Chapter 8

1. Semi-strong market efficiency implies that only public information that is available to all investors is
reflected in a security's market price.
A) True
B) False
2. The largest investors in corporate bonds are life insurance companies and pension funds.
A) True
B) False
3. As interest rates fall, the prices of bonds decline.
A) True
B) False
4. Which one of the following statements about vanilla bonds is NOT true?
A) They have no special provisions.
B) The face value, or par value, for most corporate bonds is $1,000.
C) Coupon payments are usually made quarterly.
D) The bond's coupon rate is calculated as the annual coupon payment divided by the bond's face
value.
5. Bonds sell at a discount off the par value when market rates for similar bonds are
A) less than the bond's coupon rate.
B) greater than the bond's coupon rate.
C) equal to the bond's coupon rate.
D) Market rates are irrelevant in determining a bond's price.
6. The three economic factors that determine the shape of the yield curve are
A) the real rate of interest, the expected rate of inflation, and marketability.
B) the real rate of interest, the expected rate of inflation, and interest rate risk.
C) the nominal rate of interest, the expected rate of inflation, and interest rate risk.
D) the real rate of interest, the nominal rate of interest, and interest rate risk.
7. Your friend recommends that you invest in a three-year bond issued by Trimer, Inc., that will pay
annual coupons of 10 percent. Similar investments today will yield 6 percent. How much should you pay
for the bond? (Round to the nearest dollar.)
A) $1,024
B) $979
C) $886
D) $1,107
8. The U.S. Treasury has issued 10-year zero coupon bonds with a face value of $1,000. Assume that
coupon payments are normally semiannual. What will be the current market price of these bonds if the
opportunity cost for similar investments in the market is 6.75 percent? (Round to the nearest dollar.)
A) $684
B) $860
C) $515
D) $604
9. Rachel McGovern bought a 10-year bond for $921.77 seven years ago. The bond pays a coupon of
15 percent semiannually. Today, the bond is priced at $961.92. If she sold the bond today, what would
be her realized yield? (Round to the nearest percent.)
A) 17%
B) 18%
C) 9%
D) 10%
10. Stanley Hart invested in a municipal bond that promised an annual yield of 6.7 percent. The bond
pays coupons twice a year. What is the effective annual yield (EAY) on this investment?
A) 13.4%
B) 6.81%
C) 6.70%
D) None of the above
Chapter 9
1. The largest holders of equity securities are
a. mutual funds.
b. pension funds.
c. foreign investors.
d. households.
2. Which ONE of the following statements is true about secondary markets in the United States?
a. In terms of total volume of activity and total capitalization of the firms listed, the NASDAQ is the
largest in the world and the NYSE is the second largest.
b. In terms of the number of companies listed and shares traded on a daily basis, NASDAQ is
larger than the NYSE.
c. Firms listed on the NASDAQ tend to be, on average, larger in size, and their shares trade more
frequently than firms whose securities trade on NYSE.
d. In the United States, most secondary market transactions are done over the counter.
3. Direct search markets are characterized by
a. complete price information.
b. extensive broker and dealer participation
c. private placement transactions and sale of common stock of small private companies.
d. a high level of efficiency.
4. Which ONE of the following statements is true about fast growth stocks?
a. These are firms that grow their sales at above-average rates and are expected to do so for a
length of time.
b. These are firms that grow their earnings at above-average rates and are expected to do so for a
length of time.
c. They generally pay dividends during their fast growth phase.
d. None of the above.
5. Cortez, Inc., is expecting to pay out a dividend of $2.50 next year. After that it expects its dividend to
grow at 7 percent for the next four years. What is the present value of dividends over the next five-year
period if the required rate of return is 10 percent?
a. $10.76
b. $9.80
c. $11.88
d. $11.50
6. Kleine Toymakers is introducing a new line of robotic toys, which it expects to grow their earnings at a
much faster rate than normal over the next three years. After paying a dividend of $2.00 last year, it
does not expect to pay a dividend for the next three years. After that Kleine plans to pay a dividend of
$4.00 in year 4 and then increase the dividend at a rate of 10 percent in years 5 and 6. What is the
present value of the dividends to be paid out over the next six years if the required rate of rat of return is
15 percent?
a. $13.24
b. $12.00
c. $6.57
d. $10.24
7. Ambassador Corp. sells household cleaners producing a revenue stream that has remained
unchanged in the last few years. The firm does not expect any change in its sales or earnings in the next
several years. The stock is currently selling at $46.88. If the required rate of return is 16 percent, what is
the dividend paid by this company?
a. $2.93
b. $4.65
c. $6.89
d. $7.50
8. The National Bank of Columbia has issued perpetual preferred stock with a $100 par value. The bank
pays a quarterly dividend of $1.40 on this stock. What is the current price of this preferred stock given a
required rate of return of 8.5 percent?
