

TOP: WACC

59. ANS: A

TOP: Component cost of new common stock, based on DCF, D

60. ANS: B

Calculate the nominal YTM of bond:

Output: I/YR = 3.05% periodic rate.

Calculate rd after-tax: rd,AT = 12.20(1 − T) = 12.20(1 − 0.4) = 7.32%.

TOP: Component cost of debt

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