You are on page 1of 13

1.

The specified date on which the principal amount of a bond is payable is referred to as which
one of the following?
A. coupon date
B. yield date
C. maturity
D. dirty date
E. clean date
2. A bond has a market price that exceeds its face value. Which of the following features currently
apply to this bond?
I. discounted price
II. premium price
III. yield-to-maturity that exceeds the coupon rate
IV. yield-to-maturity that is less than the coupon rate
A. III only
B. I and III only
C. I and IV only
D. II and III only
E. II and IV only
3. The secondary market is best defined by which one of the following?
A. market in which subordinated shares are issued and resold
B. market conducted solely by brokers
C. market dominated by dealers
D. market where outstanding shares of stock are resold
E. market where warrants are offered and sold
4. The dividend growth model:
I. assumes that dividends increase at a constant rate forever.
II. can be used to compute a stock price at any point in time.
III. can be used to value zero-growth stocks.
IV. requires the growth rate to be less than the required return.
A. I and III only
B. II and IV only
C. I, III, and IV only
D. I, II, and IV only
E. I, II, III, and IV
5. Miller Brothers Hardware paid an annual dividend of $1.15 per share last month. Today, the
company announced that future dividends will be increasing by 2.6 percent annually. If you
require a 12 percent rate of return, how much are you willing to pay to purchase one share of
this stock today?
A. $12.23
B. $12.55
C. $12.67
D. $12.72
E. $12.88
Answer:

6. The two-stage dividend growth model evaluates the current price of a stock based on the
assumption a stock will:
A. pay an increasing dividend for a period of time and then cease paying dividends altogether.
B. increase the dividend amount every other year.
C. pay a constant dividend for the first two quarters of each year and then increase the dividend
the last two quarters of each year.
D. grow at a fixed rate for a period of time after which it will grow at a different rate
indefinitely.
E. pay increasing dividends for a fixed period of time, cease paying dividends for a period of
time, and then commence paying increasing dividends for an indefinite period of time.

7. The current dividend yield on Clayton's Metals common stock is 2.5 percent. The company just
paid a $1.48 annual dividend and announced plans to pay $1.54 next year. The dividend growth
rate is expected to remain constant at the current level. What is the required rate of return on
this stock?
A. 6.55 percent
B. 6.82 percent
C. 7.08 percent
D. 7.39 percent
E. 7.75 percent


8. Hightower Pharmacy just paid a $3.10 annual dividend. The company has a policy of increasing the
dividend by 3.8 percent annually. You would like to purchase 100 shares of stock in this firm but
realize that you will not have the funds to do so for another four years. If you require a 16 percent
rate of return, how much will you be willing to pay per share for the 100 shares when you can afford
to make this investment?
A. $29.50
B. $30.62
C. $31.12
D. $31.78
E. $32.47


9. Two IPOs will commence trading next week. Scott places an order to buy 300 shares of IPO A. Steve
places an order to purchase 300 shares of IPO A and 300 shares of IPO B. Both IPOs are priced at $20
a share. Scott is allocated 100 shares of IPO A. Steve is allocated 100 shares of IPO A and 300 shares
of IPO B. At the end of the first day of trading, IPO A is selling for $22.70 a share and IPO B is selling
for $18.60 a share. What is the difference in the total profits or losses that Scott and Steve have as
of the end of the first day of trading?
A. $120
B. $240
C. $360
D. $420
E. $580
Scott's profit = 100 ($22.70 - $20) = $270
Steve's profit = [100 ($22.70 - $20)] + [300 ($18.60 - $20)] = -$150
Difference = $270 - (-$150) = $420

10. 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 repurchase shares. What will the WACC be after
recapitalization?
A. 16.30 percent
B. 16.87 percent
C. 17.15 percent
D. 18.29 percent
E. 18.86 percent
V
U
= $100,000(1 - 0.31)/0.18 = $383,333.33
V
L
= $383,333.33 + 0.31($61,000) = $402,243.33
R
E
= 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) =
17.15 percent

11. New Schools, Inc. expects an EBIT of $7,000 every year forever. The firm currently has no debt, and
its cost of equity is 17 percent. The firm can borrow at 8 percent and the corporate tax rate is 34
percent. What will the value of the firm be if it converts to 50 percent debt?
A. $29,871.17
B. $31,796.47
C. $32,407.16
D. $34,552.08
E. $37,119.30
V
U
= $7,000 (1 - 0.34)/0.17 = $27,176.47
V
L
= $27,176.47 + 0.34 (0.50) ($27,176.47) = $31,796.47
Note: When levered, the value of debt is equal to one-half of the unlevered value of the firm.

