T NG Fin202

26.
To start a business, the owners need

A) a market where there is demand for their product.
B) a clear vision of what products or services they want to produce.
C) the know-how to successfully market their product.
D) all of the above.
Ans: D
27. A stakeholder is
A) anyone geographically close to the firm's headquarters.
B) anyone with a claim on the cash flows of the firm.
C) any governmental agency.
Ans: B
28. If you have loaned capital to a firm, then you could be

A) a shareholder.
B) a stakeholder.
C) a partner.
Ans: B
29. Which of the following are stakeholders?

A) a shareholder
B) a lender
C) the IRS
D) all of the above
Ans: D
30. A trademark is an example of

A) a productive asset.
B) an intangible asset.
C) a nebulous asset.
D) none of the above.
Ans: B
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Format: Multiple Choice
Learning Objective: LO 1
Level of Difficulty: Medium
31. Which of the following is a basic source of funds for the firm?
A) Debt
B) Equity
C) asset liquidations
D) a and b above
Ans: D
32. The cash remaining after the firm has met its operating expenses, payments to creditors,
and taxes is called
A) earnings per share.
B) capital contributed in excess of par.
C) residual cash.
D) assets.
Ans: C
33. Cash dividends are paid out of

A) residual cash.
B) liquidated assets.
C) long-term debt.
Ans: A
34. Current liabilities are liabilities that

A) will be converted to cash within a year.
B) must be paid within a year.
C) will be converted to equity within a year.
D) none of the above
Ans: B
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35. Capital budgeting involves
A) how a firm's day-to-day financial matters should be managed.
B) how the firm should finance its assets.
C) which productive assets the firm should employ.
Ans: C
36. Working capital management decisions involve

A) how a firm's day-to-day financial matters should be managed.
B) how the firm should finance its assets.
C) which productive assets the firm should employ.
Ans: A
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37. Capital budgeting decisions generally involve
A) the fixed asset portion of the balance sheet.
B) the short-term portion of the balance sheet.
C) the current liability portion of the balance sheet.
Ans: A
38. A good capital budgeting decision is

A) one in which the benefits of the project are equal to the cost of the asset.
B) one in which the benefits of the project are less than the cost of the asset.
C) one in which the benefits of the project are more than the cost of the asset.
Ans: C
39. Financial markets in which equity and debt instruments with maturities greater than one
year are traded are called
A) money markets.
B) capital markets.
C) stock markets.
Ans: B
40. Profitability of a firm can be negatively affected by

A) too much inventory.
B) too little inventory.
C) either a or b.
D) neither a nor b.
Ans: C
41. About 75 percent of all businesses in the United States are

A) sole proprietorships.
B) partnerships.
C) corporations.
D) limited liability partnerships.
Ans: A
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42. Which of the following business organizational forms subjects the owner(s) to
unlimited liability?
A) sole proprietorship
B) partnership
C) corporation
D) a and b
Ans: D
43. Which of the following business organizational forms creates a tax liability on income
at the personal income tax rate?
B) Partnership
C) Corporation
D) a and b
Ans: D
44. Which of the following business organizational forms is easiest to raise capital?
B) Partnership
C) corporation
D) a and b
Ans: C
45. Which of the following owners is protected by limited liability?

A) a sole proprietor
B) a general partner
C) a limited partner
Ans: C
46. Which of the following cannot be engaged in managing the business?

A) a sole proprietor
B) a general partner
C) a limited partner
Ans: C
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47. Which organizational form accounts for 90 percent of the revenues of all firms in the
United States?
B) Partnership
C) Corporation
D) a and b
Ans: C
48. Which organizational form best enables a firm to sell its securities to the market?
B) Partnership
C) private corporation
D) public corporation
Ans: D
49. Which of the following organizational forms is subject to the most SEC regulations?
B) Partnership
Ans: D
50. Which organizational form best enables the owners of the firm to monitor the actions of
other owners of the same firm?
B) Partnership
Ans: B
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51. Which of the following is considered a hybrid organizational form?
B) Partnership
C) Corporation
D) limited liability partnership
Ans: D
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52. Which of the following reports directly to the owners of the firm (assume the firm is a
public corporation)
A) CFO
B) CEO
C) board of directors
D) audit committee
Ans: C
53. Which of the following is responsible for seeing that the best possible financial analysis
is presented?
A) CFO
B) CEO
C) board of directors
D) audit committee
Ans: A
54. Which of the following is responsible for performing an independent audit of the firm's
financial statements?
A) CFO
B) CEO
C) CPA firm
D) audit committee
Ans: C
55. How is the CPA firm insulated from being pressured by management?
A) The audit committee approves hiring, firing and fees paid to external auditors.
B) The chairman of the board approves the external auditor's fees as well as the
engagement letter.
C) The IRS approves the external auditor's fees as well as the engagement letter.
D) The CPA firm is not insulated from management.
Ans: A
56. Which of the following is an appropriate goal for the firm?

A) profit maximization
B) revenue maximization
C) shareholder wealth maximization
D) tax minimization
Ans: C
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57. When analysts and investors determine the value of a firm's stock, they should consider
A) the size of the expected cash flows associated with owning the stock.
B) the timing of the cash flows.
C) the riskiness of the cash flows.
Ans: D
58. One reason for the existence of agency problems between managers and shareholders is
that
A) there is a separation of ownership and control of the firm.
B) managers know how to manage the firm better than shareholders.
C) shareholders have unreasonable expectations about managerial performance.
Ans: A
59. Which of the following is a principal within the agency relationship?

A) a company engineer
B) the CEO of the firm
C) a shareholder
D) the board of directors
Ans: C

Level of Difficulty: Easy
60. Shareholders elect ______________ to represent their interest in the firm.
A) a chairman
B) CEO
C) a board of directors
D) all of the above
Ans: C
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61. An example of a direct agency cost is
A) a manager turning down a value-contributing project because of its risks.
B) a manager expensing a large dinner on the company expense report.
C) a manager using too little debt within the firm's capital structure because of the
additional risk associated with debt.
D) all of the above
Ans: B
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62. Which of the following can help align the behavior of managers with the goals of
shareholders?
A) management compensation
B) managerial labor markets
C) an independent board of directors
D) all of the above
Ans: D
63. If a firm has had an agency problem that is reflected in a poor performing stock for a
long period of time, then the firm may become a target of _________________.
A) an SEC investigation.
B) a corporate raider.
C) an IRS investigation.
D) a bankruptcy lawyer.
Ans: B
64. Executives that repeatedly put their own interests before that of the firm may find that
they have difficulty finding another job after their current one. This is an example of
A) the managerial labor market disciplining managers.
B) the market for corporate control.
C) the board of directors affecting the prospects of a manager.
Ans: A
65. Who or what is responsible for setting the agenda at meetings of the board of directors?
A) chairman of the board of directors
B) president
C) nominating committee
D) audit committee
Ans: A
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66. A director who is not an employee of the firm is called
A) an executive director.
B) an inside director.
C) an independent director.
D) an official director.
Ans: C
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67. Which of the following is NOT one of the strategies incorporated in the Sarbanes-
Oxley Act of 2002?
A) attain greater board independence
B) establish compliance programs
C) establish ethics programs
D) dictate maximum compensation levels
Ans: D
68. Which of the following powers does the audit committee have the authority to do?
A) audit the personal bank account of the CEO
B) question any person employed by the firm
C) audit the compensation files of firms in the same industry
Ans: B
69. What is the major complaint concerning the Sarbanes-Oxley Act of 2002 by firms?
A) the legislative maximum allowable compensation for a CEO
B) the legal requirement to disclose project information
C) the cost of compliance
D) the cost of maintaining an SEC-employed officer at the firm's premises
Ans: C
70. A society's ideas about what actions are right and wrong are
A) morals.
B) ethics.
C) laws.
D) unwritten laws.
Ans: B
71. The golden rule is an example of

A) a current law.
B) an historical law.
C) an unworkable rule in financial markets.
D) an ethical norm.
Ans: D
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72. An example of an economy that had trouble establishing a stock market and attracting
foreign investment is
A) Russia.
B) China.
C) the Czech Republic.
D) Japan.
Ans: A

73. Corruption in business
A) creates inefficiencies in an economy.
B) inhibits growth in an economy.
C) slows the rate of economic growth in a country.
D) all of the above
Ans: D

74. Which corporate officer, when he or she is guilty of serious misconduct, can subject the
firm to the most serious losses in financial wealth?
A) CEO
B) CFO
C) Chief Technology Officer
D) Chief Risk Officer
Ans: B
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Format
75. An officer of a firm that is a majority owner in a competing firm will probably be
subject to
A) an IRS audit.
B) a conflict of interest with his shareholders.
C) arbitrage profit returns to the SEC.
D) an FBI investigation.
Ans: B
76. _____________occur(s) when one party in a business transaction has information that
is unavailable to the other parties in the transaction.
A) Profits
B) Information asymmetry
C) Information efficiency
D) None of the above
Ans: B

77. With regard to information, a central idea of fairness suggests that
A) decisions should be made on an even playing field.
B) insiders should be able to trade whenever they want.
C) insiders should never be able to trade.
D) outsiders should not be allowed to trade since, by definition, they are at a
disadvantage.
Ans: A
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78. Which of the following individuals is typically most responsible for managing a large
corporation’s financial function?
A) The CEO.
B) The Chairman of the board.
C) The CBO.
D) The CFO.
Ans: D
79. If a firm establishes maximizing profits at the most important goal of the firm, which of
the following would not be given proper consideration?
A) Sales revenues
B) Expenses
C) Risk
D) Cost of goods sold
Ans: C
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80. Which of the following does maximizing shareholder wealth not usually account for?
A) Risk.
B) Government regulation.
C) The timing of cash flows.
D) Amount of cash flows.
Ans: B
81. Which of the following factors or activities can be controlled by the management of a
firm?
A) Capital budgeting.
B) The level of economic activity.
C) The level of interest rates.
D) Stock market conditions.
Ans: A
82. The legal system and market forces impose substantial costs on individuals and
institutions that engage in unethical behavior. Which of the following would not be an
example of the above?
A) Financial losses.
B) Legal fines.
C) Agency conflicts.
D) Jail time.
Ans: C
26. Financial statements can be analyzed from the following three different
perspectives:
A) management, regulator, and bondholder
B) management, shareholder, and creditor
C) regulator, shareholder, and creditor
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D) shareholder, creditor, and regulator
Ans: B
27. Shareholders analyze financial statements in order to:
A) assess the cash flows that the firm will generate from operations/
B) determine the firm's profitability, their return for that period, and the
dividend they are likely to receive.
C) focus on the value of the stock they hold.
D) All of the above.
Ans: D
28. The creditors of a firm analyze financial statements so that they can focus on
A) the firm's amount of debt.
B) the firm's ability to generate sufficient cash flows to meet all legal
obligations first and still have sufficient cash flows to meet debt
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repayment and interest payments.
C) the firm's ability to meet its short-term obligations.
Ans: D
29. A firm's management analyzes financial statement's so that:
A) they can get feedback on their investing, financing, and working capital
decisions by identifying trends in the various accounts that are reported in
the financial statements.
B) similar to shareholders, they can focus on profitability, dividend, capital

appreciation, and return on investment.
C) they can get more stock options.
D) a and b.
Ans: D
30. Anyone analyzing a firm's financial statements should
A) use audited financial statements only.
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B) do a trend analysis.
C) perform a benchmark analysis.
Ans: D
31. An individual analyzing a firm's financial statements should do all but one of the
following:
A) Use unaudited financial statements.
B) Do a trend analysis.
C) Perform a benchmark analysis.
D) Compare the firm's performance to that of its direct competitors.
Ans: A
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32. All but one of the following is true of common-size balance sheets.
A) Each asset and liability item on the balance sheet is standardized by

dividing it by total assets.
B) Balance sheet accounts are represented as percentages of total assets.
C) Each asset and liability item on the balance sheet is standardized by

dividing it by sales.
D) Common-size financial statements allow us to make meaningful

comparisons between the financial statements of two firms that are
different in size.
Ans: C
33. All but one of the following is true of common-size income statements.
A) Each income statement item is standardized by dividing it by total assets.
B) Income statement accounts are represented as percentages of sales.
C) Each income statement item is standardized by dividing it by sales.
D) Common-size financial statement analysis is a specialized application of

ratio analysis.
Ans: A
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34. Common-size financial statements:
A) are a specialized application of ratio analysis.
B) allow us to make meaningful comparisons between the financial

statements of two firms that are different in size.
C) are prepared by having each financial statement item expressed as a

percentage of some base number, such as total assets or total revenues.
D) All of the above are true.
Ans: D
35. Which of the following is true of ratio analysis?
A) A ratio is computed by dividing one balance sheet or income statement by

another.
B) The choice of the scale determines the story that can be garnered from the
ratio.
C) Ratios can be calculated based on the type of firm being analyzed or the
kind of analysis being performed.
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Ans: D
36. Which of the following is NOT true of liquidity ratios?
A) They measure the ability of the firm to meet short-term obligations with
short-term assets without putting the firm in financial trouble.
B) There are two commonly used ratios to measure liquidity—current ratio

and quick ratio.
C) For manufacturing firms, quick ratios will tend to be much larger than
current ratios.
D) The higher the number, the more liquid the firm and the better its ability
to pay its short-term bills.
Ans: C
37. All but one of the following is true about quick ratios.
A) The quick ratio is calculated by dividing the most liquid of current assets
by current liabilities.
B) Service firms that tend not to carry too much inventory will see
significantly higher quick ratios than current ratios.
C) Inventory, being not very liquid, is subtracted from total current assets to
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determine the most liquid assets.
D) Quick ratios will tend to be much smaller than current ratio for
manufacturing firms or other industries that have a lot of inventory.
Ans: B
38. Which one of the following does NOT change a firm's current ratio?
A) The firm collects on its accounts receivables.
B) The firm purchases inventory by taking a short-term loan.
C) The firm pays down its accounts payables.
D) None of the above.
Ans: A
39. All else being equal, which one of the following will decrease a firm's current
ratio?
A) a decrease in the net fixed assets
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B) a decrease in depreciation
C) an increase in accounts payable
Ans: C
40. All but one of the following is true about the inventory turnover ratio.
A) It is calculated by dividing inventory by cost of goods sold.
B) It measures how many times the inventory is turned over into saleable
products.
C) The more times a firm can turnover the inventory, the better.
D) Too high a turnover or too low a turnover could be a warning sign.
Ans: A
41. Which one of the following statements is NOT true?
A) The accounts receivables turnover ratio measures how quickly the firm
collects on its credit sales.
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B) One ratio that measures the efficiency of a firm's collection policy is days'
sales outstanding.
C) The more days that it takes the firm to collect on its receivables, the more
efficient the firm is.
D) DSO measures in days, the time the firm takes to convert its receivables
into cash.
Ans: C
42. One of the following statements is NOT true of asset turnover ratios.
A) Asset turnover ratios measure the level of sales per dollar of assets that
the firm has.
B) The fixed assets turnover ratio is less significant for equipment-intensive

manufacturing industry firms than the total assets turnover ratio.
C) The higher the total asset turnover, the more efficiently management is
using total assets.
Ans: B
43. Which one of the following statements is correct?
A) The lower the level of a firm's debt, the higher the firm's leverage.
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B) The lower the level of a firm's debt, the lower the firm's equity multiplier.
C) The lower the level of a firm's debt, the higher the firm's equity
multiplier.
D) The tax benefit from using debt financing reduces a firm's risk.
Ans: B
44. If firm A has a higher debt-to-equity ratio than firm B, then
A) firm A has a lower equity multiplier than firm B.
B) firm B has a lower equity multiplier than firm A.
C) firm B has lower financial leverage than firm A.
Ans: A
45. Which one of the following statements is NOT correct?
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A) A leveraged firm is more risky than a firm that is not leveraged.
B) A leveraged firm is less risky than a firm that is not leveraged.
C) A firm that uses debt magnifies the return to its shareholders.
D) All of the above statements are correct.
Ans: B
46. Coverage ratios, like times interest earned and cash coverage ratio, allow
A) a firm's management to assess how well they meet short-term liabilities.
B) a firm's shareholders to assess how well the firm will meet its short-term
liabilities.
C) a firm's creditors to assess how well the firm will meet its interest
obligations.
D) a firm's creditors to assess how well the firm will meet its short-term
liabilities other than interest expense.
Ans: C
47. For a firm that has no debt in its capital structure,
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A) ROE > ROA.
B) ROE < ROA.
C) ROE = ROA.
Ans: C
48. For a firm that has both debt and equity,
A) ROE > ROA.
B) ROE < ROA.
C) ROE = ROA
Ans: A
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49. Which one of the following statements is NOT correct?
A) The DuPont system is based on two equations that relate a firm's ROA
and ROE.
B) The DuPont system is a set of related ratios that links the balance sheet
and the income statement.
C) Both management and shareholders can use this tool to understand the
factors that drive a firm's ROE.
D) All of the above are correct.
Ans: D
50. The DuPont equation shows that a firm's ROE is determined by three factors:
A) net profit margin, total asset turnover, and the equity multiplier
B) operating profit margin, ROA, and the ROE
C) net profit margin, total asset turnover, the ROA
D) ROA, total assets turnover, and the equity multiplier
Ans: A
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51. Which one of the following is a criticism of equating the goals of maximizing
the ROE of a firm and maximizing the firm's shareholder wealth?
A) ROE is based on after-tax earnings, not cash flows.
B) ROE does not consider risk.
C) ROE ignores the size of the initial investment as well as future cash
flows.
D) All of the above are criticisms of ROE as a goal.
Ans: D
52. Which one of the following is NOT an advantage of using ROE as a goal?
A) ROE is highly correlated with shareholder wealth maximization.
B) ROE and the DuPont analysis allow management to break down the
performance and identify areas of strengths and weaknesses.
C) ROE does not consider risk.
D) All of the above are advantages of using ROE as a goal.
Ans: C
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53. Which one of the following statements about trend analysis is NOT correct?
A) This benchmark is based on a firm's historical performance.
B) It allows management to examine each ratio over time and determine

whether the trend is good or bad for the firm.
C) The Standard Industrial Classification (SIC) System is used to identify

benchmark firms.
D) All of the above are true statements.
Ans: C
54. Peer group analysis can be performed by
A) management choosing a set of firms that are similar in size or sales, or

who compete in the same market.
B) using the average ratios of this peer group, which would then be used as
the benchmark.
C) identifying firms in the same industry that are grouped by size, sales, and
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product lines in order to establish benchmark ratios.
D) Only a and b relate to peer group analysis.
Ans: D
55. Limitations of ratio analysis include all but
A) Ratios depend on accounting data based on historical costs.
B) Differences in accounting practices like FIFO versus LIFO make

comparison difficult.
C) Trend analysis could be distorted by financial statements affected by

inflation.
D) All of the above are limitations of ratio analysis.
Ans: D
56. Liquidity ratio: Lionel, Inc., has current assets of $623,122, including inventory
of $241,990, and current liabilities of 378,454. What is the quick ratio?
A) 1.65
B) 0.64
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C) 1.01
Ans: C
Feedback:
Current assets = $623,122
Current liabilities = $378,454
Inventory = $241,990
57. Liquidity ratio: Bathez Corp. has receivables of $334,227, inventory of

$451,000, cash of $73,913, and accounts payables of $469,553. What is the
firm's current ratio?
A) 1.83
B) 0.73
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C) 1.67
Ans: A
Feedback:
Current assets = $73,913 + $451,000 +$334,227 = $859,140
58. Liquidity ratio: Zidane Enterprises has a current ratio of 1.92, current liabilities
of $272,934, and inventory of 197,333. What is the firm's quick ratio?
A) 0.72
B) 1.20
C) 1.92
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Ans: B
Feedback:
Current ratio = 1.92
59. Liquidity ratio: Ronaldinho Trading Co. is required by its bank to maintain a
current ratio of at least 1.75, and its current ratio now is 2.1. The firm plans to
acquire additional inventory to meet an unexpected surge in the demand for its
products and will pay for the inventory with short-term debt. How much
inventory can the firm purchase without violating its debt agreement if their total
current assets equal $3.5 million?
A) $0
B) $777,777
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C) $1 million
Ans: B
Feedback:
Let X represent the additional borrowing against the firm's line of credit (which
also equals the addition to current assets). We can solve for that level of X that
forces the firm's current ratio to be at 1.75
$3,500,000/ Current liabilities = 2.1
Current liabilities = $1,666,667
1.75 = ($3,500,000 + X) / ($1,666,667 + X)
(1.75 * $1,666,667) + 1.75X = $3,500,000 + X
0.75X = $3,500,000 - $2,916,667
X = $777,777
60. Efficiency ratio: If Randolph Corp. has accounts receivables of $654,803 and net
sales of $1,932,349, what is its accounts receivable turnover?
A) 0.34 times
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B) 1.78 times
C) 2.95 times
Ans: C
Feedback:
Accounts receivables = $654,803
Net sales = $1,932,349
61. Efficiency ratio: If Viera, Inc., has an accounts receivable turnover of 3.9 times
and net sales of $3,436,812, what is its level of receivables?
A) $881,234
B) $13,403,567
C) $1,340,357
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D) $81,234
Ans: A
Feedback:
Accounts receivables turnover = 3.9x
Net sales = $3,436,812
62. Efficiency ratio: Jason Traders has sales of $833,587, a gross profit margin of
32.4 percent, and inventory of $178,435. What is the company's inventory
turnover ratio?
A) 4.67 times
B) 3.16 times
C) 4.1 times
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Ans: B
Feedback:
Sales = $833,587
Gross profit margin = 32.4%
63. Efficiency ratio: Gateway Corp. has an inventory turnover ratio of 5.6. What is
the firm's days' sales in inventory?
A) 65.2 days
B) 64.3 days
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C) 61.7 days
D) 57.9 days
Ans: A
Feedback:
64. Efficiency ratio: Jet, Inc., has net sales of $712,478 and accounts receivables of
$167,435. What are the firm's accounts receivables turnover and days' sales
outstanding?
A) 0.24 times; 78.5 days
B) 4.26 times; 85.7 days
C) 5.2 times; 61.3 days
Ans: B
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Feedback:
Net sales = $712,478
Accounts receivables = $167,435
65. Efficiency ratio: Ellicott City Manufacturers, Inc., has sales of $6,344,210, and a
gross profit margin of 67.3 percent. What is the firm's cost of goods sold?
A) $2,074,557
B) $2,745,640
C) $274,560
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Ans: A
Feedback:
66. Efficiency ratio: Deutsche Bearings has total sales of $9,745,923, inventories of
$2,237,435, cash and equivalents of $755,071, and days' sales outstanding of 49 days.
If the firm's management wanted its DSO to be 35 days, by how much will the
accounts receivable have to change?
A) $373,816.23
B) -$373,816.23
C) -$379,008.12
D) $379,008.12
Ans: B
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Feedback:
Sales = $9,745,923; Inventory = $2,237,435 Cash = 755,071;

