Financial MANAGEMENT: (Vip Questions)

Financial MANAGEMENT
FINAL REVISION
(VIP QUESTIONS)
1
(VIP QUESTIONS)
ANSWER ALL THE FOLLOWING QUESTIONS

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1- The cost of debt is equal to one minus the marginal tax rate multiplied by the risk free
rate.
A- True. B- False.
2- The cost of common stock is the rate of return stockholders require on the firm’s common
stock.
A- True. B- False.
3- Diversification increases the portfolio’s total systematic risk.

A- True. B- False.
4- If the company is holding cash to meet any unexpected emergency this cash balance is
referred to as compensating balance.
A- True. B- False.
5- When investors require higher rates of return for investments that demonstrate lower
variability of returns, this is evidence of risk aversion.
A- True. B- False.
6- Decreasing correlation among assets in a portfolio result in a decrease in the standard

deviation of the portfolio.
A- True. B- False.
7- The correlation coefficient is a measure of the extent to which two random variables move
in opposite directions.
A- True. B- False.
8- A share of stock which gives its holder the right to receive dividend without any right
to vote is known as founder share.
A- True. B- False.
DR. KH. DREAM BOOKSHOP

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9- Decreasing correlation among assets in a portfolio results in a decrease in the standard

deviation of the portfolio.
A- True. B- False.
10- The coefficient of variation, calculated as the standard deviation divided by the expected
return, is a standardized measure of the return per unit risk.
A- True. B- False.
11- Capital can be defined as the funds supplied by the firm suppliers.
A- True. B- False.
12- Accounts payables and accruals are considered part pf the company’s long-term capital.
A- True. B- False.
13- The combination of two assets that are completely positively correlated provides maximum
returns.
A- True. B- False.
14- The security risk premium is equal to the required rate of return on the stock minus the risk
free rate of return.
A- True. B- False.
15- When the company is planning to buy a huge amount of inventory this is an example of
capital budgeting decisions.
A- True. B- False.
16- When considering sources of financing, retained earnings appear to be more expensive than
the issuance of new common stock.
A- True. B- False.
17- If the returns of two firms are negatively correlated, this will increase the portfolio risk.
A- True. B- False.
18- When adding new securities to an existing portfolio, the lower the degree of
correlation between the new securities and those already in the portfolio, the greater the
diversification benefits to the portfolio owner.
A- True. B- False.

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19- The cost of capital should reflect the average cost of the sources of short-term funds a
firm uses to support its current assets.
A- True. B- False.
20- For a two-stock portfolio containing stocks A and B, the perfect positive correlation
coefficient of returns of the two stocks provides the investor with lowest degree of risk.
A- True. B- False.
21- The net working capital refers to current assets minus fixed assets.
A- True. B- False.
22- The lower the firm’s tax rate, the lower will be the firm’s after-tax cost of debt and WACC,
other things held constant.
A- True. B- False.
23- One advantage of the payback period method of evaluating investment possibilities is that
it provides a rough measure of a project’s liquidity and risk.
A- True. B- False.
24- The internal rate of return is that discount rate which equates the present value of the cash
outflows (or costs) with the future value of the cash inflows.
A- True. B- False.
25- According to the aggressive financing policy, the company prefers to rely heavily on long-
term financing.
A- True. B- False.
26- The conservative financing policy calls for the heavy use of short-term financing.
A- True. B- False.
27- A tight credit policy is likely to lead to lager accounts receivables and high level of bad
debts.
A- True. B- False.
28- The company’s credit policy has no effect on the average collection period.
A- True. B- False.
29- Independent projects are projects that compete with one another for a firm’s
resources, so that the acceptance of one eliminates the others form further consideration.
A- True. B- False.

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30- Mutually exclusive projects are projects whose cash flows are unrelated to one
another, the acceptance of one does not eliminates the others form further consideration.
A- True. B- False.
31- The payback period of a project that costs $1,000 initially and promises after-tax cash
inflows of $400 for the next three years are 2.50 years.
A- True. B- False.
32- Beta coefficient measures the relationship between the security return and the risk free rate
of return.
A- True. B- False.
33- When preparing the company’s pro forma income statement for next year, if the company
is currently fully utilizing its fixed assets, such assumption will have no impact on the
company’s net income for the next year.
A- True. B- False.
34- According to the Formula Method, if the company increases its payout ratio, this is
expected to lead to an increase in the amount of AFN for the next year.
A- True. B- False.
35- Issuing new shares to raise any AFN next year can be described as Internal Financing.
A- True. B- False.

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- Your expectations for a one year investment in Wang Computers are as follows:
Event Probability Sec A Return Sec B Return A&B Portfolio
Recession 0.30 8% 12%
Normal 0.40 16% 8%
Boom 0.30 24% 4%
The investor is planning to divide his wealth equally between the two securities.
17- Based on the above information, the expected return for security A will be:
A- 16% B- 8% C- 9% D- None of the above.
18- Based on the above information, the expected return for security B will be:
19- The standard deviation of your expected return for security A will be:
A- 4.65% B- 6.19% C- 5.75% D- None of the above.
20- The standard deviation of your expected return for security B will be:
21- Based on the above information, the expected return for security the portfolio will be:
22- The standard deviation of your expected return for the portfolio will be:

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- Your expectations for a one year investment in Wang Computers are as follows:
Event Probability Sec A Return Sec B Return A&B Portfolio
Recession 0.30 4% 18% ----------------
Normal 0.40 8% 12% ----------------
Boom 0.30 12% 6% ---------------
The investor is planning to divide his wealth equally between the two securities.
23- Based on the above information, the expected return for security A will be:
24- Based on the above information, the expected return for security B will be:
25- The standard deviation of your expected return for security A will be:
26- The standard deviation of your expected return for security B will be:
27- The Coefficient of Variation for security A will be:

A- 0.46 B- 0.39 C- 0.67 D- None of the above.
28- The Coefficient of Variation for security B will be:


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29- If the risk free rate is 6%, the market rate of return is 16%, Beta for the stock is 1.50,
what is the rate of return on the?
30- If the market rate of return is 14%, and the required rate of return is 16% and the
company’s beta is 1.25. The risk free rate will be:
31- An investment project has an initial investment cost $48,000. The project is expected to
generate an annual cash flow of $16,000 each year for the next six years. Based on the above
information, the project’s payback period will be:
A- 3 years B- 4 years C- 5 years D- None of the above.
32- If the required rate of return on Royal Stocks is 20%, the market rate of return is 16%,
Meta Stock Beta is 1.50. Based on the above information the risk free rate will be:
33- If the required rate of return on Meta Stock is 17%, the risk free rate of return is 5%, the
market rate of return is 15%. Based on the above information the Meta stock Beta will be:
- Brown Chemical Company has provided the following information:

Item January February
Cash Collection 45,000 56,000
Cash Payments 42,000 55,000
Net Cash for the month --------------- ---------------
Cash at the beginning of the month 6,000 ---------------
Cash at the End of the month --------------- ---------------
Target Cash Balance 5,000 5,000
Excess Cash (Shortage of Cash) --------------- ---------------
34- Based on the above information, the excess cash for January will be:
A- $3,000 B- $4,000 C- $9,000 D- None of the above.
35- Based on the above information, the excess cash for February will be:
A- $10,000 B- $5,000 C- $1,000 D- None of the above.

