公司金融final模拟题和答案

Final Practice for the course

Goal of firm Answer: d MEDIUM i. The primary operating goal of a publicly-owned firm interested in serving its

stockholders should be to

a. Maximize its expected total corporate income.

b. Maximize its expected EPS.

c. Minimize the chances of losses.

d. Maximize the stock price per share over the long run, which is the stock’s

intrinsic value.

e. Maximize the stock price on a specific target date.

Firm organization Answer: c EASY ii. Which of the following statements is CORRECT?

a. One of the advantages of the corporate form of organization is that it avoids

double taxation.

b. It is easier to transfer one’s ownership interest in a partnership than in a

corporation.

c. One of the disadvantages of a sole proprietorship is that the proprietor is

exposed to unlimited liability.

d. One of the advantages of a corporation from a social standpoint is that every

stockholder has equal voting rights, i.e., “one person, one vote.”

e. Corporations of all types are subject to the corporate income tax.

Dividends, retained earnings Answer: b EASY/MEDIUM iii. Fine Breads Inc. paid out $26,000 common dividends during 2005, and it ended the year with $150,000 of retained earnings. The prior year’s retained earnings were

$145,000. What was the firm's 2005 net income?

a. $30,000

b. $31,000

c. $32,000

d. $33,000

e. $34,000

Statement of cash flows Answer: d MEDIUM iv. Which of the following statements is CORRECT?

a. In the statement of cash flows, depreciation charges are reported as a use of

cash.

b. In the statement of cash flows, a decrease in accounts receivable is reported as a

use of cash.

c. In the statement of cash flows, a decrease in inventories is reported as a use of

cash.

d. In the statement of cash flows, a decrease in accounts payable is reported as a

use of cash.

e.

considered to be a financing activity, not an operating activity.

Effect of reducing costs on ROE Answer: a MEDIUM v. Last year, Candle Corp had $200,000 of assets, $300,000 of sales, $20,000 of net income, and a debt-to-total-assets ratio of 40%. The new CFO believes a new

computer program will enable it to reduce costs and thus raise net income to $30,000.

Assets, sales, and the debt ratio would not be affected. By how much would the cost

reduction improve the ROE?

a. 8.33%

b. 8.67%

c. 9.00%

d. 9.33%

e. 9.67%

Du Pont equation: basic calculation Answer: b EASY vi. Midwest Lumber had a profit margin of 5.1%, a total assets turnover of 1.6, and an equity multiplier of 1.8. What was the firm's ROE?

a. 14.39%

b. 14.69%

c. 14.99%

d. 15.29%

e. 15.59%

Current ratio Answer: e EASY vii. A firm wants to strengthen its financial position. Which of the following actions would INCREASE its current ratio?

a. Borrow using short-term debt and use the proceeds to repay debt that has a

maturity of more than one year.

b. Reduce the company’s days’ sales outstanding ratio to the industry average and

use the resulting cash savings to purchase plant and equipment.

c. Use cash to increase inventory holdings.

d. Use cash to repurchase some of the company’s own stock.

e. Issue new stock and use some of the proceeds to purchase additional inventory

and hold the remainder of the funds received as cash.

Estimating the 1-year forward rate Answer: e MEDIUM viii. Suppose the interest rate on a 1-year T-bond is 5.0% and that on a 2-year T-bond is

6.0%. Assuming the pure expectations theory is correct, what is the market's

forecast for 1-year rates 1 year from now?

a. 6.65%

b. 6.74%

c. 6.83%

d. 6.92%

e. 7.01%

Default risk premium Answer: b EASY

ix. If 10-year T-bonds have a yield of 5.2%, 10-year corporate bonds yield 7.5%, the maturity risk premium on all 10-year bonds is 1.1%, and corporate bonds have a

0.2% liquidity premium versus a zero liquidity premium for T-bonds, what is the

default risk premium on the corporate bond?

a. 2.00%

b. 2.10%

c. 2.20%

d. 2.30%

e. 2.40%

Amortization Answer: a MEDIUM x. Which of the following statements regarding a 30-year, $100,000 mortgage with a nominal interest rate of 10%, compounded monthly, is NOT CORRECT?

a. The monthly payments will decline over time.

b. The proportion of the monthly payment that represents interest will be lower

for the last payment than for the first payment on the loan.

c. The total dollar amount of principal being paid off each month gets larger as

the loan approaches maturity.

