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# 1.

The primary operating goal of a publicly-owned firm interested in serving its stockholders
should be to _________. (Points: 4)
maximize its expected total corporate income
maximize its expected EPS
minimize the chances of losses
maximize the stock price per share over the long run, which is the stock's intrinsic
value
maximize the stock price on a specific target date

2. What's the future value of \$2,000 after 3 years if the appropriate interest rate is 8%,
compounded semiannually? (Points: 4)
\$2,854.13
\$2,781.45
\$2,324.89
\$2,011.87
\$2,530.64

3. You own an oil well that will pay you \$25,000 per year for 8 years, with the first payment
being made today. If you think a fair return on the well is 7%, how much should you ask for if
you decide to sell it? (Points: 4)
\$159,732
\$116,110
\$217,513
\$315,976
\$288,349

4. Suppose you borrowed \$25,000 at a rate of 8% and must repay it in 4 equal installments at the
end of each of the next 4 years. How large would your payments be? (Points: 4)
\$7,691.45
\$7,548.02
\$7,324.89
\$7,011.87
\$7,854.13
5. If a bank loan officer were considering a company's request for a loan, which of the following
statements would you consider to be CORRECT? (Points: 4)
The lower the company's TIE ratio, other things held constant, the lower the interest rate
the bank would charge the firm.
The lower the company's EBITDA coverage ratio, other things held constant, the lower
the interest rate the bank would charge the firm.
Other things held constant, the lower the current asset ratio, the lower the interest rate
the bank would charge the firm.
Other things held constant, the lower the debt ratio, the lower the interest rate the
bank would charge the firm.
Other things held constant, the higher the debt ratio, the lower the interest rate the bank
would charge the firm.

6. During the latest year Ruth Corp. had sales of \$300,000 and a net income of \$20,000, and its
year-end assets were \$200,000. The firm's total debt to total assets ratio was 40%. Based on the
Du Pont equation, what was the firm's ROE? (Points: 4)
15.33%
15.67%
16.00%
16.33%
16.67%

7. Rangoon Corp's sales last year were \$400,000, and its year-end total assets were
\$300,000. The average firm in the industry has a total assets turnover ratio (TATO) of 2.5. The
new CFO believes the firm has excess assets that can be sold so as to bring the TATO down to
the industry average without affecting sales. By how much must the assets be reduced to bring
the TATO to the industry average? (Points: 4)
\$100,000
\$110,000
\$120,000
\$130,000
\$140,000

## 8. Which of the following statements is CORRECT? (Points: 4)

The NYSE does not exist as a physical location; rather it represents a loose collection of
dealers who trade stock electronically.
An example of a primary market transaction would be your uncle transferring 100
shares of Wal-Mart stock to you as a birthday gift.
Capital market instruments include both long-term debt and common stocks.
If your uncle in New York sold 100 shares of Microsoft through his broker to an
investor in Los Angeles, this would be a primary market transaction..
While the two frequently perform similar functions, investment banks generally
specialize in lending money, whereas commercial banks generally help companies raise large
blocks of capital from investors.

## 9. Which of the following statements is CORRECT? (Points: 4)

If a market is strong-form efficient, this implies that the returns on bonds and stocks
should be identical.
If a market is weak-form efficient, this implies that above-average returns can best be
achieved by focusing on past movement of stock prices.
If your uncle earned a higher return on his portfolio over a 10-year period than the return
on the overall stock market, this would demonstrate that the stock market is inefficient.
Because of increased globalization, all of the world's stock markets are equally efficient
as that term is defined in the text.
If a market is semistrong-form efficient, this implies that above-average returns
cannot be achieved by analyzing publicly available data because such information is
already reflected in stock prices.

10. Keys Corporation's 5-year bonds yield 6.50%, and 5-year T-bonds yield 4.40%. The real
risk-free rate is r* = 2.5%, the default risk premium for Keys' bonds is DRP = 0.40%, the
liquidity premium on Keys' bonds is LP = 1.7% versus zero on T-bonds, and the inflation
premium (IP) is 1.5%. What is the maturity risk premium (MRP) on a 5-year bond? (Points: 4)
0.20%
0.30%
0.40%
0.50%
0.60%

11. Leggio Corporation issued 20-year, 7% annual coupon bonds at their par value of \$1,000 one
year ago. Today, the market interest rate on these bonds has dropped to 6%. What is the new
price of the bonds, given that they now have 19 years to maturity? (Points: 4)
\$1,046.59
\$1,111.58
\$1,133.40
\$1,177.78
\$1,189.04

12. 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. The bonds have a par value of \$1,000. What is the bond's annual coupon interest rate?
(Points: 4)
5.10%
5.20%
5.30%
5.40%
5.50%

## 13. Which of the following statements is NOT CORRECT? (Points: 4)

If a bond is selling at its par value, its current yield equals its yield to maturity.
If a bond is selling at a discount to par, its current yield will be less than its yield to
maturity.
All else equal, bonds with longer maturities have more interest rate (price) risk than do
bonds with shorter maturities.
All else equal, bonds with larger coupons have greater interest rate (price) risk
than do bonds with smaller coupons.
If a bond is selling at a premium, its current yield will be greater than its yield to
maturity.