DSO = 49 Days
67. Coverage ratio: Trident Corp. has debt of $3.35 million with an interest rate of
6.875 percent. The company has an EBIT of $2,766,009. What is its times
interest earned?
A) 13 times
B) 12 times
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C) 11 times
Ans: B
Feedback:
Interest expense = $3,350,000 x 0.06875 = $230,312.50
68. Coverage ratios: Sectors, Inc., has an EBIT of $7,221,643 and interest expense
of $611,800. Its depreciation for the year is $1,434,500. What is its cash coverage
ratio?
A) 15.42 times
B) 18.34 times
C) 14.15 times
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Ans: C
Feedback:
Depreciation = $1,434,500
Interest expenses = $611,800
EDIT = $7,221,643
69. Coverage ratios: Fahr Company had depreciation expenses of $630,715, interest
expenses of $112,078, and an EBIT of $1,542,833 for the year ended June 30,
2006. What are the times interest earned and cash coverage ratios for this
company?
A) 19.4 times; 12.7 times
B) 17.3 time; 11.4 times
C) 13.8 times; 19.4 times
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Ans: C
Feedback:
Depreciation = $630,715
Interest expenses = $112,078
EDIT= $1,542,833
70. Leverage ratio: Your firm has an equity multiplier of 2.47. What is its debt-to-
equity ratio?
A) 0.60
B) 1.47
C) 1.74
1-47
D) 0
Ans: B
Feedback:
Equity multiplier = 1 + Debt to equity
Debt to equity = Equity multiplier –1
= 2.47 – 1
= 1.47
71. Leverage ratio: What will be a firm's equity multiplier given a debt ratio of
0.45?
A) 1.82
B) 1.28
C) 2.22
Ans: A
Feedback:
1-48
72. Leverage ratio: Dreisen Traders has total debt of $1,233,837 and total assets of
$2,178,990. What are the firm's equity multiplier and debt-to-equity ratio?(Round
to nearest whole percent)
A) 2.31; 1.31
B) 1.75; 0.75
C) 0.75; 1.75
D) 1.31; 2.31
Ans: A
Feedback:
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Debt ratio = $1,233,837 / $2,178,990 = 0.57
73. Market-value ratio: RTR Corp. has reported a net income of $812,425 for the
year. The company's share price is $13.45, and the company has 312,490 shares
outstanding. Compute the firm's price-earnings ratio.
A) 4.87 times
B) 8.12 times
C) 5.17 times
Ans: C
Feedback:
Net income = $812,425
1-50
Share price = $13.45
EPS = $812,425 / 312, 490 = $2.60
74. Market-value ratios: Perez Electronics Corp. has reported that its net income
for 2006 is $1,276,351. The firm has 420,000 shares outstanding and a P-E ratio
of 11.2 times. What is the firm's share price?
A) $34.05
B) $3.68
C) $11.20
D) $36.80
Ans: A
Feedback:
1-51
Net income = $1,276,351
Share outstanding= 420,000
EPS = $1,276,351 / 420,000 = $3.04
P-E ratio = 11.2 times
75. Profitability ratio: Juventus Corp has total assets of $4,744,288, total debt of
$2,912,000, and net sales of $7,212,465. Their net profit margin for the year is 18
percent. What is Juventus's ROA?
A) 25.6%
B) 18%
C) 27.4%
Ans: C
Feedback:
1-52
Total assets= $4,744,288; Total debt= $2,912,000
Net sales= $7,212,465; Net profit margin= 18%
76. DuPont equation: GenTech Pharma has reported the following information:
Sales/Total assets = 2.89; ROA = 10.74%; ROE = 20.36%
What are the firm's profit margin and equity multiplier?
A) 7.1%; 0.53
B) 7.1%; 1.90
C) 3.7%; 0.53
D) 3.7%; 1.90
Ans: D
1-53
Feedback:
Total assets turnover = 2.89
ROA = 10.74%
ROE = 20.36%
ROA = Profit margin x Total assets turnover
ROE = ROA x Equity multiplier
77. Profitability ratios: Tigger Corp. has reported the financial results for year-end
2006. Based on the information given, calculate the firm's gross profit margin and
operating profit margin.
N N
e e
t t
s
a i
l n
e c
s o
= m
e
$
1-54
4 =
,
1 $
5 7
6 7
, 8
7 ,
0 3
0 2
1
C E
o B
s I
t T
o
f =
g
o $
o 1
d ,
s 3
s 5
o 6
l ,
d 0
= 9
8
$
2
,
7
1
5
,
3
3
4
A) 34.7%; 32.6%
1-55
B) 32.6%; 18.72%
C) 34.7%; 18.72%
Ans: A
Feedback:
Net sales = $4,156,700
Net income = $778,321
Cost of goods sold = $2,715,334
EBIT = $1,356,098
78. DuPont equation: Andrade Corp has debt of $2,834,950, total assets of
$5,178,235, sales of $8,234,121, and net income of $812,355. What is the firm's
return on equity?
1-56
A) 7.1%t
B) 34.7%
C) 28.1%
D) 43.2%
Ans: B
Feedback:
1-57
79. DuPont equation: Saunders, Inc., has a ROE of 18.7 percent, an equity
multiplier of 2.53, sales of $2.75 million, and a total assets turnover of 2.7 times.
What is the firm's net income?
A) $75,281.80
B) $514,250.00
C) $51,425.00
D) $7,528.10
Ans: A
Feedback:
1-58
80. DuPont equation: Sorenstam Corp has an equity multiplier of 2.34 times, total
assets of $4,512,895, a ROE of 17.5 percent, and a total assets turnover of 3.1
times. Calculate the firm's ROA.
A) 6.23%
B) 4.53%
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C) 7.48%
D) 5.79%
Ans: C
Feedback:
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81. Which of the following is a benefit of a common-size income statement?
A) It is very useful to assess how effectively a firm collected its accounts

receivable.
B) It reveals a great deal of information about the adequacy of a firm’s net

working capital.
C) It can tell the analyst a great deal about the firm’s efficiency and
profitability.
D) It reveals how effectively a firm has increased its sales.
Ans: C
82. Why is the quick ratio considered by some to be a better measure of liquidity
than the current ratio?
A) The quick ratio more accurately reflects a firm's profitability.
B) It omits the least liquid current asset from the numerator of the ratio.
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C) The current ratio does not include accounts receivable.
D) It measures how "quickly" cash flows through the firm.
Ans: B
83. Return on Equity: In the latest year, Photon, Inc. reported $276,000 in net
income. The firm maintains a debt ratio of 30% and has total assets of
$3,000,000. What is Photon's return on equity? (Round off to the nearest 0.1%)
A) 13.1%
B) 14.6%
C) 22.5%
D) 18.7%
Ans: A
1-62
Feedback:
84. Which of the following is not a method of “benchmarking”?
A) Conduct an industry group analysis.
B) Utilize the DuPont system to analyze a firm’s performance.
C) Evaluating a single firm’s performance over time.
D) Identify a group of firms that compete with the company being analyzed.
Ans: B
85. There are those that believe that the analysis of financial statements has
limitations. Which of the statements below would qualify as a limitation of
financial statement analysis?
1-63
A) Ratio analysis requires the analyst to evaluate a firm’s performance over
too many years to be of any value.
B) Proper ratio analysis requires the analyst to rely upon audited financial
statements, which can be easily manipulated.
C) Thorough ratio analysis requires the analyst to refer to benchmarking,

which is very easy to misinterpret.
D) Ratio analysis requires the analyst to utilize accounting data that is based
on historical costs instead of current market values.
Ans: D
Chapter 5
36. The time value of money refers to the issue of
A) what the value of the stream of future cash flows is today.
B) why a dollar received tomorrow is worth more than a dollar received

today.
C) why a dollar received tomorrow is worth the same as a dollar received

today.
Ans: A
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A) The time value money refers to what the value of the stream of future
cash flows today is.
B) A dollar received today is worth more than a dollar received tomorrow.
C) A dollar received tomorrow is worth less than a dollar received today.
D) A dollar received today is worth less than a dollar received tomorrow.
Ans: D
A) The value of a dollar invested at a positive interest rate grows over time.
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B) The further in the future you receive a dollar, the less it is worth today.
C) A dollar in hand today is worth more than a dollar to be received in the

future.
D) The further in the future you receive a dollar, the more it is worth today.
Ans: D
39. Future value measures
A) what one or more cash flows are worth at the end of a specified period.
B) what one or more cash flows that is to be received in the future will be
worth today.
C) both a and b
Ans: A
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40. Which one of the following statements is true?
A) Individuals prefer to consume goods right away rather than in the future.
B) Individuals prefer to consume goods in the future rather than right away.
C) The time of consumption is irrelevant to individuals.
Ans: A
Level of Difficulty: easy
41. The process of converting an amount given at the present time into a future
value is called
A) time value of money.
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B) discounting.
C) compounding.
Ans: C
42. The process of converting future cash flows to what its present value is
A) time value of money.
B) discounting.
C) compounding.
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Ans: B
A) Present value calculations involve bringing a future amount back to

the present.
B) The present value (PV) is often called the discounted value of future
cash payments.
C) The present value factor is more commonly called the discount

factor.
Ans: D
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A) Present value calculations involve bringing a future amount back to the

present.
B) The future value is often called the discounted value of future cash
payments.
C) The present value factor is more commonly called the discount factor.
D) The higher the discount rate, the lower the present value of a dollar.
Ans: B
45. The Rule of 72
A) can be used to determine the amount of time it takes to double an

investment.
B) is fairly accurate for interest rates between 25 and 50 percent.
C) states that the time to double your money (TDM) approximately equals
72/i, where 72 represents the years it takes to double your investment.
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D) None of the above describe the Rule of 72.
Ans: A
46. Using higher discount rates will
A) not affect the present value of the future cash flow.
B) increase the present value of any future cash flow.
C) decrease the present value of any future cash flow.
Ans: C
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47. Using higher interest rates will
A) not affect the future value of the investment.
B) increase the future value of any investment.
C) decrease the future value of any investment.
Ans: B
48. Using lower discount rates will
A) not affect the present value of the future cash flow.
B) increase the present value of any future cash flow.
C) decrease the present value of any future cash flow.
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Ans: B
49. Using lower interest rates will
A) decrease the future value of any investment.
B) increase the future value of any investment.
C) not affect the future value of the investment.
Ans: A
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50. Your aunt is looking to invest a certain amount today. Which of the following
choices should she opt for?
A) three-year CD at 6.5% annual rate
B) three-year CD at 6.75% annual rate
C) three-year CD at 6.25% annual rate
D) three-year CD at 7% annual rate
Ans: D
51. Future value: You are interested in investing $10,000, a gift from your
grandparents, for the next four years in a mutual fund that will earn an annual
return of 8 percent. What will your investment be worth at the end of four years?
(Round to the nearest dollar.)
A) $10,800
B) $13,605
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C) $13,200
Ans: B
Feedback:
Present value of the investment = PV = $10,000
Return on mutual fund = i = 8%
No. of years = n = 4.
0 1 2 3 4
├───┼───┼───┼────┤
-$10,000 FV=?
1-75
52. Future value: Ning Gao is planning to buy a house in five years. She is looking
to invest $25,000 today in an index mutual fund that will provide her a return of
12 percent annually. How much will she have at the end of five years? (Round to
the nearest dollar.)
A) $45,000
B) $28,000
C) $44,059
Ans: C
Feedback:
Return on mutual fund = i = 12%
0 1 2 3 4 5
├───┼───┼───┼────┼───┤
-$25,000 FV = ?
1-76
53. Future value: Carlos Lopes is looking to invest for the next three years. He is
looking to invest $7,500 today in a bank CD that will earn interest at 5.75 percent
annually. How much will he have at the end of three years? (Round to the nearest
dollar.)
A) $8,870
B) $8,000
C) $8,681
Ans: A
Feedback:
Interest rate on CD = i = 5.75%
0 1 2 3
1-77
├───┼───┼───┤
-$7,500 FV=?
54. Future value: Wes Ottey would like to buy a condo in Florida in six years. He is
looking to invest $75,000 today in a stock that is expected to earn a return of 18.3
percent annually. How much will he have at the end of six years? (Round to the
nearest dollar.)
A) $205,575
B) $157,350
C) $184,681
Ans: A
Feedback:

1-78
Return on stock = i = 18.3%
0 1 2 3 4 5 6
├───┼───┼────┼───┼───┼───┤
-$75,000 FV=?
55. Future value: Brittany Willis is looking to invest for retirement, which she
hopes will be in 20 years. She is looking to invest $22,500 today in U.S.
Treasury bonds that will earn interest at 6.25 percent annually. How much will
she have at the end of 20 years? (Round to the nearest dollar.)
A) $68,870
B) $50,625
C) $75,642
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Ans: C
Feedback:
Return on Treasury bonds = i = 6.25%
0 1 2 3 19 20
├───┼───┼───┼……………─┼────┤
-$22,500 FV=?
56. Multiple compounding periods (FV): Your brother has asked you to help him
with choosing an investment. He has $5,000 to invest today for a period of two
years. You identify a bank CD that pays an interest rate of 4.25 percent with the
interest being paid quarterly. What will be the value of the investment in two
years?
A) $5,434
1-80
B) $5,441
C) $5,107
D) $5,216
Ans: B
Feedback:
0 2 years
├────────────────────┤
PV = $5,000 FV = ?
Amount invested today = PV = $5,000
Duration of investment = n = 2 years
Frequency of compounding = m = 4
Value of investment after 4 years = FV4
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57. Multiple compounding periods (FV): Normandy Textiles had a cash inflow of
$1 million, which it needs for a long-term investment at the end of one year. It
plans to deposit this money in a bank CD that pays daily interest at 3.75 percent.
What will be the value of the investment at the end of the year? (Round to the
nearest dollar.)
A) $1,211,375
B) $1,000,103
C) $1,037,500
D) $1,038,210
Ans: D
Feedback:
0 1
├────────────────────┤
PV = $1,000,000 FV = ?
Amount invested today = PV = $1,000,000
Duration of investment = n = 1 year
1-82
Value of investment after 1 year = FV1
58. Multiple compounding periods (FV): Your mother is trying to choose one of
the following bank CDs to deposit $10,000. Which one will have the highest
future value if she plans to invest for three years?
A) 3.5% compounded daily
B) 3.25% compounded monthly
C) 3.4% compounded quarterly
D) 3.75% compounded annually
Ans: A
Feedback:
1-83
A) Interest rate on CD = i = 3.5%
B) Interest rate on CD = i = 3.25%
C) Interest rate on CD = i = 3.4%
1-84
D) Interest rate on CD = i = 3.75%
= $10,000 x (1.0375)3
= $11,167.71
59. Multiple compounding periods (FV): Carlyn Botti wants to invest $3,500 today
in a money market fund that pays quarterly interest at 5.5 percent. She plans to
fund a scholarship with the proceeds at her alma mater, Towson University. How
much will Carlyn have at the end of seven years? (Round to the nearest dollar.)
A) $5,091
1-85
B) $3,548
C) $5,130
D) $5,075
Ans: C
Feedback:
Interest rate on money market account = i = 5.5%
1-86
60. Multiple compounding periods (FV): Hector Cervantes started on his first job
last year and plans to save for a down payment on a house in 10 years. He will be
able to invest $12,000 today in a money market account that will pay him an
interest of 6.25 percent on a monthly basis. How much will he have at the end of
10 years?
A) $12,640
B) $22,383
C) $24,839
Ans: B
Feedback:
Interest rate on money market account = i = 6.25%
1-87
61. Compounding: Trish Harris has deposited $2,500 today in an account paying 6
percent interest annually. What would be the simple interest earned on this
investment in five years? If the account paid compound interest, what would be
the interest-on-interest in five years?
A) $750; $95.56
B) $150; $845.56
C) $150; $95.56
D) $95.56; $845.56
1-88
Ans: A
Feedback:
Deposit today = PV = $2,500
Interest rate = i = 6%
No. of years = n = 5
Simple interest:
Simple interest per year = $2,500 (0.06) = $150.00
Simple interest for 5 years = $150 x 5 = $750.00
Future value with compound interest:
FV5 = $2,500 (1 + 0.06)5 = $3,345.56
Simple interest = $750
Interest on interest = $3,345.56 – $2,500 – $750 = $95.56
62. Compounding: Joachim Noah is investing $5,000 in an account paying 6.75

percent annually for three years. What is the interest-on-interest if interest is
compounded?
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A) $1,012.50
B) $1,082.38
C) $82.38
D) $69.88
Ans: D
Feedback:
Interest rate = i = 6.75%
Simple interest:
Simple interest for 3 years = $337.50 x 3 = $1,012.50
FV3 = $5,000 (1 + 0.0675)3 = $6,082.38
Simple interest = $1,012.50
Interest on interest = $6,082.38 – $5,000 – $1,012.50 = $69.88
1-90
63. Compounding: Chung Lee wants to invest $3,000 in an account paying 5.25
percent compounded quarterly. What is the interest on interest after four years?
A) $695.98
B) $65.98
C) $630.00
Ans: B
Feedback:
Simple interest:
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Simple interest for 4 years = $157.50 x 4 = $630
Interest on interest = $3,695.98 – $3,000 – $630 = $65.98
64. Compounding: Dat Nguyen is depositing $17,500 in an account paying an

annual interest rate of 8.25 percent compounded monthly. What is the interest-
on-interest after six years?
A) $8,662.50
B) $10,925
C) $2,497.63
D) $1,092.48
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Ans: C
Feedback:
Simple interest:
Simple interest per year = $17,500 (0.0825) = $1,443.75
Simple interest for 6 years = $1,443.75 x 6 = $8,662.50
Simple interest = $8,662.50
Interest on interest = $28,660.13 – $17,500 – $8,662.50 = $2,497.63
1-93
65. Compounding: Richard Delgado invested $10,000 in a money market account

that will pay 5.75 percent compounded daily. How much will the interest-on-
interest be after two years?
A) $1,218.63
B) $1,150.00
C) $33.06
D) $68.63
Ans: D
Feedback:
Simple interest:
Simple interest per year = $10,000 (0.0575) = $575
Simple interest for 2 years = $575 x 2 = $1,150
1-94
Interest-on-interest = $11,218.63 – $10,000 – $1,150 = $68.63
66. Present value: Tommie Harris is considering an investment that pays 6.5 percent
annually. How much must he invest today such that he will have $25,000 in
seven years? (Round to the nearest dollar.)
A) $23,474
B) $38,850
C) $26,625
D) $16,088
Ans: D
1-95
Feedback:
0 7 years
├────────────────────┤
PV = ? i = 6.5% FV = $25,000
Value of investment after 7 years = FV7 = $25,000
Return expected from investment = i = 6.5%
Amount to be invested today = PV
67. Present value: Jack Robbins is saving for a new car. He needs to have $ 21,000
for the car in three years. How much will he have to invest today in an account
paying 8 percent annually to achieve his target? (Round to nearest dollar.)
A) $22,680
B) $26,454
C) $16,670
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D) $19,444
Ans: C
Feedback:
0 3 years
├────────────────────┤
PV = ? i = 8% FV = $21,000
Return expected from investment = i = 8%
68. Present value: Derek's friend, Jackson, is asking to borrow today with a promise
to repay $7,418.87 in four years. If Derek could earn 5.45 percent annually on
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the any investment he makes today, how much would he be willing to lend
Jackson today? (Round to nearest dollar.)
A) $6,000
B) $7,035
C) $6,500
D) $7,150
Ans: A
Feedback:
0 4 years
├────────────────────┤
PV = ? i = 5.45% FV = $7,418.87
Loan repayment amount after 4 years = FV4 = $7,418.87
Return expected from loan = i = 5.45%
Duration of loan = n = 4 years
Amount to be loaned today = PV
1-98
69. Present value: Becky Sayers wants to buy a house in six years. She hopes to be
able to put down $25,000 at that time. If the bank CD she wants to invest in will
pay 7.5 percent annually, how much will she have to invest today? (Round to the
nearest dollar.)
A) $18,472
B) $13,987
C) $16,199
D) $23,256
Ans: C
Feedback:
0 6 years
├────────────────────┤
PV = ? i = 7.5% FV = $25,000
Amount needed for down payment after 6 years = FV6 = $25,000

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70. Present value: John Hsu wants to start a business in 10 years. He hopes to have
$100,000 at that time to invest in the business. To reach his goal, he plans to
invest a certain amount today in a bank CD that will pay him 9.50 percent
annually. How much will he have to invest today to achieve his target? (Round to
A) $54,233
B) $63,837
C) $91,324
D) $40,351
Ans: D
Feedback:
0 10 years
├────────────────────┤
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PV = ? i = 9.5% FV = $100,000
71. Multiple compounding (PV): Rick Rodriquez plans to invest some money today
so that he will receive $7,500 in three years. If the investment he is considering
will pay 3.65 percent compounded daily, how much will he have to invest today?
A) $5,276
B) $6,722
C) $6,897
D) $7,140
Ans: B
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Feedback:
0 3 years
├────────────────────┤
PV = ? i = 3.65% FV = $7,500
Target investment proceeds in 3 years = FV3 = $7,500
Present value of amount = PV
72. Multiple compounding (PV): You need to have $15,000 in five years to payoff
a home equity loan. You can invest in an account that pays 5.75 percent
compounded quarterly. How much will you have to invest today to attain your
target in five years? (Round to the nearest dollar.)
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A) $4,903
B) $11,275
C) $14,184
D) $12,250
Ans: B
Feedback:
0 5 years
├────────────────────┤
PV = ? i = 5.75% FV = $15,000
Present Value of amount = PV
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73. Multiple compounding (PV): Marcie Witter is saving for her daughter's college
education. She wants to have $50,000 available when her daughter graduates
from high school in four years. If the investment she is considering will pay 8.25
percent compounded monthly, how much will she have to invest today to reach
her target? (Round to the nearest dollar.)
A) $35,987
B) $49,659
C) $41,275
D) $36,450
Ans: A
Feedback:
0 4 years
├────────────────────┤
PV = ? i = 8.25% FV = $50,000

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74. Multiple compounding (PV): Darius Miller is seeking to accumulate $50,000 in

six years to invest in a real estate venture. He can earn 6.35 percent annual
interest with monthly compounding in a private investment. How much will he
have invest today to reach his goal? (Round to the nearest dollar.)
A) $37,527
B) $47,015
C) $34,193
D) $31,648
Ans: C
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Feedback:
0 6 years
├────────────────────┤
PV = ? i = 6.35% FV = $50,000
75. Multiple compounding (PV): Joan Alexander wants to go on a cruise in three

years. She could earn 8.2 percent compounded monthly in an account if she were
to deposit the money today. She needs to have $10,000 in three years. How much
will she have to deposit today? (Round to the nearest dollar.)
A) $6,432
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B) $7,826
C) $8,148
D) $7,763
Ans: B
Feedback:
0 3 years
├────────────────────┤
PV = ? i = 8.2% FV = $10,000
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76. Interest rate: Your tuition for the coming year is due today. You borrow $8,000
from your uncle and agree to repay in the three years an amount of $9,250. What
is the interest rate on this loan? Round to the nearest percent.
A) 5%
B) 6%
C) 7%
D) 8%
Ans: A
Feedback:
0 3 years
├────────────────────┤
PV = $8,000 FV = $9,250
Amount to be borrowed = PV = $8,000
Amount to be paid back after 3 years = FV3 = $9,250
Interest rate on investment = i = ?
Duration of investment = n = 3 years.
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Present value of investment = PV
77. Interest rate: Rachael Steele wants to borrow $6,000 for a period of four years.
She has two choices. Her bank is offering to lend her the amount at 7.25 percent
compounded annually. She can also borrow from her firm and will have to repay
a total of $8,130.93 at the end of four years. Should Rachael go with her bank or
the firm, and what is the interest rate if she borrows from her firm? (Round to the
nearest percent.)
A) Bank: 9%
B) Firm: 7%
C) Bank: 8%
D) Firm: 6%
Ans: C
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Feedback:
0 4 years
├────────────────────┤
PV = $6,000 FV = $8,130.93
Amount to be borrowed = PV = $6,000
Amount to be paid back after 4 years = FV = $8,130.93
Since borrowing from her firm results in a loan rate of 8 percent, she should take
the bank loan at 7.25 percent.
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78. Interest rate: Ray Seo has $5,000 to invest in a small business venture. His
partner has promised to pay him back $8,200 in five years. What is the return
earned on this investment?
A) 9.3%
B) 8.7%
C) 11.1%
D) 10.4%
Ans: D
Feedback:
1-111
0 5 years
├────────────────────┤
PV = $5,000 FV = $8,200
Amount being invested = PV = $5,000
Amount to be paid back after 5 years = FV = $8,200
79. Interest rate: Pedro Martinez wants to invest $25,000 in a spa that his sister is
starting. He will triple his investment in six years. What is the rate of return that
Pedro is being promised? (Rounded to the nearest percent.)
A) 18%
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B) 20%
C) 12%
D) 25%
Ans: B
Feedback:
0 6 years
├────────────────────┤
PV = $25,000 FV = $75,000
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80. Interest rate: Trayne Rice has $3,000 to invest for three years. He wants to
receive $5,000 at the end of the three years. What invest rate would his
investment have to earn to achieve his goal? (Round to the nearest percent.)
A) 19%
B) 21%
C) 13%
D) 16%
Ans: A
Feedback:
0 3 years
├────────────────────┤
PV = $3,000 FV = $5,000

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81. Growth rate: Trojan Traps manufactures an innovative mouse trap. Sales this
year are $325,000. The company expects its sales to go up to $500,000 in five
years. What is the expected growth rate in sales for this firm? (Round to the
nearest percent.)
A) 9%
B) 11%
C) 6%
D) 12%
Ans: A
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Feedback:
0 5 years
├────────────────────┤
PV = $325,000 FV = $500,000
Current sales = PV = $325,000
Expected sales five years from now = $500,000
To calculate the expected sales growth rate, we set up the future value equation.
82. Growth rate: Petry Corp. is a growing company with sales of $1.25 million this
year. The firm expects to grow at an annual rate of 25 percent for the next three
years, followed by a growth of 20 percent per year for the next two years. What
will be Petry's sales at the end of five years? (Round to the nearest percent.)
A) $2,160,000
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B) $3,515,625
C) $1,875,000
D) $2,929,688
Ans: B
Feedback:
0 5 years
├────────────────────┤
g1-3 = 25% g4-5 = 20%
PV = $1.25 million FV = $?
Current sales = PV = $1,025,000
Expected sales five years from now = FV
To calculate the expected sales, we set up the future value equation.
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Level of Difficulty: Hard
83. Growth rate: Cleargen, a detergent manufacturer, has announced this year's net
income as $832,500. It expects its net earnings to grow at a rate of 15 percent per
year for the next two years, before dropping to 12 percent for each of the
following two years. What is the firm's net income after four years? (Round to
A) $1,381,071
B) $1,266,128
C) $1,233,099
D) $1,072,260
Ans: A
Feedback:
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0 4 years
├────────────────────┤
g1-2 = 15% g3-4 = 12%
PV = $832,500 FV = $?
Current net income = PV = $832,500
Expected net income four years from now = FV
To calculate the expected net earnings, we set up the future value equation.
84. Growth rate: Peterson Electrical Supplies has generated a net income of
$161,424 this year. The firm expects to see an annual growth of 30 percent for
the next five years, followed by a growth rate of 15 percent for each of the next
three years. What will be the firm's expected net income in eight years? (Round
to the nearest dollar.)
A) $319,157
B) $241,329
C) $911,546
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D) $689,259
Ans: C
Feedback:
0 5 8 years
├────────────────┼────────────┤
g1-5 = 30% g6-8 = 15%
PV = $161,424 FV = $?
Current net income = PV = $161,424
Expected net income four years from now = FV
To calculate the expected net earnings, we set up the future value equation.
85. Growth rate: Vidmar Agencies is a fast-growing advertising agency. Currently,

their sales are at $700,000. They expect their sales to grow at an annual rate of 35
percent in the next two years, followed by an annual rate of 25 percent in years 3
through 7. Finally, their growth rate would slow down to 10 percent in years 8–
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10. What will be their sales as of year 10? (Round to the nearest dollar.)
A) $1,698,023
B) $2,843,323
C) $3,893,280
D) $5,181,956
Ans: D
Feedback:
0 5 10 years
├────────────────┼──────────────────┤
g1-2 = 35% g3-7 = 25% g8-10 = 10%
PV = $700,000 FV = $?
Current sales = PV = $700,000
Expected sales 10 years from now = FV
To calculate the expected sales, we set up the future value equation.
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86. Time to attain goal: Your uncle is looking to double his investment of $10,000.
He claims he can get earn 14 percent on his investment. How long will it be
before he can double his investment? Use the Rule of 72 and round to the nearest
year.
A) 5 years
B) 14 years
C) 10 years
Ans: A
Feedback:
Initial investment = $10,000
Rate of return on investment = i = 14%
Time to double the investment = TDM = 72/i = 72 / 14 = 5.14 years

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87. Time to attain goal: Elegant Designers have generated sales of $625,000 for the
current year. If they can grow their sales at a rate of 12 percent every year, how
long will they take to triple their sales? (Round off to the nearest year.)
A) 8 years
B) 7 years
C) 10 years
D) 9 years
Ans: C
Feedback:
Enter
PMT
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88. Time to attain goal: Franklin Foods announced that its sales were $1,233,450
this year. The company forecasts a growth rate of 16 percent for the foreseeable
future. How long will it take the firm to produce earnings of $3 million? (Round
off to the nearest year.)
A) 7 years
B) 6 years
C) 8 years
D) 10 years
Ans: B
Feedback:
Enter
PMT
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89. Time to attain goal: Ryan Holmes wants to deposit $4,500 in a bank account
that pays 8.25 percent annually. How many years will it take for his investment to
grow to $10,000? (Round off to the nearest year.)
A) 8 years
B) 11 years
C) 10 years
D) 12 years
Ans: C
Feedback:
Enter
PMT
1-125
90. Time to attain goal: Cheryl Merriweather wants to invest in a bank CD that will
pay her 7.8 percent annually. If she is investing $11,500 today, when will she
reach her goal of $15,000? (Round off to the nearest year.)
A) 5 years
B) 7 years
C) 2 years
D) 4 years
Ans: D
Feedback:
Enter
PMT
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91. Which of the following statements is true?
A) A dollar received today is worth more than a dollar to be received in the

future because future dollars are not affected by inflation.
B) A dollar to be received in the future is worth more than a dollar received

today because of the positive impact of rates of return.
C) A dollar received today is worth more than a dollar to be received in the

future because funds received today can be invested to earn a return.
D) A dollar to be received in the future is worth more than a dollar received

today because it would have less risk associated with it.
Ans: C
A) The longer the time period that funds are invested, the greater the future
value, regardless of investment rate.
B) The lower the discount rate that funds are invested at, the greater the
future value.
C) The shorter the time period that funds are invested, the greater the future
value, regardless of investment rate.
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D) The higher the interest rate, the slower the value of an investment will
grow.
Ans: A
93. Future Value: Herbert Hall just received an inheritance of $35,775 from his
great aunt. He plans to invest the funds for retirement. If Herbert can earn 4.75%
per year with quarterly compounding for 32 years, how much will he have
accumulated? (Round off to the nearest dollar.)
A) $237,416
B) $ 71,550
C) $184,622
D) $162,113
Ans: D
Feedback:
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Interest rate = i = 4.75% ÷ 4 = 1.1875%
Duration of investment = n = 32 years × 4 = 128 periods
Value of investment after 7 years, or 128 periods = FV128 = $162,113.25
94. Which of the following statements is false with respect to the present value of a
future amount? (hỏi thầy)
A) The higher the discount rate, the lower the present value of a single sum
for a given time period.
B) The relation between present value and time is exponential.
C) The greater the time period, the lower the present value of a single sum
for a given interest rate.
D) The lower the discount rate, the lower the present value of a single sum
for a given time period.
Ans: D
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95. Present Value: Juan and Carla Herman plan to buy a time-share in six years in
the amount of $16,860. In order to have adequate funds to do so, the Herman’s
want to make a deposit to their money market fund today. Assume that they will
be able to earn an investment rate of 5.75%, compounded annually. How much
will Juan and Carla need to deposit today to achieve their goal? (Round off to the
nearest dollar.)
A) $19,138
B) $ 8,885
C) $12,055
D) $14,243
Ans: C
Feedback:
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Amount needed = FV = $16,860
Present Value = PV6 = $12,055.22
96. Number of Periods it Takes an Investment to Grow a Certain Amount: Sally

