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DeVry BUSN379 Final Exam Study Questions and Answers
2. net present value method payback method internal rate of return method all of these are time-adjusted methods Chapter 8, Page 237 (TCO 4) There are several disadvantages to the payback method, among them: (4 points) payback ignores cash flows beyond the cutoff. payback can be used in conjunction with time adjusted methods of evaluation. payback is easy to use and to understand. none of the above is a disadvantage. Chapter 4, Page 237 (TCO 4) There are several disadvantages to the payback method, among them: (4 points) payback ignores the time value of money. payback can be used in conjunction with time adjusted methods of evaluation. payback is easy to use and to understand. none of the above is a disadvantage. Chapter 4, Page 237 (TCO 3 and 4) The net present value is:(4 points) negative when a project's benefits exceed its costs. equal to the present value of an investment's benefits. equal to zero when the discount rate equals the IRR. negative when a project's IRR exceeds the required rate of return. 3. the current measure of a project's cash inflows. Chapter 8, Page 241 (TCO 3 and 4) A net present value of zero implies that an investment:(4 points) has no initial cost. has an expected return that is less than the required return. should be rejected even if the discount rate is lowered. never pays back its initial cost. is earning a return that exactly matches the requirement. Chapter 8, Page 241 (TCO 3 and 4) You can ensure that an investment is expected to create value for (4 points) have a PI equal to zero. produce negative rates of return. have positive AARs. have positive IRRs. have positive NPVs. Chapter 8, Page 233 a firm's owners by selecting projects that: (TCO 3 and 4) What is the net present value of a project with the following cash flows, if the discount rate is 15 percent? Year 0 1 2 3 4 Cash flow - $45,000 $11,520 $13,630 $16,470 $18,990 (4 points) -$2,989.48 -$2,599.55 4. $1,153.37 $2,880.08 $3,312.09 (TCO 3 and 4) What is the net present value of a project with the following cash flows, if the discount rate is 10 percent? Year 0 1 2 3 4 Cash flow - $32,000 $9,000 $10,000 $15,200 $7,800 (4 points) $1,085.25 $1,193.77 $3,498.28 $4,102.86 $4,513.15 (TCO 3 and 4) Portman's is considering adding a new product to its lineup. This product is expected to generate sales for three years, after which time the product will be discontinued. What is the project's net present value, if the firm wants to earn a 12 percent rate of return? Year 0 1 2 3 Cash flow - $62,000 $10,730 $20,190 $40,340 (4 points) $7,611.08 5. $6,795.61 $1,084.41 $4,862.07 $9,682.26 (TCO 4) Howard Company is considering a new project that will require an initial cash investment of $575,000. The project will produce no cash flows for the first three years. The projected cash flows for years 4 through 8 are $73,000, $112,000, $124,000, $136,000, and $145,000, respectively. How long will it take the firm to recover its initial investment in this project?(4 points) 5.81 years 6.05 years 6.96 years 7.90 years This project never pays back Chapter 8 Pages 235-236 Payback = 7 + ($575,000 $445,000) / $145,000 = 7.90 years (TCO 4) The Inventive Co. is considering a new project. This project requires an initial cash investment of $70,000. The project will generate cash inflows of $10,500 in the first year. Then, the project will do nothing for two years, after which time cash inflows of $25,000 will be generated for four years. How long will it take the Inventive Co. to recover its $70,000 investment?(4 points) 6. 5.16 years 5.38 years 6.11 years 6.62 years 6.94 years Chapter 8 Pages 235-236 Payback = 5 + ($70,000 $60,500) / $25,000 = 5.38 years (TCO 4) Leward Manufacturing is spending $115,000 to update its equipment. This is necessary if the firm wishes to be competitive in the marketplace and provide a wide array of product models. The company estimates that these updates will improve its cash inflows by $27,500 a year, for eight years. What is the payback period?(4 points) 4.18 years 5.82 years 6.62 years 7.79 years This project never pays back Chapter 8 Pages 235-236 Payback = 4 + ($115,000 $110,000) / $27,500 = 4.18 years (TCO 4) The postponement of a project until conditions are more favorable: (4 points) is a valuable option. is referred to as the option to extend. could not cause a negative net present value project to become a positive net present value project. will generally cause the internal rate of return for a project to decline. Chapter 9, Pages 290-291 7. (TCO 4) The postponement of a project until conditions are more favorable: (4 points) is not a valuable option. is referred to as the option to extend. could cause a negative net present value project to become a positive net present value project. will generally cause the internal rate of return for a project to decline. Chapter 9, Pages 290-291 (TCO 4) Ignoring the option to expand:(4 points) overestimates the internal rate of return on a project. ignores the possibility that a negative net present value project might be positive, given changes over time. ignores the possibility that one variable is the primary source of the forecasting risk associated with a project. underestimates the net present value of a project. Chapter 9, Pages 290-291 (TCO 4) ____________, refers to the situation a firm faces when it has positive net present value projects, but cannot obtain financing for those projects.(4 points) capital planning. soft rationing. capital rationing. hard rationing. a sunk cause. Chapter 9, Pages 291-292 (TCO 4) The situation that exists when the units within a business are allotted a fixed amount of money for capital budgeting, is referred to as:(4 points) 8. soft rationing. hard rationing. unit capital rationing. allocated planning. strategic planning. Chapter 9, Pages 291-292 (TCO 4) ___________, occurs when a firm cannot raise financing for a project under any circumstances.(4 points) contingency planning. hard rationing. soft rationing. capital constraint. scenario analysis. Chapter 9, Pages 291-292 (TCO 4) ABC Cameras is considering an investment that will have a cost of $10,000 and the following cash flows: $6,000 in year 1, $4,000 in year 2 and $3,000 in year 3. Assume the cost of capital is 10%. Which of the following is true regarding this investment?(4 points) The net present value of the project is approximately $10,000 This project should be accepted because it has a positive net present value This projects payback period is 10 years or more None of the above is true Chapter 8, Pages 232-237NPV = ($6,000 x .909) + ($4,000 x .826) + ($3,000 x .751) $10,000 = $1,011 (TCO 4) ABC Cameras is considering an investment that will have a cost of $10,000 and the following cash flows: $6,000 in year 1, $4,000 in year 2 and $3,000 in year 3. Assume the cost of capital is 10%. Which of the following is true regarding this investment?(4 points) The net present value of the project is approximately $1,011 This project should be accepted because it has a negative net present value 9. This projects payback period is 10 years or more All of the above are true Chapter 8, Pages 232-237NPV = ($6,000 x .909) + ($4,000 x .826) + ($3,000 x .751) $10,000 = $1,011 (TCO 3 and 4) ABC Cameras is considering an investment that will have a cost of $10,000 and the following cash flows: $6,000 in year 1, $4,000 in year 2 and $3,000 in year 3. Assume the cost of capital is 10%. Which of the following is true regarding this investment?