12. Which one of the following bonds is the least sensitive to interest rate risk?
A. 3-year; 4 percent coupon
B. 3-year; 6 percent coupon
C. 5-year; 6 percent coupon
D. 7-year; 6 percent coupon
E. 7-year; 4 percent coupon

13. The Fisher Effect primarily emphasizes the effects of _____ on an investor's rate of return.
A. default
B. market
C. interest rate
D. inflation
E. maturity

14. Roadside Markets has a 6.75 percent coupon bond outstanding that matures in 10.5 years. The
bond pays interest semiannually. What is the market price per bond if the face value is $1,000 and
the yield to maturity is 6.69 percent?
A. $999.80
B. $999.85
C. $1,003.42
D. $1,004.47
E. $1,007.52


15. The Corner Grocer has a 7-year, 6 percent annual coupon bond outstanding with a $1,000 par value.
The bond has a yield to maturity of 5.5 percent. Which one of the following statements is correct if
the market yield suddenly increases to 6.5 percent?
A. The bond price will increase by $57.14.
B. The bond price will increase by 5.29 percent.
C. The bond price will decrease by $53.62.
D. The bond price will decrease by 5.43 percent.
E. The bond price will decrease by 5.36 percent.


Difference in prices = $972.58 - $1,028.41 = -$55.83
Percentage difference in prices =

16. A Treasury bond is quoted at a price of 101:14 with a current yield of 7.236 percent. What is the
coupon rate?
A. 7.20 percent
B. 7.28 percent
C. 7.30 percent
D. 7.34 percent
E. 7.39 percent
Price = 101 and 14/32 percent of face = 1.014375 $1,000 = $1,014.375
Annual interest = 0.07236 $1,014.375 = $73.40
Coupon rate = $73.40/$1,000 = 7.34 percent

17. Kaiser Industries has bonds on the market making annual payments, with 14 years to maturity, and
selling for $1,382.01. At this price, the bonds yield 7.5 percent. What is the coupon rate?
A. 8.00 percent
B. 8.50 percent
C. 9.00 percent
D. 10.50 percent
E. 12.00 percent


Coupon rate = $120/$1,000 = 12 percent
18. Which of the following should be considered when selecting a venture capitalist?
I. level of involvement
II. past experiences
III. termination of funding
IV. financial strength
A. I and III only
B. II and IV only
C. I, III, and IV only
D. I, II, and IV only
E. I, II, III, and IV

19. With firm commitment underwriting, the issuing firm:
A. is unsure of the total amount of funds it will receive until after the offering is completed.
B. is unsure of the number of shares it will actually issue until after the offering is completed.
C. knows exactly how many shares will be purchased by the general public during the offer period.
D. retains the financial risk associated with unsold shares.
E. knows up-front the amount of money it will receive from the stock offering.


20. Wear Ever is expanding and needs $12.6 million to help fund this growth. The firm estimates it can
sell new shares of stock for $32.50 a share. It also estimates it will cost an additional $340,000 for
filing and legal fees related to the stock issue. The underwriters have agreed to a 7.5 percent spread.
How many shares of stock must Wear Ever sell if it is going to have $12.6 million available for its
expansion needs?
A. 370,376 shares
B. 419,127 shares
C. 430,437 shares
D. 454,209 shares
E. 461,806 shares
Total value of issue = ($12,600,000 + $340,000)/(1 - 0.075) = $13,989,189.19
Number of shares needed = $13,989,189.19/$32.50 = 430,437 shares

21. 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 theory of capital structure.
B. M&M Proposition I.
C. M&M Proposition II.
D. the capital asset pricing model.
E. the open markets theorem.

22. A firm should select the capital structure that:
A. produces the highest cost of capital.
B. maximizes the value of the firm.
C. minimizes taxes.
D. is fully unlevered.
E. equates the value of debt with the value of equity

23. 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 of debt exceeds the cost of equity.
E. debt-equity ratio results in the lowest possible weighted average cost of capital.

24. The capital structure that maximizes the value of a firm also:
A. minimizes financial distress costs.
B. minimizes the cost of capital.
C. maximizes the present value of the tax shield on debt.
D. maximizes the value of the debt.
E. maximizes the value of the unlevered firm.

25. Sewer's Paradise is an all equity firm that has 5,000 shares of stock outstanding at a market price of
$15 a share. The firm's management has decided to issue $30,000 worth of debt and use the funds
to repurchase shares of the outstanding stock. The interest rate on the debt will be 10 percent.
What are the earnings per share at the break-even level of earnings before interest and taxes?
Ignore taxes.
A. $1.46
B. $1.50
C. $1.67
D. $1.88
E. $1.94
Number of shares repurchased = $30,000/$15 = 2,000
EBIT/5,000 = [EBIT - ($30,000 .0.10)]/(5,000 - 2,000); EBIT = $7,500
EPS = [$7,500 - ($30,000 0.10)]/(5,000 - 2,000); EPS = $1.50