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36- Based on the above information, the excess cash in January will most likely be
invested in:
A- Fixed Assets B- Notes Payable
C- Marketable Securities. D- None of the above.
37- The Cash Conversion Cycle is equal to:

A- Average Collection Period plus the average payment period.
B- Average Collection Period minus the average payment period.
C- The average payment period plus the cash-operating period.
D- None of the above.
- The management of Suez Chemicals is currently evaluating two investment projects. The
cash flow forecasts for both projects are presented below. The Company’s cost of capital is
10%.
Project A Cash Flows Project B Cash Flows

0 -140.50 -81.00
1 40.00 0
2 60.00 0
3 80.00 120.00
38- Based on the above information, the payback period for project A is:
A- 2.67 years. B- 2.5 years.
C- 3 years. D- None of the above.
39- Based on the above information, the payback period for project B is:
A- 1.5 years. B- 2.5 years.
C- 3 years. D- None of the above.
40- The net present value for project A is:

A- $5.55 B- $14.55 C- $9.16 D- None of the above.
41- The net present value for project B is:

A- $5.78 B- $90.12 C- $9.16 D- None of the above.

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(Most Important Questions on Ch. 8)
1. The constant growth model is an approach to dividend valuation that assumes that
dividends grow at a constant rate indefinitely. TRUE
2. The number of authorized shares of common stock is most of the time greater than or
equal to the number of outstanding shares of common stock. FALSE
3. Like bonds, common stock is usually sold with a par value. TRUE
4. In the case of liquidation bondholders are paid first followed by preferred stockholders
followed by common stockholders. TRUE
5. Interest paid to bondholders is tax deductible but dividends paid to stockholders are not.
TRUE
6. If the expected return were above the required return, investors would not buy the asset,
driving its price up and its expected return down. FALSE
7. A preferred stockholder is sometimes referred to as a residual owner, since in essence he or
she receives what is left-the residual after all other claims on the firm's income and assets have
been satisfied. FALSE
8. Preferred stock is often considered a quasi-debt since it yields a fixed periodic payment.
TRUE
9. From an investor’s perspective, a firm’s preferred stock is generally considered to be less
risky than its common stock but more risky than its bonds. However, from a corporate issuer’s
standpoint, these risk relationships are reversed: bonds are the most risky for the firm, preferred
is next, and common is least risky. TRUE
1. Goode Inc.'s stock has a required rate of return of 11.50%, and it sells for $25.00 per share.
Goode's dividend is expected to grow at a constant rate of 7.00% per year. What was Goode's
last dividend, D0?
A. $0.95
B. $1.05
C. $1.16
D. $1.27
E. $1.40
Answer: B

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2. The expected return on Natter Corporation’s stock is 14%. The stock’s dividend is
expected to grow at a constant rate of 8%, and it currently sells for $50 a share. Which of
the following statements is CORRECT?
A. The stock’s dividend yield is 7%.
B. The stock’s dividend yield is 8%.
C. The current dividend per share is $4.00.
D. The stock price is expected to be $54 a share one year from now.
E. The stock price is expected to be $57 a share one year from now.
Answer: D
3. Reddick Enterprises’ stock currently sells for $35.50 per share. The dividend is projected to
increase at a constant rate of 5.50% per year. The required rate of return on the stock, rs, is
9.00%. What is the stock’s expected price 3 years from today?
A. $37.86
B. $38.83
C. $39.83
D. $40.85
E. $41.69
ANSWER: E
4. Goode Inc.’s stock has a required rate of return of 11.50%, and it sells for $25.00 per share.
Goode’s dividend is expected to grow at a constant rate of 7.00%. What was the last dividend,
D0?
A. $0.95
B. $1.05
C. $1.16
D. $1.27
E. $1.40
ANSWER: B
5. The Ramirez Company’s last dividend was $1.75. Its dividend growth rate is expected
to be constant at 25% for 2 years, after which dividends are expected to grow at a rate of
6% forever. Its required return (rs) is 12%. What is the best estimate of the current stock
price?
A- $41.58
B- $42.64
C- $43.71
D- $44.80
E- $45.92
ANSWER: B

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6. Schnusenberg Corporation just paid a dividend of D0 = $0.75 per share, and that dividend is
expected to grow at a constant rate of 6.50% per year in the future. The company’s beta is 1.25,
the required return on the market is 10.50%, and the risk-free rate is 4.50%. What is the
company’s current stock price?
a. $14.52
b. $14.89
c. $15.26
d. $15.64
e. $16.03
ANSWER: A
7. Francis Inc.’s stock has a required rate of return of 10.25%, and it sells for $57.50 per share.
The dividend is expected to grow at a constant rate of 6.00% per year. What is the expected
year-end dividend, D1?
a. $2.20
b. $2.44
c. $2.69
d. $2.96
e. $3.25
ANSWER: B
8. The Isberg 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 is the company’s current stock
price, P0?
a. $18.62
b. $19.08
c. $19.56
d. $20.05
e. $20.55
ANSWER: A
9. The Francis Company is expected to pay a dividend of D1 = $1.25 per share at the end of the
year, and that dividend is expected to grow at a constant rate of 6.00% per year in the future.
The company’s beta is 1.15, the market risk premium is 5.50%, and the risk-free rate is 4.00%.
What is the company’s current stock price?
a. $28.90
b. $29.62
c. $30.36
d. $31.12
e. $31.90
ANSWER: A

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10. Molen Inc. has an outstanding issue of perpetual preferred stock with an annual dividend of
$7.50 per share. If the required return on this preferred stock is 6.5%, at what price should the
stock sell?
a. $104.27
b. $106.95
c. $109.69
d. $112.50
e. $115.38
ANSWER: E
11. Whited Inc.’s stock currently sells for $35.25 per share. The dividend is projected to
increase at a constant rate of 4.75% per year. The required rate of return on the stock, rs, is
11.50%. What is the stock’s expected price 5 years from now?
a. $40.17
b. $41.20
c. $42.26
d. $43.34
e. $44.46
ANSWER: E
12. Gay Manufacturing is expected to pay a dividend of $1.25 per share at the end of the year
(D1 = $1.25). The stock sells for $32.50 per share, and its required rate of return is 10.5%. The
dividend is expected to grow at some constant rate, g, forever. What is the equilibrium
expected growth rate?
a. 6.01%
b. 6.17%
c. 6.33%
d. 6.49%
e. 6.65%
ANSWER: E
13. An increase in a frm’s expected growth rate would cause its required rate of return to
a. increase.
b. decrease.
c. ﬂuctuate less than before.
d. ﬂuctuate more than before.
e. possibly increase, possibly decrease, or possibly remain constant.
14. The preemptive right is important to shareholders because it
a. allows managers to buy additional shares below the current market price.
b. will result in higher dividends per share.
c. is included in every corporate charter.
d. protects the current shareholders against a dilution of their ownership interests.
e. protects bondholders, and thus enables the firm to issue debt with a relatively low interest
rate.