a. $23.06
b. $65.88
c. $37.57
d. $43.25
9. BioSci, Inc., a biotech firm has forecast the following growth rates for the next three years: 30 percent,
25 percent, and 20 percent. The company then expects to grow at a constant rate of 7 percent for the
next several years. The company paid a dividend of $2.00 last week. If the required rate of return is 16
percent, what is the market value of this stock?
a. $51.03
b. $36.86
c. $56.12
d. $46.37
10. Durango Water Works has an outstanding issue of preferred stock that has a par (maturity value) of
$75.00. The stock, which pays a quarterly dividend of $1.10, will be retired by the firm in 20 years. If the
preferred stock is currently selling for $68.00, what is the preferred stock’s yield-to-maturity? (Round off
to the nearest 0.01%)
A) 6.72%
B) 5.64%
C) 4.28%
D) 7.73%
Chapter 11
1. Stillwater Drinks is trying to determine when to harvest the water from the fountain of youth that it
currently owns. If it harvests the water in year 1, the NPV of the project would increase over an
immediate harvest by 18 percent. A year 2 harvest would create an NPV increase of 12 percent over
that of year 1 and year 3 would create an NPV increase of 8 percent over that of year 2. If the cost of
capital is 17 percent for Stillwater, then which harvest year would maximize the NPV for the firm?
Assume that all NPVs are calculated from the perspective of today.
A) Harvest immediately.
B) Harvest in year 1.
C) Harvest in year 2.
D) Harvest in year 3.
Use the following to answer questions 61-64:
Provo, Inc., had revenues of $10 million, cash operating expenses of $5 million, and depreciation and
amortization of $1 million during 2008. The firm purchased $500,000 of equipment during the year while
increasing its inventory by $300,000 (with no corresponding increase in current liabilities). The marginal
tax rate for Provo is 40 percent.
2. What is Provo's cash flow from operations for 2008?
A) $2,400,000
B) $2,600,000
C) $3,400,000
D) $4,000,000
3. What is Provo's free cash flow for 2008?
A) $2,400,000
B) $2,600,000
C) $3,400,000
D) $4,000,000
4. What is Provo's NOPAT for 2008?
A) $2,400,000
B) $2,600,000
C) $3,400,000
D) $4,000,000
5. What is Provo's cash flows associated with investments for 2008?
A) $300,000
B) $500,000
C) $800,000
D) None of the above.
6. Use the tax rate taken from Exhibit 11.6 to calculate the average tax rate for Lansing, Inc., this year.
Lansing's pretax income was $275,000.
Exhibit 11.6 U.S. Corporate Tax Rate Schedule in 2007
Taxable Income
More
Than But Not More Than
Tax Owed
$0 $50,000 15% of amount beyond $0
$50,000 $75,000 $7,500 + 25% of amount beyond $50,000
$75,000 $100,000 $13,750 + 34% of amount beyond $75,000
$100,000 $335,000 $22,250 + 39% of amount beyond $100,000
$335,000 $10,000,000 $113,900 + 34% of amount beyond $335,000
$10,000,000 $15,000,000 $3,400,000 + 35% of amount beyond $10,000,000
$15,000,000 $18,333,333 $5,150,000 + 38% of amount beyond $15,000,000
$18,333,333 ------- 35% on all income
A) 8.2%
B) 24.8%
C) 33.0%
D) 39.0%
7. Babaloo Nightclubs. purchased a disco mirror that currently has a book value of $10,000. If Babaloo
sells the disco mirror for $500 today, then what is the amount of cash that it will net after taxes if the firm
is subject to a 39 percent marginal tax rate?
A) $500
B) $3,705
C) $4,205
D) $9,500
8. Farmer Ag owns a special species of cotton-producing plant that, if left unharvested, grows a bigger
bowl of cotton through time. The NPV, at the beginning of the year that harvesting takes place, is as
follows. When should Farmer Ag harvest its cotton? Assume a discount rate of 14 percent.
NPV1 = $50,000
NPV2 = $60,000
NPV3 = $69,000
NPV4 = $77,280
NPV5 = $85,008
A) Harvest now
B) Harvest in year 1
C) Harvest in year 2
D) Harvest in year 3
9. Your firm is considering an investment that will cost $750,000 today. The investment will produce
cash flows of $250,000 in year 1, $400,000 in year 2, and $600,000 in year 3. The discount rate that
your firm uses for projects of this type is 11.75%.
What is the investment's equivalent annual cost? (Round off to the nearest)
A) $163,613
B) $225,008
C) $ 68,888
D) $ 92,845