14. Over the past 75 years, we have observed that investments with the highest average annual
returns also tend to have the highest standard deviations of their annual returns. This observation
supports the notion that there is a positive correlation between risk and return. Which of the
following lists correctly ranks investments from highest to lowest returns and risk (thus, the
highest risk security should be shown first, the lowest risk securities shown last)? (Points: 4)
small-company stocks, large-company stocks, long-term corporate bonds, long-
term government bonds, U.S. Treasury bills
small-company stocks, long-term corporate bonds, large-company stocks, long-term
government bonds, U.S. Treasury bills
large-company stocks, small-company stocks, long-term corporate bonds, U.S. Treasury
bills, long-term government bonds
U.S. Treasury bills, long-term government bonds, long-term corporate bonds, small-
company stocks, large-company stocks
large-company stocks, small-company stocks, long-term corporate bonds, long-term
government bonds, U.S. Treasury bills

15. 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.) (Points: 4)
10.50%
11.00%
11.50%
12.00%
12.50%

16. The Connors Company's last dividend was \$1.00. Its dividend growth rate is expected to be
constant at 15% for 2 years, after which dividends are expected to grow at a rate of 10% forever.
Connors' required return (rs) is 12%. What is Connors' current stock price? (Points: 4)
\$54.91
\$56.82
\$58.15
\$60.07
\$62.87

17. Assume that Mary Brown Inc. hired you as a consultant to help it estimate the cost of capital.
You have been provided with the following data: D0 = \$1.20; P0 = \$40.00; and g = 7%
(constant). Based on the DCF approach, what is Brown's cost of equity from retained earnings?
(Points: 4)
10.06%
10.21%
10.37%
10.54%
10.68%
18. You were hired as a consultant to Locke Company, and you were provided with the
following data: Target capital structure: 40% debt, 10% preferred, and 50% common equity.
The interest rate on new debt is 7.5%, the yield on the preferred is 7.0%, the cost of retained
earnings is 11.50%, and the tax rate is 40%. The firm will not be issuing any new stock. What is
the firm's WACC? (Points: 4)
8.25%
8.38%
8.49%
8.61%
8.76%

19. Safeco Company and Risco Inc are identical in size and capital structure. However, the
riskiness of their assets and cash flows are somewhat different, resulting in Safeco having a
WACC of 10% and Risco a 12% WACC. Safeco is considering Project X, which has an IRR of
10.5% and is of the same risk as a typical Safeco project. Risco is considering Project Y, which
has an IRR of 11.5% and is of the same risk as a typical Risco project.
Now assume that the two companies merge and form a new company, Safeco/Risco Inc.
Moreover, the new company's market risk is an average of the pre-merger companies' market
risks, and the merger has no impact on either the cash flows or the risks of projects X and Y.
Which of the following statements is CORRECT?
(Points: 4)
Safeco/Risco's WACC, as a result of the merger, would be 10%.
If evaluated using the correct post-merger WACC, Project X would have a
negative NPV.
After the merger, Safeco/Risco would have a corporate WACC of 11%. Therefore, it
should reject Project X but accept Project Y.
If the firm evaluates these projects and all other projects at the new overall corporate
WACC, it will become riskier over time.
After the merger, Safeco/Risco should select Project Y but reject Project X.

20. Blanchford Enterprises is considering a project that has the following cash flow data. What
is the project's IRR? Note that a project's projected IRR can be less than the WACC (and even
negative), in which case it will be rejected.
Year: 0 1 2 3
Cash flows: -\$1,000 \$450 \$450 \$450
(Points: 4)
16.20%
16..65%
17.10%
17.55%
18.00%

21. Swannee Resorts is considering a new project whose data are shown below. The equipment
that would be used has a 3-year tax life, would be depreciated by the straight line method over
the project's 3 year life, and would have zero salvage value. No new working capital would be
required. Revenues and other operating costs are expected to be constant over the project's 3-year
life. What is the project's NPV? If you are working this problem by hand rather than by
computer, ignore small rounding differences between your answer and the choices given. (Hint:
Cash flows are constant in Years 1-3.)
WACC 10%
Net investment cost (depreciable basis) \$65,000
Straight line depr’n rate 33.33%
Sales revenues \$70,000
Operating costs excl. depr’n \$25,000
Tax rate 35%
(Points: 4)
\$22,156.24
\$23,791.14
\$24,354.87
\$25,189.71
\$26,599.05