(4 points) The net present value of the project is $11,000 This project should be accepted because it has a negative net present value This project should be accepted because it has a payback higher than 3 years The net present value of the project is close to $1,000 Chapter 8, Pages 232-237NPV = ($6,000 x .909) + ($4,000 x .826) + ($3,000 x .751) $10,000 = $1,011 (TCO 4) Assume Company X plans to invest $60,000 in industrial equipment. Using Tables 9.6 and 9.7 of your textbook (Page 277), which is the first year depreciation amount under MACRS?(4 points) $12,000 $8,574 $19,800 None of the above Chapter 9, Page 277 $60,000 x 14.29% = $8,574 (TCO 4) Assume Company X plans to invest $60,000 in new computers. Using Tables 9.6 and 9.7 of your textbook (Page 277), which is the first year depreciation amount under MACRS?(4 points) $12,000 $8,575 $19,800 None of the above 10. Chapter 9, Page 277 $60,000 x 20% = $12,000 (TCO 4) Assume Company X plans to invest $60,000 in new computers. Using Tables 9.6 and 9.7 of your textbook (Page 277), which is the second year depreciation amount under MACRS?(4 points) $12,000 $19,200 $19,800 None of the above Chapter 9, Page 277 $60,000 x 32% = $19,200 (TCO 1 and 4) Assume a corporation has earnings before depreciation, and taxes of $100,000, depreciation of $40,000, and that it has a 30 percent tax bracket. What are the after-tax cash flows for the company? (4 points) $82,000 $110,000 $42,000 none of these Chapter 2, Pages 34-39, Chapter 9 Page 275 After Tax Cash Flows: Net Income + Depreciation Net Income = $100,000 - $40,000 = $60,000 Taxes Taxes = $60,000 x 30% = $18,000 Net Income = $60,000 18,000 = $42,000 After Tax Cash Flows: Net Income + Depreciation = $42,000 + 40,000 = $82,000 (TCO 1 and 4) Assume a project has earnings before depreciation, and taxes of $110,000, depreciation of $40,000, and that 11. the firm has a 30 percent tax bracket. What are the after-tax cash flows for the project? (4 points) $47,000 $89,000 a loss of $21,000 none of these Chapter 2, Pages 34-39, Chapter 9 Page 275 After Tax Cash Flows: Net Income + Depreciation Net Income = $110,000 - $40,000 = $70,000 Taxes Taxes = $70,000 x 30% = $21,000 Net Income = $70,000 21,000 = $49,000 After Tax Cash Flows: Net Income + Depreciation = $49,000 + 40,000 = $89,000 (TCO 1 and 4) Assume a project has earnings before depreciation and taxes of $120,000, depreciation of $40,000, and that the firm has a 30 percent tax bracket. What are the after-tax cash flows for the project? (4 points) $56,000 $96,000 a loss of $21,000 none of these Chapter 2, Pages 34-39, Chapter 9 Page 275 After Tax Cash Flows: Net Income + Depreciation Net Income = $120,000 - $40,000 = $80,000 Taxes Taxes = $80,000 x 30% = $24,000 Net Income = $80,000 24,000 = $56,000 After Tax Cash Flows: Net Income + Depreciation = $56,000 + 40,000 = $96,000 12. (TCO 8) Which of the following statements is true regarding systematic risk?(4 points) is diversifiable is the total risk associated with surprise events it is measured by beta it is measured by standard deviation Chapter 11, Pages 354-355 (TCO 8) Which of the following statements is true regarding systematic risk?(4 points) is diversifiable is the total risk associated with surprise events it is not project or firm specific it is measured by standard deviation Chapter 11, Pages 354-355 (TCO 8) Which of the following factors will affect the expected rate of return on a security?(4 points) multiple states of the economy probability of occurrence for any one economic state market rate of return given a particular economic state all of the above will affect the expected rate of return Chapter 11, Pages 354-355 (TCO 8) Which statement is true regarding risk? (4 points) the expected return is usually the same as the actual return a key to assess risk is determining how much risk an investment adds to a portfolio risks can always be decreased or mitigated by the financial manager the higher the risk, the lower the return investors require for the investment Week 5 Lecture 13. (TCO 8) Which statement is not true regarding risk?(4 points) the expected return is always the same as the actual return a key to assess risk is determining how much risk an investment adds to a portfolio risks can not always be diversified the higher the risk, the higher the return investors require for the investment Week 5 Lecture (TCO 8) Which statement is not true regarding risk?(4 points) the expected return is usually not the same as the actual return a key to assess risk is determining how much risk an investment adds to a portfolio some risks can not be decreased or mitigated by the financial manager. the higher the risk, the higher the return investors require for the investment all of the above are true statements Week 5 Lecture (TCO 8) The stock of Uptown Men's Wear is expected to produce the following returns, given the various states of the economy. What is the expected return on this stock? State of Economy Probability of State of Economy Rate of Return Recession .20 -.10 Normal .75 .14 Boom .05 .22 (4 points) 9.6 percent 10.4 percent 12.8 percent 13.6 percent 15.3 percent Chapter 11, Pages 340-341 14. Expected return = (.20 -41; -.10) + (.75 -41; .14) + (.05 -41; .22) = -.02 + .105 + .011 = .096 = 9.6 percent (TCO 8) The stock of Chocolate Galore is expected to produce the following returns, given the various states of the economy. What is the expected return on this stock? State of Economy Probability of State of Economy Rate of Return Recession .02 -.06 Normal .88 .11 Boom .10 .17 (4 points) 7.33 percent 9.82 percent 11.26 percent 11.33 percent 11.50 percent Chapter 11, Pages 340-341 Expected return = (.02 -41; -.06) + (.88 -41; .11) + (.10 -41; .17) = -.0012 + .0968 + .0170 = .1126 = 11.26 percent (TCO 8) The stock of Hobby Town has an expected return of 8.8 percent. Given the information below, what is the expected return on this stock if the economy is normal? State of Economy Probability of State of Economy Rate of Return Recession .10 -.09 Normal .70 ? Boom .20 .26 (4 points) 3.86 percent 4.42 percent 6.43 percent 7.28 percent 8.21 percent Chapter 11, Pages 340-341 15. .088 = (.10 -41; -.09) + (.70 -41; x) + (.20 -41; .26) = .088 = -.009 + .7x + .052 x = .06429 = 6.43 percent (TCO 8) You own a portfolio that consists of $8,000 in stock A, $4,600 in stock B, $13,000 in stock C, and $5,500 in stock D. What is the portfolio weight of stock D?(4 points) 17.68 percent 17.91 percent 18.42 percent 19.07 percent 19.46 percent Chapter 11, Page 344 Answer: $5,500/(8,000+4,600+13,000+5,500) = $5,500/31,100 = 17.68% (TCO 8) You own a portfolio that consists of $8,000 in stock A, $4,600 in stock B, $13,000 in stock C, and $5,500 in stock D. What is the portfolio weight of stock B?(4 points) 14.79 percent 15.91 percent 18.42 percent 19.07 percent 19.46 percent Chapter 11, Page 344 Answer: $4,600/(8,000+4,600+13,000+5,500) = $4,600/31,100 = 14.79% (TCO 8) You own a portfolio that consists of $8,000 in stock A, $4,600 in stock B, $13,000 in stock C, and $5,500 in stock D. What is the portfolio weight of stock A?(4 points) 14.79 percent 15.91 percent 18.42 percent 16. 19.07 percent 25.72 percent Chapter 11, Page 344 Answer: $8,000/(8,000+4,600+13,000+5,500) = $8,000/31,100 = 25.72% (TCO 8) You would like to create a portfolio that is equally invested in a risk-free asset and two stocks. The one stock has a beta of .80. What does the beta of the second stock have to be if you want the portfolio risk to equal that of the overall market?