Wilson is planning her retirement. She is presently investing in a 401(k) but
needs an additional $500,000 to reach her retirement goal. As luck would have it,
Sally just won a brand new car that is worth $36,000 in a raffle. If Sally were to
sell the car and invest the $36,000 proceeds at a rate of 6.50%, compounded
annually, how long will it be before Sally could retire? (Round off to the nearest
1/10 of a year)
A) 36.6 years
B) 41.8 years
C) 52.2 years
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D) 24.0 years
Ans: B
Present Value = PV = $36,000
Future Value = FV = $500,000
Number of Periods = n = 41.8 years
97. Rate of growth: Link Net, Inc. just generated earnings per share of $3.75 for the
fiscal year ending September 30, 2010. The firm is expected to achieve earnings
per share of $8.76 in 5-years. At what rate will Link Net, Inc.’s earnings per
share be growing over this 5-year period? (Round off to the nearest 1/10
percent)
A) 15.7%
B) 18.5%
C) 21.3%
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D) 13.4%
Ans: B
Feedback:
Present Value = PV = $3.75
Period = n = 5 years
Future Value = FV5 = $8.76
Chapter 6
31. To solve future value problems with multiple cash flows involves
which of the following steps?
A) First, draw a time line to make sure that each cash flow is
placed in the correct time period.
B) Second, calculate the future value of each cash flow for its time
period.
C) Third, add up the future values.
D) All of the above are necessary steps.
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Ans D
:
32. Which one of the following steps is NOT involved in solving future
value problems?
A) First, draw a time line to make sure that each cash flow is placed
in the correct time period.
B) Second, discount each cash flow for its time period.
C) Third, add up the values.
Ans B
:
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33. To solve present value problems with multiple cash flows involves
which of the following steps?
B) Second, calculate the present value of each cash flow for its
time period.
C) Third, add up the present values.
Ans D
:
34. Which one of the following steps is NOT involved in solving present
value problems?
B) Second, compound each cash flow for its time period.
C) Third, add up the values.
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Ans B
:
Level of Difficulty: easy
35. Calculating the present and future values of multiple cash flows is
relevant
A) for businesses only.
B) for individuals only
C) for both individuals and businesses.
Ans C
:
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36. In computing the present and future value of multiple cash flows,
A) each cash flow is discounted or compounded at the same rate.
B) each cash flow is discounted or compounded at a different rate.
C) earlier cash flows are discounted at a higher rate.
D) later cash flows are discounted at a higher rate.
Ans A
:
37. In computing the present and future value of multiple cash flows,
A) earlier cash flows are discounted at a lower rate.
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B) each cash flow is discounted or compounded at the same rate.
C) earlier cash flows are discounted at a higher rate.
Ans B
:
38. The present value of multiple cash flows is
A) greater than the sum of the cash flows.
B) equal to the sum of all the cash flows.
C) less than the sum of the cash flows.
Ans C
:
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39. The future value of multiple cash flows is
A) greater than the sum of the cash flows.
B) equal to the sum of all the cash flows.
C) less than the sum of the cash flows
Ans A
:
40. If your investment pays the same amount at the end of each year for a
period of six years, the cash flow stream is called
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A) a perpetuity.
B) an ordinary annuity.
C) an annuity due.
Ans B
:
41. If your investment pays the same amount at the beginning of each year
for a period of 10 years, the cash flow stream is called
A) a perpetuity.
C) an annuity due.
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Ans C
:
42. If your investment pays the same amount at the end of each year
forever, the cash flow stream is called không biết
A) a perpetuity.
C) an annuity due.
Ans A
:
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43. Cash flows associated with annuities are considered to be
A) an uneven cash flow stream.
B) a cash flow stream of the same amount (a constant cash flow

stream).
C) a mix of constant and uneven cash flow streams.
Ans B
:
44. Which ONE of the following statements is true about amortization?
A) Amortization refers to the way the borrowed amount (principal)

is paid down over the life of the loan.
B) With an amortized loan, each loan payment contains some

payment of principal and an interest payment.
C) A loan amortization schedule is just a table that shows the loan

balance at the beginning and end of each period, the payment
made during that period, and how much of that payment
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represents interest and how much represents repayment of
principal.
Ans D
:
45. Which one of the following statements is NOT true about

amortization?
A) Amortization refers to the way the borrowed amount (principal)

is paid down over the life of the loan.
B) With an amortized loan, each loan payment contains some

payment of principal and an interest payment.
C) With an amortized loan, a smaller proportion of each month's

payment goes toward interest in the early periods.
D) A loan amortization schedule is just a table that shows the loan

balance at the beginning and end of each period, the payment
made during that period, and how much of that payment
represents interest and how much represents repayment of
principal.
Ans C
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:
46. Which one of the following statements is true about amortization?
A) With an amortized loan, a bigger proportion of each month's

B) With an amortized loan, a bigger proportion of each month's

payment goes toward interest in the later periods.
C) With an amortized loan, a smaller proportion of each month's

Ans A
:
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47. The annuity transformation method is used to transform không biết
A) a present value annuity to a future value annuity.
B) a present value annuity to an annuity due.
C) an ordinary annuity to an annuity due.
D) a perpetuity to an annuity.
Ans C
:
48. A firm receives a cash flow from an investment that will increase by
10 percent annually for an infinite number of years. This cash flow
stream is called
A) an annuity due.
B) a growing perpetuity.
C) an ordinary annuity.
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D) a growing annuity.
Ans B
:
49. Your investment in a small business venture will produce cash flows
that increase by 15 percent every year for the next 25 years. This cash
flow stream is called
A) an annuity due.
B) a growing perpetuity.
C) an ordinary annuity.
D) a growing annuity.
Ans D
:
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50. Which one of the following statements is TRUE about the effective
annual rate (EAR)?
A) The effective annual interest rate (EAR) is defined as the annual

growth rate that takes compounding into account.
B) The EAR conversion formula accounts for the number of

compounding periods and, thus, effectively adjusts the
annualized interest rate for the time value of money.
C) The EAR is the true cost of borrowing and lending.
Ans D
:
51. The true cost of borrowing is the
A) annual percentage rate.
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B) effective annual rate.
C) quoted interest rate.
D) periodic rate.
Ans B
:
52. The true cost of lending is the
A) annual percentage rate.
B) effective annual rate.
C) quoted interest rate.
Ans B
:
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A) The APR is the appropriate rate to do present and future value

calculations.
B) The EAR is the appropriate rate to do present and future value

calculations.
C) The EAR is the true cost of borrowing and lending.
D) The EAR takes compounding into account.
Ans A
:
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A) The Truth-in-Lending Act was passed by Congress to ensure
that the true cost of credit was disclosed to consumers.
B) The Truth-in-Savings Act was passed to provide consumers an

accurate estimate of the return they would earn on an
investment.
C) The above two pieces of legislation require by law that the APR
be disclosed on all consumer loans and savings plans.
Ans D
:
A) The correct way to annualize an interest rate is to compute the

effective annual interest rate (EAR).
B) The APR is the annualized interest rate using simple interest.
C) The correct way to annualize an interest rate is to compute the

annual percentage rate (APR).
D) You can find the interest rate per period by dividing the quoted
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annual rate by the number of compounding periods.
Ans C
:
56. FV of multiple cash flows: Chandler Corp. is expecting a new project to

start producing cash flows, beginning at the end of this year. They expect
cash flows to be as follows:
$643,547
$678,214
$775,908
$778,326
$735,444
If they can reinvest these cash flows to earn a return of 8.2 percent, what
is the future value of this cash flow stream at the end of five years?
A) $3,889,256
B) $4,227,118
C) $5,214,690
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D) $4, 809,112
Ans B CTTT
:
Feedback:
57. FV of multiple cash flows: Stiglitz, Inc., is expecting the following

cash flows starting at the end of the year—$113,245, $132,709,
$141,554, and $180,760. If their opportunity cost is 9.6 percent, find
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the future value of these cash flows. (Round to the nearest dollar.)
A) $644,406.10
B) $732,114
C) $685,312
D) $900,810
Ans A
:
Feedback:
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58. FV of multiple cash flows: Tariq Aziz will receive from his
investment cash flows of $3,125, $3,450, and $3, 800. If he can earn
7.5 percent on any investment that he makes, what is the future value
of his investment cash flows at the end of three years? (Round to the
nearest dollar.)
A) $11,120
B) $10,944
C) $10,812
D) $12,770
Ans A
:
Feedback:
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59. FV of multiple cash flows: Shane Matthews has invested in an

investment that will pay him $6,200, $6,450, $7,225, and $7,500 over
the next four years. If his opportunity cost is 10 percent, what is the
future value of the cash flows he will receive? (Round to the nearest
dollar.)
A) $27,150
B) $29,900
C) $30,455
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D) $31,504
Ans D
:
Feedback:
60. FV of multiple cash flows: International Shippers, Inc., have forecast

earnings of $1, 233,400, $1,345,900, and $1,455,650 for the next three
years. What is the future value of these earnings if the firm's
opportunity cost is 13 percent? (Round to the nearest dollar.)
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A) $4,214,360
B) $4,551,446
C) $3,900,865
D) $4,875,212
Ans B
:
Feedback:
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61. PV of multiple cash flows: Jack Stuart has loaned money to his
brother at an interest rate of 5.75 percent. He expects to receive $625,
$650, $700, and $800 at the end of the next four years as complete
repayment of the loan with interest. How much did he loan out to his
brother? (Round to the nearest dollar.)
A) $2,713
B) $2,250
C) $2,404
D) $2,545
Ans C
:
Feedback:
0 1 2 3 4
$625 $650 $700 $800
n = 4; i=5.75%
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62. PV of multiple cash flows: Ferris, Inc., has borrowed from their bank at
a rate of 8 percent and will repay the loan with interest over the next five
years. Their scheduled payments, starting at the end of the year are as
follows—$450,000, $560,000, $750,000, $875,000, and $1,000,000.
What is the present value of these payments? (Round to the nearest
dollar.)
A) $2,735,200
B) $2,615,432
C) $2431,224
D) $2,815,885
Ans D
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:
Feedback:
63. PV of multiple cash flows: Hassan Ali has made an investment that
will pay him $11,455, $16,376, and $19,812 at the end of the next
three years. His investment was to fetch him a return of 14 percent.
What is the present value of these cash flows? (Round to the nearest
dollar.)
A) $33,124
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B) $36,022
C) $41,675
D) $39,208
Ans B
:
Feedback:
1-161
64. PV of multiple cash flows: Ajax Corp. is expecting the following cash
flows—$79,000, $112,000, $164,000, $84,000, and $242,000—over the
next five years. If the company’s opportunity cost is 15 percent, what is
the present value of these cash flows? (Round to the nearest dollar.)
A) $429,560
B) $414,322
C) $480,906
D) $477,235
Ans A
:
Feedback:
1-162
65. PV of multiple cash flows: Pam Gregg is expecting cash flows of

$50,000, $75,000, $125,000, and $250,000 from an inheritance over
the next four years. If she can earn 11 percent on any investment that
she makes, what is the present value of her inheritance? (Round to the
nearest dollar.)
A) $361,998
B) $309,432
C) $412,372
D) $434,599
Ans A
:
Feedback:
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66. Present value of an annuity: Transit Insurance Company has made an

investment in another company that will guarantee it a cash flow of
$37,250 each year for the next five years. If the company uses a discount
rate of 15 percent on its investments, what is the present value of this
investment? (Round to the nearest dollar.)
A) $101,766
B) $124,868
C) $251,154
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D) $186,250
Ans B
:
Feedback:
1-165
Annual payment = PMT = $37,250
No. of payments = n = 5
Required rate of return = 15%
Present value of investment = PVA5
CTTT
67. Present value of an annuity: Herm Mueller has invested in a fund that
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will provide him a cash flow of $11,700 for the next 20 years. If his
opportunity cost is 8.5 percent, what is the present value of this cash flow
stream? (Round to the nearest dollar.)
A) $234,000
B) $132,455
C) $110,721
D) $167,884
Ans C
:
Feedback:
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68. Present value of an annuity: Myers, Inc., will be making lease payments
of $3,895.50 for a 10-year period, starting at the end of this year. If the
firm uses a 9 percent discount rate, what is the present value of this
annuity? (Round to the nearest dollar.)
A) $23,250
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B) $29,000
C) $25,000
D) $20,000
Ans C
:
Feedback:
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69. Present value of an annuity: Lorraine Jackson won a lottery. She will
have a choice of receiving $25,000 at the end of each year for the next 30
years, or a lump sum today. If she can earn a return of 10 percent on any
investment she makes, what is the minimum amount she should be willing
to accept today as a lump-sum payment? (Round to the nearest hundred
dollars.)
A) $750,000
B) $334,600
C) $212,400
D) $235,700
Ans D
:
Feedback:
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70. Present value of an annuity: Craymore Tech is expecting cash flows of

$67,000 at the end of each year for the next five years. If the firm's
discount rate is 17 percent, what is the present value of this annuity?
A) $214,356
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B) $241,653
C) $278,900
D) $197,776
Ans A
:
Feedback:
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71. Future value of an annuity: Carlos Menendez is planning to invest

$3,500 every year for the next six years in an investment paying 12
percent annually. What will be the amount he will have at the end of the
six years? (Round to the nearest dollar.)
A) $21,000
B) $28,403
C) $24,670
D) $26,124
Ans B
:
Feedback:
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72. Future value of an annuity: Jayadev Athreya has started on his first job.
He plans to start saving for retirement early. He will invest $5,000 at the
end of each year for the next 45 years in a fund that will earn a return of
10 percent. How much will Jayadev have at the end of 45 years? (Round
A) $2,667,904
B) $3,594,524
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C) $1,745,600
D) $5,233,442
Ans B
:
Feedback:
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73. Future value of an annuity: You plan to save $1,250 at the end of
each of the next three years to pay for a vacation. If you can invest it at
7 percent, how much will you have at the end of three years? (Round
A) $3,750
B) $3,918
C) $4,019
D) $4,589
Ans C
:
Feedback:
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74. Future value of an annuity: Zhijie Jiang is saving to buy a new car in
four years. She will save $5,500 at the end of each of the next four
years. If she invests her savings at 6.75 percent, how much will she
have after four years? (Round to the nearest dollar.)
A) $22,000
B) $23,345
C) $27,556
D) $24,329
Ans D
:
Feedback:
1-177
75. Future value of an annuity: Terri Garner will invest $3,000 in an IRA
for the next 30 years starting at the end of this year. The investment will
earn 13 percent annually. How much will she have at the end of 30 years?
A) $897,598
B) $912,334
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C) $748,212
D) $1,233,450
Ans A
:
Feedback:
1-179
76. Computing annuity payment: Maricela Sanchez needs to have $25,000
in five years. If she can earn 8 percent on any investment, what is the
amount that she will have to invest every year at the end of each year for
the next five years? (Round to the nearest dollar.)
A) $5,000
B) $4,261
C) $4,640
D) $4,445
Ans B
:
Feedback:
1-180
77. Computing annuity payment: Jane Ogden wants to save for a trip to
Australia. She will need $12,000 at the end of four years. She can invest
a certain amount at the beginning of each of the next four years in a
bank account that will pay her 6.8 percent annually. How much will she
have to invest annually to reach her target? (Round to the nearest
dollar.)
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A) $3,000
B) $2,980
C) $2,538
D) $2,711
Ans C
:
Feedback:
1-182
78. Computing annuity payment: Jackson Electricals has borrowed $27,850

from its bank at an annual rate of 8.5 percent. It plans to repay the loan in
eight equal installments, beginning in a year. What is its annual loan
payment? (Round to the nearest dollar.) không biết
A) $4,708
B) $5,134
C) $4,939
D) $4,748
Ans C
:
Feedback:
PVAn = $27,850 n = 8; i = 8.5%
Present value of annuity = PVA = $27,850
Return on investment = i = 8.5%
Payment required to meet target = PMT
1-183
Using the PVA equation:
Each payment made by Jackson Electricals will be $4,938.66, starting at

the end of next year.
79. Computing annuity payment: John Harper has borrowed $17,400 to

pay for his new truck. The annual interest rate on the loan is 9.4
percent, and the loan needs to be repaid in four payments. What will be
his annual payment if he begins his payment beginning now? (Round
to the nearest dollar.) không biết
A) $5,229
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B) $5,450
C) $4,850
D) $4,953
Ans D
:
Feedback:
1-185
PVAn = $17,400 n = 4; i = 9.4%
Present value of annuity = PVA = $17,400
Return on investment = i = 9.4%
Payment required to meet target = PMT
Type of annuity = Annuity due
Using the PVA equation:
= $4,952.53
Each payment made by John Harper will be $4,952.53, starting today.
1-186
80. Computing annuity payment: Trevor Smith wants to have a million

dollars at retirement, which is 15 years away. He already has $200,000
in an IRA earning 8 percent annually. How much does he need to save
each year, beginning at the end of this year to reach his target?
Assume he could earn 8 percent on any investment he makes. (Round
A) $13,464
B) $14,273
C) $10,900
D) $16,110
Ans A
:
Feedback:
Retirement investment target in 15 years = $1,000,000
Amount invested in IRA account now = PV = $200,000
Return earned by investment = i = 8%
1-187
Value of current investment in 15 years = FV15
Balance of money needed to buy car = $1,000,000 -$634,433.82

=$365,566.18 = FVA
Payment needed to reach target = PMT
81. Perpetuity: Your father is 60 years old and wants to set up a cash
flow stream that would be forever. He would like to receive $20,000
every year, beginning at the end of this year. If he could invest in
account earning 9 percent, how much would he have to invest today to
receive his perpetual cash flow? (Round to the nearest dollar.)
A) $222,222
B) $200,000
C) $189,000
1-188
D) $235,200
Ans A
:
Feedback:
Annual payment needed = PMT = $20,000
Investment rate of return = i = 9%
Term of payment = Perpetuity
Present value of investment needed = PV
82. Perpetuity: A lottery winner was given a perpetual payment of $11,

444. She could invest the cash flows at 7 percent. What is the present
value of this perpetuity? (Round to the nearest dollar.)
A) $112,344
B) $163,486
1-189
C) $191,708
D) $201,356
Ans B
:
Feedback:
Annual payment needed = PMT = $11,444
83. Perpetuity: Roger Barkley wants to set up a scholarship at his alma

mater. He is willing to invest $500,000 in an account earning 10
percent. What will be the annual scholarship that can be given from
this investment? (Round to the nearest dollar.)
A) $5,000
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B) $500,000
C) $50,000
Ans C
:
Feedback:
Annual payment needed = PMT
Present value of investment = PVA = $500,000
= $50,000
1-191
84. Perpetuity: Chris Collinge has funded a retirement investment with
$250,000 earning a return of 5.75 percent. What is the value of the
payment that he can receive in perpetuity? (Round to the nearest
dollar.)
A) $12,150
B) $15,250
C) $14,375
D) $14,900
Ans C
:
Feedback:
Annual payment needed = PMT
Present value of investment = PVA = $250,000
Investment rate of return = i = 5.75%
1-192
85. Perpetuity: Jeff Conway wants to receive $25,000 in perpetuity and

will invest his money in an investment that will earn a return of 13.5
percent annually. What is the value of the investment that he needs to
make today to receive his perpetual cash flow stream? (Round to the
nearest dollar.)
A) $640,225
B) $252,325
C) $144,350
D) $185,185
Ans D
:
Feedback:
Annual Payment needed = PMT = $25,000
Investment rate of return = i = 13.5%
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86. Annuity due: You plan to save $1,400 for the next four years,
beginning now, to pay for a vacation. If you can invest it at 6 percent,
how much will you have at the end of four years? Round to the
nearest dollar.
A) $6,124
B) $5,618
C) $4,019
D) $6,492
Ans: D
Feedback:
0 1 2 3 4
├───────┼────────┼───────┼────────┤
$1,400 $1,400 $1,400 $1,400
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n = 4; i = 6%
1-195
87. Annuity due: Mark Holcomb has a five-year loan on which he will
make annual payments of $2,235, beginning now. If the interest rate on
the loan is 8.3 percent, what is the present value of this annuity? (Round
A) $9,588
B) $8,854
C) $8,612
D) $9,122
Ans A
:
Feedback:
0 1 2 3 4 5
├───────┼────────┼───────┼────────┼─────
──┤
$2,235 $2,235 $2,235 $2,235 $2,235
n = 5; i = 8.3%
Required rate of return = 8.3%
1-196
88. Annuity due: Jenny Abel is investing $2,500 today and will do so at
the beginning of each of the next six years for a total of seven
payments. If her investment can earn 12 percent, how much will she
have at the end of seven years? (Round to the nearest dollar.)
A) $25,223
B) $28,249
C) $31,127
D) $29,460
Ans B
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:
Feedback:
0 1 2 3 6
7
├───────┼────────┼───────┼………………
┼───────┤
PMT PMT PMT PMT PMT
n = 7; i = 12%
Present value of annuity = PVA Return on investment = i = 9.4%
Payment required to meet target = $2,500
Type of annuity = Annuity due
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89. Annuity due: Your inheritance will pay you $100,000 a year for five
years beginning now. You can invest it in a CD that will pay 7.75
percent annually. What is the present value of your inheritance? (Round
A) $399,356
B) $401,916
C) $433,064
D) $467,812
Ans C
:
Feedback:
0 1 2 3 4
5
├───────┼────────┼───────┼────────┼─────
──┤
$100,000 $100,000 $100,000 $100,000

$100,000
n = 5; i = 7.75%
Required rate of return = 7.75%
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90. Growing perpetuity: Jack Benny is planning to invest in an insurance

company product. The product will pay $10,000 at the end of this
year. Thereafter, the payments will grow annually at a 3 percent rate
forever. Jack will be able to invest his cash flows at a rate of 6.5
percent. What is the present value of this investment cash flow
stream? (Round to the nearest dollar.) CTTT
A) $326,908
B) $312,766
C) $285,714
D) $258,133
Ans C
1-200
:
Feedback:
Cash flow at t=1 = CF1 = $10,000
Annual growth rate = g = 3%
Discount rate = i = 6.5%
Present value of growing perpetuity = PVA¥
91. Growing perpetuity: Norwood Investments is putting out a new

product. The product will pay out $25,000 in the first year, and after
that the payouts will grow by an annual rate of 2.5 percent forever. If
you can invest the cash flows at 7.5 percent, how much will you be
willing to pay for this perpetuity? (Round to the nearest dollar.)
A) $312,000
B) $233,000
C) $250,000
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D) $500,000
Ans D
:
Feedback:
Cash flow at t=1 = CF1 = $25,000
Annual growth rate = g = 2.5%
Discount rate = i = 7.5%
Present value of growing perpetuity = PVA¥
92. Growing annuity: Hill Enterprises is expecting tremendous growth

from its newest boutique store. Next year the store is expected to bring
in net cash flows of $675,000. The company expects its earnings to
grow annually at a rate of 13 percent for the next 15 years. What is the
present value of this growing annuity if the firm uses a discount rate of
18 percent on its investments? (Round to the nearest dollar.)
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A) $6,448,519
B) $6,750,000
C) $7,115,449
D) $5,478,320
Ans A
:
Feedback:
Time of growth = n = 15 years
Next year's expected net cash flow = CF1 = $675,000
Expected annual growth rate = g = 13%
Firm's required rate of return = i = 18%
Present value of growing annuity = PVAn
=$13,500,000 x .477668
= $6,448,519.47
1-203
93. Growing annuity: Wilbon Corp. is evaluating whether it should take

over the lease of an ethnic restaurant in Manhattan. The current owner
had originally signed a 25-year lease, of which 16 years still remain.
The restaurant has been growing steadily at a 7 percent growth for the
last several years. Wilbon Corp. expects the restaurant to continue to
grow at the same rate for the remaining lease term. Last year, the
restaurant brought in net cash flows of $310,000. If the firm evaluates
similar investments at 15 percent, what is the present value of this
investment? (Round to the nearest dollar.)
A) $2,966.350
B) $2,838,182
C) $3,109,460
D) $2,709,124
Ans B
:
Feedback:
Time for lease to expire = n = 16 years
1-204
Last year's net cash flow = CF0 = $310,000
Expected annual growth rate = g = 7%
Firm's required rate of return = i = 15%
Expected cash flow next year = CF1 = $310,000(1 + g) =