22. Harmon Industries is considering adding a new store. As a final step in reviewing the
proposed project, the CFO wants to take into account two real options that are attached to the
proposed project.
First, there is a timing option. One year from now, the company will have a much better idea of
whether the county will raise or lower its property taxes. The firm might want to wait a year to
decide whether it makes sense to proceed with their proposed project because the county taxes
could significantly affect the project’s cash flows.
Second, there is an abandonment option. After two years, the company will have the option to
shut down the store if it is determined that the store is losing money and will continue to lose
money.
Which of the following statements is most correct?
(Points: 4)
In this case, the option to delay the project actually takes value away from the project.
The abandonment option is likely to increase the project’s expected cash flows.
The abandonment option is likely to increase the project’s risk.
An abandonment and investment timing option can not exist for the same project.
In this case, the option to delay the project is likely to increase the project’s risk.

23. Business risk is concerned with the operations of the firm. Which of the following is NOT
associated with (or not a part of) business risk? (Points: 4)
demand variability
sales price variability
the extent to which operating costs are fixed
changes in required returns due to financing decisions
the ability to change prices as costs change

24. Brandi Co. has an unlevered beta of 1.10. The firm currently has no debt, but is considering
changing its capital structure to be 30% debt and 70% equity. If its corporate tax rate is 40%,
what is Brandi's levered beta? (Points: 4)
1.2549
1.3829
1.5764
1.6235
1.7458

25. Ronaldo Inc. has a capital budget of \$1,000,000, but it wants to maintain a target capital
structure of 60% debt and 40% equity. The company forecasts this year’s net income to be
\$600,000. If the company follows a residual dividend policy, what will be its dividend payout
ratio? (Points: 4)
16.67%
20.00%
25.00%
33.33%
35.00%

26. Which of the following actions would tend to reduce conflicts of interest between
stockholders and bondholders?
(Points: 4)
Including restrictive covenants in the company’s bond indenture (which is the contract between
the company and its bondholders)..
Compensating managers with more stock options and less cash income.
The passage of laws that make it harder for hostile takeovers to succeed.
A government regulation that banned the use of convertible bonds.
Have the firm use only long-term debt, e.g., debt that matures in 30 years or more rather than in
less than one year.

27.
The U.S. Treasury offers to sell you a bond for \$613.81. No payments will be made until the
bond matures 10 years from now, at which time it will be redeemed for \$1,000. What interest
rate would you earn if you bought this bond at the offer price? (Points: 4)

5.91%
6.71%
7.10%
5.59%
5.00%

28.
Temple Square Inc. reported that its retained earnings for 2005 were \$490,000. In its 2006
financial statements, it reported \$60,000 of net income, and it ended 2006 with \$510,000 of
retained earnings. How much were paid as dividends to shareholders during 2006?(Points: 4)

\$20,000
\$25,000
\$30,000
\$35,000

\$40,000

29.
Collins Inc's latest net income was \$1 million, and it had 200,000 shares outstanding. The
company wants to pay out 40% of its income. What dividend per share should the company
declare?(Points: 4)
\$1.60

\$1.70

\$1.80

\$1.90

\$2.00
30. f the Federal Reserve sells \$50 billion of short-term U.S. Treasury securities to the public, other things held
constant, what would be the most likely effect on short-term securities prices and interest rates?
(Points: 4)

## Prices and interest rates will both rise.

Prices will rise and interest rates will decline.
Prices and interest rates will both decline.
Prices will decline and interest rates will rise.
There is no reason to expect a change in either prices or interest rates.

31.
Your uncle would like to limit both his interest rate price risk (the risk that rising rates will cause
the value of his bonds to decline) and his default risk, but he would still like to invest in
corporate bonds. He is considering the following bonds. Which of these bonds would best meet
his criteria?

(Points: 4)

## AAA bonds with 10 years to maturity.

BBB perpetual bonds.
BBB bonds with 10 years to maturity.
AAA bonds with 5 years to maturity.
BBB bonds with 5 years to maturity.

32.
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?(Points: 4)

0.93
0.98
1.03
1.08
1.13

33.
A share of common stock has just paid a dividend of \$2..00. If the expected long-run growth
rate for this stock is 7%, and if investors require a(n) 11% rate of return, what is the price of the
stock?(Points: 4)

\$47.50
\$49.00
\$50.50
\$52.00
\$53.50

34.
Wagner Inc estimates that its average-risk projects have a WACC of 10%, its below-average risk
projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which
of the following projects (A, B, and C) should the company accept?(Points: 4)

## Project A is of average risk and has a return of 9%.

Project B is of below-average risk and has a return of 8.5%.
Project C is of above-average risk and has a return of 11%.
None of the projects should be accepted.
All of the projects should be accepted.