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15. Stocks A and B have the following data. Assuming the stock market is efficient and the
stocks are in equilibrium, which of the following statements is CORRECT?
A B
Required return 10% 12%
Market price $25 $40
Expected growth 7% 9%
a. These two stocks should have the same price.

b. These two stocks must have the same dividend yield.
c. These two stocks should have the same expected return.
d. These two stocks must have the same expected capital gains yield.
e. These two stocks must have the same expected year-end dividend.
16. Stocks A and B have the following data. Assuming the stock market is efficient and the
stocks are in equilibrium, which of the following statements is CORRECT?
A B
Price $25 $40
Expected growth 7% 9%
Expected Return 10% 12%
a. The two stocks should have the same expected dividend.

b. The two stocks could not be in equilibrium with the numbers given in the question.
c. A’s expected dividend is $0.50.
d. B’s expected dividend is $0.75.
e. A’s expected dividend is $0.75 and B’s expected dividend is $1.20.
17. Stocks A and B have the same price and are in equilibrium, but Stock A has the higher
required rate of return. Which of the following statements is CORRECT?
a. If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must
be higher than Stock B’s.
b. Stock B must have a higher dividend yield than Stock A.
c. Stock A must have a higher dividend yield than Stock B.
d. If Stock A has a higher dividend yield than Stock B, its expected capital gains yield
must be lower than Stock B’s.
e. Stock A must have both a higher dividend yield and a higher capital gains yield than
Stock B.

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18. Two constant growth stocks are in equilibrium, have the same price, and have the same
required rate of return. Which of the following statements is CORRECT?
a. The two stocks must have the same dividend per share.
b. If one stock has a higher dividend yield, it must also have a lower dividend growth
rate.
c. If one stock has a higher dividend yield, it must also have a higher dividend growth rate.
d. The two stocks must have the same dividend growth rate.
e. The two stocks must have the same dividend yield
19. A stock is expected to pay a year-end dividend of $2.00, i.e., D1 = $2.00. The dividend is
expected to decline at a rate of 5% a year forever (g = -5%). Which of the following statements
is CORRECT?
a. The company’s current stock price is $20.
b. The company’s dividend yield 5 years from now is expected to be 10%.
c. The constant growth model cannot be used because the growth rate is negative.
d. The company’s expected capital gains yield is 5%.
e. The company’s expected stock price at the beginning of next year is $9.50
20. If a stock’s dividend is expected to grow at a constant rate of 5% a year, which of the
following statements is CORRECT?
a. The expected return on the stock is 5% a year.
b. The stock’s dividend yield is 5%.
c. The price of the stock is expected to decline in the future.
d. The stock’s required return must be equal to or less than 5%.
e. The stock’s price one year from now is expected to be 5% above the current price.
21. Stocks A and B have the following data. Which of the following statements is CORRECT?
A B
Price $25 $25
Expected growth (constant) 10% 5%
a. Stock A’s expected dividend at t = 1 is only half that of Stock B.

b. Stock A has a higher dividend yield than Stock B.
c. Currently the two stocks have the same price, but over tme Stock B’s price will pass that
of A.
d. Since Stock A’s growth rate is twice that of Stock B, Stock A’s future dividends will always
be twice as high as Stock B’s.
e. The two stocks should not sell at the same price. If their prices are equal, then a
disequilibrium must exist.

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22. Stocks X and Y have the following data. Which of the following statements is CORRECT?
A B
Price $30 $30
Expected growth (constant) 6% 4%
a. Stock X has a higher dividend yield than Stock Y.

b. Stock Y has a higher dividend yield than Stock X.
c. One year from now, Stock X’s price is expected to be higher than Stock Y’s price.
d. Stock X has the higher expected year-end dividend.
e. Stock Y has a higher capital gains yield.
23. Stock X has the following data. Which of the following statements is CORRECT?
Expected dividend, D1 $3.00
Current Price, P0 $50
Expected constant growth rate 6.0%
a. The stock’s required return is 10%.

b. The stock’s expected dividend yield and growth rate are equal.
c. The stock’s expected dividend yield is 5%.
d. The stock’s expected capital gains yield is 5%.
e. The stock’s expected price 10 years from now is $100.00.
24. Stocks X and Y have the following data. Which of the following statements is CORRECT?
X Y
Price $25 $25
Expected dividend yield 5% 3%
Required return 12% 10%
a. Stock Y pays a higher dividend per share than Stock X.

b. Stock X pays a higher dividend per share than Stock Y.
c. One year from now, Stock X should have the higher price.
d. Stock Y has a lower expected growth rate than Stock X.
e. Stock Y has the higher expected capital gains yield.

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25. Stocks A and B have the following data. The market risk premium is 6.0% and the risk-free
rate is 6.4%. Which of the following statements is CORRECT?
A B
Beta 1.10 0.90
Constant growth rate 7.00% 7.00%
a. Stock A must have a higher stock price than Stock B.

b. Stock A must have a higher dividend yield than Stock B.
c. Stock B’s dividend yield equals its expected dividend growth rate.
d. Stock B must have the higher required return.
e. Stock B could have the higher expected return
26. Which of the following statements is CORRECT?

a. Preferred stockholders have a priority over bondholders in the event of bankruptcy to the
income, but not to the proceeds in a liquidation.
b. The preferred stock of a given firm is generally less risky to investors than the same
firm’s common stock.
c. Corporations cannot buy the preferred stocks of other corporations.
d. Preferred dividends are not generally cumulative.
e. A big advantage of preferred stock is that dividends on preferred stocks are tax deductible by
the issuing corporation.
27. If D0 = $2.25, g (which is constant) = 3.5%, and P0 = $50, what is the stock’s expected
dividend yield for the coming year?
a. 4.42%
b. 4.66%
c. 4.89%
d. 5.13%
e. 5.39%
ANSWER: b
28. If D1 = $1.50, g (which is constant) = 6.5%, and P0 = $56, what is the stock’s expected
capital gains yield for the coming year?
a. 6.50%
b. 6.83%
c. 7.17%
d. 7.52%
e. 7.90%
29. If D0 = $1.75, g (which is constant) = 3.6%, and P0 = $32.00, what is the stock’s expected
total return for the coming year?
a. 8.37% b. 8.59% c. 8.81% d. 9.03%
e. 9.27%

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30. Sorenson Corp.’s expected year-end dividend is D1 = $1.60, its required return is rs =
11.00%, its dividend yield is 6.00%, and its growth rate is expected to be constant in the future.
What is Sorenson’s expected stock price in 7 years?
a. $37.52
b. $39.40
c. $41.37
d. $43.44
e. $45.61
31. Ackert Company’s last dividend was $1.55. The dividend growth rate is expected to be
constant at 1.5% for 2 years, afar which dividends are expected to grow at a rate of 8.0%
forever. The firm’s required return (rs) is 12.0%. What is the best estimate of the current stock
price?
a. $37.05
b. $38.16
c. $39.30
d. $40.48
e. $41.70
32. Savickas Petroleum’s stock has a required return of 12%, and the stock sells for $40 per
share. The firm just paid a dividend of $1.00, and the dividend is expected to grow by 30% per
year for the next 4 years, so D4 = $1.00(1.30)4 = $2.8561. After t = 4, the dividend is expected
to grow at a constant rate of X% per year forever. What is the stock’s expected constant growth
rate afar t = 4, i.e., what is X?
a. 5.17%
b. 5.44%
c. 5.72%
d. 6.02%
e. 6.34%
33. E. M. Roussakis Inc.'s stock currently sells for $45 per share. The stock’s dividend is
projected to increase at a constant rate of 3.75% per year. The required rate of return on the
stock, rs, is 15.50%. What is Roussakis' expected price 5 years from now?
A. $48.88
B. $50.14
C. $51.42
D. $52.74
E. $54.09
34. and the dividends are expected to grow at a constant rate of 4% forever. If the current price
of the stock is $20 per share calculate the expected return or the cost of equity capital for the
firm:
a. 10% b. 4% C. 14% d. None of the above