(4 points) 1.4 1.6 1.8 2.0 2.2 Chapter 11, Pages 356-358 1/3(0) + 1/3(.80) + 1/3(x) = 1.0 0 + .80 + x = 3 x = 2.2 (TCO 8) You currently own a portfolio valued at $24,000 that has a beta of 1.1. You have another $8,000 to invest, and would like to invest it in a manner such that the risk of the new portfolio matches that of the overall market. What does the beta of the new security have to be?(4 points) .46 .55 .61 .70 .90 Chapter 11, Pages 356-358 17. (TCO 8) Stock A has an expected return of 14 percent and a beta of 1.3. Stock B has an expected return of 10 percent and a beta of .9. Both stocks have the same reward-to-risk ratio. What is the risk-free rate?(4 points) 1.0 percent 1.8 percent 2.3 percent 2.5 percent 3.1 percent Chapter 11, Pages 356-358 (TCO 8) Company insiders cannot earn excess profits based on the knowledge they have related to their employer if the financial markets are:(4 points) weak form efficient. strong form efficient. semistrong form efficient. efficient at any level. aware that the trader is an insider. Chapter 10, Pages 329-330 (TCO 8) If the financial markets are strong form efficient, then:(4 points) 18. only the most talented analysts can determine the true value of a security. only company insiders have a marketplace advantage. technical analysis provides the best tool to gain a marketplace advantage. no one person has an advantage in the marketplace. every security offers the same rate of return. Chapter 10, Pages 329-330 (TCO 8) Weak form market efficiency states that the value of a security is based on:(4 points) all public and private information. historical information only. all publicly available information. all publicly available information, plus any data that can be gathered from insider trading. random information with no clear distinction as to the source of that information. Chapter 10, Pages 329-330 (TCO 5) Royal Petroleum Co. can buy a piece of equipment that can be financed with debt at a cost of 6 percent (after-tax) and common equity at a cost of 18 percent. Assume debt and common equity each represent 50 percent of the firm's capital structure. What is the weighted average cost of capital?(4 points) between 3 and 9% exactly 12% more than 14% exactly 11% none of the above Weighted Cost Weights Cost 19. Debt 6% 50% 3% Common equity 18% 50% 9% Weighted average cost of capital 12% (TCO 5) Royal Petroleum Co. can buy a piece of equipment that can be financed with debt at a cost of 9 percent (after-tax) and common equity at a cost of 16 percent. Assume debt and common equity each represent 50 percent of the firm's capital structure. What is the weighted average cost of capital?(4 points) between 4.5% and 8% more than 13% between 12 and 13% between 13 and 14% none of the above Weighted Cost Weights Cost Debt 9% 50% 4.5% Common equity 16% 50% 8.0% Weighted average cost of capital 12.5% (TCO 5) Royal Petroleum Co. can buy a piece of equipment that can be financed with debt at an after-tax cost of 8 percent and common equity at a cost of 20 percent. Assume debt and common equity each represent 50 percent of the firm's capital structure. What is the weighted average cost of capital?(4 points) between 4% and 10% between 11 and 12% between 12 and 13% exactly 14% more than 14% Weighted 20. Cost Weights Cost Debt 8% 50% 4% Common equity 20% 50% 10% Weighted average cost of capital 14% (TCO 5, 6 and 7) An issue of common stock is selling for $57.20. The year end dividend is expected to be $2.32, assuming a constant growth rate of six percent. What is the required rate of return? (4 points) 10.3% 10.1% 4.1% 5.8% Chapter 12, Pages 380-382 Answer: R = D1/P0 + g = 2.32/57.20 + 0.06 = 0.1006 = 10.06% (TCO 5, 6 and 7) An issue of common stock is expected to pay a dividend of $4.80 at the end of the year. Its growth rate is equal to eight percent. If the required rate of return is 13 percent, what is its current price? (4 points) $103.68 $36.92 $96.00 none of these Chapter 12, Pages 380-382 Answer: P = D1/R-g = $4.80 /(0.13-0.08) = $96 (TCO 5, 6 and 7) An issue of common stock's most recent dividend is $3.75. Its growth rate is eight percent. What is its price if the market's rate of return is 16 percent? (4 points) $25.01 $46.88 $50.63 21. none of these Chapter 12, Pages 380-382 Answer: P = D1/R-g = $4.80 /(0.13-0.08) = $96 (TCO 5, 6 and 7) Which of the following is not true regarding the cost of debt?(4 points) It is the return that the firms creditors demand on new borrowing. It is the interest rate that the firm pays on current/existing borrowing. An appropriate method to compute the cost of debt is using the YTM of current bonds outstanding. It needs to be converted into an after-tax cost. Chapter 12, Pages 384-385 and Week 6 Lecture (TCO 5, 6 and 7) Which of the following is true regarding the cost of debt?(4 points) It is the return that the firms creditors demand on new borrowing. It is always equal to the weighted cost of capital. An appropriate method to compute the cost of debt is using the coupon rate of current bonds outstanding. All of the above are true. Chapter 12, Pages 384-385 and Week 6 Lecture (TCO 5, 6 and 7) Which of the following is true regarding the cost of debt?(4 points) It is the same as cost of equity. It is the interest rate that the firm pays on current/existing borrowing. An appropriate method to compute the cost of debt is using the YTM of current bonds outstanding. All of the above are true. Chapter 12, Pages 384-385 and Week 6 Lecture (TCO 5) Retained earnings has a cost associated with it because: (4 points) new funds must be raised. there is an opportunity cost associated with stockholder funds. 22. Ke> g flotation costs increase the cost of funding. Week 6 Lecture (TCO 5) Which of the following is true regarding the cost of retained earnings?(4 points) it is irrelevant to the WACC requires new funds to be raised need to be adjusted for the flotation costs have a cost, which is the opportunity cost associated with stockholder funds Week 6 Lecture (TCO 5) Which of the following is not true regarding the cost of retained earnings?(4 points) it is relevant to the WACC does not require new funds to be raised has associated flotation costs has a cost, which is the opportunity cost associated with stockholder funds Week 6 Lecture (TCO 4) A project has the following cash flows. What is the internal rate of return? Year 0 1 2 3 Cash flow -$195,600 $99,800 $87,600 $75,300 (4 points) less than 5% between 5 and 15% between 15 and 18% more than 21% Chapter 8, Pages 241-243 23. Answer: For this problem, you need to use the approximation method on Example 8.3 of your text, page 243 or a financial calculator. If you use the approximation method, the net present value at the IRR should equal zero. This value is 17.23% (TCO 4) A project has the following cash flows. What is the internal rate of return? Year 0 1 2 3 Cash flow -$443,600 $224,800 $224,800 $67,200 (4 points) less than 7% between 8 and 11% more than 13% exactly 15% Chapter 8, Pages 241-243 Answer: For this problem, you need to use the approximation method on Example 8.3 of your text, page 243 or a financial calculator. If you use the approximation method, the net present value at the IRR should equal zero. This value is 9.55% (TCO 4) A project has the following cash flows. What is the internal rate of return? Year 0 1 2 3 Cash flow - $520,000 $112,900 $367,200 $204,600 (4 points) less than 10% approximately 14% more than 16% more than 18% but less than 20% Chapter 8, Pages 241-243 Answer: For this problem, you need to use the approximation method on Example 8.3 of your text, page 243 or a financial calculator. If you use the approximation method, the net present value at the IRR should equal zero. This value is 13.97% 24. (TCO 5, 6 and 7) Which one of the following is a correct statement?