$310,000(1.07) = $331,700
Present value of growing annuity = PVAn
94. Effective annual rate: Desire Cosmetics borrowed $152,300 from a

bank for three years. If the quoted rate (APR) is 11.75 percent, and the
compounding is daily, what is the effective annual rate (EAR)?
(Round to one decimal place.)
A) 11.75%
B) 14.3%
C) 12.5%
D) 11.6%
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Ans C
:
Feedback:
Loan amount = PV = $152,300
Interest rate on loan = i = 11.75%
Effective annual rate = EAR
95. Effective annual rate: Largent Supplies Corp. has borrowed to invest
in a project. The loan calls for a payment of $17,384 every month for
three years. The lender quoted Largent a rate of 8.40 percent with
monthly compounding. At what rate would you discount the payments
to find amount borrowed by Largent? (Round to two decimal places.)
A) 8.40%
B) 8.73%
C) 8.95%
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Ans B
:
Feedback:
Loan amount = PV
Interest rate on loan = i = 8.4%
Effective annual rate = EAR
To discount present or future value of cash flows, the most appropriate

rate is the EAR, that is, 8.73 percent.
36.
The expected return for a portfolio without borrowing
A) should never be less than the expected return of the asset with
lowest expected return.
B) should never be greater than the expected return of the asset

with highest expected return.
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C) may not be an event with even a positive probability of
occurrence.
Ans D
:
37. In a game of chance, the probability of winning a $50 prize is 40

percent, and the probability of winning a $100 prize is 60 percent.
What is the expected value of a prize in the game?
A) $50
B) $75
C) $80
D) $100
Ans C
:
1-208
Feedback:
$50(0.4) + $100 (0.6) = $80
38. In a game of chance, the probability of winning a $50 is 40 percent

and the probability of losing a $50 prize is 60 percent. What is the
expected value of a prize in the game?
A) –$10
B) $0
C) $10
D) $25
Ans A
:
Feedback:
$50(0.4) – $50 (0.6) = -$10
1-209
39. Which of the following is the best measure of the systematic risk in a
portfolio?
A) variance
B) standard deviation
C) covariance
D) Beta
Ans D
:
40. Use the following table to calculate the expected return for the asset.
1-210
R P
et ro
ur b
a
bi
lit
y
0. 0.
2
5
0. 0.
5
0. 0.
25 2
5
A) 15.00%
B) 17.50%
C) 18.75%
D) 20.00%
Ans C
:
Feedback:
1-211
(0.1)(0.25) + (0.2)(0.5) + (0.25)(0.25) = 0.1875
41. Use the following table to calculate the expected return for the asset.
R P
et ro
ur b
a
bi
lit
y
0. 0.
05 1
0. 0.
1
5
0. 0.
15 5
0. 0.
25 2
5
1-212
A) 12.50%
B) 13.75%
C) 15.75%
D) 16.75%
Ans C
:
Feedback:
(0.5)(0.1) + (0.1)(0.15) + (0.15)(0.5) + (0.25)(0.25) = 0.1575
42. The expected return for the asset below is 18.75 percent. If the return
distribution for the asset is described as in the following table, what is
the variance for the asset's returns?
Ret Pr
urnob
abi
lit
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0.10.2
0.20.5
0.20.2
A) 0.002969
B) 0.000613
C) 0.015195
D) 0.054486
Ans A
:
Feedback:
(0.1)(0.25 – 0.1875)2 + (0.2)(0.5 – 0.1875) 2 + (0.25)(0.25 – 0.1875) 2 =

0.002969
1-214
43. The expected return for the asset shown in the following table is
18.75 percent. If the return distribution for the asset is described as
below, what is the standard deviation for the asset's returns? CTTT
RetPro
urnbab
ilit
0.2
0.5
0.250.2
A) 0.002969
B) 0.000613
C) 0.015195
D) 0.054486
1-215
Ans D
:
Feedback:
{ (0.25)(0.10 – 0.1875)2 + (0.5)(0.2 – 0.1875) 2 + (0.25)(0.25 – 0.1875)

2 1/2
} = 0.054486
44. If you are dealing with percentage returns, then which of the following
is generally true?
A) The variance of the return distribution is generally smaller than

the standard deviation.
B) The variance of the return distribution is generally larger than

the standard deviation.
C) The variance of the return distribution is measured in the same

units as expected return.
D) None of the above is generally true.
Ans D
:
1-216
45. The return distribution for an asset is as shown in the following table.
What are the missing values if the expected return is 10 percent?
Return
Proba
bility
0.25
0.25
A) 0.20
B) 0.15
C) 0.10
Ans C
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:
46. The expected return for Stock Z is 30 percent. If we know the

following information about Stock Z, then what return will it produce
in the Lukewarm state of the world?
CTTT
Retur
Proba
Poor
Luke
warm
Dyna
mite!
A) 20%
B) 30%
C) 40%
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D) It is impossible to determine.
Ans B
:
Feedback:
(0.25)(0.2) + (0.5)(X) + (0.25)(0.4) = 0.3 , X = 0.3
47. The expected return for Stock V is 24.5 percent. If we know the
following information about Stock Z, then what is the probability of
the Dynamite state of the world occurring?
CTTT
Retur
Proba
bility
Poor
Luke
warm
1-219
Dyna
mite!
A) 5%
B) 10%
C) 15%
D) 20%
Ans B
:
Feedback:
0.2 + 0.7 + X = 1.0 ===> X = 0.1 or 10%
48. Ahmet purchased a stock for $45 one year ago. The stock is now
worth $65. During the year, the stock paid a dividend of $2.50. What
is the total return to Ahmet from owning the stock? (Round your
answer to the nearest whole percent.) CTTT
1-220
A) 5%
B) 44%
C) 35%
D) 50%
Ans D
:
Feedback:
49. Julio purchased a stock one year ago for $27. The stock is now worth
$32, and the total return to Julio for owning the stock was 37 percent.
What is the dollar amount of dividends that he received for owning the
stock during the year?
A) $4
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B) $5
C) $6
D) $7
Ans B
:
Feedback:
50. Francis purchased a stock one year ago for $20, and it is now worth
$24. The stock paid a dividend of $3 during the year. What was the
stock's rate of return from capital appreciation during the year?
(Round your answer to the nearest percent.)
A) 17%
B) 20%
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C) 29%
D) 35%
Ans B
:
Feedback:
51. Gwen purchased a stock one year ago for $25, and it is now worth
$31. The stock paid a dividend of $1.50 during the year. What was the
stock's rate of return income during the year? (Round your answer to
the nearest percent.)
A) 6%
B) 15%
C) 24%
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D) 26%
Ans A
:
Feedback:
52. Gunther earned a 62.5 percent return on a stock that he purchased one
year ago. The stock is now worth $12, and he received a dividend of
$1 during the year. How much did Gunther originally pay for the
stock?
A) $7.00
B) $7.50
C) $8.00
D) $8.50
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Ans C
:
Feedback:
53. Moshe purchased a stock for $30 last year. He found out today that he
had a –100 percent return on his investment. Which of the following
must be true?
A) The stock is worth $30 today.
B) The stock is worth $0 today
C) The stock paid no dividends during the year.
D) Both b and c must be true.
Ans D
:
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54. Babs purchased a piece of real estate last year for $85,000. The real
estate is now worth $102,000. If Babs needs to have a total return of
25 percent during the year, then what is the dollar amount of income
that she needed to have to reach her objective?
A) $3,750
B) $4,250
C) $4,750
D) $5,250
Ans B
:
Feedback:
1-226
55. Genaro needs to capture a return of 40 percent for his one-year

investment in a property. He believes that he can sell the property at
the end of the year for $150,000 and that the property will provide him
with rental income of $25,000. What is the maximum amount that
Genaro should be willing to pay for the property?
A) $112,500
B) $125,000
C) $137,500
D) $150,000
Ans B
:
Feedback:
1-227
56. Books Brothers stock was priced at $15 per share two years ago. The
stock sold for $13 last year and now it sells for $18. What was the
total return for owning Books Brothers stock during the most recent
year? Assume that no dividends were paid and round to the nearest
percent.
A) 17%
B) 20%
C) 23%
D) 38%
Ans D
:
Feedback:
57. Serox stock was selling for $20 two years ago. The stock sold for $25
one year ago, and it is currently selling for $28. Serox pays a $1.10
dividend per year. What was the rate of return for owning Serox in the
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most recent year? (Round to the nearest percent.)
A) 12%
B) 16%
C) 32%
D) 40%
Ans B
:
Feedback:
58. You have observed that the average size of a particular goldfish is 1.5
inches long. The standard deviation of the size of the goldfish is 0.25
inches. What is the size of a goldfish such that 95 percent of the
goldfish are smaller? Assume a normal distribution for the size of
goldfish.
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A) 1.01 inches
B) 1.09 inches
C) 1.91 inches
D) 1.99 inches
Ans C
:
Feedback:
1.5 + 1645 (0.25) = 1.91 inches
59. You know that the average college student eats 0.75 pounds of food at
lunch. If the standard deviation of that eating is 0.2 pounds of food,
then what is the total amount of food that a cafeteria should have on
hand to be 95percent confident that it will not run out of food when
feeding 50 college students.
A) 17.90 pounds
1-230
B) 21.05 pounds
C) 53.95 pounds
D) 57.10 pounds
Ans C
:
Feedback:
50 students * {0.75 pounds per student + 1.645 (0.2 pounds per

student)} = 53.95 pounds of food required.
60. If a random variable is drawn from a normal distribution, what is the

probability that the random variable is larger than 1.96 standard
deviations larger than the mean?
A) 1.25%
B) 2.50%
C) 3.75%
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D) 5.00%
Ans B
:
61. If a random variable is drawn from a normal distribution, what is the

probability that the random variable is larger than 1.96 standard
deviations below the mean? Không biết
A) 95.00%
B) 96.25%
C) 97.50%
D) 98.75%
Ans C
:
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62. Niles is making an investment with an expected return of 12 percent.

If the standard deviation of the return is 4.5 percent, and if Niles is
investing $100,000, then what dollar amount is Niles 95 percent sure
that he will have at the end of the year? Không biết
A) $100,000.00
B) $104,597.50
C) $116,500.00
D) $119,402.50
Ans B
:
Feedback:
{ 1 + [0.12 – 1.645 (0.045)]} X $100,000 = $104,597.50
1-233
63. Which of the following investment classes had the greatest average
return based on recent historical data?
A) Intermediate-Term Government Bonds
B) Long-Term Government Bonds
C) Large U.S. Stocks
D) Small U.S. Stocks
Ans D
:
64. Which of the following investment classes had the greatest variability
in returns for recent historical data?
A) Intermediate-Term Government Bonds
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B) Long-Term Government Bonds
C) Large U.S. Stocks
D) Small U.S. Stocks
Ans D
:
65. If you were to compare the returns of an individual stock to a market

index, select the answer below that is most true.
A) The returns of the individual stock will show more variability

than those of the market index.
B) The returns of the individual stock will show less variability

than those of the market index.
C) The returns of the individual stock will show the same level of
variability than those of the market index, if they have the same
beta.
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Ans A
:
66. Tommie has made an investment that will generate returns that are
subject to the state of the economy during the year. Use the following
information to calculate the standard deviation of the return
distribution for Tommie's investment. Không biết đọc lại thôi
StR P
at etro
e ur b
na
bi
lit
y
W0.0.
e 13
a 3
k
O 0.0.
K24
G0.0.
1-236
re 2 3
at 5
A) 0.0453
B) 0.0467
C) 0.0481
D) 0.0495
Ans B
:
Feedback:
67. Elrond has made an investment that will generate returns that are subject
to the state of the economy. Use the following information to calculate
the variance of the return distribution for Elrond's investment.
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State
Retu
Prob
abilit
Wea
0.10
k
OK
0.17
Grea
0.28
t
A) 0.0536
B) 0.0543
C) 0.0550
D) 0.0557
Ans D
:
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Feedback:
68. Braniff Ground Services stock has an expected return of 9 percent and
a variance of 0.25 percent. What is the coefficient of variation for
Braniff? CTTT
A) 0.0278
B) 0.5556
C) 1.800
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D) 36.00
Ans B
:
Feedback:
69. Sayers purchased a stock with a coefficient of variation equal to 0.125.

The expected return on the stock is 20 percent. What is the variance of
the stock?
A) 0.000625
B) 0.025000
C) 0.625000
D) 0.790500
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Ans A
:
Feedback:
Coefficient of variation
O: the variance of the stock
70. You have invested 40 percent of your portfolio in an investment with

an expected return of 12 percent and 60 percent of your portfolio in an
investment with an expected return of 20 percent. What is the
expected return of your portfolio? CTTT
A) 15.2%
B) 16.0%
C) 16.8%
D) 17.6%
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Ans C
:
Feedback:
71. You have invested 20 percent of your portfolio in Homer, Inc., 40

percent in Marge Co., and 20 percent in Bart Resources. What is the
expected return of your portfolio if Homer, Marge, and Bart have
expected returns of 2 percent, 18 percent, and 3 percent, respectfully?
A) 7.7%
B) 8.2%
C) 8.7%
D) 9.2%
Ans B
:
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Feedback:
72. You invested $3,000 in a portfolio with an expected return of 10

percent and $2,000 in a portfolio with an expected return of 16
percent. What is the expected return of the combined portfolio? CTTT
A) 6.2%
B) 12.4%
C) 13.0%
D) 13.6%
Ans B
:
Feedback:
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73. Given the returns for two stocks with the following information, calculate
the covariance of the returns for the two stocks. Assume the expected
return is 10.8 percent for Stock 1 and 9.7 percent for Stock 2. CTTT
Stock
Stock
A) 0.000094
B) 0.00051600
C) 0.00032100
D) 0.71750786
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Ans A
:
Feedback:
Cov(R1,R2)
=0.4*(0.09-0.108)*(0.11-0.097)+0.5*(0.11-0.108)*(0.08-0.097)+0.1*(0.17-
0.108)*(0.13-0.097) = 0.000094
Cov(R1,R2)
=0.5*(0.09-0.108)*(0.11-0.097)+0.5*(0.11-0.108)*(0.08-0.097)+0.1*(0.17-
0.108)*(0.13-0.097) = 0.000094
74. Given the returns for two stocks with the following information,
calculate the correlation coefficient of the returns for the two
stocks. Assume the expected return for Stock 1 is 10.8 percent and 9.7
percent for Stock 2.
Stock
Stock
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A) 0.230967
B) –0.00002548
C) 0.00032100
D) 0.17671455
Ans A
:
Feedback:
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From the solution to Problem 73, we find that the covariance between
the stocks is 0.000094. We must now solve for the standard deviation of
the returns of each individual stock. CTTT
75. Given the returns for two stocks with the following information, calculate
the covariance of the returns for the two stocks. Assume the expected
return is 14.4 percent for Stock 1 and 15.9 percent for Stock 2.
Stock
Stock
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A) 0.001204001
B) 0.000549003
C) -0.00079
D) –0.3372012
Ans C
:
Feedback:
Cov(R1,R2) = .
(0.5*(0.11-0.144)*(0.18-0.159)+0.3*(0.17-0.144)*(0.15-0.159)+0.2*(0.19-
0.144)*(0.12-0.159)
= -0.00079
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76. Given the returns for two stocks with the following information,
calculate the correlation coefficient of the returns for the two stocks.
Assume the expected return is 14.4 percent for Stock 1 and 15.9 percent
for Stock 2.
Stock
Stock
A) 0.001204001
B) 0.000549003
C) –0.00271370
D) -0.971689
Ans D
:
Feedback:
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Cov(R1,R2) = -0.00079
so p = - .00079 = -.971689
(.03469873)(.02343075)
77. The covariance of the returns between Einstein Stock and Bohr Stock
is 0.0087. The standard deviation of Einstein is 0.26, and the standard
deviation of Bohr is 0.37. What is the correlation coefficient between
the returns of the two stocks? CTTT
A) 0.090437
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B) 0.096200
C) 0.90437
D) 0.96200
Ans A
:
Feedback:
78. The covariance of the returns between Wildcat Stock and Sun Devil
Stock is 0.09875. The variance of Wildcat is 0.2116, and the variance
of Sun Devil is 0.1369. What is the correlation coefficient between the
returns of the two stocks?
A) 0.170200
B) 0.293347
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C) 0.340823
D) 0.578731
Ans D
:
Feedback:
79. Horse Stock returns have exhibited a standard deviation of 0.57,

whereas Mod T Stock returns have a standard deviation of 0.63. The
correlation coefficient between the returns is 0.078042. What is the
covariance of the returns? CTTT
A) 0.028025
B) 0.217327
C) 0.359100
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D) 0.993094
Ans A
:
Feedback:
80. Batman Stock has exhibited a standard deviation in stock returns of 0.5,
whereas Superman Stock has exhibited a standard deviation of 0.6. The
correlation coefficient between the stock returns is 0.5. What is the
variance of a portfolio composed of 70 percent Batman and 30 percent
Superman? Không biết
A) 0.1549
B) 0.2179
C) 0.4668
D) 0.5500
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Ans B
:
Feedback:
CTTT
81. Aquaman Stock has exhibited a standard deviation in stock returns of

0.7, whereas Green Lantern Stock has exhibited a standard deviation of
0.8. The correlation coefficient between the stock returns is 0.1. What is
the standard deviation of a portfolio composed of 70 percent Aquaman
and 30 percent Green Lantern? Không biết
A) 0.32122
B) 0.54562
C) 0.56676
D) 0.75000
Ans C
:
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Feedback:
82. Most of the risk-reduction benefits from diversification can be

achieved in a portfolio consisting of
A) 5 to 10 stocks
B) 10 to 15 stocks
C) 15 to 20 stocks
D) 20 to 25 stocks
Ans C
:
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83. Which of the following investors should be willing to pay the highest
price for an asset?
A) An investor with a single-asset portfolio. Không biết
B) An investor with a 50-asset portfolio.
C) An investor who is not completely diversified.
D) An investor who is so risk-averse that he does not recognize the

benefits of diversification.
Ans B
:
84. A portfolio with a level of systematic risk the same as that of the
market has a beta that is không biết
A) equal to zero.
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B) equal to one.
C) less than the beta of the risk-free asset.
D) less than zero.
Ans B
:
85. The beta of Elsenore, Inc., stock is 1.6, whereas the risk-free rate of
return is 8 percent. If the expected return on the market is 15 percent,
then what is the expected return on Elsenore? CTTT
A) 11.20%
B) 19.20%
C) 24.00%
D) 32.00%
Ans B
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:
Feedback:
86. CTTT The beta of RicciCo.'s stock is 3.2, whereas the risk-free rate of
return is 9 percent. If the expected return on the market is 18 percent,
then what is the expected return on RicciCo.?
A) 28.80%
B) 37.80%
C) 48.60%
D) 57.60%
Ans B
:
Rrf risk-free rate of return
B The beta of RicciCo.'s stock
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E(rm) expected return on the market
Rrf:
Feedback:
Systematic risk
87. The risk-free rate of return is currently 3 percent, whereas the market
risk premium is 6 percent. If the beta of Lenz, Inc., stock is 1.8, then
what is the expected return on Lenz? Không biết CTTT
A) 8.40%
B) 10.80%
C) 13.80%
D) 19.20%
Ans C
:
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Feedback:
88. The expected return on Kiwi Computers stock is 16.6 percent. If the risk-
free rate is 4 percent and the expected return on the market is 10 percent,
then what is Kiwi's beta? CTTT
A) 1.26
B) 2.10
C) 2.80
D) 3.15
Ans B
:
Feedback:
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89. The expected return on Mike's Seafood stock is 17.9 percent. If the
expected return on the market is 13 percent and the beta for Kiwi is 1.7,
then what is the risk-free rate? CTTT
A) 4.5%
B) 5.0%
C) 5.5%
D) 6.0%
Ans D
:
Feedback:
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90. The expected return on KarolCo. stock is 16.5 percent. If the risk-free rate
is 5 percent and the beta of KarolCo is 2.3, then what is the risk premium
on the market?
A) 2.5%
B) 5.0%
C) 7.5%
D) 10.0%
Ans B
:
Feedback:
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91. Which of the following statements is most correct?
A) The greater the risk associated with an investment, the lower the
return investors expect from it.
B) When choosing between two investments that have the same

level of risk, investors prefer the investment with the higher
return.
C) If two investments have the same expected return, investors

prefer the riskiest alternative.
D) When choosing between two investments that have the same

level of risk, investors prefer the investment with the lower
return.
Ans B
:
92. Holding Period Return: George Wilson purchased Bright Light

Industries common stock for $47.50 on January 31, 2010. The firm
paid dividends of $1.10 during the last 12 months. George sold the
stock today (January 30, 2011) for $54.00. What is George’s holding
period return? Round off the nearest 0.01%.
A) 16.00%
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B) 14.35%
C) 11.28%
D) 19.60%
Ans A
:
Feedback:
CTTT Portfolio beta
P1: stock today // P0 Commong stock//CF dividends//
93.CTT Expected Return: Security Analysts that have evaluated Concordia

T Corporation have determined that there is a 15% chance that the firm
will generate earnings per share of $2.40; a 60% probability that the
firm will generate earnings per share of $3.10; and a 25% probability
that the firm will generate earnings per share of $3.80. What are the
expected earnings per share for Concordia Corporation? (Round
off to the nearest $0.01)
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A) $3.10
B) $3.17
C) $2.75
D) $2.91
Ans B
:
Feedback:
Projected Expected
Probability EPS EPS
15.00% $2.40 $0.36
60.00% 3.10 1.86
25.00% 3.80 0.95
100.00% $3.17
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94. Standard Deviation: View Point Industries has forecast a rate of

return of 20.00% if the economy booms (25.00% probability); a rate
of return of 15.00% if the economy in in a growth phase (45.00%
probability); a rate of return of 2.50% if the economy in in decline
(20.00% probability); and a rate of return of -15.00% if the economy
in a depression (10.00% probability). What is View Point’s standard
deviation of returns?
A) 17.31%
B) 9.25%
C) 15.00%
D) 10.46%
Ans D
:
Feedback:
Standard Deviation
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A B C D E F G
Calc. Of
Proj. Ret.
Projected Expected Minus Col. F
State of Probability Col. E times
Economy of Occurance Return Return Exp. Ret. Squared Col. B
Boom 25.00% 20.00% 5.00% 9.25% 0.856% 0.214%
Growth 45.00% 15.00% 6.75% 4.25% 0.181% 0.081%
Decline 20.00% 2.50% 0.50% -8.25% 0.681% 0.136%
Depression 10.00% -15.00% -1.50% -25.75% 6.631% 0.663%
100.00% Total 10.75% Variance 1.09
Standard Deviation 10.46%
95. Which of the following represents a plot of the relation between

expected return and systemic risk?
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A) The beta coefficient.
B) The covariance of returns line.
C) The security market line.
D) The variance.
Ans C
:
31. In an efficient capital market,
A) security prices fully reflect the knowledge and expectations of all

investors at a particular point in time.
B) investors and financial managers have no reason to believe the securities

are not priced at or near their true value.
C) prices of securities adjust as new information becomes available to the

market.
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Ans: D
A) The overall efficiency of a capital market depends on its operational

efficiency and its informational efficiency.
B) Operational efficiency focuses on bringing buyers and sellers together at

the lowest possible cost.
C) If market prices reflect all relevant information about securities at a

particular point in time, the market is operationally efficient.
Ans: C
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A) Competition among investors is an important driver of informational

efficiency.
B) If market prices reflect all relevant information about securities at a

particular point in time, the market is informationally efficient.
C) In an informationally efficient market, market prices adjust quickly to

new information about a security as it becomes available.
Ans: D
34. With strong-form market efficiency, không biết
A) the price of a security in the market reflects all public information only.
B) it would not be possible to earn abnormally high returns by trading on

private information.
C) investors who have access to inside or private information will be able to
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earn abnormal returns.
Ans: B
35. With semistrong-form market efficiency,
A) the price of a security in the market reflects all public information only.
B) it would be possible to earn abnormally high returns by trading on public

information.
C) investors who have access to inside or private information will be unable

to earn abnormal returns.
Ans: A
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A) Weak-form market efficiency implies that investors who have access to

inside or private information will be able to earn abnormal returns.
B) Semistrong-form market efficiency implies that investors who have

access to inside or private information will be able to earn abnormal
returns.
C) Strong-form market efficiency implies that investors who have access to

inside or private information will be able to earn abnormal returns.
Ans: C
37. Which ONE of the following statements is true?
A) The largest investors in corporate bonds are life insurance companies and
pension funds.
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B) The market for corporate bonds is thin.
C) Prices in the corporate bond market also tend to be more volatile.
Ans: D
A) Prices in the corporate bond market also tend to be more volatile than the
markets for stocks or money market securities.
B) Corporate bonds are more marketable than the securities that have higher
daily trading volumes.
C) The market for corporate bonds is thin.
D) The largest investors in corporate bonds are life insurance companies and
pension funds.
Ans: B
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39. It is easy for individuals to trade in the corporate bond market because
A) the corporate bond market is considered to be very transparent.
B) prices in the corporate bond market tend to be more stable.
C) centralized reporting of deals between buyers and sellers take place.
D) None of the above statements are true.
Ans: D
40. Which one of the following statements about vanilla bonds is NOT true?
A) They have no special provisions.
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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.
Ans: C
A) Zero coupon bonds have no coupon payments over its life and only offer
a single payment at maturity.
B) Zero coupon bonds sell well below their face value (at a deep discount)
because they offer no coupons.
C) The most frequent and regular issuer of zero coupon securities is the U.S.
Treasury Department.
Ans: D
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A) To secure the conversion option on a bond, bondholders would be willing

to pay a premium.
B) The conversion ratio is set so that the firm's stock price must appreciate
15 to 20 percent before it is profitable to convert bonds into equity.
C) Convertible bonds can be converted into shares of common stock at some

predetermined ratio at the discretion of the bondholder.
Ans: D
43. Which one of the following statements about bond price is NOT true?
A) To compute a bond's price, one needs to calculate the present value of the
bond's expected cash flows.
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B) The value, or price, of any asset is the future value of its cash flows.
C) The required rate of return, or discount rate, for a bond is the market
interest rate called the bond's yield to maturity
D) Estimate the expected future cash flows using the coupons that the bond
will pay and the maturity value to be received.
Ans: B
44. If a bond's coupon rate is equal to the market rate, then the bond will sell
A) at a price equal to its face value.
B) at a price greater than its face value.
C) at a price less than its face value.
D) None of the above are true.
Ans: A
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45. 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.
Ans: B
46. Bonds sell at a premium over the par value when market rates for similar bonds
are
A) less than the bond's coupon rate.
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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.
Ans: A
47. In calculating the current price of a bond paying semiannual coupons, one needs
to
A) use double the number of years for the number of payments.
B) use half the annual coupon.
C) use half the annual rate as the discount rate.
D) All of the above need to be done.
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Ans: D
48. Which one of the following statements about zero coupon bonds is NOT true?
A) Zero coupon bonds have no coupon payments but promise a single

payment at maturity.
B) Zero coupon bonds must sell for less than similar bonds that make
periodic coupon payments.
C) Zero coupon bonds make coupon payments but no principal payment at

maturity.
D) All of the above statements are true.
Ans: C
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A) The yield to maturity of a bond is the discount rate that makes the present
value of the coupon and principal payments equal to the price of the bond.
B) It is the yield that the investor earns if the bond is held to maturity, and all
the coupon and principal payments are made as promised.
C) A bond's yield to maturity changes daily as interest rates increase or