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35. Deluxe Company expects to pay a dividend of $2 per share at the end of year-1, $3 per
share at the end of year -2 and then be sold for $32 per share. If the required rate on the stock is
15%, what is the current value of the stock?
A. $28.20
b. $32.17
c. $32.00
d. None of the given answers
36. Which of the following statements is most correct?

a. The constant growth model takes into consideration the capital gains earned on a
stock.
b. It is appropriate to use the constant growth model to estimate stock value even if the
growth rate never becomes constant.
c. Two firms with the same dividend and growth rate must also have the same stock price.
d. Statements a and c are correct.
e. All of the statements above are correct.
37. Stock A has a required return of 10 percent. Its dividend is expected to grow at a constant
rate of 7 percent per year. Stock B has a required return of 12 percent. Its dividend is expected
to grow at a constant rate of 9 percent per year. Stock A has a price of $25 per share, while
Stock B has a price of $40 per share. Which of the following statements is most correct?
a. The two stocks have the same dividend yield.
b. If the stock market were efficient, these two stocks should have the same price.
c. If the stock market were efficient, these two stocks should have the same expected return.
38. A stock’s dividend is expected to grow at a constant rate of 5 percent a year. Which of the
following statements is most correct?
a. The expected return on the stock is 5 percent a year.

b. The stock’s dividend yield is 5 percent.
c. The stock’s price one year from now is expected to be 5 percent higher.
39. Stocks A and B have the same required rate of return and the same expected year-end dividend
(D1). Stock A’s dividend is expected to grow at a constant rate of 10 percent per year, while Stock
B’s dividend is expected to grow at a constant rate of 5 percent per year. Which of the following
statements is most correct?
a. The two stocks should sell at the same price.

b. Stock A has a higher dividend yield than Stock B.
c. Currently Stock B has a higher price, but over time Stock A will eventually have a higher
price.
d. Statements b and c are correct.
e. None of the statements above is correct.

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40. Stock X is expected to pay a dividend of $3.00 at the end of the year (that is, D1 = $3.00). The
dividend is expected to grow at a constant rate of 6 percent a year. The stock currently trades at a
price of $50 a share. Assume that the stock is in equilibrium, that is, the stock’s price equals its
intrinsic value. Which of the following statements is most correct?
a. The required return on the stock is 12 percent.
b. The stock’s expected price 10 years from now is $89.54.
c. The stock’s dividend yield is 6 percent.
d. Statements a and b are correct.
41. Stock X has a required return of 12 percent, a dividend yield of 5 percent, and its dividend will
grow at a constant rate forever. Stock Y has a required return of 10 percent, a dividend yield of 3
percent, and its dividend will grow at a constant rate forever. Both stocks currently sell for $25 per
share. Which of the following statements is most correct?
a. Stock X pays a higher dividend per share than Stock Y.
b. Stock X has a lower expected growth rate than Stock Y.
c. One year from now, the two stocks are expected to trade at the same price.
d. Statements a and b are correct.
e. Statements a and c are correct.
42. Stock X has a required return of 10 percent, while Stock Y has a required return of 12 percent.
Which of the following statements is most correct?
a. Stock Y must have a higher dividend yield than Stock X.
b. If Stock Y and Stock X have the same dividend yield, then Stock Y must have a lower
expected capital gains yield than Stock X.
c. If Stock X and Stock Y have the same current dividend and the same expected dividend
growth rate, then Stock Y must sell for a higher price.
d. All of the statements above are correct.
e. None of the statements above is correct.
43. A stock expects to pay a year-end dividend of $2.00 a share (D1 = $2.00). The dividend is
expected to fall 5 percent a year, forever (g = -5%). The company’s expected and required rate of
return is 15 percent. Which of the following statements is most correct?
a. The company’s stock price is $10.

b. The company’s expected dividend yield 5 years from now will be 20 percent.
c. The company’s stock price 5 years from now is expected to be $7.74.
d. Statements b and c are correct.

20
44. The Nikko Company's last dividend was $1.50. The dividend growth rate is expected to be
constant at 15% for 3 years, after which dividends are expected to grow at a rate of 6% forever.
If Nikko's required return (rs) is 11%, what is the company's current stock price?
a. $36.69 b. $37.82 c. $38.99 d. $40.20 e. $41.40
45. Rentz RVs Inc. (RRV) is presently enjoying relatively high growth because of a surge in
the demand for recreational vehicles. Management expects earnings and dividends to grow at a
rate of 25% for the next 4 years, after which high gas prices will probably reduce the growth
rate in earnings and dividends to zero, i.e., g = 0. The company’s last dividend, D0, was $1.25.
RRV’s beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is 3.00%. What is
the current price of the common stock?
a. $26.77
b. $27.89
c. $29.05
d. $30.21
e. $31.42
46. McNally Motors has yet to pay a dividend on its common stock. However, the company expects
to pay a $1.00 dividend starting two years from now (D2 = $1.00). Thereafter, the stock’s dividend
is expected to grow at a constant rate of 5 percent a year. The stock’s beta is 1.4, the risk-free rate is
kRF = 0.06, and the expected market return is kM = 0.12. What is the stock’s expected price four years
from now, that is, what is P̂4 ?
a. $10.63
b. $12.32
c. $11.87
d. $13.58
e. $11.21
47. Given the following information, calculate the expected capital gains yield for Chicago Bears
Inc.: beta = 0.6; kM = 15%; kRF = 8%; D1 = $2.00; P0 = $25.00. Assume the stock is in equilibrium
and exhibits constant growth.
a. 3.8%
b. 0%
c. 8.0%
d. 4.2%
e. 2.5%
48. Berg Inc. has just paid a dividend of $2.00. Its stock is now selling for $48 per share. The firm
is half as risky as the market. The expected return on the market is 14 percent, and the yield on
U.S. Treasury bonds is 11 percent. If the market is in equilibrium, what growth rate is expected?
a. 13%
b. 10%
c. 4%
d. 8%
e. -2%