d. The amount paid toward interest in the first payment would be lower if the

nominal interest rate were 8%.

e. Over 90% of the first payment goes toward interest

PV of an annuity due Answer: a EASY xi. Your father is about to retire, and he wants to buy an annuity that will provide him with $50,000 of income a year for 20 years, with the first payment coming

immediately. The going rate on such annuities is 6%. How much would it cost him

a. $607,905.82

b. $416,110.34

c. $517,513.68

d. $615,976.84

e. $488,349.15

Comparing the effective cost of two bank loans Answer: e MEDIUM/HARD xii. Bank A offers to lend you $10,000 at a nominal rate of 6%, simple interest, with interest paid monthly. Bank B offers to lend you the $10,000, but it will charge 7%,

simple interest, with interest paid at the end of the year. What is the difference in the

effective annual rates charged by the two banks?

a. 1.17%

b. 1.12%

c. 0.91%

d. 1.28%

e. 0.83%

Interest rate price risk Answer: b EASY/MEDIUM xiii. Assume that all interest rates in the economy decline from 10% to 9%. Which of the following bonds will have the largest percentage increase in price?

a. A 10-year bond with a 10% coupon.

b. A 10-year zero coupon bond.

c. An 8-year bond with a 9% coupon.

d. A 1-year bond with a 15% coupon.

e. A 3-year bond with a 10% coupon.

Determining the coupon rate Answer: c MEDIUM/HARD xiv. Moussawi Ltd's outstanding bonds have a $1,000 par value, and they mature in 5 years. Their yield to maturity is 9%, based on semiannual compounding, and the

current market price is $853.61. What is the bond's annual coupon interest rate?

a. 5.10%

b. 5.20%

c. 5.30%

d. 5.40%

e. 5.50%

Constant growth rate Answer: b EASY xv. Hahn Manufacturing is expected to pay a dividend of $1.00 per share at the end of the year (D1 = $1.00). The stock sells for $40 per share, and its required rate of return is

11%. The dividend is expected to grow at a constant rate, g, forever. What is Hahn's

expected growth rate?

a. 8.00%

b. 8.50%

c. 9.00%

d. 9.50%

e. 10.00%

Nonconstant growth stock price Answer: a HARD xvi. The Ehrhardt Company's last dividend was $2.00. The dividend growth rate is expected to be constant at 3% for 2 years, after which dividends are expected to grow

at a rate of 8% forever. Erhardt’s required return (r s) is 12%. What is Erhardt's

current stock price?

a. $49.20

b. $51.40

c. $53.80

d. $55.10

e. $57.30

WACC Answer: c MEDIUM xvii. Which of the following statements about the cost of capital is CORRECT?

a. A change in a company’s target capital structure cannot affect its WACC.

b. WACC calculations should be based on the before-tax costs of all the individual

capital components.

c. If a company’s tax rate increases, then, all else equal, its weighted average cost of

capital will decrease.

d. Flotation costs associated with issuing new common stock normally lead to a

decrease in the WACC.

e. An increase in the risk-free rate will normally lower the marginal costs of both

debt and equity financing.

Risk and project selection Answer: b MEDIUM

xviii. Wagner Inc estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a

WACC of 12%. Which of the following projects (A, B, and C) should the company

accept?

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

b. Project B is of below-average risk and has a return of 8.5%.

c. Project C is of above-average risk and has a return of 11%.

d. None of the projects should be accepted.

e. All of the projects should be accepted.

WACC Answer: a MEDIUM xix. You were hired as a consultant to Locke Company, and you were provided with the following data: Target capital structure: 40% debt, 10% preferred, and 50%

common equity. The interest rate on new debt is 7.5%, the yield on the preferred is

7.0%, the cost of retained earnings is 11.50%, and the tax rate is 40%. The firm will

not be issuing any new stock. What is the firm’s WACC?

a. 8.25%

b. 8.38%

c. 8.49%

d. 8.61%

e. 8.76%

Component cost of preferred stock Answer: e EASY xx. Klieman Company’s perpetual preferred stock sells for $90 per share and pays a $7.50 annual dividend per share. If the company were to sell a new preferred issue, it

would incur a flotation cost of 5.00% of the price paid by investors. What is the

company's cost of preferred stock?

a. 7.50%

b. 7.79%

c. 8.21%

d. 8.57%

e. 8.77%

Component cost of debt Answer: a MEDIUM xxi. Several years ago the Haverford Company sold a $1,000 par value bond that now has