decrease.
Ans: D
50. The yield to maturity of a bond is the discount rate that makes the present value
of the coupon and principal payments
A) exceed the price of the bond.
B) equal to zero.
C) equal to the price of the bond.
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D) less than the price of the bond.
Ans: C
A) The realized yield is the return earned on a bond given the cash flows
actually received by the investor.
B) The realized yield is equal to the yield to maturity even if the bond is sold
prior to maturity.
C) It is the interest rate at which the present value of the actual cash flows
generated by the investment equals the bond's price at the time of sale of
the bond.
Ans: C
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A) Interest rate risk is the risk that bond prices will change as interest rates
change.
B) Interest rate changes and bond prices are inversely related.
C) As interest rates increase, bond prices increase.
D) Long-term bonds are more price volatile than short-term bonds of similar
risk.
Ans: C
A) Long-term bonds have lower price volatility than short-term bonds.
B) As interest rates decline, the prices of bonds rise; and as interest rates rise,
the prices of bonds decline.
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C) All other things being equal, short-term bonds are more risky than long-
term bonds.
D) Interest rate risk decreases as maturity increases.
Ans: B
54. Marketability is the ability of an investor
A) to sell a security quickly, at a low transaction cost, and at a price close to

its fair market value.
B) to sell at a profit under all circumstances.
C) to sell the security above its par value.
Ans: A
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A) The lower the transaction costs are, the greater a security's marketability.
B) The interest rate, or yield, on a security varies inversely with its degree of
marketability.
C) U.S. Treasury bills have the largest and most active secondary market and
are considered to be the most marketable of all securities.
Ans: D
A) The risk that the lender may not receive payments as promised is called
default risk.
B) Investors must pay a premium to purchase a security that exposes them to
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default risk.
C) U.S. Treasury securities do not have any default risk and are the best
proxy measure for the risk-free rate.
Ans: B
57. Inverted yield curves are observed when
A) the economy is growing.
B) the economy is stagnant.
C) the economy is in recession.
Ans: C
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A) The relationship between yield and marketability is known as the term

structure of interest rates.
B) The shape of the yield curve is not constant over time.
C) As the general level of interest rises and falls over time, the yield curve
shifts up and down and has different slopes.
D) Yield curves show graphically how market yields vary as term to maturity
changes.
Ans: A
59. The three economic factors that determine the shape of the yield curve are không
biết
A) the real rate of interest, the expected rate of inflation, and marketability.
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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.
Ans: B
A) The longer the maturity of a security, the greater its interest rate risk.
B) If investors believe inflation will be subsiding in the future, the prevailing

yield will be upward sloping.
C) The real rate of interest varies with the business cycle, with the lowest
rates seen at the end of a period of business expansion and the lowest at
the bottom of a recession.
D) The interest risk premium always adds a downward bias to the slope of
the yield curve.
Ans: A
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61. Bond price: Briar Corp is issuing a 10-year bond with a coupon rate of 7 percent. The
interest rate for similar bonds is currently 9 percent. Assuming annual payments, what
is the present value of the bond? (Round to the nearest dollar.) không biết
A) $872
B) $1,066
C) $990
D) $945
Ans: A
Feedback:
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Years to maturity = n = 10
Coupon rate = C = 7%
Annual coupon = $1,000 x 0.07 = $70
Current market rate = i = 9%
Present value of bond = PB
62. Bond price: Regatta, Inc., has six-year bonds outstanding that pay a 8.25 percent
coupon rate. Investors buying the bond today can expect to earn a yield to maturity
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of 6.875 percent. What should the company's bonds be priced at today? Assume
annual coupon payments. (Round to the nearest dollar.)
A) $972
B) $1,066
C) $1,014
D) $923
Ans: B
Feedback:
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Coupon rate = C = 8.25%
Annual coupon = $1,000 x 0.0825 = $82.50
Current market rate = i = 6.875%
63. Bond price: Triumph Corp. issued five-year bonds that pay a coupon of 6.375
annually. The current market rate for similar bonds is 8.5 percent. How much will
you be willing to pay for Triumph's bond today? Round to the nearest dollar.
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A) $1,023
B) $1,137
C) $916
D) $897
Ans: C
Feedback:
Annual coupon = $1,000 x 0.06375 = $63.75
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64. Bond price: 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
Ans: D
Feedback:
Annual coupon = $1,000 x 0.10 = $100
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65. Bond price: Kevin Rogers is interested in buying a five-year bond that pays a coupon
of 10 percent on a semiannual basis. The current market rate for similar bonds is 8.8
percent. What should be the current price of this bond? (Round to the nearest dollar.)
A) $1,048
B) $965
C) $1,099
D) $982
Ans: A
Feedback:
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Frequency of payment = m = 2
Semiannual coupon = $1,000 x (0.10/2) = $50.00
66. Bond price: Giant Electronics is issuing 20-year bonds that will pay coupons
semiannually. The coupon rate on this bond is 7.8 percent. If the market rate for
such bonds is 7 percent, what will the bonds sell for today? (Round to the nearest
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dollar.)
A) $1,037
B) $1,085
C) $861
D) $923
Ans: B
Feedback:
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67. Bond price: Jane Thorpe has been offered a seven-year bond issued by Barone, Inc.,
at a price of 943.22. The bond has a coupon rate of 9 percent and pays the coupon
semiannually. Similar bonds in the market will yield 10 percent today. Should she buy
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the bonds at the offered price? (Round to the nearest dollar.)
A) Yes, the bond is worth more at $1,015.
B) No, the bond is only worth $921.
C) Yes, the bond is worth more at $951.
D) No, the bond is only worth $912.
Ans: C
Feedback:
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68. Bond price: Kevin Oh is planning to sell a bond that he owns. This bond has four
years to maturity and pays a coupon of 10 percent on a semiannual basis. Similar
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bonds in the current market will yield 12 percent. What will be the price that he
will get for his bond? (Round to the nearest dollar.)
A) $1,044
B) $938
C) $970
D) $1,102
Ans: B
Feedback:
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69. Bond price: Jeremy Kohn is planning to invest in a 10-year bond that pays a 12
percent coupon. The current market rate for similar bonds is 9 percent. Assume
semiannual coupon payments. What is the maximum price that should be paid for
this bond? (Round to the nearest dollar.)
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A) $951
B) $882
C) $1,033
D) $1,195
Ans: D
Feedback:
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70. Zero coupon bonds: Shana Norris wants to buy five-year zero coupon bonds
with a face value if $1,000. Her opportunity cost is 8.5 percent. Assuming annual
compounding, what would be the current market price of these bonds? (Round to
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A) $1,023
B) $665
C) $890
D) $1,113
Ans: B
Feedback:
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71. Zero coupon bonds: 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
Ans: C
Feedback:
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Years to maturity = n = 10; Coupon rate = C = 0%
72. Zero coupon bonds: Robertsons, Inc., is planning to expand ita specialty stores into
five other states and finance the expansion by issuing 15-year zero coupon bonds with
a face value of $1,000. If your opportunity cost is 8 percent and similar coupon-
bearing bonds will pay semiannually, what will be the price at which you will be
willing to purchase these bonds? (Round to the nearest dollar.)
A) $308
B) $383
C) $803
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D) $866
Ans: A
Feedback:
73. Zero coupon bonds: Jarmine Corp. is planning to fund a project by issuing 10-year
zero coupon bonds with a face value of $1,000. Assuming semiannual coupons to be
the norm, what will be the price of these bonds if the appropriate discount rate is 14
percent? (Round to the closest answer.)
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A) $852
B) $258
C) $419
D) $841
Ans: B
Feedback:
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74. Yield to maturity: Jenny LePlaz is looking to invest in some five-year bonds
that pay annual coupons of 6.25 percent and are currently selling at $912.34.
What is the current market yield on such bonds? (Round to the closest answer.)
A) 9.5%
B) 8.5%
C) 6.5%
D) 7.5%
Ans: B
Feedback:
Annual coupon = $1,000 x (0.0625) = $62.50
Yield to maturity = i
Present value of bond = PB = $912.34
Use the trial-and-error approach to solve for YTM. Since the bond is selling at a
discount, we know that the yield to maturity is higher than the coupon rate. Try
YTM = 8%:
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Try a higher rate, say YTM = 8.5%:
The YTM is approximately 8.5 percent. Using a financial calculator provided an

exact YTM of 8.47 percent.
Enter 5 $62.50 -$912.34 $1,000
75. Yield to maturity: Nathan Akpan is planning to invest in a seven-year bond that
pays annual coupons at a rate of 7 percent. It is currently selling at $927.23.
What is the current market yield on such bonds? (Round to the closest answer.)
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A) 10.4%
B) 9.5%
C) 8.4%
D) 7.5%
Ans: C
Feedback:
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Annual coupon = $1,000 x (0.07) = $70
YTM = 8%:
Try a lower rate, say YTM = 8.4%:

Enter 7 $70 –$927.23 $1,000
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76. Yield to maturity: Jane Almeda is interested in a 10-year bond issued by

Roberts Corp. that pays a coupon of 10 percent annually. The current price of this
bond is $1,174.45. What is the yield that Jane would earn by buying it at this
price and holding it to maturity? (Round to the closest answer.)
A) 7%
B) 7.5%
C) 8%
D) 8.5%
Ans: B
Feedback:
Annual coupon = $1,000 x (0.10) = $100
Present value of bond = PB = $1,174.45
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premium, we know that the yield to maturity is lower than the coupon rate. Try
YTM = 8%:

Enter 10 $100 -$1,174.45 $1,000
77. Yield to maturity: Shawna Carter wants to invest her recent bonus in a four-year
bond that pays a coupon of 11 percent semiannually. The bonds are selling at
$962.13 today. If she buys this bond and holds it to maturity, what would be her
yield? (Round to the closest answer.)
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A) 11.5%
B) 11.8%
C) 12.5%
D) 12.2%
Ans: D
Feedback:
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Semiannual coupon = $1,000 x (0.011/2) = $55
YTM = 12%:

exact YTM of 12.22 percent (2 x 6.11%).
Enter 8 $55 - $962.13 $1,000
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78. Yield to maturity: Alice Trang is planning to buy a six-year bond that pays a
coupon of 10 percent semiannually. Given the current price of $878.21, what is the
yield to maturity on these bonds?
A) 11%
B) 12%
C) 13%
D) 14%
Ans: C
Feedback:
YTM = 12%:
Try a higher rate, say YTM = 13%:
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The YTM is approximately 13 percent. Using a financial calculator provided an
Enter 12 $50 - $878.21 $1,000
79. Yield to maturity: John Wong purchased a five-year bond today at $1,034.66. The
bond pays 6.5 percent semiannually. What will be his yield to maturity?
A) 6.7%
B) 6.2%
C) 5.9%
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D) 5.7%
Ans: D
Feedback:
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Present value of bond = PB = $1,034.66
premium, we know that the yield to maturity is lower than the coupon rate. Try YTM
= 6%:

Enter 10 $32.50 - $1,034.66 $1,000
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80. Yield to maturity: Huan Zhang bought a 10-year bond that pays 8.25 percent
semiannually for $911.10. What is the yield to maturity on this bond?
A) 7.6%
B) 8.6%
C) 9.6%
D) 10.6%
Ans: C
Feedback:
YTM = 9.4%:

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exact YTM of 9.656percent (2 x 4.828%).
Enter 20 $41.25 - $911.10 $1,000
81. Realized yield: Five years ago, Shirley Harper bought a 10-year bond that pays 8
percent semiannually for $981.10. Today, she sold it for $1,067.22. What is the
realized yield on her investment? (Round to the nearest percent.)
A) 7%
B) 8%
C) 9%
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D) 10%
Ans: D
Feedback:
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Purchase price of bond = $981.10
Years investment held = n = 5
Annual coupon = $1,000 x (0.08/2) = $40
Realized Yield = i
Selling price of bond = PB = $1,067.22
To compute the realized return, either the trial-and-error approach or the

financial calculator can be used. Since the price has increased, market rates must
have decreased. So, the realized return is going to be greater than the bond's
coupon. Try rates higher than the coupon rate.
Try i = 10%, or i/2 = 5%:
Try a lower rate, i = 9.6% or i/2 = 4.8%:
The realized rate of return is approximately 9.6 percent. Using a financial

calculator provided an exact yield of 9.56 percent.
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82. Realized yield: 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%
Ans: A
Feedback:
Purchase price of bond = $921.77
Annual coupon = $1,000 x (0.015/2) = $75.00
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Realized Yield = i
Selling price of bond = PB = $961.92

Try i = 17%, or i/2 = 8.5%:
Try a lower rate, i = 16.6% or i/2 = 8.3%:

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83. Realized yield: Jorge Cabrera paid $980 for a 15-year bond 10 years ago. The
bond pays a coupon of 10 percent semiannually. Today, the bond is priced at
$1,054.36. If he sold the bond today, what would be his realized yield? (Round to
A) 12%
B) 8%
C) 11%
D) 9%
Ans: C
Feedback:
Purchase price of bond = $980
Annual coupon = $1,000 x (0.010/2) = $50.00
Realized Yield = i
Selling price of bond = PB = $1,054.36

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Try i = 10.5%, or i/2 = 5.25%:
Try a higher rate, i = 10.7% or i/2 = 5.35%:

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84. Effective annual yield: Suppose an investor earned a semiannual yield of 6.4
percent on a bond paying coupons twice a year. What is the effective annual
yield (EAY) on this investment?
A) 12.80%
B) 6.40%
C) 6.50%
Ans: C
Feedback:
Semiannual yield = 6.4%
The effective annual yield can be computed as:
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85. Effective annual yield: 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%
Ans: B
Feedback:
Annual yield = 6.81%
The effective annual yield can be computed as:
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86. Which of the following statements is true about convertible bonds?
A) The most significant disadvantage to a corporation of issuing convertible

bonds is that they increase the cash that the firm must use to make interest
payments.
B) The typical conversion ratio is set so that the firm’s stock price must
appreciate 5% or less before it is profitable for the holder to convert the
bond to stock.
C) Firms that issue convertible bonds can do so at a lower interest rate.
D) The typical issue of convertible bonds allows the holder of the bond to
convert it to preferred stock.
Ans: C
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87. Which of the following statements is most true about zero coupon bonds?
A) They typically sell at a premium over par when they are first issued.
B) They typically sell for a higher price than similar coupon bonds.
C) They are always convertible to common stock.
D) They typically sell at a deep discount below par when they are first
issued.
Ans: D
A) For a given change in market interest rates, the prices of higher-coupon

bonds change more that the prices of lower-coupon bonds.
B) If market interest rates rise, a 1-year bond will fall in value more than a
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10-year bond.
C) If interest rates rise, bond prices will rise.
D) If market interest rates rise, a 10-year bond will fall in value more than a
1-year bond.
Ans: D
A) Investment grade bonds are those rated single B and higher.
B) Federal laws typically allow insurance companies and pension funds to

purchase non-investment grade bonds.
C) Because investors are risk averse, they require a premium to purchase a

security that exposes them to default risk.
D) All else equal, the higher a bond’s rating the higher the coupon rate.
Ans: C
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A) Downward sloping yield curves typically appear in the early to mid-

period of a business expansion.
B) Interest rate risk always provides an upward bias to the slope of the yield
curve.
C) If investors believe that inflation will be increasing in the near future, the
yield curve will be downward sloping.
D) Downward or inverted yield curves are the type most commonly

observed.
Ans: B
1. The largest holders of equity securities are
a. mutual funds.
b. pension funds.
c. foreign investors.
d. households.
Ans: d
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2. Which ONE of the following statements is true about secondary markets?
a. In secondary markets, outstanding shares of stock are bought and sold among
investors.
b. For an investor, the function of secondary markets is to provide profitability for
the shares of securities they own.
c. An active secondary market causes firms to sell their new debt or equity issues at
a higher cost of funds.
d. All of the above are true statements
Ans: a

3. 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.
Ans: b

4. Which one of the following statements is NOT true about secondary markets?
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, the
NASDAQ is larger than the NYSE.
c. Firms listed on the NYSE tend to be, on average, larger in size and their shares
trade more frequently than firms whose securities trade on NASDAQ.
d. In the United States, most secondary market transactions are done on one of the
many stock exchanges.
Ans: a
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5. In comparison to the NYSE,
a. NASDAQ has less companies listed.

b. total share volume is lower on the NASDAQ.
c. firms listed on the NASDAQ tend to be smaller.
d. NASDAQ firms exceed NYSE listed firms in total capitalization.
Ans: c

6. 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.
Ans: c

7. The least efficient of all the different types of secondary markets is the
a. auction market.
b. direct search market.
c. dealer market.
d. broker market.
Ans: b

8. Which one of the following statements is NOT true about broker markets?
a. Brokers bring buyers and sellers together to earn a fee, called a commission.
b. Brokers’ extensive contacts provide them with a pool of price information that
individual investors could not economically duplicate themselves.
c. Investors have an incentive to hire a broker because they charge a commission
that is less than the cost of direct search.
d. Brokers can guarantee an order because they have an inventory of securities.
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Ans: d

9. In brokered markets
a. the commission charged by brokers is a lower cost to buyers and sellers than the
cost of direct search.
b. buyers and sellers are brought together for a transaction fee.
c. brokers build a pool of price information through their extensive contacts.
d. All of the above are true of broker markets.
Ans: d

10. Which ONE of the following statements is true about dealer markets?
a. NYSE is the best-known example of a dealer market.

b. A dealer market involves time-consuming search for a fair deal.
c. The advantage of a dealer over a brokered market is that brokers cannot guarantee
that an order will be executed promptly, while dealers can because they have an
inventory of securities.
d. All of the above are true of dealer markets.
Ans: c

11. Dealer markets are characterized by
a. no time-consuming search for a fair deal.

b. a guarantee of order fulfillment because the dealer holds an inventory of
securities.
c. improved market efficiency because dealers provide continuous bid and ask prices
for securities.
d. All of the above characterize dealer markets.
Ans: d

12. Which one of the following statements is NOT true about auction markets?
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a. In an auction market, buyers and sellers face each other directly and bargain over
price.
b. The NASDAQ is the most efficient stockmarket in the United States.
c. The New York Stock Exchange is the best-known example of an auction market.
d. The auctioneer in this case is the specialist, who is designated by the exchange to
represent orders placed by public customers.
Ans: b

13. Which one of the following statements is NOT true about common stock?
a. Common-stock holders have the right to vote on the selection of the board of
directors for the firm.
b. Common stock is considered to have no fixed maturity.
c. Owners of common stock are guaranteed dividend payments by the firm.
d. Common-stock holders have limited liability.
Ans: c

14. Which ONE of the following statements is true about common stock?
a. Common stock is considered to have a fixed maturity.

b. Owners of common stock are guaranteed dividend payment by the firm.
c. Owners of common stock have the lowest-priority claim on the firm’s assets in
the event of bankruptcy.
d. Common-stock holders have unlimited liability.
Ans: c

15. Which one of the following statements is NOT true about preferred stock?
a. Preferred stock represents ownership in the firm.

b. Owners of preferred stock are not guaranteed dividend payments by the firm.
c. Preferred stock dividends are fixed financial amounts paid regularly by the firm
just like bond coupon payments.
d. Preferred stock holders have limited voting privileges relative to common-stock
owners.
Ans: b
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16. Which ONE of the following statements is NOT true about preferred stock?
a. Preferred dividend payments are fixed amounts paid regularly by the firm,
similar to the interest payments on corporate bonds.
b. Preferred dividends are deductable from taxable income just like the interest on
bonds.
c. Preferred stock holders have limited voting privileges relative to common-stock
owners.
d. While preferred stock is legally classified as perpetuities, some issues do have a
fixed maturity.
Ans: b

17. Owners of preferred stock
a. have limited voting rights.

b. usually receive fixed dividend payments.
c. are given priority treatment over common stock with respect to dividends
payments and the claims against the firm’s assets in the event of bankruptcy or
liquidation.
d. All of the above statements are true.
Ans: d

18. Preferred stock is sometimes regarded like a debt security because
a. legally preferred stock is a debt security.

b. preferred dividend payments like bond interest payments are fixed amounts
regardless of the firm’s earnings.
c. preferred dividends are deductable from taxable income just like interest
payments on bonds.
d. preferred stock holders receive a residual value and not a stated value.
Ans: b

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19. Applying the valuation procedure to common stocks is more difficult than
applying it to bonds because
a. the size and timing of the dividend cash flows are less certain than the coupon
payments for bonds.
b. common stocks have no final maturity date.
c. unlike the rate of return, or yield, on bonds, the rate of return on common stock is
not directly observable.
d. All of the above are true.
Ans: d

20. Which one of the following statements is NOT true about the general dividend
valuation model?
a. The model does not assume any specific pattern for dividend growth.
b. It makes a specific assumption about when the stock is going to be sold in the
future.
c. The model calls for forecasting an infinite number of dividends for a stock.
d. All of the above are true.
Ans: b

21. 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.
Ans: b

22. The three simplifying assumptions that cover most stock growth patterns are
a. dividends that stay constant over time, dividends that grow at a constant rate,
and dividends that are equal to zero.
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b. dividends that have a zero-growth rate, dividends that grow at a varying rate, and
dividends that are equal to zero.
c. dividends that stay constant over time, dividends that grow at a constant rate,
and dividends that have a mixed growth pattern.
Ans: c

23. Which one of the following statements is NOT true about zero-growth stocks?
a. Dividend stays constant over time.

b. The cash flow pattern resembles a perpetuity with a constant cash flow.
c. Dividend payment pattern shows constant growth over time.
d. There is no growth in dividends over time.
Ans: c

24. Which one of the following statements is NOT true about constant-growth
stocks?
a. Dividend stays constant over time.

b. Mature companies with a history of stable growth show this pattern.
c. Dividends grow at a constant rate each period forever.
d. Dividends that are to be paid out in the distant future have a very small present
value and add little to the stock’s price.
Ans: a

25. The constant-growth dividend model will provide invalid solutions when
a. the growth rate of the stock exceeds the required rate of return for the stock.
b. the growth rate of the stock is less than the required rate of return for the stock.
c. the growth rate of the stock is smaller than 10%.
Ans: a

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26. PV of dividends: 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
Ans: a
Feedback:
Expected dividends for Cortez, Inc., and their present value:
D2 = D1(1 + g) = $2.50(1 + 0.07) = $2.675
D3 = D2(1 + g) = $2.675(1.07) = $2.862
D4 = D3(1 + g) = $2.862(1.07) = $3.063
D5 = D4(1 + g) = $3.063(1.07) = $3.277
Present value of the dividends = PV(D1) + PV(D2) + PV(D3) + PV(D4) + PV(D5)

27. PV of dividends: Next year Jenkins Traders will pay a dividend of $3.00. It
expects to increase its dividend by $0.25 in each of the following three years. If their
required rate of return is 14 percent, what is the present value of their dividends over the
next four years?
a. $13.50
b. $9.72
c. $12.50
d. $11.63
Ans: b
Feedback:
Expected dividends for Jenkins Traders and their present value:

D1 = $3.00; D2 = $3.25; D3 = $3.50; D4 = $3.75
Present value of the dividends = PV(D1) + PV(D2) + PV(D3) + PV(D4)

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28. PV of dividends: 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
Ans: c
Feedback:
Expected dividends for Kleine Toymakers and their present value:

D0 = $2.00; D1 = D2 = D3 = $0
D4 = $4.00
D5 = D4(1 + g) = $4.00(1.10) = $4.40
D6 = D5(1 + g) = $4.40(1.10) = $4.84
Present value of the dividends = PV(D1) + PV(D2) +…………+ PV(D6)

29. PV of dividends: Givens, Inc., is a fast growing technology company that paid a
$1.25 dividend last week. The company’s expected growth rates over the next four years
are as follows: 25 percent, 30 percent 35 percent, and 30 percent. The company then
expects to settle down to a constant-growth rate of 8 percent annually. If the required rate
of return is 12 percent, what is the present value of the dividends over the fast growth
phase?
a. $1.25
b. $6.46
c. $8.37
d. $7.23
Ans: d
Feedback:
Expected dividends for Givens, Inc., and their present value:

D0 = $1.25
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D1 = D0(1 + g) = $1.25(1.25) = $1.563
D2 = D1(1 + g) = $1.563(1.30) = $2.031
D3 = D2(1 + g) = $2.031(1.35) = $2.742
D4 = D3(1 + g) = $2.742(1.30) = $3.565
Present value of the dividends = PV(D1) + PV(D2) + PV(D3) + PV(D4)

30. PV of dividends: Jacobs Suppliers has not paid out any dividend in the last three
years. It does not expect to pay dividends in the next two years either as it recovers from
an economic slowdown. Three years from now it expects to pay a dividend of $2.50 and
then $3.00 in the following two years. What is the present value of the dividends to be
received over the next five years if the discount rate is 15 percent?
a. $4.85
b. $5.37
c. $5.50
d. $6.14
Ans: a
Feedback:
Expected dividends for Jacobs Suppliers and their present value:

D0 = D1 = D2 = $0; D3 = $2.50; D4 = $3.00; D5 = $3.00
Present value of the dividends = PV(D1) + PV(D2) +…………+ PV(D5)

31. Zero growth: Xinhua Manufacturing Company has been generating stable
revenues but sees no growth in it for the foreseeable future. The company’s last dividend
was $3.25, and it is unlikely to change the amount paid out. If the required rate of return
is 12 percent, what is the stock worth today?
a. $39.00
b. $3.69
c. $27.08
d. $21.23
Ans: c
Feedback:
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D0 = $3.25; g = 0; R = 12%

32. Zero growth: Zephyr Electricals is a company with no growth potential. Its last
dividend was $4.50, and it expects no change in future dividends. What is the current
price of the company’s stock given a discount rate of 9 percent?
a. $40.50
b. $50.00
c. $45.00
d. $500.00
Ans: b
Feedback:
D0 = $4.50; g = 0; R = 9%

33. Zero growth: Metasteel Limited Co. has a stable sales track record but does not
expect to grow in the next several years. Its last annual dividend was $5.75. If the
required rate of return on similar investments is 18 percent, what is the current stock
price?
a. $103.50
b. $13.50
c. $39.30
d. $31.94
Ans: d
Feedback:
D0 = $5.75; g = 0; R = 18%

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34. Zero growth: 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
Ans: d
Feedback:
P0 = $46.88; g = 0; R = 16%

35. Zero growth: A communications company pays annual dividends of $8.50 with
no possibility of it changing in the next several years. If the firm’s stock is currently
selling at $60.71, what is the required rate of return? (Round to nearest whole number.)
a. 14%
b. 16%
c. 13%
d. 15%
Ans: a
Feedback:
P0 = $60.71; g = 0; D0 = $8.50

36. Constant growth: You are interested in investing in a company that expects to
grow steadily at an annual rate of 6 percent for the foreseeable future. The firm paid a
dividend of $2.30 last year. If your required rate of return is 10 percent, what is the most
you would be willing to pay for this stock? (Round to the nearest dollar.)
a. $58
b. $61
c. $23
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d. $24
Ans: b
Feedback:
D0 = $2.30; g = 6%; R = 10%