(4 points) Current tax laws favor debt financing. A decrease in the dividend growth rate increases the cost of equity. An increase in the systematic risk of a firm will decrease the firm's cost of capital. A decrease in a firm's debt-equity ratio will usually decrease the firm's cost of capital. The cost of preferred stock decreases when the tax rate increases. Chapter 12, Pages 385-389 (TCO 5, 6 and 7) All else constant, the weighted average cost of capital for a firm will decrease if:(4 points) a firm's bonds start selling at a premium, rather than at a discount. the market risk premium increases. the firm replaces some of its debt with preferred stock. corporate taxes are eliminated. the dividend yield on the common stock increases. Chapter 12, Pages 385-389 (TCO 5, 6 and 7) Which one of the following is a correct statement regarding a firm's weighted average cost of capital (WACC)?(4 points) the WACC can be used as the required return for all new projects. the WACC of a leveraged firm will decrease when the tax rate decreases. an increase in the market risk premium will tend to decrease a firm's WACC. the WACC is a starting point for the subjective approach to setting discount rates. a reduction in the risk level of a firm will tend to increase the firm's WACC. Chapter 12, Pages 385-389 (TCO 5, 6 and 7) The nine percent preferred stock of Bean Coffee is selling for $39 a share. What is the firm's cost of 25. preferred stock if the tax rate is 35 percent and the par value per share is $100?(4 points) 17.97% 19.25% 23.08% 24.67% 25.65% Chapter 12, Pages 384-385 Rp = (.09 $100) / $39 = .23077 = 23.08 percent (TCO 5, 6 and 7) The six percent preferred stock of FKH Manufacturing is selling for $62 a share. What is the firm's cost of preferred stock, if the tax rate is 34 percent and the par value per share is $100?(4 points) 5.98% 7.06% 8.05% 9.68% 10.10% Chapter 12, Pages 384-385 Rp = (.06 $100) / $62 = .09677 = 9.68 percent (TCO 5, 6 and 7) The preferred stock of Blue Sky Air pays an annual dividend of $7.25 a share and sells for $54 a share. The tax rate is 35 percent. What is the firm's cost of preferred stock?(4 points) 8.56 percent 9.32 percent 11.85 percent 13.43 percent 14.47 percent 26. Chapter 12, Pages 384-385 Rp = $7.25 / $54 = .13426= 13.43 percent (TCO 2) Which one of the following statements is true concerning a bankruptcy?(4 points) a Chapter 7 bankruptcy is a reorganization proceeding. a "prepack" is intended to shorten the time a firm spends in bankruptcy. the absolute priority rule applies to both Chapter 7 and Chapter 11 bankruptcy proceedings, and must be adhered to by the courts. creditors cannot force a firm into bankruptcy, even though they might like to do so. a reorganization plan, can only be approved if the firm's creditors all agree with the plan. Chapter 13, Pages 427-431 (TCO 2) The bankruptcy process has been utilized by firms as a means of:(4 points) renegotiating labor contracts. reducing labor costs. avoiding payment of a legal judgment. improving the firm's competitive position. all of the above Chapter 13, Pages 427-431 (TCO 2) Which one of the following occurs if a firm files for Chapter 7 bankruptcy, but does not generally occur if the firm files for Chapter 11 bankruptcy?(4 points) a petition is filed in federal court administrative fees are incurred a list of creditors is compiled pre-bankruptcy shareholders tend to lose part, if not all, of their investment in the firm a trustee-in-bankruptcy is elected by the creditors 27. Chapter 13, Pages 427-431 (TCO 5) Which of the following statements is true regarding the cost of capital?(4 points) The cost of capital should not consider any flotation costs. All other being equal, it is preferable to use book value weights than market value weights. The WACC is the most appropriate discount rate for all projects. Depends primarily on the use of the funds, not the source. Week 6 Lecture, Chapter 12 (TCO 5) Which of the following statements is false regarding the cost of capital?(4 points) The cost of capital should consider the flotation costs. All other being equal, it is preferable to use market value weights than book value weights. The WACC is the most appropriate discount rate for all projects. Should include the cost of retained earnings. Week 6 Lecture, Chapter 12 (TCO 5) Which of the following statements is true regarding the cost of capital?(4 points) All other being equal, it is preferable to use market value weights than book value weights The WACC is the most appropriate discount rate for all projects. Should not include the cost of retained earnings. Depends primarily on the source of the funds, not the use. Week 6 Lecture, Chapter 12 (TCO 2) Select any actions that do not affect the cash account.(4 points) Goods are sold cash An interest payment on a notes payable is made A payment due is received from a client Dividends are paid to shareholders 28. Inventory is purchased and paid for with credit Chapter 16, Pages 498-499 (TCO 2) Which of the following decreases the cash account?(4 points) A payment due is received from a client Dividends are paid to shareholders Raw materials are purchased and paid for with credit A new machine is purchased and paid for with the business line of credit Chapter 16, Pages 498-499 (TCO 2) Which of the following increases the cash account?(4 points) Goods are sold on credit An interest payment on a notes payable is made A payment due is received from a client Raw materials are purchased and paid for with credit Chapter 16, Pages 498-499 (TCO 2) Which of the following statements is true?(4 points) The optimal credit policy minimizes the total cost of granting credit. Firms should avoid offering credit at all cost. An increase in a firm's average collection period generally indicates that an increased number of customers are taking advantage of the cash discount. Character, refers to the ability of a firm to meet its credit obligations out its operating cash flows. The optimal credit policy, is the policy that produces the largest amount of sales for a firm. Chapter 17, Pages 545-548 and Week 7 Lecture (TCO 2) Which of the following statements is true? (4 points) Firms should avoid offering credit at all cost. An increase in a firm's average collection period generally indicates that an increased 29. number of customers are taking advantage of the cash discount. The costs of the credit application process and the costs expended in the collection process are carrying costs of granting credit. Character, refers to the ability of a firm to meet its credit obligations out its operating cash flows. The optimal credit policy, is the policy that produces the largest amount of sales for a firm. Chapter 17, Pages 545-548 and Week 7 Lecture (TCO 2) Which of the following statements is true? (4 points) There is an opportunity cost associated with not offering credit. The costs of the credit application process and the costs expended in the collection process are not carrying costs of granting credit. Character, refers to the ability of a firm to meet its credit obligations out its operating cash flows. The optimal credit policy, is the policy that produces the largest amount of sales for a firm. Chapter 17, Pages 545-548 and Week 7 Lecture (TCO 2) Which one of the following credit terms is most apt to produce the shortest accounts receivable period? (4 points) net 25 net 10 1/10, net 30 3/10, net 15 2/20, net 45 Chapter 17, Page 542 (TCO 2) All else constant, a decrease in the accounts receivable period will:(4 points) lengthen the accounts payable period. shorten the inventory period. 