Mid-term practice questions

1. (TRUE/FALSE) On the balance sheet, total assets must always equal total liabilities and equity.

2. Below are the year-end balance sheets for Wolken Enterprises:

Assets: 2013 2012

Cash $ 200,000 $ 170,000
Accounts receivable 864,000 700,000
Inventories 2,000,000 1,400,000
Total current assets $3,064,000 $2,270,000
Net fixed assets 6,000,000 5,600,000
Total assets $9,064,000 $7,870,000

Liabilities and equity:

Accounts payable $1,400,000 $1,090,000
Notes payable 1,600,000 1,800,000
Total current liabilities $3,000,000 $2,890,000
Long-term debt 2,400,000 2,400,000
Common stock 3,000,000 2,000,000
Retained earnings 664,000 580,000
Total common equity $3,664,000 $2,580,000
Total liabilities and equity $9,064,000 $7,870,000

Wolken has never paid a dividend on its common stock, and it issued $2,400,000 of 10-year non-callable,
long-term debt in 2012. As of the end of 2013, none of the principal on this debt had been repaid. Assume
that the company's sales in 2012 and 2013 were the same. Which of the following statements must be
CORRECT?
a. Wolken increased its short-term bank debt in 2013.
b. Wolken issued long-term debt in 2013.
c. Wolken issued new common stock in 2013.
d. Wolken repurchased some common stock in 2013.
e. Wolken had negative net income in 2013.

3. Frederickson Office Supplies recently reported $12,500 of sales, $7,250 of operating costs other than
depreciation, and $1,250 of depreciation. The company had no amortization charges and no non-operating
income. It had $8,000 of bonds outstanding that carry a 7.5% interest rate, and its federal-plus-state income
tax rate was 40%. How much was the firm's taxable income, or earnings before taxes (EBT)?

a. $3,230.00
b. $3,400.00
c. $3,570.00
d. $3,748.50
e. $3,935.93

Solution:
S

Bonds $8,000.00
Interest rate 7.50%
Sales $12,500.00
Operating costs excluding depr'n $7,250.00
Depreciation $1,250.00
 Mid-term practice questions

Operating income (EBIT) $4,000.00

Interest charges −$600.00
EBT $3,400.00

4. (TRUE/FALSE) A decline in a firm's inventory turnover ratio suggests that it is managing its inventory
more efficiently and also that its liquidity position is improving, i.e., it is becoming more liquid.

5. The Cavendish Company recently issued new common stock and used the proceeds to pay off some of its
short-term notes payable. This action had no effect on the company's total assets or operating income. Which
of the following effects would occur as a result of this action?
a. The company's debt ratio increased.
b. The company's current ratio increased.
c. The company's times interest earned ratio decreased.
d. The company's basic earning power ratio increased.
e. The company's equity multiplier increased.

6. Orono Corp.'s sales last year were $435,000, its operating costs were $362,500, and its interest charges
were $12,500. What was the firm's times interest earned (TIE) ratio?
a. 4.72
b. 4.97
c. 5.23
d. 5.51
e. 5.80
Solution
Sales $435,000
Operating costs 362,500
Operating income (EBIT) 72,500
Interest charges $ 12,500
TIE ratio 5.80

7. A perpetuity pays $85 per year and costs $950. What is the rate of return?
a. 8.95%
b. 9.39%
c. 9.86%
d. 10.36%
e. 10.88%

8. (TRUE/FALSE) For bonds, price sensitivity to a given change in interest rates is generally greater the longer
before the bond matures.

9. Which of the following events would make it more likely that a company would choose to call its
outstanding callable bonds?
a. Market interest rates rise sharply.
b. Market interest rates decline sharply.
c. The company's financial situation deteriorates significantly.
 Mid-term practice questions

d. Inflation increases significantly.

e. The company's bonds are downgraded.

10. Perry Inc.'s bonds currently sell for $1,150. They have a 6-year maturity, an annual coupon of $85, and a par
value of $1,000. What is their current yield?
a. 7.39%
b. 7.76%
c. 8.15%
d. 8.56%
e. 8.98%
11. (TRUE/FALSE) When adding a randomly chosen new stock to an existing portfolio, the higher (or more
positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the
additional stock will reduce the portfolio's risk.

12. Which of the following statements is CORRECT?

a. The higher the correlation between the stocks in a portfolio, the lower the risk inherent in
the portfolio.
b. An investor can eliminate almost all risk if he or she holds a very large and well
diversified portfolio of stocks.
c. Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by
even a small amount.
d. An investor can eliminate almost all diversifiable risk if he or she holds a very large,
well-diversified portfolio of stocks.
e. An investor can eliminate almost all market risk if he or she holds a very large and well
diversified portfolio of stocks.

13. Zacher Co.'s stock has a beta of 1.40, the risk-free rate is 4.25%, and the market risk premium is 5.50%.
What is the firm's required rate of return?
a. 11.36%
b. 11.65%
c. 11.95%
d. 12.25%
e. 12.55%

14. Martin Ortner holds a $200,000 portfolio consisting of the following stocks:

Stock Investment Beta

A $50,000 0.95
B 50,000 0.80
C 50,000 1.00
D 50,000 1.20
Total $200,000

What is the portfolio's beta?

a. 0.938
b. 0.988
c. 1.037
d. 1.089
e. 1.143
 Mid-term practice questions

15. Your bank offers a savings account that pays 3.5% interest, compounded annually. If you invest $1,000 in
the account, then how much will it be worth at the end of 25 years?
a. $2,245.08
b. $2,363.24
c. $2,481.41
d. $2,605.48
e. $2,735.75