26. Winter's Toyland has a debt-equity ratio of 0.72. The pre-tax cost of debt is 8.7 percent and the
required return on assets is 16.1 percent. What is the cost of equity if you ignore taxes?
A. 19.31 percent
B. 19.74 percent
C. 20.29 percent
D. 20.46 percent
E. 21.43 percent
R
E
= 0.161 + (0.161 - 0.087) 0.72 = 21.43 percent

27. Johnson Tire Distributors has debt with both a face and a market value of $12,000. This debt has a
coupon rate of 6 percent and pays interest annually. The expected earnings before interest and
taxes are $2,100, the tax rate is 30 percent, and the unlevered cost of capital is 11.7 percent. What
is the firm's cost of equity?
A. 22.46 percent
B. 22.87 percent
C. 23.20 percent
D. 23.59 percent
E. 25.14 percent
V
U
= [$2,100 (1 - 0.30)]/0.117 = $12,564.10
V
L
= $12,564.10 + (0.30 $12,000) = $16,164.10
V
E
= $16,164.10 - $12,000 = $4,164.10
R
E
= 0.117 + [(0.117 - 0.06) ($12,000/$4,164.10) (1 - 0.30)] = 23.20 percent

28. Which one of the following favors a low dividend policy?
A. the tax on capital gains is deferred until the gain is realized
B. few, if any, positive net present value projects are available to a firm
C. a majority of the shareholders has a low relevant tax rate
D. a majority of the shareholders has better investment opportunities with similar risks
E. corporate tax rates exceed personal tax rates

29. Which of the following tend to keep dividends low?
I. shareholders desiring current income
II. terms contained in bond indenture agreements
III. the desire to maintain constant dividends over time
IV. flotation costs
A. II and III only
B. I and IV only
C. II, III, and IV only
D. I, II, and III only
E. I, II, III, and IV

30. You own 2,200 shares of Deltona Hardware. The company has stated that it plans on issuing a
dividend of $0.42 a share at the end of this year and then issuing a final liquidating dividend of $2.90
a share at the end of next year. Your required rate of return on this security is 16 percent. Ignoring
taxes, what is the value of one share of this stock to you today?
A. $2.30
B. $2.43
C. $2.52
D. $2.92
E. $3.32
Value per share = ($0.42/1.16
1
) + ($2.90/1.16
2
) = $2.52

31. Consider the following information on Stocks I and II:



The market risk premium is 8 percent, and the risk-free rate is 3.6 percent. The beta of stock I is
_____ and the beta of stock II is _____.
A. 2.08; 2.47
B. 2.08; 2.76
C. 3.21; 3.84
D. 4.47; 3.89
E. 4.47; 4.26
E(R
I
) = 0.06(0.15) + 0.25(0.35) + 0.69(0.43) = 0.3932
B
I
: 0.3932 = 0.036 + B
I
(0.08); B
I
= 4.47
E(R
II
) = 0.06(-0.35) + 0.25(0.35) + 0.69(0.45) = 0.0377
B
II
: 0.0377 = 0.036 + B
II
(0.08); B
II
= 4.26

32. Suppose you observe the following situation:



Assume the capital asset pricing model holds and stock A's beta is greater than stock B's beta by
0.21. What is the expected market risk premium?
A. 8.8 percent
B. 9.5 percent
C. 12.6 percent
D. 17.9 percent
E. 20.0 percent
E(R
A
) = 0.22(-0.12) + 0.48(0.10) + 0.30(0.23) = .0906
E(R
B
) = 0.22(-0.27) + 0.48(0.05) + 0.30(0.28) = .0486
Slope
SML
= (.0906 - 0.486)/0.21 = 20 percent


33. The common stock of Alpha Manufacturers has a beta of 1.47 and an actual expected return of
15.26 percent. The risk-free rate of return is 4.3 percent and the market rate of return is 12.01
percent. Which one of the following statements is true given this information?
A. The actual expected stock return will graph above the Security Market Line.
B. The stock is underpriced.
C. To be correctly priced according to CAPM, the stock should have an expected return of 21.95
percent.
D. The stock has less systematic risk than the overall market.
E. The actual expected stock return indicates the stock is currently overpriced.
E(r) = 0.043 + 1.47 (0.1201 - 0.043) = 15.63 percent
The stock is overpriced because its actual expected return is less than the CAPM return.

34. The common stock of United Industries has a beta of 1.34 and an expected return of 14.29 percent.
The risk-free rate of return is 3.7 percent. What is the expected market risk premium?
A. 7.02 percent
B. 7.90 percent
C. 10.63 percent
D. 11.22 percent
E. 11.60 percent
E(r) = 0.1429 = 0.037 + 1.34 M
rp
; M
rp
= 7.90 percent

35. The common stock of Jensen Shipping has an expected return of 16.3 percent. The return on the
market is 10.8 percent and the risk-free rate of return is 3.8 percent. What is the beta of this stock?
A. .92
B. 1.23
C. 1.33
D. 1.67
E. 1.79
E(r) = 0.163 = 0.038 + (0.108 - 0.038); = 1.79