30. lengthen the operating cycle. shorten the cash cycle. shorten the accounts payable period. Chapter 17, Page 541-543 (TCO 2) Which one of the following industries is most apt to have the shortest cash cycle?(4 points) electric utility company airplane manufacturer fast-food restaurant furniture store clothing manufacturer Chapter 17, Page 534-535 (TCO 2) Delphinia's has the following estimated quarterly sales for next year. The accounts receivable period is 30 days. What is the expected accounts receivable balance at the end of the second quarter? Assume each month has 30 days. Q1 Q2 Q3 Q4 Sales $1,800 $1,700 $2,100 $1,900 (4 points) $567 $600 $821 $1,134 $1,200 Q2 accounts receivable balance = (30 / 90) -41; $1,700 = $567 (TCO 2) The Yellow Box has the following estimated quarterly sales for next year. The accounts receivable period is 45 days. What is the expected accounts receivable balance at the end of the third quarter? Assume each month has 30 days. 31. Q1 Q2 Q3 Q4 Sales $1,200 $1,400 $1,800 $1,700 (4 points) $600 $750 $900 $1,050 $1,200 Q3 accounts receivable balance = (45 / 90) -41; $1,800 = $900 (TCO 2) Highland, Inc. has the following estimated quarterly sales for next year. The accounts receivable period is 30 days. How much does the firm expect to collect in the fourth quarter? Assume that each month has 30 days. Q1 Q2 Q3 Q4 Sales $3,200 $4,500 $4,400 $2,900 (4 points) $3,250 $3,400 $3,600 $3,750 $3,900 Q4 collections = (30/90) -41; $4,400 + (60/90) -41; $2,900 = $1,466.67 + $1,933.33 = $3,400 (TCO 1) Which of the following statements is true regarding the goal of financial management?(4 points) The goal of maximizing the value per share of existing stock is relevant to all organizations. The ultimate goal of financial management is maximizing earnings and profits. For a company considering international operations, the goal will be the same but the company will have to consider the local, social, economical, 32. and political environment in the decision-making process. None of the above are true statements. Chapter 1, pages 10-11 (TCO 1) Which one of the following actions best matches the primary goal of financial management?(4 points) increasing the net, working capital while lowering the long-term asset requirements improving the operating efficiency, thereby increasing the market value of the stock increasing the firms market share reducing fixed costs and increasing variable costs increasing the liquidity of the firm by transferring short-term debt into long-term debt Chapter 1, pages 10-11 (TCO 1) Why is maximization of the current value per share a more appropriate financial management goal than profit maximization?(4 points) Because by maximizing the current stock value, you also maximize the companys profit for the year. Because this criterion is non-ambiguous. Because financial managers always act in the best interest of shareholders. Because it creates short-term gains in the financial statements. Chapter 1, pages 10-11 (TCO 1) Which of the these activities is a capital budgeting task?(4 points) determining the amount of cash needed on a daily basis to operate a firm . identifying assets that produce value in excess of the cost to acquire those assets establishing the inventory level establishing a new credit policy Chapter 1, Page 5, Week 1 Lecture 33. M (TCO 3) You deposited $8,000 in your bank account today. Which of the following will increase the future value of your deposit, assuming that all interest is reinvested? Assume the interest rate is a positive value. Select all that apply: (4 points) a decrease in the interest rate increasing the initial amount of your deposit decreasing the frequency of the interest payments extending the length of the investment period Chapter 4, Pages 96-101 M (TCO 3) You deposited $11,000 in your bank account today. Which of the following will decrease the future value of your deposit, assuming that all interest is reinvested? Assume the interest rate is a positive value. Select all that apply: (4 points) a decrease in the interest rate increasing the initial amount of your deposit increasing the frequency of the interest payments decreasing the length of the investment period Chapter 4, Pages 96-101 (TCO 1) Which one of the following activities best exemplify working capital management?(4 points) Sale long-term bonds to raise funds for a new machine. Determine the return of a potential project. Calculate the cash flows for a project. Manage payments to suppliers. 34. Chapter 1, Page 5, Week 1 Lecture (TCO 1) Which of the following are capital structure concerns? I. how to obtain short-term financing II. the company's financing mix III. the cost of funds IV. how and where to raise money(4 points) I and II I, II and III II, III and IV I, III and IV All of the above Chapter 1, Page 5, Week 1 Lecture M (TCO 3) You deposited $5,000 in your bank account today. An increase in which of the following will increase the future value of your deposit, assuming that all interest is reinvested? Assume the interest rate is a positive value. Select all that apply: (4 points) interest rate initial amount of your deposit frequency of the interest payments length of the investment period Chapter 4, Pages 96-101 (TCO 1) Market values reflect which of the following:(4 points) 35. The amount someone is willing to pay today for an asset. The value of the asset based on generally-accepted accounting principles. The assets historical cost. A and B only None of the above Chapter 2, Page 26 (TCO 1) Book values are different from market values because:(4 points) Book values reflect the value of the asset based on generally-accepted accounting principles. Book values are used in the companys balance sheet. Book values do not reflect the amount someone is willing to pay today for an asset. All of the above None of the above Chapter 2, Page 26 (TCO 1) Market value is important to the financial manager because:(4 points) It reflects the value of the asset based on generally-accepted accounting principles. Is a crucial component of the balance sheet, and can impact the financial statements. Market values reflect the amount someone is willing to pay today for an asset. The market value of an asset reflects its historical cost. Chapter 2, Page 26-27 (TCO 1) Use the following tax table to answer this : Taxable Income Tax Rate 36. $0- $50,000 15% $50,001- 75,000 25 $75,001- 100,000 34 $100,001- 335,000 39 $335,001- 10,000,000 34 John has taxable income of $389,745. What is Johns average tax rate?(4 points) 33% 34% 36% 37% 38% Chapter 2, Page 33 Total tax = ($50,000)(.15) + ($25,000)(.25) + ($25,000)(.34) + ($235,000)(.39) + ($389,745 $335,000)(.34) = $132,513 $132,513/389,745 = 33.99 = 34% (TCO 1) Use the following tax table to answer this : Taxable Income Tax Rate $0- $50,000 15% $50,001- 75,000 25 $75,0 1- 100,000 34 $100,001- 335,000 39 $335,001- 10,000,000 34 Riddell, Inc. earned $144,320 in taxable income for the year. How much tax does the company owe on this income?