21
(Most Important Questions on Ch. 15 & 16)
1. If a firm takes actions that reduce its DSO, then, other things held constant, this will
lengthen its CCC.
FALSE
2. Other things held constant, if a firm stretches its accounts payable, this will lengthen its CCC
FALSE
3. Determining a firm’s optimal investment in net operating working capital and how that
investment is financed are elements of working capital policy
TRUE
4. Permanent net operating working capital reflects the fact that net operating working capital
does not shrink to zero even when a business is at its seasonal or cyclical low. Thus, permanent
net operating working capital represents a minimum level of net operating working capital that
must be financed.
TRUE
5. A conservative financing approach to working capital will result in most of the permanent
net operating working capital being financed by long-term securities.
TRUE
6. Shorter-term cash budgets, in general, are used for actual cash control, while longer-term
cash budgets are used for planning purposes.
TRUE
7. Although short-term interest rates have historically averaged less than long-term rates, the
heavy use of short-term debt is considered to be an aggressive working capital financing
strategy because of the inherent risks of using short-term financing.
TRUE
8. Short-term financing is riskier than long-term financing since, during periods of tight credit,
the firm may not be able to rollover (renew) its debt. This is especially true if the funds are
used to finance long-term rather than short-term assets.
TRUE
9. Net operating working capital, defined as current assets minus current liabilities, is also
equal to the current ratio. FALSE
10. Working capital management deals with the management of current assets and current
liabilities such as accounts receivable and accruals, etc. FALSE

22
11. The four major elements in a firm’s credit policy are (1) credit standards, (2) discounts
offered, (3) credit period, and (4) collection policy. FALSE
12. The credit period is the amount of time it takes to do a credit search on a potential
customer. FALSE
13. You receive some goods on April 1 with the following terms: 3/20, net 30, June 1 dating.
This means that you will receive a 3% discount if the bill is paid on or before June 20 and also
that the full amount must be paid 30 days after receipt of the goods. FALSE
14. Trade credit can be separated into two components: free trade credit, which is credit
received after the discount period ends, and costly trade credit, which is the cost of discounts
not taken. FALSE
15. As a rule, managers should try to always use the free component of trade credit but should
use the costly component only if the cost of this credit is lower than the costs of credit from
other sources. TRUE
16. The trade credit that a firm receives during the discount period is referred to as free trade
credit. TRUE
17. Accruals are “free” capital in the sense that no explicit interest must be paid on accruals.
TRUE
18. Accruals are spontaneous, but, unfortunately, due to law and economic forces, firms have
little control over the level of these accounts. TRUE
19. The effect of compensating balances is to decrease the effective interest rate of a loan.
FALSE
20. The inventory conversion period of the operating cycle terminates when the inventory is
paid for with cash. FALSE
21. When the accounts receivable turnover and payables deferral period are decreased, a firm’s
cash conversion cycle will be lengthened. TRUE
22. A firm that follows an aggressive working capital financing approach is more exposed to
unexpected changes in the term structure of interest rates than is a firm that follows a
conservative financing policy. TRUE
23. Since depreciation is a noncash charge, it neither appears on, nor has any effect on, the cash
budget. FALSE
24. The fact that no explicit interest is paid on accruals, and that the firm can vary the level of
these accounts, makes accruals an attractive and flexible source of funding to meet increased
working capital needs. FALSE

23
25. Helena Furnishings wants to reduce its cash conversion cycle sharply. Which action should
it take?
a. The company should increase its average inventory without increasing its sales.
b. The company should reduce its DSO.
c. The company should start paying its bills sooner, which reduces its average accounts
payable without reducing its sales.
d. The company should increase its DSO.
ANSWER: b
26. Other things held constant, which strategy would tend to reduce the cash conversion cycle?
a. maintaining the same level of receivables as sales decline
b. placing larger orders for raw materials to take advantage of price breaks
c. taking all discounts that are offered
d. not taking all discounts that are offered to get more trade credit
ANSWER: d
27. Which action would NOT be likely to shorten the length of the cash conversion cycle?
a. adopting a new inventory system that reduces the inventory conversion period
b. reducing the average DSO on its accounts receivable
c. reducing the amount of time the company takes to pay its suppliers
d. increasing sales while maintaining the same level of receivables
ANSWER: c
28. Why do firms generally choose to finance temporary net operating working capital with
short-term debt?
a. Matching the maturities of assets and liabilities reduces risk.
b. Short-term interest rates have traditionally been more stable than long-term interest rates.
c. A firm that borrows heavily on a long-term basis is more apt to be unable to repay the
debt than a firm that borrows short term.
d.The yield curve has traditionally been downward sloping.
29. Which of the following statements best describes alternatives to short-term financing
policies?
a. Accruals are an expensive way to finance working capital.
b. A conservative financing policy is one in which the firm finances all of its fixed assets with
long-term capital and part of its permanent net operating working capital with short-term,
nonspontaneous credit.
c. If a company receives trade credit under terms 2/10, net 30, this implies the company has 10
days of free trade credit.
d. A firm following an aggressive financing policy would finance all its permanent NOWC
with long-term capital.
ANSWER: c

24
30. Which factor is typically NOT considered when constructing a cash budget?
a. payments lag
b. payment for plant
construction
c. cumulative cash
d. writing off bad debts
ANSWER: d
31. Which statement best describes cash budgets?

a. Depreciation expense is not explicitly included, but depreciation effects are reflected in the
estimated tax payments.
b. Cash budgets do not include financial expenses such as interest and dividend payments.
c. Cash budgets do not include cash inflows from long-term sources such as bond issues.
d. Changes that affect the DSO do not affect the cash budget.
ANSWER: a
32. Which item should a company report directly in its monthly cash budget?
a. its monthly depreciation expense
b. cash proceeds from selling one of its divisions
c. accrued interest on zero coupon bonds that it issued
d. new shares issued in a stock split
ANSWER: b
33. Carroll & King Corporation has $5 million of inventory and $2 million of accounts
receivable. Its average daily sales are $120,000. The company’s payables deferral period
(accounts payable divided by daily purchases) is 30 days. What is C&K’s cash conversion
cycle?
a. 24
b. 26
c. 27
d. 28
ANSWER: d
34. Westley Company’s average age of accounts receivable is 50 days, the average age of
accounts payable is 45 days, and the average age of inventory is 72 days. Assuming a 365-day
year, what is the length of its cash conversion cycle?
a. 66
b. 69
c. 73
d. 77
ANSWER: d

25
35. Miletkov Company’s total assets fluctuate between $320,000 and $410,000, while its fixed
assets remain constant at $260,000. If the firm follows a maturity matching, or moderate,
working capital financing policy, what is the likely level of its long-term debt and equity
financing?
a. $274,360
b. $288,800
c. $304,000
d. $320,000
36. Schoof Inc. expects to have sales of $30,000 in January, $35,000 in February, and $40,000
in March. If 20% of sales are for cash, 40% are credit sales paid in the month following the
sale, and another 40% are credit sales paid 2 months following the sale, what are the cash
receipts for the firm in March?
a. $29,151
b. $30,685
c. $32,300
d. $34,000
ANSWER: d
37. Filbeck Company buys on terms of 2/15, net 30 days. It does not take discounts, and it
typically pays 30 days after the invoice date. Net purchases amount to $500,000 per year. On
average, how much free trade credit does the firm receive during a 365-day year?
a. $20,548
b. $21,575
c. $22,654
d. $23,787
ANSWER: a
38. On average, Bragg Inc. has sales of $2,000,000 per month. It keeps inventory equal to 50%
of its monthly sales on hand at all times. Based on using a 365-day year, what is the inventory
conversion period?
a. 11.7
b. 13.0
c. 14.4
d. 15.2
ANSWER: d
39. Cyree Inc. has annual sales of $80,000,000, its average inventory is $20,000,000, and its
average accounts receivable is $16,000,000. The firm buys all raw materials on terms of net 35
days, and it pays on time. The firm is searching for ways to shorten the cash conversion cycle.
If sales can be maintained at existing levels while lowering inventory by $4,000,000 and
accounts receivable by $2,000,000, by how many days would the cash conversion cycle be
changed? Use a 365-day year.
a. –27.4 b. –28.7 c. –30.2 d. –31.7
ANSWER: a