37. Constant growth: Johnson Corporation has just paid a dividend of $4.45. The
company has forecasted a growth rate of 8 percent for the next several years. If the
appropriate discount rate is 14 percent, what is the current price of this stock? (Round to
a. $74
b. $32
c. $80
d. $60
Ans: c
Feedback:
D0 = $4.45; g = 8%; R = 14%

38. Constant growth: Ryder Supplies has its stock currently selling at $63.25. The
company is expected to grow at a constant rate of 7 percent. If the appropriate discount
rate is 17 percent, what is the expected dividend, a year from now? CTTT
a. $4.43
b. $3.25
c. $10.75
d. $6.33
Ans: d
Feedback:
P0 = $63.25; g = 7%; R = 17%
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39. Constant growth: Prior, Inc., is expected to grow at a constant rate of 9 percent.
If the company’s next dividend is $2.75 and its current price is $37.35, what is the
required rate of return on this stock? (Round to the nearest percent.)
a. 13%
b. 16%
c. 20%
d. 21%
Ans: b
Feedback:
D1 = $2.75; P0 = $37.35; g = 9%

40. Constant growth: A company is growing at a constant rate of 8 percent. Last
week it paid a dividend of $3.00. If the required rate of return is 15 percent, what is the
price of the stock three years from now? Không biết
a. $58.31
b. $46.29
c. $51.02
d. $42.83
Ans: a
Feedback:
R = 15%; D0 = $3.00; g= 8%

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41. Preferred stock valuation: Ajax Company has issued perpetual preferred stock
with a par of $100 and a dividend of 5.5 percent. If the required rate of return is 7.75
percent, what is the stock’s current market price? CTTT
a. $12.90
b. $70.97
c. $53.27
d. $62.14
Ans: b
Feedback:
D = 5.5% ($100) = $5.50; R = 7.75%

42. Preferred stock valuation: 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? Không biết
a. $23.06
b. $65.88
c. $37.57
d. $43.25
Ans: b
Feedback:
Quarterly dividend = $1.40

Required rate of return = R = 8.5%

43. Preferred stock: The preferred stock of Acme International is selling currently at
$110.35. If your required rate of return is 9.75 percent, what is the dividend paid by this
stock?
a. $9.75
b. $11.32
c. $10.76
d. $8.53
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Ans: c
Feedback:
P0 = $110.35; R = 9.75%

44. Preferred stock: Each quarter, Transam, Inc., pays a dividend on its perpetual
preferred stock. Today, the stock is selling at $83.45. If the required rate of return for
such stocks is 10.5 percent, what is the quarterly dividend paid by this firm?
a. $8.76
b. $10.50
c. $2.19
d. $2.63
Ans: c
Feedback:
P0 = $83.45; R = 10.5%
Annual dividend = $8.76

Quarterly dividend = $8.76 /4 = $2.19

45. Preferred stock valuation: The Columbia Consumer Products Co. has issued
perpetual preferred stock with a $100 par value. The firm pays a quarterly dividend of
$2.60 on this stock. What is the current price of this preferred stock given a required rate
of return of 12.5 percent?
a. $47.25
b. $80.00
c. $20.80
d. $83.20
Ans: d
Feedback:
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Quarterly dividend = $2.60
Required rate of return = R = 12.5%
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46. Nonconstant growth: Starskeep, Inc., is a fast growing technology company. The
firm projects a rapid growth of 40 percent for the next two years and then a growth rate of
20 percent for the following two years. After that, the firm expects a constant-growth rate
of 8 percent. The firm expects to pay its first dividend of $1.25 a year from now. If your
required rate of return on such stocks is 20 percent, what is the current price of the stock?
CTTT
a. $15.63
b. $4.70
c. $30.30
d. $22.68
Ans: a
Feedback:
g1 = g2 = 40%, g3 = g4 = 20%, g = 8%, D1 = $1.25, R=

20%
D1 = $1.25, D2 = $1.25(1.40) = $1.75, D3 = $1.75(1.20) = $2.10
D4 = $2.10(1.20) = $2.52, D5 = 2.52(1.08) = $2.722

47. Nonconstant growth: 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
Ans: b
Feedback:
g1 = 30%; g2 = 25%, g4 = 20%, g = 7%, D0 = $2.00, R = 16%

D1 = $2.00(1.30) = $2.60, D2 = $2.60(1.25) = $3.25, D3 = $3.25(1.20) =
$3.90
D4 = $3.90(1.07) = $4.173;
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48. Nonconstant growth: Grant, Inc., is a fast growth stock and expects to grow at a
rate of 25 percent for the next four years. It then will settle to a constant-growth rate of 10
percent. The first dividend will be paid out in year 3 and will be equal to $5.00. If the
required rate of return is 18 percent, what is the current price of the stock?
a. $85.94
b. $97.19
c. $50.59
d. $65.68
Ans: c
Feedback:
g1-4 = 25%; g = 10%; D3 = $5.00; R = 18%

D4 = D3 (1.25) = $5.00(1.25) = $6.25; D5 = $6.25(1.10) =$6.875

49. Nonconstant growth: Stag Corp. will pay dividends of $4.75, $5.25, $5.75, and
$7 for the next four years. Thereafter, the company expects its growth rate to be at a
constant rate of 7 percent. If the required rate of return is 15 percent, what is the current
market price of the stock?
a. $69.41
b. $93.63
c. $57.54
d. $80.29
Ans: a
Feedback:
D1 = $4.75; D2 = $5.25; D3 = 5.75; D4 = $7; g = 7%; R = 15%
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50. Nonconstant growth: Lincoln, Inc. expects to pay no dividends for the next four
years. It has projected a growth rate of 35 percent for the next four years. After four
years, the firm will grow at a constant rate of 6 percent. Its first dividend to be paid in
year 5 will be worth $4.25. If your required rate of return is 20 percent, what is the stock
worth today?
a. $14.64
b. $32.18
c. $36.43
d. $21.82
Ans: a
Feedback:
gconstant = 6%; R = 20%; D5 = $4.25; D1 – D4 = 0

PV (D1)+PV(D2)+PV(D3)+PV(D4) = 0
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51. Which of the following is not a widely know stock market index?
A) The Dow Jones Industrial Average.
B) The OTQ Composite Index.
C) The New York Stock Exchange Index.
D) The Standard and Poor’s 500 Index.
Ans: B

A) Preferred stockholders are considered to be the true owners of public
corporations.
B) Dividends paid to preferred stockholders are not fixed.
C) Preferred stockholders do not typically have voting rights.
D) Preferred stock can never be converted to common stock.
Ans: C

53. One-Period Model: Assume that you are considering the purchase of a stock which
will pay dividends of $4.50 during the next year. Further assume that you will be able
to sell the stock for $85.00 one year from today and that your required rate of return is
15 percent. How much would you be willing to pay for the stock today? (Round off to
the nearest $0.01) không biết
A) $89.50
B) $65.37
C) $94.10
D) $77.82
Ans: D
Feedback:

54. Which of the following statements is true about the general dividend valuation model?
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A) It implies that the underlying value of a share of stock is determined by the
market’s expectations of the future dividends that the firm will generate.
B) It implies that the value of a firm’s common stock can be determined only if the
expected future dividends are infinite.
C) It implies that the value of a growth stock can be determined by forecasting the
future price of the stock.
D) The model cannot be used to calculate the value of a common stock unless the
dividends exceed the firm’s expected growth rate.
Ans: A

55. Which of the following is the most typical example of a zero-growth dividend stock?
A) The common stock of a firm in the biotechnology industry.
B) The preferred stock of a utility company.
C) The stock of a firm in the health care industry.
D) The stock of a firm in the information technology industry.
Ans: B

56. The constant growth dividend model would be useful to determine the value of all but
which of the following firms?
A) A firm whose earnings and dividends are declining at a fairly steady rate.
B) A firm whose sales, profits, and dividends are growing at an annual average
compound rate of 5 percent.
C) A firm whose earnings and dividends are growing at a fairly steady rate.
D) A firm whose expected sales, profits, and dividends are flat.
Ans: D
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57. Supernormal growth: Suppose a firm’s expected dividends for the next three years are
as follows: D1 = $1.10, D2 = $1.20, and D3 = $1.30. After three years, the firm’s
dividends are expected to grow at 5.00 percent per year. What is should the current
price of the firm’s stock (P0) be today if investors require a rate of return of 12.00
percent on the stock? (Round off to the nearest $0.01) không biết
A) $61.30
B) $10.10
C) $16.74
D) $24.12
Ans: C
Feedback:

A) In order for the constant growth dividend model to properly value a firm’s
common stock, R must be greater than g.
B) From a practical perspective, the growth rate in the constant growth dividend
model must be greater than the sum of the long-term rate of inflation and the
long-term real growth rate of the economy.
C) In order for the constant growth dividend model to properly value a firm’s
common stock, g must be greater than R.
D) The constant growth dividend model can be used effectively to value the
common shares of a mixed growth stock.
Ans: A
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59. Which of the following statements about preferred stock is false?
A) Preferred stock has a higher-priority claim on the firm’s assets than common
stock.
B) Failure to pay dividends will result in default.
C) Preferred stock has a lower-priority claim on the firm’s assets than the firm’s
creditors in the event of default.
D) Preferred stock typically pays a fixed dividend.
Ans: B

60. Preferred Stock Yield-to-Maturity: 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%
Ans: A
Feedback:
N = 20 × 4 = 80
PV = -$68.00
PMT = $ 1.10
FV = $75.00
Solve for I% = 1.68% × 4 = 6.72%
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31. Which of the following is NOT true about capital budgeting.
A) It involves identifying projects that will add to the firm's value.
B) It involves large capital investments.
C) The large capital investments can be reversed at any time.
D) It allows the firm's management to analyze potential business opportunities and
decide on which ones to undertake.
Ans: C

32. Which of the following are aspects of independent projects?
A) Their cash flows are related.
B) Their cash flows are unrelated.
C) Selecting one would automatically eliminate accepting the other.
Ans: B

33. Two projects are considered to be independent if
A) selecting one would have no bearing on accepting the other.
B) their cash flows are unrelated.
C) Both a and b.
Ans: C

34. Two projects are considered to be mutually exclusive if
A) the projects perform the same function.
B) selecting one would automatically eliminate accepting the other.
C) Both a and b.
Ans: C
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35. Two projects are considered to be contingent projects if
A) selecting one would automatically eliminate accepting the other.
B) the acceptance of one project is dependent on the acceptance of the other.
C) rejection of one project does not eliminate the selection of the other.
Ans: B

36. Contingent projects would imply that
A) the acceptance of one project is dependent on the acceptance of the other.
B) the projects can be either mandatory or optional.
C) Both a and b.
Ans: C
Use the following to answer questions 37-38:
A construction firm is evaluating two value-adding projects. The first project deals with building
access roads to a new terminal at the local airport. The second project is to build a parking
garage on a piece of land that the firm owns adjacent to the airport.
Reference: Ref 10-1

37. The firm's decision will be to
A) accept both projects because they are independent projects.
B) accept both projects because they are contingent projects.
C) pick the one that adds the most value because they are mutually exclusive
projects.
D) pick neither project.
Ans: A
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Reference: Ref 10-1
38. If both projects are positive-NPV projects, then the firm should
A) accept both projects because they are independent projects.
B) select the higher NPV project because they are mutually exclusive.
C) accept both projects because they are contingent projects.
D) Not enough information is given to make a decision.
Ans: A

39. The cost of capital is
A) the minimum return that a capital budgeting project must earn for it to be
accepted.
B) the maximum return a project can earn.
C) the return that a previous project for the firm had earned.
Ans: A

40. Capital rationing implies that
A) the firm does not have enough resources to fund all of the available projects.
B) funding needs equal funding resources.
C) the available capital will be allocated equally to all available projects.
Ans: A
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41. Capital rationing implies that
A) funding resources exceed funding needs.
B) funding needs exceed funding resources.
C) funding needs equal funding resources.
Ans: B

A) Accepting a positive-NPV project increases shareholder wealth.
B) Accepting a negative-NPV project has no impact on shareholder wealth.
C) Accepting a negative-NPV project decreases shareholder wealth.
D) Managers are indifferent about accepting or rejecting a zero NPV project.
Ans: B

A) Accepting a positive-NPV project increases shareholder wealth.
B) Accepting a negative-NPV project decreases shareholder wealth.
C) Accepting a zero NPV project has a negative impact on shareholder wealth.
D) Managers are indifferent about accepting or rejecting a zero NPV project.
Ans: C
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44. In computing the NPV of a capital budgeting project, one should NOT
A) estimate the cost of the project.
B) discount the future cash flows over the project's expected life.
C) ignore the salvage value.
D) make a decision based on the project's NPV.
Ans: C

45. The net present value
A) uses the discounted cash flow valuation technique.
B) will provide a direct measure of how much the firm value will change because of
the capital project.
C) is consistent with shareholder wealth maximization goal.
Ans: D

46. To accept a capital project when using NPV,
A) the project NPV should be less than zero.
B) the project NPV should be greater than zero.
C) both a and b.
Ans: B
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47. Which ONE of the following statements about the payback method is true?
A) The payback method is consistent with the goal of shareholder wealth
maximization
B) The payback method represents the number of years it takes a project to recover
its initial investment plus a required rate of return.
C) There is no economic rational that links the payback method to shareholder
wealth maximization.
D) None of the above statements are true.
Ans: C

48. Which one of the following statements about the discounted payback method is NOT
true?
A) The discounted payback method represents the number of years it takes a project
to recover its initial investment.
B) The discounted payback method calls for the project to be accepted if the
payback period is greater than a target period.
C) The discount payback method is a risk indicator.
D) The expected cash flows from the project are discounted at the cost of capital.
Ans: B

49. Advantages of the payback method include the following.
A) The technique is simple for managers to compute and interpret.
B) It is a good measure of liquidity risk.
C) Both a and b,
Ans: C
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50. Disadvantages of the payback method include the following.
A) It ignores the time value of money.
B) It is inconsistent with the goal of maximizing shareholder wealth.
C) It ignores cash flows beyond the payback period.
Ans: D

51. Which one of the following statements about IRR is NOT true?
A) The IRR is the discount rate that makes the NPV greater than zero.
B) The IRR is a discounted cash flow method.
C) The IRR is an expected rate of return.
Ans: A

52. The internal rate of return is
A) the discount rate that makes the NPV greater than zero.
B) the discount rate that makes the NPV equal to zero.
C) the discount rate that makes the NPV less than zero.
D) both a and c.
Ans: B
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53. When evaluating capital projects, the decisions using the NPV method and the IRR
method will agree if
A) the projects are independent.
B) the cash flow pattern is conventional.
C) the projects are mutually exclusive.
D) both a and b.
Ans: D

54. In evaluating capital projects, the decisions using the NPV method and the IRR method
may disagree if
A) the projects are independent.
B) the cash flows pattern is unconventional.
C) the projects are mutually exclusive.
D) both b and c.
Ans: D

55. Which one of the following cash flow patterns is NOT an unconventional cash flow
pattern?
A) A positive initial cash flow is followed by negative future cash flows.
B) Future cash flows from a project could include both positive and negative cash
flows.
C) A negative initial cash flow is followed by positive future cash flows.
D) A cash flow stream looks similar to a conventional cash flow stream except for a
final negative cash flow.
Ans: C
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56. Net present value: The Cyclone Golf Resorts is redoing its golf course at a cost of
$2,744,320. It expects to generate cash flows of $1, 223,445, $2,007,812, and
$3,147,890 over the next three years. If the appropriate discount rate for the firm is 13
percent, what is the NPV of this project?
A) $7,581,072
B) $2,092,432
C) $4,836,752
D) $3,112,459
Ans: B
Feedback:
Initial investment = $2,744,320
Length of project = n = 3 years
Required rate of return = k = 13%
Net present value = NPV

57. Net present value: Johnson Entertainment Systems is setting up to manufacture a new
line of video game consoles. The cost of the manufacturing equipment is $1,750,000.
Expected cash flows over the next four years are $725,000, $850,000, $1,200,000, and
$1,500,000. Given the company's required rate of return of 15 percent, what is the NPV
of this project?
A) $1,169,806
B) $2,919,806
C) $4,669,806
D) $3,122, 607
Ans: A
Feedback:
Initial investment = 1,750,000
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58. Net present value: Cortez Art Gallery is adding to its existing buildings at a cost of $2
million. The gallery expects to bring in additional cash flows of $520,000, $700,000,
and $1,000,000 over the next three years. Given a required rate of return of 10 percent,
what is the NPV of this project?
A) $1,802,554
B) $197,446
C) -$1,802,554
D) -$197,446
Ans: D
Feedback:

59. Net present value: Gao Enterprises plans to build a new plant at a cost of $3,250,000.
The plant is expected to generate annual cash flows of $1,225,000 for the next five
years. If the firm's required rate of return is 18 percent, what is the NPV of this project?
A) $2,875,000
B) $3,830,785
C) $580,785
D) $2,1225,875
Ans: C
Feedback:
Annual cash flows = $1,225,000
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60. Net present value: Jenkins Corporation is investing in a new piece of equipment at a
cost of $6 million. The project is expected to generate annual cash flows of $1,850,000
over the next six years. The firm's cost of capital is 20 percent. What is the project's
NPV?
A) $722,604
B) $351,097
C) $152,194
D) $261,008
Ans: C
Feedback:
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61. Payback: Binder Corp. has invested in new machinery at a cost of $1,450,000. This
investment is expected to produce cash flows of $640,000, $715,250, $823,330, and
$907,125 over the next four years. What is the payback period for this project?
A) 2.12 years
B) 1.88 years
C) 4.00 years
D) 3.00 years.
Ans: A
Feedback:
Binder Corp.
Year CF Cumulative CF
0 $(1,450,000) $(1,450,000)
1 640,000 (810,000)
2 715,250 (94,750)
3 823,330 728,580
4 907,125 1,635,705
PB = Years before cost recovery + (Remaining cost to recover/ Cash flow during the
year
= 2 + ($94,750 / $823,330)
= 2.12 years
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62. Payback: Elmer Sporting Goods is getting ready to produce a new line of golf clubs by
investing $1.85 million. The investment will result in additional cash flows of
$525,000, $812,500, and 1,200,000 over the next three years. What is the payback
period for this project?
A) 3 years
B) 2.43 years
C) 1.57 years
D) More than 3 years
Ans: B
Feedback:
Elmer Sporting Goods

0 $(1,850,000) $(1,850,000)
1 525,000 (1,325,000)
2 812,500 (512,500)
3 1,200,000 687,500
year
= 2 + ($512,500 / $1,200,000)
= 2.43 years
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63. Payback: Creighton, Inc., has invested $2,165,800 on equipment. The firm uses
payback period criteria of not accepting any project that takes more than four years to
recover costs. The company anticipates cash flows of $424,386, $512,178, $561,755,
$764,997, $816,500, and $825,375 over the next six years. What is the payback period,
and does this investment meet the firm's payback criteria?
A) 4.13 years; no
B) 4.13 years; yes
C) 3.87 years; yes
D) 3.87 years; no
Ans: C
Feedback:
Creighton Inc.
0 $(2,165,800) $(2,165,800)
1 424,386 (1,741,414)
2 512,178 (1,229,236)
3 561,755 (667,481)
4 764,997 97,516
5 816,500 914,016
6 825,375 1,739,391
year
= 3 + ($667,481 / $764,997)
= 3.87 years
Since the payback period of 3.87 years is less than the decision criteria of 4 years, this
project should be accepted.
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64. Payback: Kathleen Dancewear Co. has bought some new machinery at a cost of
$1,250,000. The impact of the new machinery will be felt in the additional annual cash
flows of $375,000 over the next five years. What is the payback period for this project?
If their acceptance period is three years, will this project be accepted?
A) 2.67 years; yes
B) 2.67 years; no
C) 3.33 years; yes
D) 3.33 years; no
Ans: D
Feedback:
Kathleen Dancewear Inc.

0 $(1,250,000) $(1,250,000)
1 375,000 (875,000)
2 375,000 (500,000)
3 375,000 (125,000)
4 375,000 250,000
5 375,000 625,000
year
= 3 + ($125,000 / $375,000)
= 3.33 years
Since the payback period of 3.33 years exceeds the decision criteria of 3 years, this
project should be rejected.
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65. Payback: Carmen Electronics bought new machinery for $5 million. This is expected
to result in additional cash flows of $1.2 million over the next seven years. What is the
payback period for this project? If their acceptance period is five years, will this project
be accepted?
A) 4.17 years; yes
B) 4.17 years; no
C) 3.83 years; yes
D) 3.83 years; no
Ans: A
Feedback:
Carmen Electronics
0 $(5,000,000) $(5,000,000)
1 1,200,000 (3,800,000)
2 1,200,000 (2,600,000)
3 1,200,000 (1,400,000)
4 1,200,000 (200,000)
5 1,200,000 1,000,000
6 1,200,000 2,200,000
7 1,200,000 3,400,000
year
= 4 + ($200,000 / $1,200,000)
= 4.17 years
Since the payback period of 4.17 years is less than the decision criteria of 5 years, this
project should be accepted.
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66. Discounted payback: Roswell Energy Company is installing new equipment at a cost
of $10 million. Expected cash flows from this project over the next five years will be
$1,045,000, $2,550,000, $4,125,000, $6,326,750, and $7,000,000. The company's
discount rate for such projects is 14 percent. What is the project's discounted payback
period?
A) 4.2 years
B) 4.4 years
C) 4.8 years
D) 5.0 years
Ans: A
Feedback:
Roswell Energy
i = 14%
Cumulative PVCF
Year CF PVCF
0 $(10,000,000) $(10,000,000) $(10,000,000
1 1,045,000 916,667 (9,083,333)
2 2,550,000 1,962,142 (7,121,191)
3 4,125,000 2,784,258 (4,336,934)
4 6,326,750 3,745,944 (590,990)
5 7,000,000 3,635,581 3,044,591
year
= 4 + ($590,990/ $3,635,581)
= 4.16 years
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67. Discounted payback: Carmen Electronics bought new machinery for $5 million. This
is expected to result in additional cash flows of $1.2 million over the next seven years.
The firm's cost of capital is 12 percent. What is the discounted payback period for this
project? If the firm's acceptance period is five years, will this project be accepted?
A) 5.4 years; no
B) 6.1 years; no
C) 4.6 years; yes
D) 4.2 years; yes
Ans: B
Feedback:
Carmen Electronics
i = 12%
Cumulative PVCF
Year CF PVCF
0 $(5,000,000) $(5,000,000) $(5,000,000
1 1,200,000 1,071,429 (3,928,571)
2 1,200,000 956,633 (2,971,938)
3 1,200,000 854,136 (2,117,802)
4 1,200,000 762,622 (1,355,180)
5 1,200,000 680,912 (674,268)
6 1,200,000 607,957 (66,311)
7 1,200,000 542,819 476,508
year
= 6 + ($66,311 / $542,819)
= 6.12 years
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68. Discounted payback: Kathleen Dancewear Co. has bought some new machinery at a
cost of $1,250,000. The impact of the new machinery will be felt in the additional
annual cash flows of $375,000 over the next five years. The firm's cost of capital is 10
percent. What is the discounted payback period for this project? If their acceptance
period is three years, will this project be accepted?
A) 2.7 years; yes
B) 4.7 years; no
C) 2.3 years; yes
D) 4.3 years; no
Ans: D
Feedback:
Kathleen Dancewear Inc.

i = 10%
Cumulative PVCF
Year CF PVCF
0 $(1,250,000) $(1,250,000) $(1,250,000
1 375,000 340,909 (909,091)
2 375,000 309,917 (599,174)
3 375,000 281,743 (317,431)
4 375,000 256,130 (61,300)
5 375,000 232,845 171,545
year
= 4 + ($61,300 / $232,845)
= 4.26 years
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69. Accounting rate of return (ARR): LaGrange Corp. has forecasted that over the next
four years the average annual after-tax income will be $45,731. The average book value
of the manufacturing equipment that is used is $167,095. What is the accounting rate of
return?
A) 33.3%
B) 27.4%
C) 29.8%
D) 22.3%
Ans: B
Feedback:
Annual after-tax income = $45,731
Average after-tax income = ($45,731+$45,731 + $45,731+$45,731) / 4 = $45,731
Average book value of equipment = $167,095

70. Accounting rate of return (ARR): Stump Storage Co. is expecting to generate after-
tax income of $155,708, $159,312, and $161,112 for each of the next three years. The
equipment used will have an average book value of $251,575 over that period. What is
the ARR?
A) 65.7%
B) 69.4%
C) 63.1%
D) 66.8%
Ans: C
Feedback:
Average after-tax income = ($155,708+$159,312 +$161,112) / 3 = $158,711
Average book value of equipment = $215,575
1-379
71. Internal rate of return: Quick Sale Real Estate Company is planning to invest in a
new development. The cost of the project will be $23 million and is expected to
generate cash flows of $14,000,000, $11,750,000, and $6,350,000 over the next three
years. The company's cost of capital is 20 percent. What is the internal rate of return on
this project? (Round to the nearest percent.)
A) 22%
B) 20%
C) 24%
D) 28%
Ans: A
Feedback:
To determine the IRR, the trial-and-error approach can be used. Set NPV = 0.
Try IRR = 21.6%.
The IRR of the project is 21.6 percent. Using a financial calculator, we find that the
IRR is 21.572 percent.
1-380
72. Internal rate of return: Modern Federal Bank is setting up a brand new branch. The
cost of the project will be $1.2 million. The branch will create additional cash flows of
$235,000, $412,300, $665,000 and $875,000 over the next four years. The firm's cost of
capital is 12 percent. What is the internal rate of return on this branch expansion?
(Round to the nearest percent.)
A) 20%
B) 23%
C) 25%
D) 27%
Ans: B
Feedback:
Try IRR =23.1%.
1-381
73. Internal rate of return: Signet Pipeline Co. is looking to install new equipment that
will cost $2,750,000. The cash flows expected from the project are $612,335, $891,005,
$1,132,000, and $1,412,500 for the next four years. What is Signet's internal rate of
return? (Round to the nearest percent.)
A) 11%
B) 13%
C) 15%
D) 17%
Ans: C
Feedback:
Try IRR =15.1%.
1-382
74. Internal rate of return: Casa Del Sol Property Development Company is refurbishing
a 200-unit condominium complex at a cost of $1,875,000. It expects that this will lead
to expected annual cash flows of $415,350 for the next seven years. What internal rate
of return can the firm earn from this project? (Round to the nearest percent.)
A) 10%
B) 12%
C) 14%
D) 16%
Ans: B
Feedback:
Annual cash flows = $415,350
Length of investment = n = 7 years
Try IRR =12.3%.
1-383
75. Internal rate of return: Lowell Communications, Inc., has been installing a fiber-optic
network at a cost of $18 million. The firm expects annual cash flows of $3.7 million
over the next 10 years. What is this project's internal rate of return? (Round to the
nearest percent.)
A) 10%
B) 12%
C) 14%
D) 16%
Ans: D
Feedback:
Try IRR =15.8%.
Turnbull Corp. is in the process of constructing a new plant at a cost of $30 million. It expects
the project to generate cash flows of $13,000,000, $23,000,000, and 29,000,000 over the next
three years. The cost of capital is 20 percent.
1-384
Reference: Ref 10-2
76. Payback: What is the payback period for this project?
A) 1.7 years
B) 2.2 years
C) 1.2 years
D) 2.7 years
Ans: A
Feedback:
Turnbull Corp.
i = 20.00%
0 $(30,000,000) $(30,000,000)
1 13,000,000 (17,000,000)
2 23,000,000 6,000,000
3 29,000,000 35,000,000
year
= 1 + ($17,000,000 / $23,000,000)
= 1.74 years
1-385
Reference: Ref 10-2
77. Net present value: What is the net present value of this project? (Round to the nearest
million dollars.)
A) $10 million
B) $12 million
C) $14 million
D) $16 million
Ans: C
Feedback:
Reference: Ref 10-2