(4 points) $39,535 $49,069 37. $51,285 $56,285 $78,535 Chapter 2, Page 33 Total tax = ($50,000)(.15) + ($25,000)(.25) + ($25,000)(.34) + ($144,320 $100,000)(.39) = $39,535 $39,535 (TCO 1) Use the following tax table to answer this : Taxable Income Tax Rate $0- 50,000 15% $50,001- 75,000 25 $75,001- 100,000 34 $100,001- 335,000 39 $335,001- 10,000,000 34 Kenzie, Inc. earned $144,320 in taxable income for the year. What is the companys approximate average tax rate?(4 points) 27% 29% 31% 33% 35% Chapter 2, Page 33 Total tax = ($50,000)(.15) + ($25,000)(.25) + ($25,000)(.34) + ($144,320 $100,000)(.39) = $39,535 $39,535 $39,535/$144,320=27.4% (TCO 3) Regional Bank offers you an APR of 19 percent compounded semiannually, and Local Bank offers you an EAR of 19.50 percent for a new automobile loan. You should choose ______________ because 38. its _______ is lower.(4 points) Regional Bank, APR Local Bank, EAR Regional Bank, EAR Local Bank, APR Chapter 5, page 140 Answer: You need to compare the EAR. EAR for Regional Bank = (1+APR/m)^m 1 = (1+0.19/2)^2 1 = 19.90% (TCO 3) Regional Bank offers you an APR of 19 percent compounded semiannually, and Local Bank offers you an EAR of 20.10 percent for a new automobile loan. You should choose ______________ because its _______ is lower.(4 points) Regional Bank, APR Local Bank, EAR Regional Bank, EAR Local Bank, APR Chapter 5, page 140 Answer: You need to compare the EAR. EAR for Regional Bank = (1+APR/m)^m 1 = (1+0.19/2)^2 1 = 19.90% (TCO 3) Regional Bank offers you an APR of nine percent compounded quarterly, and Local Bank offers you an EAR of 9.15 percent for a new automobile loan. You should choose ______________ because its _______ is lower.(4 points) Regional Bank, APR Local Bank, EAR Regional Bank, EAR Local Bank, APR Chapter 5, page 140 Answer: You need to compare the EAR. 39. EAR for Regional Bank = (1+APR/m)^m 1 = (1+0.09/4)^4 1 = 9.31% (TCO 3) Thirteen years from now, you will be inheriting $30,000. What is this inheritance worth to you today, if you can earn four percent interest compounded annually?(4 points) $18,017.22 $20,741.87 $23,190.98 $26,359.88 $28,846.15 (TCO 3) You want to have $15,000 for a down payment on a house five years from now. If you can earn 13 percent, compounded annually, on your savings, how much do you need to deposit today to reach your goal?(4 points) $7,858.11 $8,141.40 $9,803.58 $12,464.28 $14,213.25 (TCO 3) Amy needs to save $20,000 in cash to buy a new car five years from today. She expects to earn 6.5 percent, compounded annually, on her savings. How much does she need to deposit today, if this is the only money she saves for this purpose?(4 points) $12,468.07 $12,502.14 $14,597.62 40. $17,044.32 $17,129.01 (TCO 3) Paper Pro needed a new store. The company spent $65,000 to refurbish an old shop and create the current facility. The firm borrowed 75 percent of the refurbishment cost at eight percent interest for 11 years. What is the amount of each monthly payment?(4 points) $91.05 $284.13 $556.50 $682.87 $731.60 (TCO 3) High Risk Operations, Inc. owes your firm $52,800. This amount is delinquent, so you have offered to arrange a payment plan in the hopes that you might at least collect a portion, if not all, of this money. Your offer will consist of weekly payments for two years, at an interest rate of four percent. What is the amount of each payment? (Current (TCO 3) The new home that you want to buy costs $249,500. You plan to make a cash down payment of 20 percent and finance the balance over 10 years at 6.75 percent. What will be the amount of your monthly mortgage payment?(4 points) $2,291.89 41. $2,809.10 $3,287.46 $3,412.67 $4,145.68 (TCO 3) John borrowed $5,500 four years ago at an annual interest rate of 10 percent. The loan term is seven years. Since he borrowed the money, Sonny has been making annual payments of $550 to the bank. Which type of loan does John have?(4 points) interest-only pure discount compounded amortized complex Chapter 5, Pages 144-174 (TCO 3) Amy borrowed $5,000 from her bank three years ago. The loan term is five years. Each year, Amy must repay the bank $1,000 plus the annual interest. Which type of loan does Amy have?(4 points) amortized blended discount interest-only 42. pure discount complex Chapter 5, Pages 144-174 (TCO 3) Which type of loan is comparable to the present value of a future lump sum?(4 points) effective annual rate amortized interest-only annual percentage pure discount Chapter 5, Pages 144-174 (TCO 3) Fanta Cola has $1,000 par value bonds outstanding at 12 percent interest. The bonds mature in 25 years. What is the current price of the bond, if the YTM is 11 percent? Assume annual payments.(4 points) $1080 $1085 $925 $1000 Chapter 6 Pages 163-166, Week 3 Lecture Determine coupon/interest payments = $1,000 x 12% = $120 PV of interest payments (as an annuity) = $120 x 8.422 = $1010.64 (25 periods, 11% rate) PV of principal (single amount) = $1000 x 0.074 = $74 Total = $1010.64 + $74 = $1,084.64 (TCO 3) Fanta Cola has $1,000 par value bonds outstanding at 12 percent interest. The bonds mature in 25 years. What is the current price of the bond if the YTM is 13 percent? Assume annual payments.(4 points) $1078 43. $1085 $927 $1000 Chapter 6 Pages 163-166, Week 3 Lecture Determine coupon/interest payments = $1,000 x 12% = $120 PV of interest payments (as an annuity) = $120 x 7.33 = $879.60 (25 periods, 13% rate) PV of principal (single amount) = $1000 x 0.047 = $47 Total = $879.60 + $47 = $926.60 (TCO 3) Fanta Cola has $1,000 par value bonds outstanding at 12 percent interest. The bonds mature in 25 years. What is the current price of the bond if the YTM is 16 percent? Assume annual payments.(4 points) $1315 $1300 $756 $1000 Chapter 6 Pages 163-166, Week 3 Lecture Determine coupon/interest payments = $1,000 x 12% = $120 PV of interest payments (as an annuity) = $120 x 6.097= $731.64 PV of principal (single amount) = $1000 x 0.024 = $24 Total = $731.64 + $24 = $755.64 (TCO 6) Which of the following is true regarding the primary market?(4 points) it is the market where the largest number of shares are traded on a daily basis. it is the market in which the largest number of issues are listed. it is the market with the largest number of participants. it is the market where new securities are offered. it is the market where shareholders trade most frequently with each other. Chapter 7 Page 216 (TCO 6) The market where one shareholder 44. sells shares to another shareholder is called the _____ market.(4 points) primary main secondary principal dealer Chapter 7 Page 216 (TCO 6) The market where new securities are offered is called the _____ market.(4 points) primary main secondary principal dealer Chapter 7 Page 216 (TCO 7) Which one of the following statements concerning financial leverage is correct?(4 points) The benefits of leverage are unaffected by the amount of a firm's earnings. The use of leverage will always increase a firm's earnings per share. The shareholders of a firm are exposed to greater risk anytime a firm uses financial leverage. Earnings per share are unaffected by changes in a firm's debt-equity ratio. Financial leverage is beneficial to a firm only when the firm has minimal earnings. Chapter 13, Pages 409-413 (TCO 7) Which one of the following statements concerning financial leverage is correct?