26
40. You were recently hired as CFO to improve the performance of Dennis Systems, which is
highly profitable but has been experiencing cash shortages due to its high rate of growth. As
one part of your analysis, you want to determine the firm’s cash conversion cycle. Using the
following information and a 365-day year, what is your estimate of the firm’s present cash
conversion cycle?
Average inventory: $120,000
Annual sales: $600,000
Average accounts receivable: $160,000
Average accounts payable: $25,000
Total annual purchases: $365,000
Buy on net 30 days, no discounts: 30
Sell on net 50 days, no discounts: 50
a. 118.4
b. 124.6
c. 131.2
d. 145.3
41. Ferson Inc. has annual sales of $36,500,000, or $100,000 a day on a 365-day basis. On
average, the company has $12,000,000 in inventory and $8,000,000 in accounts receivable.
The firm is looking for ways to shorten its cash conversion cycle, which is calculated on a 365-
day basis. Its CFO has proposed new policies that would result in a 20% reduction in both
average inventories and accounts receivables. She also anticipates that these policies would
reduce sales by 10%, while accounts payable would remain unchanged. What effect would
these policies have on the company’s cash conversion cycle? Round to the nearest whole day.
a. –40 days
b. –22 days
c. +22 days
d. +40 days
ANSWER: b
42. Bello Corp. has annual sales of $50,735,000, an average inventory level of $15,012,000,
and average accounts receivable of $10,008,000. The company makes all purchases on credit
and has always paid on the 30th day. However, it now plans to take full advantage of trade
credit and pay its suppliers on the 40th day. The CFO also believes that sales can be
maintained at the existing level but inventory can be lowered by $1,946,000 and accounts
receivable by $1,946,000. What will be the net change in the cash conversion cycle, assuming
a 365-day year?
a. –14.0 days
b. –18.8 days
c. –25.6 days
d. –38.0 days
ANSWER: d

27
43. Nagel Corporation’s budgeted monthly sales are $5,000, and they are constant from month
to month. Its customers pay as follows: 40% pay in the first month and take the 2% discount,
while the remaining 60% pay in the month following the sale and do not receive a discount.
The firm has no bad debts. Purchases for next month’s sales are constant at 50% of projected
sales for the next month. “Other payments,” which include payments for wages, rent, and
taxes, are 25% of sales for the month. Construct a cash budget for a typical month. What is the
average cash gain or loss during the month?
a. $1,092
b. $1,150
c. $1,210
d. $1,271
ANSWER: c
44. Shanklin Inc. purchases merchandise on terms of 2/15, net 40, and its total gross purchases
(i.e., purchases before taking off the discount) are $800,000 per year. What is the maximum
amount of costly trade credit Shanklin could get, assuming it abides by the supplier’s credit
terms? (Assume a 365-day year.)
a. $53,699
b. $56,384
c. $59,203
d. $62,163
ANSWER: a
45. A firm needs $45,000 to purchase inventory. The bank requires a 5% compensating
balance. With a stated interest rate of 15%, what is the effective interest rate?
a. 14.25%
b. 15.00%
c. 15.79%
d. 16.67%
ANSWER: c
46. Your firm needs $630 for one quarter to finance a deficit. Interest charges are 2% per
quarter. Your bank requires a 10% compensating balance. How much must your firm borrow
in order to obtain the needed funds?
a. $693.00
b. $700.00
c. $705.60
d. $715.91
ANSWER: b

28
47. Margetis Inc. carries an average inventory of $1,000,000. Its annual sales are $10 million,
and its receivables conversion period is twice as long as its inventory conversion period. The
firm buys on terms of net 30 days, and it pays on time. Its new CFO wants to decrease the cash
conversion cycle by 10 days, based on a 365-day year. He believes he can reduce the average
inventory to $863,000 with no effect on sales. By how much must the firm also reduce its
accounts receivable to meet its goal of a 10-day reduction in the cash conversion cycle?
a. $0
b. $101,900
c. $136,986
d. $333,520
ANSWER: c
48. Which of the following best describes gross working capital?

a. current assets used in operations
b. fixed assets and retained earnings used in operation.
c. long-term assets used in operations
d. current liabilities and inventory used in operation.
ANSWER: a
49. Which of the following describes net working capital?

a. current assets minus current liabilities
b. current assets minus inventory
c. current assets minus cash
d. long –term minus current liabilities
ANSWER: a
50. Which of the following are included in the cash conversion cycle?
a. inventory conversion period, the receivables collection period, and the payables deferral
period
b. inventory conversion period, the receivables collection period, and the long-term assets
cycle
c. acid test period, the receivables collection period, and the payables deferral period
d. the inventory conversion period and the payables deferral period
ANSWER: a
51. What is the purpose of the cash conversion cycle (CCC)?

a. It shows how long a firm must finance its long-term capital.
b. It shows how long a firm must finance its operating working capital.
c. It shows how long a firm must finance its mortgage capital.
d. It shows how long is must finance its inventories.
ANSWER: b

29
52. Other things held constant, what happens with a short CCC?
a. The firm’s working capital management is more effective.
b. The firm’s working capital management is less effective.
c. The firm’s inventory management is more effective..
d. The firm’s administrative costs are more effective.
ANSWER: a
53. What is one of the advantages of short-term debt financing.

a. Firms can obtain short-term credit more quickly than long-term credit.
b. Firms can obtain long-term more quickly than short-term credit.
c. Firms can obtain short-term credit to pay preferred dividends in the short-run.
d. Firms can obtain short-term credit to from accounts receivable in the short-run at
cheaper rates.
ANSWER: a
54. Canada Corp., needs $16,000 for one quarter to finance a deficit. Interest charges are 4%
per quarter. Your bank requires an 8% compensating balance. How much must your firm
borrow in order to obtain the needed funds?
a. $16,320
b. $17,392
c. $17,270
d. $19,900
ANSWER: b
55. BC Corp., needs $10,000 for one quarter to finance a deficit. Interest charges are 2% per
quarter. Your bank requires a 10% compensating balance. How much must your firm borrow
in order to obtain the needed funds?
a. $11,111
b. $8,888
c. $15,270
d. $11,000
ANSWER: b
56. Wintoki Company writes checks averaging $15,000 a day, and it takes 5 days for these
checks to clear. The firm also receives checks in the amount of $17,000 per day, and it takes 3
days for these checks to be deposited and cleared. What is the firm's net float, in dollars?
a. $20,577
b. $21,660
c. $22,800
d. $24,000
e. $25,200