78. Internal rate of return: What is the internal rate of return that Turnbull can earn on
this project? (Round to the nearest percent.)
A) 41%
B) 42%
C) 43%
D) 44%
Ans: D
Feedback:
Since NPV > 0, try IRR > 20%. Try IRR = 43.6%.
1-386
Reference: Ref 10-2
79. Modified Internal rate of return: What is the MIRR on this project? (Round to the
nearest percent.)
A) 36%
B) 37%
C) 38%
D) 39%
Ans: A
Feedback:
PV of costs = $30,000,000
Cost of capital = k = 20%
Jamaica Corp. is adding a new assembly line at a cost of $8.5 million. The firm expects the
project to generate cash flows of $2 million, $3 million, $4 million, and $5 million over the next
four years. Its cost of capital is 16 percent.
1-387
Reference: Ref 10-3
A) 2.8 years
B) 2.9 years
C) 3.1 years
D) 3.4 years
Ans: B
Feedback:
Jamaica Inc.
i = 16.00%
0 $(8,500,000) $(8,500,000)
1 2,000,000 (6,500,000)
2 3,000,000 (3,500,000)
3 4,000,000 500,000
4 5,000,000 1,500,000
year
= 2 + ($3,500,000/ $4,000,000)
= 2.88 years
1-388
Reference: Ref 10-3
81. Net present value: What is the net present value of this project?
A) $645,366
B) $1,213,909
C) $905,888
D) $777,713
Ans: D
Feedback:
1-389
Reference: Ref 10-3
82. Internal rate of return: What is the internal rate of return that Jamaica can earn on this
project? (Round to the nearest percent.)
A) 18%
B) 19%
C) 20%
D) 21%
Ans: C
Feedback:
Reference: Ref 10-3

83. Modified internal rate of return: What is the MIRR on this project? (Round to the
nearest percent.)
A) 18%
B) 19%
C) 20%
D) 21%
Ans: B
Feedback:
Cost of capital = k = 16%
1-390
Strange Manufacturing Company is purchasing a production facility at a cost of $21 million. The
firm expects the project to generate annual cash flows of $7 million over the next five years. Its
cost of capital is 18 percent.
Reference: Ref 10-4

A) 2.8 years
B) 3.0 years
C) 3.2 years
D) 3.4 years
Ans: B
Feedback:
Strange Manufacturing
i = 18.00%
0 $(21,000,000) $(21,000,000)
1 7,000,000 (14,000,000)
2 7,000,000 (7,000,000)
3 7,000,000 --
4 7,000,000 7,000,000
5 7,000,000 14,000,000
year
= 3 + ($0 / $7,000,000)
= 3.0 years
1-391
Reference: Ref 10-4
85. Discounted payback: What is the discounted payback period for this project?
A) 3.9 years
B) 4.3 years
C) 4.7 years
D) 5.1 years
Ans: C
Feedback:
Strange Manufacturing
i = 18.00%
Cumulative PVCF
Year CF PVCF
0 $(21,000,000) $(21,000,000) $(21,000,000)
1 7,000,000 5,932,203 (15,067,797)
2 7,000,000 5,027,291 (10,040,506)
3 7,000,000 4,260,416 (5,780,090)
4 7,000,000 3,610,522 (2,169,568)
5 7,000,000 3,059,765 890,197
Discounted payback period = Years before Recovery + (Remaining Cost / Next Year's
CF)
= 4 + ($2,169,567/$3,059,765)
= 4.7 years
1-392
Reference: Ref 10-4
86. Net present value: What is the net present value of this project?
A) $890,197
B) $1,213,909
C) $905,888
D) $777,713
Ans: A
Feedback:
Reference: Ref 10-4

87. Internal rate of return: What is the internal rate of return on this project? (Round to
A) 17%
B) 18%
C) 19%
D) 20%
Ans: D
Feedback:
1-393
88. Which of the following is true about the Net Present Value method?
A) The NPV does not utilize time value of money concepts.
B) The NPV assumes that all cash flows are reinvested at the firm’s discount rate
(the firm’s cost of capital).
C) The NPV allows projects to be ranked by rate of return.
D) The NPV is a rate of return that is acceptable to the firm.
Ans: B
1-394
Level of Difficulty: Difficult
89. Crossover Point/Rate: Packard Electronics Corp. is evaluating the two mutually
exclusive projects shown below.
Boundless Corp. Project A Project B

Period Cash Flows Cash Flows
0 $ (100,000) $ (150,000)
1 50,000 15,000
2 40,000 30,000
3 30,000 50,000
4 20,000 70,000
5 10,000 80,000
What is the “crossover rate” of the two projects? (Round off to the nearest (0.01%)
A) 10.82%
B) 8.24%
C) 13.76%
D) 16.38%
Ans: A
Feedback:
Boundless Corp. Project A Project B Project A Project B Diff in CF's

Period Cash Flows Cash Flows WACC NPV NPV A vs. B
0 $ (100,000) $ (150,000) 0.0% 50,000 95,000 50,000
1 50,000 15,000 5.0% 34,105 54,960 35,000
2 40,000 30,000 10.0% 20,921 23,480 10,000
3 30,000 50,000 12.5% 15,155 10,249 (20,000)
4 20,000 70,000 15.0% 9,856 (1,600) (50,000)
5 10,000 80,000 17.5% 4,976 (12,240) (70,000)
IRR IRR IRR = 10.82%
20.27% 14.65%
1-395
90. Payback: You have been asked to analyze an investment project. The project’s cost is
$180,000. Cash inflows are projected to be: year 1 = $55,000, year 2 = $65,000; year 3
= $75,000; year 4 = $85,500; year 5 = $95,000.
What is the investment project’s payback? (Round off to the nearest (0.1 years)
A) 4.1 years
B) 1.6 years
C) 3.5 years
D) 2.8 years
Ans: D
Feedback:
Payback Method
Estimated Cumulative
Year Cash Flows Cash Flows Year
0 ($180,000) (180,000) 0
1 55,000 (125,000) 1
2 65,000 (60,000) 2
3 75,000 15,000 3
4 85,000 100,000 4
5 95,000 195,000 5
= 2.80 Years
31. The cash flows used in capital budgeting calculations are based on.
A) historical estimates.
B) forecasts of future cash revenues, expenses, and investment outlays.
C) forecasts of net income.
D) forecasts of retained earnings available for financing projects.
Ans: B
1-396
32. The NPV of a project is estimated by
A) discounting the expected cash flows of a project in the future.
B) discounting only the certain cash flows of a project in the future.
C) discounting the variance of the expected cash flows of a project in the future.
Ans: A

33. The ___________ is intended to reconcile changes in the balance sheet cash accounts.
A) capital budgeting cash flow calculation
B) accounting statement of cash flows
C) accounting statement of income
Ans: B

34. The term ___________ refers to the fact that these cash flows reflect the amount by
which the firm's total after-tax free cash flows will change if the project is adopted.
A) periodic
B) ending cash flows
C) incremental
Ans: C
1-397
35. _________ refers to the cash flow that a project is expected to generate after all
operating expenses and taxes have been paid.
A) Incremental cash flow from operations
B) Operating income
C) EBITDA
Ans: A

36. In order to calculate free cash flow by starting with incremental cash flow from
operations, we should
A) subtract the incremental capital expenditures and add the incremental additions to
working capital.
B) add the incremental capital expenditures and the incremental additions to
working capital.
C) subtract the incremental capital expenditures and the incremental additions to
working capital.
Ans: C

37. The idea that we can evaluate the cash flows from a project independently of the cash
flows for the firm is known as
A) the stand-alone principle.
B) the dependent principle.
C) the independent principle.
Ans: A
1-398
38. The firm's ____________ is used to calculate NOPAT because the profits from a
project are assumed to be incremental to the firm.
A) average tax rate
B) marginal tax rate
C) lowest marginal tax rate
Ans: B

39. Additions to tangible assets, intangible assets ,and current assets can be described as
A) cash flows associated with investments.
B) operating cash flows.
C) free cash flows.
Ans: A

40. The impact of a project on a firm's overall value depends on
A) a firm's accounting earnings.
B) a firm's cash flow.
C) a project's cash flow.
Ans: C
1-399
41. Which of the following should not be included in a project's cash flow calculations?
A) cash expenses
B) cash revenues
C) allocated expenses
Ans: C

42. Corporate overhead allocations should only be taken into account on project analysis if
A) the firm is currently covering all of its overhead allocations.
B) the firm is currently unable to cover all of its overhead allocations.
C) the overhead allocations involve cash expenditures.
Ans: D

43. Brown Mack, Inc., currently has two large manufacturing divisions that share a single
plant. Brown Mack owns the plant but has calculated that $6 million of overhead
expenses should be allocated to the two equal-sized divisions. If Brown Mack starts a
third manufacturing division, of equal size to the other two divisions, then what
overhead cost should the new division take into account on its capital budgeting cash
flow analysis?
A) $0
B) $2 million
C) $3 million
D) $6 million
Ans: A
1-400
44. A firm is considering taking a project that will produce $12 million of revenue per year.
Cash expenses will be $5 million, and depreciation expenses will be $1 million per
year. If the firm takes that project, then it will reduce the cash revenues of an existing
project by $2 million. What is the free cash flow on the project, per year, if the firm is
in the 40 percent marginal tax rate?
A) $2.4 million
B) $3.4 million
C) $4.6 million
D) $5.0 million
Ans: B
Feedback:
Revenue $12,000,000
Cash exp (5,000,000)
Deprec exp (1,000,000)
Lost revenue (2,000,000)
Pretax income $ 4,000,000
Less taxes 1,600,000
Net income $ 2,400,000
Deprec 1,000,000
Free Cash Flow/yr $ 3,400,000

45. Whenever a project has a negative impact on an existing project's cash flows, then that
effect should
A) be ignored.
B) be ignored if the project is evaluated using the correct cost of capital.
C) be included as a negative revenue amount on the new project's cash flow analysis.
D) be included if the impact is limited to noncash expenditures.
Ans: C
1-401
46. If a firm has the option of leasing some factory space to another firm or utilizing it for
another product line, then if the firm chose the product line how should it handle the
lost lease payments on the factory space?
A) Ignore it.
B) Include it as an opportunity cost.
C) Include half of it as additional revenue for the project.
Ans: B

47. Which of the following is the best example of a sunk cost?
A) Future payments on a leased building.
B) Future research and development costs.
C) Historical research and development costs.
D) Historical noncash expenses.
Ans: C

48. _____________ represent dollars stated in terms of constant purchasing power.
A) Nominal dollars
B) Real dollars
C) Inflated dollars
Ans: B
1-402
49. If inflation is anticipated to be 10 percent during the next year while a nominal rate of
20 percent will be earned on U.S. Treasury bills, then what is the accurate real rate of
return on these securities?
A) 20.00%
B) 10.00%
C) 9.09%
Ans: C
Feedback:
1 + k = (1 + ΔPe) x (1 + r)
1 + 0.2 = (1 + 0.1) x (1 + r)
1.0909 = 1 + r
0.0909 = r

50. If the real return on U.S. Treasury bills is 14 percent while the rate of expected inflation
is anticipated to be 8 percent, then what should nominal rate of return be?
A) 14.00%
B) 33.00%
C) 23.12%
D) all of the above
Ans: C
Feedback:
1 + k = (1 + ΔPe) x (1 + r)
1 + k = (1 + 0.08) x (1 + 0.14)
1 + k = 1.2312
k = 0.2312
1-403
51. If you are discounting a project's cash flows using the nominal cost of capital, then that
means that you have taken the following into account:
A) the real rate of return
B) the expected rate of inflation
C) both of the above
Ans: C

52. A tax system in which taxpayers pay a progressively larger share of their income in
taxes as their income rises is called
A) a flat tax system.
B) a progressive tax system.
C) a digressive tax system.
D) a political tax system.
Ans: B

53. For a U.S. corporation with income above $20 million,
A) the average tax rate is less than the marginal tax rate.
B) the average tax rate is equal to the marginal tax rate.
C) the average tax rate is greater than the marginal tax rate.
Ans: B
1-404
54. When compared to the straight-line depreciation method, MACRS has
A) a greater proportion of its depreciation early in the life of the asset.
B) a lesser proportion of its depreciation early in the life of the asset.
C) an equal proportion of its depreciation early in the life of the asset.
Ans: A

55. In order for a project to generate a positive net working capital cash flow at the
conclusion of a project,
A) the project must have generated a cumulative negative cash flow during the life
of the project.
B) the project must have generated a cumulative positive cash flow during the life of
the project.
C) the project must have generated a cumulative negative cash flow at the
conclusion of the project.
D) the project could not have generated a positive cash flow at the opening of the
project.
Ans: A

56. If you are deciding whether to take one project or another, where the projects have
different useful lives, then you could utilize
A) a repeated investment analysis to decide which project is better for the firm.
B) an equivalent annual annuity analysis to decide which project is better for the
firm.
C) either of the above.
Ans: C
1-405
57. Windy Burgers is trying to determine when to harvest a herd of cows that it currently
owns. If it harvests the herd in year 1, the NPV of the project would increase over an
immediate harvest by 25 percent. A year 2 harvest would create an NPV increase of 15
percent over that of year 1 and year 3 would create an NPV increase of 7 percent over
that of year 2. If the cost of capital is 12 percent for Windy, 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.
Ans: C

58. 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.
Ans: B
1-406
59. The proper time to harvest an asset is when
A) the percentage NPV increase of harvesting a project at a future point in time is at
the last date where the increase is greater than the cost of capital.
B) the percentage NPV increase of harvesting a project at a future point in time is at
the first date where the increase is less than the cost of capital.
C) the percentage NPV increase of harvesting a project at a future point in time is at
the first date where the increase is greater than the cost of capital.
Ans: A

60. Norman, Inc. is considering two mutually exclusive projects. Project A is a six-year
project with a NPV of $3,000 and Project B is a four-year project with an NPV of
$2,278. Project A has an equivalent annual cash flow of $730 and Project B has an
equivalent annual cash flow of $750. Which project should the firm select?
A) Choose Project A because it has the higher NPV.
B) Choose Project B because it has the lower NPV.
C) Choose Project B because it has the higher equivalent annual cash flow.
D) Choose Project A because it has the lower equivalent annual cash flow.
Ans: C
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.
1-407
Reference: Ref 11-1
61. Free cash flow: 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
Ans: C
Feedback:
Provo, Inc.
Revenue $10,000,000
- Operating Ex 5,000,000
EBITDA $ 5,000,000
- D&A 1,000,000
EBIT $ 4,000,000
x (1 – t) 60%
NOPAT $ 2,400,000
+ D&A 1,000,000
CF Opns $ 3,400,000
1-408
Reference: Ref 11-1
62. Free cash flow: 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
Ans: B
Feedback:
Provo, Inc.
Revenue $10,000,000
EBITDA $ 5,000,000
- D&A 1,000,000
EBIT $ 4,000,000
x (1 – t) 60%
NOPAT $ 2,400,000
+ D&A 1,000,000
CF Opns $ 3,400,000
- Cap Exp $500,000
- Add WC 300,000
FCF $ 2,600,000
1-409
Reference: Ref 11-1
63. Free cash flow: What is Provo's NOPAT for 2008?
A) $2,400,000
B) $2,600,000
C) $3,400,000
D) $4,000,000
Ans: A
Feedback:
Provo, Inc.
Revenue $10,000,000
EBITDA $ 5,000,000
- D&A 1,000,000
EBIT $ 4,000,000
x (1 – t) 60%
NOPAT $ 2,400,000
Reference: Ref 11-1

64. Free cash flow: What is Provo's cash flows associated with investments for 2008?
A) $300,000
B) $500,000
C) $800,000
Ans: C
Champagne, Inc., had revenues of $12 million, cash operating expenses of $8 million, and
depreciation and amortization of $1.5 million during 2008. The firm purchased $700,000 of
equipment during the year while increasing its inventory by $500,000 (with no corresponding
increase in current liabilities). The marginal tax rate for Champagne is 30 percent.
1-410
Reference: Ref 11-2
65. Free cash flow: What is Champagne's cash flow from operations for 2008?
A) $2,050,000
B) $2,500,000
C) $3,250,000
D) $4,000,000
Ans: C
Feedback:
Champagne, Inc.
Revenue $12,000,000
EBITDA $ 4,000,000
- D&A 1,500,000
EBIT $ 2,500,000
x (1 – t) 70%
NOPAT $ 1,750,000
+ D&A 1,500,000
CF Opns $ 3,250,000
1-411
Reference: Ref 11-2
66. Free cash flow: What is Champagne's free cash flow for 2008?
A) $2,050,000
B) $2,500,000
C) $3,250,000
D) $4,000,000
Ans: A
Feedback:
Champagne, Inc.
Revenue $12,000,000
EBITDA $ 4,000,000
- D&A 1,500,000
EBIT $ 2,500,000
x (1 – t) 70%
NOPAT $ 1,750,000
+ D&A 1,500,000
CF Opns $ 3,250,000
- Cap Exp $700,000
- Add WC 500,000
FCF $ 2,050,000
1-412
Reference: Ref 11-2
67. Free cash flow: What is Champagne's NOPAT for 2008?
A) $1,750,000
B) $2,500,000
C) $3,250,000
D) $4,000,000
Ans: A
Feedback:
Champagne, Inc.
Revenue $12,000,000
EBITDA $ 4,000,000
- D&A 1,500,000
EBIT $ 2,500,000
x (1 – t) 70%
NOPAT $ 1,750,000
Reference: Ref 11-2

68. Free cash flow: What are Champagne's cash flows associated with investments for
2008?
A) $500,000
B) $700,000
C) $1,200,000
Ans: C
Feedback:
Cash flows associated with investments equal the purchase of tangible and intangible
assets as well as increases in working capital. Therefore, the cash flows associated with
investments equal $700,000 + $500,000 = $1,200,000.
1-413
69. Marginal and average tax rates: Use the tax rate taken from Exhibit 11.6 to calculate
the total taxes paid 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 But Not More
Than 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) $22,500
B) $68,250
C) $90,750
D) $107,250
Ans: C
Feedback:
From the instruction in the table, we can see that the tax bill should be equal to $22,500
+ 0.39 x ($275,000 - $100,000) = $22,500 + $68,250 = $90,750
1-414
70. Marginal and average tax rates: 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 But Not More
Than 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%
Ans: C
Feedback:
From the instruction in the table, we can see that the tax bill should be equal to $22,500
+ 0.39 x ($275,000 – $100,000) = $22,500 + $68,250 = $90,750. We see that the taxes
due are $90,750 and with pretax income of $275,000, we then have an average tax rate
of $90,750 / $275,000 = 33.00%.
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71. Computing the terminal-year FCF: Miles Cyprus Corp. purchased a truck that
currently has a book value of $1,000. If the firm sells the truck for $5,000 today, then
what is the amount of cash that it will net after taxes if the firm is subject to a 30
percent marginal tax rate?
A) $1,200
B) $3,800
C) $4,000
D) $5,000
Ans: B
Feedback:
The gain on the sale was $5,000 – $1,000 = $4,000
Taxes on the gain are: $4,000 x .3 = $1,200
Net cash flow from the sale is $5,000 – $1,200 = $3,800

72. Computing the terminal-year FCF: 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
Ans: C
Feedback:
The loss on the sale was $10,000 – $500 = $9,500
The tax refund on the loss is: $9,500 x .39 = $3,705
Net cash flow from the sale is $500 + $3,705= $4,205
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73. Expected cash flows: FireRock Wheel Corp is evaluating a project in which there is a
40 percent probability of revenues totaling $3 million and a 60 percent probability of
revenues totaling $1 million per year. If cash expenses will be $1.0 million while
depreciation expense will be $200,000, then what is the expected free cash flow from
taking the project if the marginal tax rate for the firm is 30 percent?
A) $200,000
B) $420,000
C) $600,000
D) $620,000
Ans: D
Feedback:
Expected revenue = 0.4(3,000,000) + 0.6(1,000,000) = $1,800,000
Expected revenue $1,800,000
- Cash Expenses 1,000,000
- Deprec Expense 200,000
EBIT $ 600,000
- Tax 180,000
NI $ 420,000
+ Deprec Expense 200,000
FCF $ 620,000
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74. Projects with different lives: Your firm is deciding whether to purchase a durable
delivery vehicle or a short-term vehicle. The durable vehicle costs $25,000 and should
last five years. The short-term vehicle costs $10,000 and should last two years. If the
cost of capital for the firm is 15 percent, then what is the equivalent annual cost for the
best choice for the firm? (Round to the nearest dollar.)
A) $5,000, either vehicle
B) $5,000, short-term vehicle
C) $6,151, short-term vehicle
D) $7,458, long-term vehicle
Ans: C
Feedback:
, therefore the
, since we are analyzing costs, we should choose the lowest cost per year, which is the
short-term vehicle.

75. Projects with different lives: Your firm is deciding whether to purchase a high-quality
printer for your office or one of lesser quality. The high-quality printer costs $40,000
and should last four years. The lesser quality printer costs $30,000 and should last three
years. If the cost of capital for the firm is 13 percent, then what is the equivalent annual
cost for the best choice for the firm? Round to the nearest dollar.
A) $10,000, either printer
B) $10,000, lesser quality printer
C) $12,706, lesser quality printer
D) $13,448, high-quality printer
Ans: C
Feedback:
; therefore the
, since we are analyzing costs, we should choose the lowest cost per year, which is the
lesser quality printer.
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76. When to harvest an asset: Cleveland Millicrum is considering when to harvest its
moldy bread supply for antibiotics. It has calculated that the current NPV dollars for
harvesting the bread are increasing according to the following schedule. When should
the firm harvest the bread? The cost of capital for the firm is 14 percent.
NPV increase if harvested next year over that of harvesting now 25%
NPV increase if harvested year 2 over that of harvesting year 1 20%
A) Harvest now
B) Harvest year 2
C) Harvest year 3
D) Harvest year 4
Ans: C
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77. When to harvest an asset: 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
Ans: D
Feedback:
NPV1 = $50,000 ===> NPV 0,1 = $50,000 / (1.14) = $43,860
NPV2 = $60,000 ===> NPV 0,2 = $60,000 / (1.14)2 = $46,168
NPV3 = $69,000 ===> NPV 0,3 = $69,000 / (1.14)3 = $46,573
NPV4 = $77,280 ===> NPV 0,4 = $77,280 / (1.14)4 = $45,756
NPV5 = $85,008 ===> NPV 0,5 = $85,008 / (1.14)5 = $44,150
The current NPV is maximized with a harvest at year 3.
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78. When to replace an asset: Nemo Haulers is considering whether to purchase a new
mini tractor for moving furniture within its warehouse. Nemo calculates that its current
mini tractor generates $3,100 of cash flow per year. A new mini tractor would cost
$3,000 and would provide cash flow of $4,000 per year for five years. What is the
equivalent annual cash flow for the new mini tractor (round to the nearest dollar), and
should Nemo purchase the new tractor? Assume the cost of capital for Nemo is 10
percent.
A) $3,000, do not purchase the new tractor
B) $3,209, purchase the new tractor
C) $4,000, purchase the new tractor
D) $12,163, purchase the new tractor
Ans: B
Feedback:
, Since this is greater than the annual cash flow of $3,100 produced by the old tractor,
the new tractor should be purchased.

79. When to replace an asset: Burt's Pizzas is considering whether to purchase an oven.
Burt's calculates that its current oven generates $4,000 of cash flow per year. A new
oven would cost $15,000 and would provide cash flow of $6,000 per year for six years.
What is the equivalent annual cash flow for the new oven (round to the nearest dollar),
and should Burt's purchase the new oven? Assume the cost of capital for Burt's is 12
percent.
A) $2,352, do not purchase the oven
B) $6,000, purchase the oven
C) $9,668, purchase the oven
D) $24,668, purchase the new oven
Ans: A
Feedback:
, Since this is less than the annual cash flow of $4,000 produced by the old oven, the
new oven should not be purchased.
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80. The cost of using an existing asset: Small Appliances, Inc., is considering starting a
new line of business with the excess capacity it currently has on its rivet machine. The
current machine is expected to last four years at the current rate of production.
However, if a new line of business is taken on, then the machine will have to be
replaced in three years instead of four. A new machine that will last four years would
cost $50,000. What is the cost of taking on the new line of business? Round to the
nearest dollar and assume a 9 percent cost of capital.
A) $11,917
B) $12,500
C) $15,433
D) $50,000
Ans: A
Feedback:
The EAC for the new machine is
, now the firm would have to economically incur this additional equivalent cost in year
3. Therefore, the present value of that cost is

81. Which of the following statements is correct?
A) Incremental net operating profits after-tax should include sunk costs associated
with a project.
B) Incremental net operating profits after-tax should include the effects of financing
costs associated with a project.
C) Incremental net operating profits after-tax should exclude the effects of
depreciation costs associated with a project.
D) Incremental net operating profits after-tax should exclude the effects of financing
costs associated with a project.
Ans: D
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A) The calculation of free cash flow does not include the impact of income taxes.
B) Accounting earnings are an unreliable measure of the costs and benefits of a
project.
C) The idea that we can evaluate the cash flows from a project independently of the
cash flows for the firm is known as the incremental principle.
D) Depreciation expense should not be included in the calculation of incremental net
operating profits after-tax.
Ans: B
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83. General Mills just is undertaking an analysis on a new cereal. The firm realizes that if
they come out with a new product it would affect sales of existing products? What is
the best course of action for General Mills in this analysis?
A) Treat the reduction of sales from existing cereals as a sunk cost.
B) Account for the reduction of sales from existing cereals in the projection of cash
flows on the new product.
C) Include the allocated costs of the new cereal in the sales of the pre-existing
products.
D) Ignore the fact that sales of other products will be affected.
Ans: B
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Level of Difficulty: Difficult
84. Operating Cash Flow: Premier Steel, Inc. is considering the purchase of a new
machine for $100,000 that has a useful life of 3 years. The firm’s cost of capital is
11.0% and the tax rate is 40%. This machine will be sold for its salvage value of
$20,000 at the end of 3-years. The machine will require an investment of $2,500 in
spare parts inventory upon installation. The machine will cost $8,000 to ship and
$4,000 to install and modify it.
Sales are as follows: year 1 = $90,000; year 2 = $97,500; year 3 = $105,000. Operating
expenses are year 1 = $25,000; year 2 = $27,000; year 3 = $29,000. The investment in
working capital will be liquidated at termination of the project at the end of year 3.
MACRS Rates 33% 45% 15% 7%
Using MACRS, what is the operating cash flow in year 1?