(4 points) 45. Financial leverage increases profits and decreases losses. Financial leverage has no effect on a firm's return on equity. Financial leverage, refers to the use of common stock. Financial leverage magnifies both profits and losses. Increasing financial leverage will always increase the earnings per share. Chapter 13, Pages 409-413 (TCO 7) A taxpaying, levered firm's optimal capital structure:(4 points) is 100 percent equity financing. consists of equal amounts of debt and equity financing. is the mixture of debt and equity financing that minimizes the firm's aftertax cost of debt. is the mixture of debt and equity financing that minimizes the weighted average cost of capital. is 100 percent debt financing. Chapter 13, Pages 409-413 (TCO 3) A 10-year bond pays 11 percent interest on a $1000 face value annually. If it currently sells for $1,195, what is its approximate yield to maturity?(4 points) 9.33% 7.94% 12.66% 8.10% Week 3 Lecture Use the trial and error approach or the formula provided on the lecture for an approximation. Using the formula = See week 3 formula Approximate YTM = [$110+($1000-1195/10)]/[(0.6*1195)+(0.4x1000)] = $90.50/1,117 = 8.10% 46. (TCO 3) What is the approximate yield to maturity for a seven-year bond that pays 11 percent interest on a $1000 face value annually if the bond sells for $952?(4 points) 10.5% 10.6% 11.5% 12.1% Week 3 Lecture Use the trial and error approach or the formula provided on the lecture for an approximation. Using the formula = See lecture in week 3 Approximate YTM = [$110+($1000-952/7)]/[(0.6*952)+(0.4x1000)] = $117/971 = 12.1% (TCO 3) SmithKline Company's bonds are currently selling for $1,157.75 per $1000 par-value bond. The bonds have a 10 percent coupon rate and will mature in 10 years. What is the approximate yield to maturity?(4 points) 6.96% 7.69% 11.0% 12.1% Week 3 Lecture Use the trial and error approach or the formula provided on the lecture for an approximation. Using the formula = see week 3 lecture Approximate YTM = [$100+($1000-1157.75/10)]/[(0.6*1157.75)+(0.4x1000)] = $84.23/1094.65 = 7.69% (TCO 8) Which of the following is true regarding bonds?(4 points) Bonds do not carry default risk. Bonds are sensitive to changes in the interest rates. 47. Moodys and Standard and Poors provide information regarding a bonds interest rate risk. Municipal bonds are free of default risk. None of the above is true Week 3 Lecture (TCO 8) Which of the following is true regarding bonds?(4 points) Bonds do not carry default risk. Bonds are not sensitive to changes in the interest rates. Moodys and Standard and Poors provide information regarding a bonds interest rate risk. Municipal bonds are not free of default risk. None of the above is true Week 3 Lecture (TCO 8) Which of the following is true regarding bonds?(4 points) Most bonds do not carry default risk. Municipal bonds are free of default risk. Bonds are not sensitive to changes in the interest rates. Moodys and Standard and Poors provide information regarding a bonds interest rate risk. None of the above is true Week 3 Lecture (TCO 8) Two years ago, Maple Enterprises issued six percent, 20-year bonds and Temple Corp issued six percent, 10-year bonds. Since their time of issue, interest rates have increased. Which of the following statements is true of each firm's bond prices in the market, assuming they have equal risk?(4 points) Maple's decreased more than Temple's Temple's decreased more than Maple's 48. Maple's increased more than Temple's They are both priced the same Chapter 6, Page 167 (TCO 8) Which one of the following bonds is the most sensitive to interest rate movements? (4 points) zero-coupon, five year seven percent annual coupon, five year zero-coupon, 10 year five percent semi-annual coupon, 10 year five percent annual coupon, 10 year Chapter 6, Page 167 (TCO 8) Two years ago, MorningStar Company issued seven percent, 25- year bonds and Track, Inc. issued seven percent, 10-year bonds. Since their time of issue, interest rates have increased. Which of the following statements is true of each firm's bond prices in the market, assuming they have equal risk?(4 points) Track's decreased more than Morningstar's Morningstar's increased more than Track's Morningstar's decreased more than Track's They are both priced the same Chapter 6, Page 167 (TCO 6) A sinking fund is an account managed by a bond trustee for the sole purpose of:(4 points) paying interest payments on a semi-annual basis. redeeming bonds early. repaying the face value at maturity. paying the expenses required to reissue outstanding bonds. 49. paying the "balloon payment" at maturity. Chapter 6, Page 167 (TCO 6) A call provision in a bond agreement grants the issuer the right to:(4 points) repurchase the bonds prior to maturity at a pre-specified price. replace the bonds with equity securities. repurchase the bonds after maturity at a pre-specified price. change the coupon rate, provided the bondholders are notified in advance. buy back the bonds on the open market prior to maturity. Chapter 6, Page 176 (TCO 6) Star Industries has one bond issue outstanding. An indenture provision prohibits the firm from redeeming the bonds during the first two years. This provision is referred to as a _____ provision.(4 points) deferred call market liquidity debenture sinking fund Chapter 6 Page 176 (TCO 6) Which of the following is true regarding put bonds?(4 points) Have coupons that depend on the companys income Can be exchanged for a fixed number of shares before maturity only Can be exchanged for a fixed number of shares before maturity Allow the holder to require the issuer to buy the bond back (TCO 1) Provide three examples of situations in which business ethics play 50. a role in the financial management process. Explain your rationale, and how these situations may affect the value of the firm. (10 points) Chapter 1, Pages 10-12 - environmental clean-up - employee safety programs - outsourcing and offshoring - move operations to foreign countries for tax advantages - downsizing / cut jobs to increase shareholder value Students should recognize the costs and benefits of each example. (TCO 1) Provide three examples of recent well-known unethical behavior cases. Explain the situation in one or two paragraphs. How do you believe that this behavior affected the firms value?(10 points) Week 1 Lecture. - Parmalats fraudulent accounting practices - Martha Stewarts insider trading on Ilone - Microsoft antitrust case - Worldcom, Enron, Tyco Students should recognize that these types of situations may result in bankruptcy or penalties for corporate management. (TCO 6) Which of the following is true regarding income bonds?(4 points) Are relatively uncommon Can be exchanged for a fixed number of shares at maturity only Can be exchanged for a fixed number of shares before maturity Allow the holder to require the issuer to buy the bond back Chapter 6 Page 182 (TCO 6) Which of the following is true regarding convertible bonds?(4 points) Are relatively uncommon Can be exchanged for a fixed number of shares after the maturity only Can be exchanged for a fixed number of shares before maturity Allow the holder to require the issuer to buy the bond back Chapter 6 Page 182 (TCO 1) Recent announcements of massive layoffs have increased stock prices for certain companies. Critics argue that this reaction encourages companies to fire employees. Do 51. you agree or disagree?(10 points) Chapter 1, Pages 10-12. Such layoffs generally occur in the context of corporate restructurings. To the extent that the market views a restructuring as value-creating, stock prices will rise. So, its not the layoffs per se that are being cheered on, but the cost savings associated with the layoffs. Nonetheless, Wall Street does encourage corporations to take actions to create value, even if such actions involve layoffs. It is an ethical decision of the companys managers. (TCO 4) What are sunk costs? Provide at least two real-life examples of sunk costs for a project. Should sunk costs be included as incremental cash flows? Why or why not? Explain your rationale.