35.
The regular payback method has a number of disadvantages. Which of the following items is
NOT a disadvantage of this method?(Points: 4)

## Lack of an objective, market-determined benchmark for making decisions.

Ignores cash flows beyond the payback period.
Does not directly account for the time value of money.
Does not provide any indication regarding a project’s liquidity.
Does not directly account for differences in risk among projects.

36.
The relative risk of a proposed project is best accounted for by(Points: 4)

Adjusting the discount rate upward if the project is judged to have above average risk.
Adjusting the discount rate downward if the project is judged to have above average risk.
Reducing the NPV by 10% for risky projects.
Picking a risk factor equal to the average discount rate.
Ignoring it because project risk cannot be measured accurately.

37.
A firm is considering the purchase of an asset whose risk is greater than the firm’s current risk,
based on all methods for assessing risk. In evaluating this asset, it would be reasonable for the
decision maker to(Points: 4)

## Increase the IRR of the asset to reflect its greater risk.

Increase the NPV of the asset to reflect the greater risk.
Reject the asset, since its acceptance would increase the firm’s risk.
Ignore the risk differential if the project would amount to only a small fraction of the firm’s total
assets.
Increase the cost of capital used to evaluate the project to reflect the project’s higher risk.

38.
Brandi Co. has an unlevered beta of 1.10. The firm currently has no debt, but is considering
changing its capital structure to be 30% debt and 70% equity. If its corporate tax rate is 40%,
what is Brandi's levered beta?

(Points: 4)
1.2549
1.3829
1.5764
1.6235
1.7458

39.
Ridgefield Enterprises has total assets of \$300 million. The company currently has no debt in its
capital structure. The company’s basic earning power is 15%. The company is contemplating a
recapitalization where it will issue debt at 10% and use the proceeds to buy back shares of the
company’s common stock. If the company proceeds with the recapitalization, its operating
income, total assets, and tax rate will remain the same. Which of the following will occur as a
result of the recapitalization?

(Points: 4)
The company’s ROA will increase.
The company’s ROA will remain unchanged.
The company’s basic earning power will decline.
The company’s basic earning power will increase.
The company’s ROE will increase.

40.
You are analyzing the value of an investment by calculating the present value of its expected
cash flows. Which of the following would cause the investment to look better?(Points: 4)

## The discount rate decreases.

The cash flows are extended over a longer period of time, but the total amount of the
cash flows remains the same.
The discount rate increases.
The riskiness of the project’s cash flows increases.
The total amount of cash flows remains the same, but more of the cash flows are
received in the later years and less are received in the earlier years.

41.
You are considering buying a new, \$15,000 car, and you have \$2,000 to put toward a down
payment. If you can negotiate a nominal annual interest rate of 10% and finance the car over 60
months, what are your monthly car payments?(Points: 4)
\$216.67
\$252.34
\$276.21
\$285.78
\$318.71

42.
Elizabeth has \$35,000 in an investment account, but she wants the account to grow to \$100,000
in 10 years without making any additional contributions to the account. What effective annual
rate of interest does she need to earn on the account to meet her goal?(Points: 4)
9.03%
11.07%
10.23%
8.65%
12.32%

43.
If the CEO of a firm were filling out a fitness report on a division manager (i.e., “grading” the
manager), which of the following situations would be likely to cause the manager to get a
BETTER GRADE? In all cases, assume that other things are held constant.

(Points: 4)

The division’s total assets turnover ratio is below the average for other firms in the industry.
The division’s DSO (days’ sales outstanding) is 40, whereas the average for competitors is 30.
The division’s inventory turnover is 6, whereas the average for competitors is 8.
The division’s debt ratio is above the average for other firms in the industry.

The division’s basic earning power ratio is above the average of other firms in the
industry.
44.
McGwire Company’s pension fund projects that most of its employees will take advantage of an
early retirement program the company plans to offer in five years. Anticipating the need to fund
these pensions, the firm bought zero coupon U.S. Treasury Trust Certificates maturing in five
years. When these instruments were originally issued, they were 12% coupon, 30-year U.S.
Treasury bonds. The stripped Treasuries are currently priced to yield 10%. Their total maturity
value is \$6,000,000. What is their total cost (price) to McGwire today?(Points: 4)
\$ 553,776
\$5,142,600
\$3,404,561
\$4,042,040

\$3,725,528