30
(Most Important Questions on Ch. 7)
1. The NPV method’s assumption that cash inflows are reinvested at the cost of capital is more
reasonable than the IRR’s assumption that cash flows are reinvested at the IRR. This is an
important reason that the NPV method is generally preferred over the IRR method. TRUE
2. The internal rate of return is that discount rate that equates the present value of the cash
outflows (or costs) with the present value of the cash inflows. TRUE
3. Other things held constant, an increase in the cost of capital will result in a decrease in a
project's IRR. FALSE
4. If a project's NPV exceeds its IRR, then the project should be accepted. FALSE
5. The NPV method's assumption that cash inflows are reinvested at the cost of capital is more
reasonable than the IRR's assumption that cash flows are reinvested at the IRR. This is an
important reason why the NPV method is generally preferred over the IRR method. TRUE
6. One advantage of the payback method for evaluating potential investments is that it provides
some information about a project's liquidity and risk. TRUE
7. A decrease in the firm's discount rate (r, or WACC) will increase projects' NPVs, which
could change the accept/reject decision for any potential project. However, such a change
would have no impact on the project's IRR; therefore, the accept/reject decision under the IRR
method is independent of the cost of capital. FALSE
8. A firm should never undertake an investment if accepting the project would lead to an
increase in the firm’s cost of capital. FALSE
9. Because “present value” refers to the value of cash flows that occur at different points in
time, a series of present values should not be summed to determine the value of a capital
budgeting project. FALSE
10. 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 NPV is found by compounding the cash inflows at the IRR to find the terminal
value (TV), then discounting the TV at the WACC.
b. The lower the WACC used to calculate it, the lower the calculated NPV will be.
c. If a project’s NPV is less than zero, then its IRR must be less than the WACC.
d. If a project’s NPV is greater than zero, then its IRR must be less than zero.
e. The NPV of a relatively low risk project should be found using a relatively high WACC.
Answer: C

31

a. One defect of the IRR method is that it does not take account of cash flows over a project’s
full life.
b. One defect of the IRR method is that it does not take account of the time value of money.
c. One defect of the IRR method is that it does not take account of the cost of capital.
d. One defect of the IRR method is that it values a dollar received today the same as a dollar
that will not be received until some time in the future.
e. One defect of the IRR method is that it assumes that the cash flows to be received from a
project can be reinvested at the IRR itself, and that assumption is often not valid.
Answer: E
12.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 compounding the cash inflows at the WACC to find the
terminal value (TV), then discounting this TV at the WACC.
b. A project’s regular IRR is found by discounting the cash inflows at the WACC to find the
present value (PV), then compounding this PV to find the IRR.
c. If a project’s IRR is greater than the WACC, then its NPV must be negative.
d. To find a project’s IRR, we must solve for the discount rate that causes the PV of the
inflows to equal the PV of the project’s costs.
e. To find a project’s IRR, we must find a discount rate that is equal to the WACC.

a. The regular payback method recognizes all cash flows over a project’s life.
b. The discounted payback method recognizes all cash flows over a project’s life, and it also
adjusts these cash flows to account for the time value of money.
c. The regular payback method was, years ago, widely used, but virtually no companies even
calculate the payback today.
d. The regular payback is useful as an indicator of a project’s liquidity because it gives
managers an idea of how long it will take to recover the funds invested in a project.
e. The regular payback does not consider cash flows beyond the payback year, but the
discounted payback overcomes this defect.
14. 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 longer a project’s payback period, the more desirable the project is normally considered
to be by this criterion.
b. One drawback of the payback criterion for evaluating projects is that this method does
not properly account for the time value of money.
c. If a project’s payback is positive, then the project should be rejected because it must have a
negative NPV.
d. The regular payback ignores cash flows beyond the payback period, but the discounted
payback method overcomes this problem.
e. If a company uses the same payback requirement to evaluate all projects, say it requires a
payback of 4 years or less, then the company will tend to reject projects with relatively short l
lives and accept long-lived projects, and this will cause its risk to increase over time.

32

a. The shorter a project’s payback period, the less desirable the project is normally considered
to be by this criterion.
b. One drawback of the payback criterion for evaluating projects is that this method does
not take account of cash flows beyond the payback period.
c. If a project’s payback is positive, then the project should be accepted because it must have a
positive NPV.
d. The regular payback ignores cash flows beyond the payback period, but the discounted
payback method overcomes this problem.
e. One drawback of the discounted payback is that this method does not consider the time value
of money, while the regular payback overcomes this drawback.
16. Assume a project has normal cash flows. All else equal, which of the following statements
is CORRECT?
a. The project’s IRR increases as the WACC declines.
b. The project’s NPV increases as the WACC declines.
c. The project’s MIRR is unaffected by changes in the WACC.
d. The project’s regular payback increases as the WACC declines.
e. The project’s discounted payback increases as the WACC declines.

a. The internal rate of return method (IRR) is generally regarded by academics as being the
best single method for evaluating capital budgeting projects.
b. The payback method is generally regarded by academics as being the best single method for
evaluating capital budgeting projects.
c. The discounted payback method is generally regarded by academics as being the best single
method for evaluating capital budgeting projects.
d. The net present value method (NPV) is generally regarded by academics as being the
best single method for evaluating capital budgeting projects.
e. The modified internal rate of return method (MIRR) is generally regarded by academics as
being the best single method for evaluating capital budgeting projects.
18. 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. If a project’s NPV is greater than zero, then its IRR must be less than the WACC.
c. If a project’s NPV is greater than zero, then its IRR must be less than zero.
d. The NPVs of relatively risky projects should be found using relatively low WACCs.

33
19. Which of the following statements is correct?

a. The NPV method assumes that cash flows will be reinvested at the WACC, while the
IRR method assumes reinvestment at the IRR.
b. The NPV method assumes that cash flows will be reinvested at the risk-free rate, while the
IRR method assumes reinvestment at the IRR.
c. The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR
method assumes reinvestment at the risk-free rate.
d. The NPV method does not consider all relevant cash flows, particularly cash flows beyond
the payback period.
20. The regular payback method has a number of disadvantages, some of which are listed
below. Which of these items is NOT a disadvantage of this method?
a. Lack of an objective, market-determined benchmark for making decisions.
b. Ignores cash flows beyond the payback period.
c. Does not directly account for the time value of money.
d. Does not provide any indication regarding a project’s liquidity.
e. Does not directly account for differences in risk among projects.
21. Edmondson Electric Systems is considering a project that has the following cash flow and
WACC data. What is the project’s NPV?
a. $243.43
b. $255.60
c. $268.38
d. $281.80
22. Johnson Enterprises is considering a project that has the following cash flow and WACC
data. What is the project’s NPV?
a. $98.78
b. $103.98
c. $109.45
d. $114.93

34
23. Tucker Corp. is considering a project that has the following cash flow data. What is the
project’s IRR?
a. 15.82% b. 16.65% c. 17.48% d. 18.36%
24. Wells Inc. is considering a project that has the following cash flow data. What is the
project’s payback?
a. 1.62 years b. 1.80 years c. 2.00 years d. 2.20 years
25. Van Auken Inc. is considering a project that has the following cash flows:
The company’s WACC is 10%. What are the project’s payback, IRR, and NPV?
a. payback = 2.4, IRR = 10.00%, NPV = $600
b. payback = 2.4, IRR = 21.22%, NPV = $260
c. payback = 2.6, IRR = 21.22%, NPV = $300
d. payback = 2.6, IRR = 21.22%, NPV = $260
26. Babcock Inc. is considering a project that has the following cash flow and WACC data.
What is the project’s NPV?
a. $54.62
b. $57.49
c. $60.52
d. $63.54