(10 points) Chapter 9, Page 269 Some examples of sunk costs will include the marketing costs related to launching a new product into the market, or research and development costs on a pharmaceutical product. Sunk costs are not incremental, and therefore, not relevant to the decision at hand. Sunk costs are incurred regardless of the decision of accepting or rejecting a project and therefore, should not be included as part of the project cash flows. (TCO 6 and 7) Financial leverage deals with:(4 points) the relationship of fixed and variable costs. the percentage of debt in the capital structure. the entire income statement. the entire balance sheet. Chapter 2, Page 26 (TCO 6 and 7) The term debenture refers to(4 points) long-term, secured debt. long-term, unsecured debt. the after-acquired property clause. a document covering the specific terms of the debt issue. Chapter 6, Page 175 (TCO 4) What are erosion costs? Provide one real-life example of an erosion cost for a 52. project. Should erosion costs be included as project cash flows? Why or why not? Explain your rationale.(10 points) Chapter 9, Page 269 General Motors' decision of launching a new car into the market can negatively affect an existing model. The lost sales should be included in the project analysis process, and cash flows should be adjusted to reflect the declining sales on other models. (TCO 4) What is an opportunity cost? Provide two real-life examples of opportunity costs for a project. Should opportunity costs be included in the project analysis process? Why or why not? Explain your rationale. (10 points) Chapter 9, Page 269 Opportunity costs are the most valuable alternative that is given up if a particular investment is undertaken. A typical example is the use of land or buildings. Even if we own these properties, their use is not free. We could alternatively lease or sell the assets. Opportunity costs need to be included into the project analysis process. (TCO 6 and 7) The document that outlines the covenants and duties existing between bondholders and the issuing corporation is called(4 points) an indenture. a debenture. secured debt. protective covenants. Chapter 6, Page 174 (TCO 6) Company A has a bond outstanding with $90 annual interest payment, a market price of $820 and a maturity date in five years. Assume the par value to be $1,000. What is the bonds coupon rate and current yield, respectively?(4 points) 11% and 9% 9% and 11% 9% and 14% Cannot be determined 53. None of the above Chapter 6, Pages 169-172 Answer: Coupon Rate = $90/1,000 = 9% Current yield = $90/820 = 10.98% = 11% (TCO 8) Consider the following statement: Any risk is diversifiable. Do you agree or disagree? Why?(10 points) Chapter 11, Pages 350-353 Some of the risk in holding any asset is unique to the asset in . By investing in a variety of assets, this unsystematic portion of the total risk can be eliminated at little cost. On the other hand, there are systematic risks that affect all investments. This portion of the total risk of an asset cannot be costlessly eliminated. In other words, systematic risk can be controlled, but only by a costly reduction in expected returns. (TCO 8) What is the difference between systematic and unsystematic risk? Provide one example of each. Can both systematic and unsystematic risks be diversified? Why or why not? (10 points) Chapter 11, Pages 350-353 Some of the risk in holding any asset is unique to the asset in ; these are unsystematic risks. On the other hand, systematic risks such as inflation or interest rates, have market-wide effects. By investing in a variety of assets, only the unsystematic portion of the total risk can be eliminated at little cost. (TCO 6) Company A has a bond outstanding with $90 annual interest payment, a market price of $820, and a maturity date in five years. Assume the par value to be $1,000. What is the bonds yield to maturity?(4 points) 9% 14% 11% Cannot be determined None of the above Chapter 6, Pages 169-172 Using the formula = See lecture in week 3 Approximate YTM = [$90+($1000-820/5)]/[(0.6*820)+(0.4x1000)] = $126/892 = 14.13% 54. (TCO 6) Company A has a bond outstanding with $90 annual interest payment, a market price of $820, and a maturity date in five years. Assume the par value to be $1,000. What is the bond's current yield?(4 points) 9% 14% 11% Cannot be determined None of the above Chapter 6, Pages 169-172 Answer: Current yield = $90/820 = 10.98% = 11% (TCO 8) What is the difference between business risk and financial risk? If Company A has a higher business risk than Company B, should its cost of capital be higher? Why or why not? Explain your rationale. (10 points) Chapter 13, Pages 416-417 Business risk, is the equity risk arising from the nature of the firms operating activity, and is directly related to the systematic risk of the firms assets. Financial risk, is the equity risk that is due entirely to the firms chosen capital structure. As financial leverage, or the use of debt financing, increases, so does financial risk and hence the overall risk of the equity. Thus, Company B could have a higher cost of equity if it uses greater leverage. (TCO 2) What are some important factors to consider when conducting a credit evaluation and scoring? (10 points) Chapter 17, Pages 546-547 Answers will vary, but students should relate to credit information, as well as the five Cs of credit. (TCO 2) Which of the following does not reduce collection float?(4 points) installing a lockbox system. deposit collections weekly, instead of daily. requiring all customers pay by cash, rather than with check. utilize the benefits of the Check Clearing Act for the 21st Century. 55. Chapter 17, Pages 531-533 (TCO 2) Which one of the following practices will reduce a firm's collection float? (4 points) utilizing zero-balance accounts depositing checks weekly, rather than daily requiring all customers pay by check, rather than with cash installing a lockbox system paying all bills five days sooner Chapter 17, Pages 531-533 (TCO 2) What are the costs associated with extending (or not extending) a credit policy to customers?(10 points) Chapter 17, Pages 541-549 The costs of granting credit are carrying costs, specifically the cost of debt, possibility of default, and the cash discount. The major cost of not grating credit is the opportunity cost of lost sales. The sum of these costs for different levels of receivables creates the total credit cost curve. (TCO 2) What are some important elements of the collection policy? (10 points) Chapter 17, Pages 547-548 Monitoring receivables through aging schedules, conduct collection efforts such as sending out delinquency letters, following up by phone or email, contracting a collection agency, and taking legal action against customers. (TCO 2) Which of the following does not reduce collection float?(4 points) consolidate all lockboxes into one lockbox, located near the home office. consolidate all lockboxes into one lockbox, located far from the home office. make sure all checks it receives are properly dated and signed. utilize the benefits of the Check Clearing Act for the 21st Century. Chapter 17, Pages 531-533 (TCO 2) Storage and tracking costs, insurance and taxes, and losses due to theft are examples of:(4 points) Inventory depletion costs 56. Sunk costs Inventory costs None of the above Chapter 17, Page 550