A) $53,784
B) $35,238
C) $86,999
D) $42,512
Ans: A
Feedback:
OPERATING CASH FLOWS

Year 1 2 3
Sales Revenues $ 90,000 $97,500 $105,000
Operating expenses (25,000) (27,000) (29,000)
Depreciation (36,960) (50,400) (16,800)
Income Before Tax 28,040 20,100 59,200
Income Taxes 11,216 8,040 23,680
Net income 16,824 12,060 35,520
Add: depreciation 36,960 50,400 16,800
Project Net Cash Flow 53,784 62,460 52,320
Useful Life in Years 3 Tax Rate 40%

MACRS Rates 33% 45% 15% 7%
Invoice Cost $100,000
Shipping $ 8,000
Install & Modify $ 4,000
Depreciable Cost Basis $112,000
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85. Average versus Marginal Tax Rate: Suppose Franklin Corporation had pre-tax
income of $300,000 in 2010 and that the firm would have paid $100,250.00 in federal
income taxes. What is Franklin’s average income tax rate? (Round off to the nearest
0.1%)
A) 39.0%
B) 34.7%
C) 33.4%
D) 38.6%
Ans: C
Feedback:
Average tax rate is equal to total income tax divided by taxable income.
Income tax on first $100,000 = $22,250
Income tax on next $200,000 = 39% × ($300,000 - $100,000) = .39 × $200,000 = $78,000
Thus, total tax = $22,250 + $78,000 = $100,250
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86. Which of the following should not be included in a schedule of cash flows from
operations when evaluating a capital project?
A) Fixed costs.
B) Sunk costs.
C) Depreciation and amortization.
D) Variable costs.
Ans: B

87. Which of the following is an example of a fixed cost?
A) Cost of equipment purchased for an assembly line to be used in the production of
a new product.
B) Assembly costs associated with the production of a new product.
C) Labor costs associated with the production of a new product.
D) Shipping costs associated with the sale of a new product.
Ans: A
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88. Your firm is evaluating the merits of several different machines. Machine A has a
useful life of 5-years, generates an NPV of $53,250, an IRR of 13.6% and an equivalent
annual cost of $10,316. Machine B has a useful life of 3-years, an NPV of $61,051, an
IRR of 12.5%, and an equivalent annual cost of $9,724. Machine C has a useful life of
4-years, generates an NPV of $55,225, an IRR of 15.2% and an equivalent annual cost
of $7,535 Machine D has a useful life of 7-years, generates an NPV of $64,020, an IRR
of 11.4% and an equivalent annual cost of $8,885.
Which machine should be purchased and why?

A) Machine C, because it has the highest IRR.
B) Machine D, because it has the highest NPV.
C) Machine A, because it has the most positive EAC.
D) Machine B, because it has the shortest useful life.
Ans: C

89. Equivalent Annual Cost: 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
Ans: D
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Feedback:
Equivalent Annual Cost

PV of
Estimated Cash Flows at
Year Cash Flows 11.75%
0 ($750,000)
1 250,000 223,714
2 400,000 320,306
3 600,000 429,941
Total PV of CF's $973,960
Minus Cost ($750,000)
Net Present Value $223,960
EAC $92,845
Discount Rate 11.75%
PV = $223,960; N = 3, I% = 11.75%; Thus PMT (EAC) = $92,845

90. When is the appropriate time to harvest an asset?
A) That point in time where harvesting the asset yields the largest internal rate of
return.
B) That point in time where harvesting the asset yields the smallest payback.
C) That point in time where harvesting the asset yields the largest accounting rate of
return.
D) That point in time where harvesting the asset yields the largest net present value.
Ans: D
Format: Essay
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31. EBITDA stands for
A) earnings before interest, taxes, and amortized depreciation.
B) earnings before interest, taxes, depreciation, and amortization.
C) earnings before interest and taxes.
Ans: B

32. Revenue minus variable and fixed costs best describes
A) EBIT.
B) EBITDA.
C) NOPAT.
Ans: B

33. Another name for EBITDA is
A) pretax operating cash flow.
B) operating cash flow.
C) net income before tax.
D) net income.
Ans: A

34. A firm with a higher proportion of fixed costs will create
A) a higher degree of sensitivity of EBITDA to a change in revenues.
B) a lower degree of sensitivity of EBITDA to a change in revenues.
C) no discernible difference of a change in sensitivity of EBITDA to a change in
revenues.
D) a firm with a much more stable net income stream as a function of revenues.
Ans: A
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35. If a firm is about to operate in an environment in which there will be a great deal of
variability in the level of revenues, then the firm
A) should structure its cost structure to have high fixed costs and higher total
variable costs.
B) should structure its cost structure to have high fixed costs and consequently lower
per unit variable costs.
C) should structure its cost structure to have low fixed costs and consequently higher
per unit variable costs.
Ans: C

36. The degree of pretax cash flow operating leverage provides us with
A) a measure of how sensitive pretax operating cash flows are to changes in revenue.
B) a measure of how sensitive accounting operating profits are to changes in
revenue.
C) a measure of how sensitive NOPAT is to changes in revenue.
Ans: A

37. ___________ is a measure of the sensitivity of EBITDA or EBIT to changes in
revenue.
A) Total leverage
B) Financial leverage
C) Operating leverage
Ans: C
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38. Depreciation and amortization are treated like fixed costs
A) in the calculation of the degree of pretax cash flow operating leverage.
B) in the calculation of the degree of accounting operating leverage.
C) for cash flow purposes.
Ans: A

39. If the degree of accounting leverage is 1.3 for a firm, then a 10 percent increase in
revenue should drive a
A) 13% increase in pretax operating cash flows.
B) 13% increase in EBIT.
C) 30% increase in EBIT.
Ans: B

40. Gilligan's Boat Tours finds that if it were to increase its price by 10 percent, it would
have a 6 percent reduction in the NPV of its new 3-Hour Tour. Gilligan's analysis could
be described as
A) a Monte Carlo simulation.
B) scenario analysis.
C) sensitivity analysis.
Ans: B
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41. If a firm were interested in knowing the effect of a single input change on the net
present value of a project, then the firm would most likely want to perform
A) a Monte Carlo simulation.
C) sensitivity analysis.
Ans: C

42. If a firm wanted to find the effect of a change in the variable cost per unit of production
on the net present value of a project, then the firm might perform
A) a sensitivity analysis.
B) a scenario analysis.
C) a Monte Carlo simulation.
Ans: A

43. At times, when a firm is considering an alternative such that a set of variables affecting
a project are interrelated, then analysis that considers this interrelation could be
performed. This is called
Ans: B
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44. A firm is considering two distinct set of circumstances that assume high inflation and
low inflation. In the high inflationary set of circumstances, the price per unit will be
affected as well as the variable and fixed costs. If the low-inflation set of circumstances
is considered the baseline, then the analysis concerning the high inflationary
circumstances could be considered
Ans: B

45. Scenario analysis can help a firm to
A) understand the degree of uncertainty that a different set of project-affecting
circumstances may hold.
B) eliminate all of the uncertainty that a different set of project-affecting
circumstances may hold.
C) transform a risky project into a risk-free project.
Ans: A

46. If a project holds an 80 percent probability of high demand and a 20 percent probability
of low demand, then the expected value of the net present value of the two different
demand assumptions would give us a weighted average net present value for the
project. Such an analysis is called
C) a simulation analysis.
Ans: B
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47. An analysis in which each of the inputs and assumptions for a project takes on a
separate assumed distribution whereby a computer draws on each of those input and
assumption distributions to create a distribution for the NPV of the entire project is
called
Ans: C

48. Rouf-Mart has analyzed a new type of all-in-one retail center where the NPV of the
project has an expected value with a distribution that yields a standard deviation of $25
million. Rouf-Mart came to this conclusion by analyzing the individual input
distributions for the project. This analysis is called.
Ans: C

49. If a firm is interested in the distribution of the NPV for a project that it is considering,
then the firm should be most interested in
Ans: C
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50. Which of the following methods of project risk analysis requires a computer?
A) sensitivity analysis.
C) simulation analysis.
Ans: C

51. Which of the following project risk analyses is best able to analyze the effect of a single
input, uncorrelated with other inputs, on the NPV of a project?
Ans: A

52. Which of the following project risk analyses is best able to analyze the effect of a single
set of circumstances, with correlated inputs, on the NPV of a project?
A) sensitivity analysis
B) scenario analysis
C) simulation analysis
Ans: B
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53. A change in sales price of a product sold by a firm will probably involve a reduction in
the number of units sold, as well as the possibility of a change in the cost structure of
the firm's product in question. If a firm were interested in the entire price change effect
on the NPV of a project, then it would be interested in
Ans: B

54. The process of identifying the bundle of projects that creates the greatest total value and
allocating the available capital to the projects is known as
A) risk analysis.
B) budgeting.
C) rationing.
D) capital rationing.
Ans: D

55. Capital constraints can occur due to
A) difficulties in accurately assessing the risks and returns associated with a firm's
projects.
B) the capital market's inability to fund all of a firm's projects due to a lack of funds.
C) the capital market's policy of not funding all of a firm's projects.
Ans: A
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56. The capital market may not be able to fund all of a firm's positive NPV project because
A) the capital market will always speculate that it is not going to get a fair return.
B) even the capital market has a constraint for the amount of capital that it can
supply a firm.
C) it can be difficult for outside investors to accurately assess the risks and returns
associated with the firm's projects.
Ans: C

57. The profitability index is useful in a capital rationing situation because
A) it helps identify projects by the amount of value created per dollar invested.
B) if followed, then it is only necessary to take the projects with the highest PI first.
C) it will rank the best project to be taken in an absolute manner.
Ans: A
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58. Variable costs, fixed costs, and project risk. Solutions Bank Textbooks had sales and
operating expenses of $1 million last year. If the firm had fixed costs of $300,000 on
sales of 35,000 books, then what is the firm's per-unit contribution?
A) $28.57
B) $20.00
C) $8.57
Ans: C
Feedback:
Unit sales = 35,000 units
Sales = $1,000,000
Total fixed costs = $300,000 ===>
Total variable costs = $1,000,000 – $300,000 = $700,000 ===>
Unit variable costs = $700,000 / 35,000 = $20.00
Sale price/unit = $1,000,000 / 35,000 units = $28.57 ===>
Unit contribution margin = $28.57 – $20.00 = $8.57

59. Calculating operating leverage. Marvelous Corporation has a degree of cash flow
operating leverage equal to 1.25. If the firm's EBITDA was $1,000 last year while its
depreciation and amortization expense was $50 in the same year, then what was the
firm's degree of accounting operating leverage?
A) 1.26
B) 1.30
C) 1.32
D) 1.35
Ans: C
Feedback:
Degree of cash flow operating leverage =
Degree of accounting operating leverage =

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60. Calculating operating leverage. Potter Corporation has a degree of cash flow
operating leverage equal to 1.266. If the firm's EBITDA was $1,500 last year while its
depreciation and amortization expense was $100 in the same year, then what was the
firm's degree of accounting operating leverage?
A) 1.29
B) 1.33
C) 1.36
D) 1.39
Ans: C
Feedback:
Degree of cash flow operating leverage =

61. Calculating operating leverage. Coach K Sneakers, Inc., had EBIT of $1,850 last year
with fixed costs equal to $500 (depreciation and amortization not included) and
depreciation and amortization equal to $150. What was Coach K's degree of accounting
operating leverage?
A) 1.25
B) 1.35
C) 1.38
D) 1.40
Ans: B
Feedback:
Degree of accounting operating =

leverage
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62. Calculating operating leverage. SunBucks Tea Supplies had EBITDA of $3,000 and
EBIT of $2,750, with fixed cash expenses of $600 last year. What was SunBucks
degree of accounting operating leverage?
A) 1.20
B) 1.25
C) 1.28
D) 1.31
Ans: D
Feedback:
EBITDA = $3,000 and EBIT = $2,750 ==> D&A = $250

63. Calculating operating leverage. TurkeyJerkey Dried Meats, Inc., had a degree of
accounting operating leverage equal to 1.714 during the most recent period. If the firm's
EBITDA was $4,000 and depreciation and amortization was equal to $500, then what
was TurkeyJerkey's fixed cash expenses during the same period?
A) $1,499
B) $1,999
C) $5,499
D) $5,999
Ans: B
Feedback:
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64. Calculating operating leverage. Swan's Bicycle Boats had a degree of accounting
operating leverage equal to 1.50 during the most recent period. If the firm's EBITDA
was $5,000 and its fixed costs were equal to $1,750, then what was Swan's depreciation
and amortization expense during the same period?
A) $500
B) $1,000
C) $1,500
D) $2,833
Ans: A
Feedback:

65. Break-even analysis. IronVerks Ribshack has total fixed costs of $8,500 per month. It
sells rib plates for $15 each, and the variable cost of providing each plate is $10. What
is the pretax operating cash flow break-even point for IronVerks?
A) 567 plates
B) 1,700 plates
C) 8,500 plates
Ans: B
Feedback:
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66. Break-even analysis. Markovian Caviar Sales has discovered that the extent of the
demand for its caviar harvest is 20,000 tins per year. If the fixed costs for the new
product are $2,300,000 and the variable harvest cost per tin is $35, then what price can
Markovian charge per tin if the firm needs to break even on a pretax operating cash
flow basis?
A) $135.00
B) $150.00
C) $185.00
Ans: B
Feedback:

67. Break-even analysis. Monochrome Sun Glasses has found that its pretax operating
cash flow basis break-even number of glasses sold is 770,000 pairs. If each pair is sold
for $25 and the variable cost per unit is $15, then what is the amount of Monochrome's
fixed costs?
A) $77,000
B) $1,155,000
C) $7,700,000
D) $11,550,000
Ans: C
Feedback:
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68. Break-even analysis. TimeKeepers is about to introduce a new LED clock and has
determined that it will charge $30 per clock. The firm must decide whether or not to
purchase a high-capacity clock-making machine. If the high-capacity machine is
selected, then the fixed costs for the firm will be $5,000 per year, with variable costs of
$5 per clock. Otherwise the fixed costs will be $1,000, with variable costs of $15 per
clock. Above what level of expected sales should TimeKeepers choose the high fixed
cost alternative to maximize pretax operating cash flow?
A) 400 units
B) 500 units
C) 4,000 units
D) 5,000 units
Ans: A
Feedback:

69. Break-even analysis. Binders-For-School, Inc., is in the process of determining
whether to purchase a high-capacity machine to make textbooks for the upcoming
school year. The high-capacity machine will generate fixed costs of $10,000 per year
versus the $2,000 fixed costs of using a low-capacity machine. The variable costs per
unit when using the high-capacity machine will be $30. The firm will charge $60 for
each textbook and has determined that the high-capacity machine will maximize pretax
operating cash flow if sales are greater than 800 books. What is the contribution margin
under the low-capacity machine scenario?
A) $10
B) $20
C) $30
D) $40
Ans: B
Feedback:
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70. Break-even analysis. Binders-For-School, Inc., is in the process of determining
whether to purchase a high-capacity machine to make textbooks for the upcoming
school year. The high-capacity machine will generate fixed costs of $10,000 per year
versus the $2,000 fixed costs of using a low-capacity machine. The variable costs per
unit when using the high-capacity machine will be $30. The firm will charge $60 for
each textbook and has determined that the high-capacity machine will maximize pretax
operating cash flow if sales are greater than 800 books. What is the variable cost per
unit under the low-capacity machine scenario?
A) $20
B) $40
C) $60
D) $80
Ans: B
Feedback:

71. Break-even analysis. A cement contractor has determined that he will maximize pretax
operating cash flow buying a large cement truck if he is able to sell more than 500
yards of cement per month. The price of a yard of cement is $60, and the variable costs
for a large truck are $20 per yard. The variable costs for a small truck are $40 per yard,
and the fixed costs for the small truck are $10,000. What are the fixed costs associated
with the large truck?
A) $0
B) $10,000
C) $20,000
D) $30,000
Ans: C
Feedback:
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72. Break-even analysis. Max's Brakes is introducing a new revolutionary brake-pad for
vehicles that will never wear out. Max's will sell the pads for $100 a pair, and they will
cost $80 in variable costs to produce. If cash fixed expenses are $1,500 per year and the
depreciation and amortization expenses are $600 per year, then what is the Accounting
Operating Profit Break-Even point for Max's?
A) 8 pairs
B) 21 pairs
C) 75 pairs
D) 105 pairs
Ans: D
Feedback:

73. Break-even analysis. Yoo Computers is introducing a new game system that promises
to never become outdated. Yoo will sell the systems for $200, and it will accrue $130 in
variable costs to produce. If cash fixed expenses are $35 million per year and the
depreciation and amortization expenses are $7 million per year, then what is the
Accounting Operating Profit Break-Even point for Yoo?
A) 210,000 units
B) 323,077 units
C) 500,000 units
D) 600,000 units
Ans: D
Feedback:
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74. Break-even analysis. ClockWatchers is about to introduce a new employee monitoring tool and
has determined that it will charge $100 per unit. The firm must decide whether or not to
purchase a high-capacity manufacturing machine. If the high-capacity machine is selected, then
the cash fixed costs will be $5,000 per year, with variable costs of $50 per unit and depreciation
and amortization expenses of $2,000. Otherwise the fixed costs will be $2,000, with variable
costs of $75 per unit and depreciation and amortization expenses of $500. If EBIT Break-even
is how the firm evaluates its projects, then above what level of expected sales should
ClockWatchers choose the high fixed cost alternative?
A) 60 units
B) 90 units
C) 120 units
D) 180 units
Ans: D
Feedback:

75. Break-even analysis. Bright Light Auto Lamps has found that it is indifferent between purchasing a
high-capacity vacuum sealing machine or a lower capacity machine as long as sales are 200 units per
month. The price of each sealed beam light is $50. The high-capacity machine has cash expenses of
$10,000 per month, while the alternative has cash expenses of $5,000 per month and depreciation and
amortization expenses of $2,000 per month. Under high capacity, the variable costs per unit are $10;
and they are $40 for the other alternative. If the firm bases its decisions on the Accounting Operating
Profit Break-even, then what are the depreciation expenses under the high-capacity alternative?
A) $3,000
B) $4,000
C) $9,000
Ans: A
Feedback:
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76. Break-even analysis. Poisson Calculators has found that it is indifferent between purchasing a high-
capacity vacuum component assembly machine or a lower capacity machine as long as sales are
1,900 units per month. The price of each calculator is $70. The high-capacity machine has cash
expenses of $100,000 per month and depreciation and amortization expenses of $30,000 per month,
while the alternative has cash expenses of $30,000 per month and depreciation and amortization
expenses of $5,000 per month. Under the low-capacity alternative, variable costs per unit are $60. If
the firm bases its decisions on the Accounting Operating Profit Break-even, then what is the variable
cost per unit under the high-capacity alternative?
A) $10
B) $47
C) $60
D) $70
Ans: A
Feedback:

77. Capital rationing. Mick's Pub's is considering expanding the number of restaurants it
owns. If it decides on the expansion, it will invest $2,300,000, and the NPV of the
project is $900,000. What is the profitability index of the project?
A) 0.39
B) 1.00
C) 1.39
D) 2.39
Ans: C
Feedback:
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78. Capital rationing. You are considering a project that has an initial cost of $1,200,000.
If you take the project, it will produce net cash flows of $300,000 per year for the next
six years. If the appropriate discount rate for the project is 10 percent, what is the
profitability index of the project?
A) 0.09
B) 1.09
C) 2.09
D) 2.18
Ans: B
Feedback:

79. Capital rationing. TuleTime Comics is considering a new show that will generate
annual cash flows of $100,000 into the infinite future. If the initial outlay for such a
production is $1,500,000 and the appropriate discount rate is 6 percent for the cash
flows, then what is the profitability index for the project?
A) 0.11
B) 0.90
C) 1.11
D) 1.90
Ans: C
Feedback:
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80. Capital rationing. The profitability index for a project is 1.18. If the project will
produce cash inflows of $60,000 for the next 12 years, what is the initial outlay for the
project if the appropriate discount rate is 5 percent? (Round to the nearest $10.)
A) $450,670
B) $627,520
C) $1,016,950
Ans: A
Feedback:

81. Which of the following statements is most correct?
A) Variable costs are expenses that do not change if sales revenues rise.
B) A firm can reduce project risk by increasing the sensitivity of EBITDA to
revenue changes.
C) A project that has a higher proportion of fixed costs will have cash flows that are
more sensitive to changes in revenues than an otherwise identical project with a
lower proportion of fixed costs.
D) An investment in new manufacturing equipment that will automate a production
process would be an example of a variable cost.
Ans: C
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82. Which of the following statements is false?
A) The purchase of equipment to replace labor in a manufacturing process will
increase a firms operating leverage.
B) The higher the proportion of fixed costs to variable costs in a project, the greater
the sensitivity of EBIT to revenue changes.
C) Depreciation and amortization are considered fixed costs.
D) The lower the proportion of fixed costs to variable costs in a project, the more
pre-tax operating cash flows will vary as revenue varies.
Ans: D

83. The higher a project’s operating leverage, _________________.
A) The lower the sensitivity of EBIT to changes in revenue.
B) The greater the sensitivity of EBITDA to changes in revenue.
C) The lower the sensitivity of net profit to changes in variable costs.
D) The greater the sensitivity of net profit to changes in variable costs.
Ans: B

84. Calculation of operating leverage. Mega Line, Inc. had the following financial results
for the fiscal year ending September 30, 2010. Sales $1,550,250; depreciation and
amortization $80,785; fixed costs $125,000; net profit $237,500; operating income
$620,100. What was the firm's degree of pre-tax cash flow operating leverage during
fiscal 2010?
A) 1.18
B) 1.64
C) 1.27
D) 1.45
Ans: A
Feedback:
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85. Which is the term used to define how many units must be sold for pre-tax operating
cash flow to be equal to zero?
A) Pre-tax accounting operating profit break-even point.
B) Pre-tax operating financial leverage break-even point.
C) Pre-tax accounting sensitivity break-even point.
D) Pre-tax operating cash flow break-even point.
Ans: D

86. Which of the following differentiates accounting operating profit break-even point from
pre-tax operating cash flow break-even point?
A) Accounting operating profit break-even point includes interest expense in the
numerator, whereas pre-tax operating cash flow does not.
B) Pre-tax operating cash flow break-even point includes income taxes in the
denominator, whereas accounting operating profit break-even point does not.
C) Accounting operating profit break-even point includes depreciation &
amortization in the numerator, whereas pre-tax operating cash flow does not.
D) Pre-tax operating cash flow break-even point includes interest expense in the
numerator, whereas accounting operating profit break-even point does not.
Ans: C
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87. Break-even point units: Ski & Surf manufactures snow boards. The firm has fixed
costs of $1,090,275. The snow boards sell for $335 each and have a variable cost of
$165 each. What is the pretax operating cash flow break-even point for Ski & Surf?
(Round off to the nearest unit)
A) 9,000
B) 6,413
C) 8,511
D) 5,876
Ans: B
Feedback:

88. What decision criteria should managers use in selecting projects when there is not
enough capital to invest in all available positive NPV projects?
A) The profitability index.
B) The internal rate of return.
C) The discounted payback.
D) The modified internal rate of return.
Ans: A
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89. What might cause a firm to face capital rationing?
A) If a firm has more than one project with a positive NPV.
B) If a firm rejects some capital investments that are expected to generate positive
NPV’s.
C) If investors require returns for their capital that are too high.
D) If a firm has several projects that are expected to generate negative IRR’s.
Ans: C

90. Capital Rationing: Myers Limited is considering the purchase of automated
equipment that is expected to generate an NPV of $632,500. The cost of the equipment
is $2,375,500. What is the profitability index of the project? (Round off to the nearest
0.01)
A) 1.54
B) 1.12
C) 1.44
D) 1.27
Ans: D
Feedback:
≈1.27
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26.

To start a business, the owners need

28. If you have loaned capital to a firm, then you could be

29. Which of the following are stakeholders?

30. A trademark is an example of

33. Cash dividends are paid out of

34. Current liabilities are liabilities that

36. Working capital management decisions involve

38. A good capital budgeting decision is

40. Profitability of a firm can be negatively affected by

41. About 75 percent of all businesses in the United States are

45. Which of the following owners is protected by limited liability?

46. Which of the following cannot be engaged in managing the business?

56. Which of the following is an appropriate goal for the firm?

59. Which of the following is a principal within the agency relationship?

Format: Multiple Choice

71. The golden rule is an example of

Format: Multiple Choice

Format: Multiple Choice

Format: Multiple Choice

A) management, regulator, and bondholder

B) management, shareholder, and creditor

C) regulator, shareholder, and creditor

27. Shareholders analyze financial statements in order to:

C) focus on the value of the stock they hold.

D) All of the above.

A) the firm's amount of debt.

C) the firm's ability to meet its short-term obligations.

D) All of the above.

29. A firm's management analyzes financial statement's so that:

B) similar to shareholders, they can focus on profitability, dividend, capital

C) they can get more stock options.

30. Anyone analyzing a firm's financial statements should

A) use audited financial statements only.

C) perform a benchmark analysis.

D) All of the above.

A) Use unaudited financial statements.

C) Perform a benchmark analysis.

D) Compare the firm's performance to that of its direct competitors.

A) Each asset and liability item on the balance sheet is standardized by

B) Balance sheet accounts are represented as percentages of total assets.

C) Each asset and liability item on the balance sheet is standardized by

D) Common-size financial statements allow us to make meaningful

A) Each income statement item is standardized by dividing it by total assets.

B) Income statement accounts are represented as percentages of sales.

C) Each income statement item is standardized by dividing it by sales.

D) Common-size financial statement analysis is a specialized application of

A) are a specialized application of ratio analysis.

B) allow us to make meaningful comparisons between the financial

C) are prepared by having each financial statement item expressed as a

D) All of the above are true.

35. Which of the following is true of ratio analysis?

A) A ratio is computed by dividing one balance sheet or income statement by

D) All of the above are true.

36. Which of the following is NOT true of liquidity ratios?

B) There are two commonly used ratios to measure liquidity—current ratio

A) The firm collects on its accounts receivables.

B) The firm purchases inventory by taking a short-term loan.

C) The firm pays down its accounts payables.

D) None of the above.

A) a decrease in the net fixed assets

C) an increase in accounts payable

D) None of the above