35
27. Rentz Recreation Inc. is considering a project that has the following cash flow data. What
is the project’s IRR?
a. 14.04%
b. 15.44%
c. 16.99%
d. 18.69%
28. Flint Fruits is considering two equally risky, mutually exclusive projects, Projects A and B,
that have the following cash flows:
|
At what WACC would the two projects have the same NPV?
a. 9.56%
b. 10.33%
c. 11.21%
d. 12.55%
29. Stewart Associates is considering a project that has the following cash flow data. What is
the project’s payback?
a. 2.34 years
b. 2.60 years
c. 2.89 years
d. 3.21 years
30. Garvin Enterprises is considering a project that has the following cash flow and WACC
data. What is the project’s discounted payback?|
a. 2.12 years
b. 2.35 years
c. 2.59 years
d. 2.85 years

36
31. Bey Bikes is considering a project that has the following cash flow and WACC data. What
is the project’s discounted payback?
a. 1.72 years
b. 1.92 years
c. 2.13 years
d. 2.36 years
32. Last month, Smith Systems Inc. decided to accept the project whose cash flows are shown
below. However, before actually starting the project, the Bank of Canada took actions that
lowered interest rates and therefore Smith’s WACC. By how much did the change in the
WACC affect the project’s forecasted NPV? Assume that the Bank of Canada’s action does not
affect the cash flows.
a. $57.18
b. $60.19
c. $63.36
d. $66.69
33. Sorenson Stores is considering a project that has the following cash flows:
The project has a payback of 2.5 years, and the firm’s cost of capital is 12%. What is the
project’s NPV?
a. $577.68
b. $765.91
c. $1,049.80
d. $2,761.32

37
34. Project A and B both have positive NPVs. If A and B are mutually exclusive, others thing
held constant, which project will management accept?
a. Management will accept the project with the lower NPV.
b. Management will accept the project with the higher NPV.
c. Management will accept both A and B since they both have positive NPVs.
d. When projects are mutually exclusive, the NPV rule is ignored and neither project is
accepted.
35. Project Delta has the following cash flows:

CF 0 –$10,000
CF 1 $0
CF 2 $500
CF 3 $800
CF 4 $3,000
CF 5 $6,000
If this project has a required rate of return of 15%, will management accept or reject the
project?
a. Management would reject the project since there are no cash flows greater than zero
in year 1.
b. Management would reject the project because the project has a NPV of $4,398.
c. Management would reject the project because the project has a NPV of –$4,398.
d. Management would reject the project because the project has a NPV of –$10,000.
36. Project Delta has the following cash flows:

CF 0 –$1,000,000
CF 1 $100,000
CF 2 $500,000
CF 3 $500,000
CF 4 $30,000
Calculate the project’s IRR given a required rate of return of 22%.
a. IRR = 22.00%
b. IRR = 5.24%
c. IRR = 10.56%
d. IRR = –5.24%
37. Which of the following is correct regarding profitability indices (PI)?

a. The higher the PI, the lower the ranking.
b. The lower the PI, the lower the ranking.
c. A project with a PI above 1.0 should be accepted.
d. Both B and C are correct regarding profitability indices.

38
38. A project has the following cash flows:

CF 0 –1,000
CF 1 $500
CF 2 $400
CF 3 $300
CF 4 $100
Assuming a required rate of return of 10% what is this project’s PI?
a. 1.58
b. 1.08
c. 1.00
d. 1.33

CF 0 –10,000
CF 1 $1,500
CF 2 $4,400
CF 3 $5,000
CF 4 $3,800
Assuming a required rate of return of 15%, would management accept this project?
a. 1.01
b. 1.10
c. 1.20
d. 1.33

CF 0 –10,000
CF 1 $1,500
CF 2 $4,400
CF 3 $8,000
CF 4 $8,800
Assuming a required rate of return of 6%, would management accept this project?
a. 1.01
b. 1.90
c. 1.20
d. 1.33

Financial MANAGEMENT: (Vip Questions)

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Financial MANAGEMENT

ANSWER ALL THE FOLLOWING QUESTIONS

3- Diversification increases the portfolio’s total systematic risk.

6- Decreasing correlation among assets in a portfolio result in a decrease in the standard

DR. KH. DREAM BOOKSHOP

9- Decreasing correlation among assets in a portfolio results in a decrease in the standard

DR. KH. DREAM BOOKSHOP

DR. KH. DREAM BOOKSHOP

DR. KH. DREAM BOOKSHOP

Event Probability Sec A Return Sec B Return A&B Portfolio

Recession 0.30 8% 12%

Normal 0.40 16% 8%

Boom 0.30 24% 4%

DR. KH. DREAM BOOKSHOP

Event Probability Sec A Return Sec B Return A&B Portfolio

Recession 0.30 4% 18% ----------------

Normal 0.40 8% 12% ----------------

Boom 0.30 12% 6% ---------------

27- The Coefficient of Variation for security A will be:

28- The Coefficient of Variation for security B will be:

DR. KH. DREAM BOOKSHOP

- Brown Chemical Company has provided the following information:

DR. KH. DREAM BOOKSHOP

37- The Cash Conversion Cycle is equal to:

Project A Cash Flows Project B Cash Flows

40- The net present value for project A is:

41- The net present value for project B is:

DR. KH. DREAM BOOKSHOP

(Most Important Questions on Ch. 8)

DR. KH. DREAM BOOKSHOP

DR. KH. DREAM BOOKSHOP

DR. KH. DREAM BOOKSHOP

DR. KH. DREAM BOOKSHOP

a. These two stocks should have the same price.

a. The two stocks should have the same expected dividend.

DR. KH. DREAM BOOKSHOP

a. Stock A’s expected dividend at t = 1 is only half that of Stock B.

DR. KH. DREAM BOOKSHOP

a. Stock X has a higher dividend yield than Stock Y.

a. The stock’s required return is 10%.

a. Stock Y pays a higher dividend per share than Stock X.

DR. KH. DREAM BOOKSHOP

a. Stock A must have a higher stock price than Stock B.

26. Which of the following statements is CORRECT?

DR. KH. DREAM BOOKSHOP

DR. KH. DREAM BOOKSHOP

36. Which of the following statements is most correct?

a. The expected return on the stock is 5 percent a year.

a. The two stocks should sell at the same price.

DR. KH. DREAM BOOKSHOP

a. The company’s stock price is $10.

DR. KH. DREAM BOOKSHOP

DR. KH. DREAM BOOKSHOP

(Most Important Questions on Ch. 15 & 16)

DR. KH. DREAM BOOKSHOP

DR. KH. DREAM BOOKSHOP

DR. KH. DREAM BOOKSHOP

31. Which statement best describes cash budgets?

DR. KH. DREAM BOOKSHOP

DR. KH. DREAM BOOKSHOP

DR. KH. DREAM BOOKSHOP

DR. KH. DREAM BOOKSHOP

48. Which of the following best describes gross working capital?