25 years to maturity and an 8.00% annual coupon that is paid quarterly. The bond

currently sells for $900.90, and the company’s tax ra te is 40%. What is the

component cost of debt for use in the WACC calculation?

a. 5.40%

b. 5.73%

c. 5.98%

d. 6.09%

e. 6.24%

Component cost of retained earnings: DCF, D0Answer: b MEDIUM xxii. Assume that Mary Brown Inc. hired you as a consultant to help it estimate the cost of capital. You have been provided with the following data: D0 = $1.20; P0 = $40.00;

and g = 7% (constant). Based on the DCF approach, what is Brown's cost of equity

from retained earnings?

a. 10.06%

b. 10.21%

c. 10.37%

d. 10.54%

e. 10.68%

NPV, IRR, and MIRR Answer: a MEDIUM xxiii. Which of the following statements is CORRECT?

a. If a project with normal cash flows has an IRR greater than the WACC, the

project must have a positive NPV.

b. If Project A’s IRR exceeds Project B’s, then A must have the higher NPV.

c. A project’s MIRR can never exceed its IRR.

d. If a project with normal cash flows has an IRR less than the WACC, the project

must have a positive NPV.

e. If the NPV is negative, the IRR must also be negative.

Discounted payback (nonconstant cash flows; 4 years) Answer: d MEDIUM xxiv. Reynolds Bikes is considering a project that has the following cash flow and WACC data. What is the project's discounted payback?

WACC = 10%

Year: 0 1 2 3 4

Cash flows: -$1,000 $525 $485 $445 $405

a. 1.66 years

b. 1.82 years

c. 2.03 years

d. 2.36 years

e. 2.41 years

IRR (uneven cash flows; 4 years) Answer: a EASY/MEDIUM xxv. Rockmont Recreation Inc. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be less

than the WACC (and even negative), in which case it will be rejected.

Year: 0 1 2 3 4

Cash flows: -$1,000 $250 $230 $210 $190

a. -5.15%

b. -3.44%

c. -1.17%

d. 2.25%

e. 3.72%

NPV vs IRR (size differences) Answer: c MEDIUM/HARD xxvi. Pettway Inc. is considering Projects S and L, whose cash flows are shown below.

These projects are mutually exclusive, equally risky, and not repeatable. If the

decision is made by choosing the project with the higher IRR, how much value will

be forgone? Note that under some conditions choosing projects on the basis of the

IRR will cause $0.00 value to be lost.

WACC = 12%

Year: 0 1 2 3 4

CF S: -$1,025 $375 $380 $385 $390

CF L: -$2,153 $750 $759 $768 $777

a. $15.57

b. $21.49

c. $27.52

d. $33.69

e. $37.39

Relevant cash flows Answer: e EASY xxvii. Which of the following is NOT a cash flow that should be included in the analysis of a project?

a. Changes in net operating working capital.

b. Shipping and installation costs.

c. Cannibalization effects.

d. Opportunity costs.

e. Sunk costs that have been expensed for tax purposes.

Sunk costs Answer: d EASY/MEDIUM xxviii. Which of the following statements is CORRECT?

a.An example of a sunk cost is the cost associated with restoring the site of a

strip mine once the ore has been depleted.

b.Sunk costs must be considered if the IRR method is used but not if the firm

relies on the NPV method.

c. A good example of a sunk cost is a situation where a bank opens a new office,

and that new office leads to a decline in deposits of the bank’s other offices.

d. A good example of a sunk cost is money that a banking corporation spent last

year to investigate the site for a new office, expensed those funds for tax

purposes, and now is deciding whether or not to go forward with the project.

e.If sunk costs are considered and reflected in a project’s cash flows, then the

project’s calculated NPV will be higher than it otherwise would be.

Beta coefficient Answer: d MEDIUM xxix. Stock A has a beta of 1.5 and Stock B has a beta of 0.5. Which of the following statements must be true about these securities? (Assume the market is in

a. When held in isolation, Stock A has more risk than Stock B.

b. Stock B would be a more desirable addition to a portfolio than Stock A.

c. Stock A would be a more desirable addition to a portfolio than Stock B.

d. In equilibrium, the expected return on Stock A will be greater than that on

Stock B.

e. In equilibrium, the expected return on Stock B will be greater than that on

Stock A.

Required return Answer: b MEDIUM xxx. In the next year, the market risk premium, (r M - r RF), is expected to fall, while the risk-free rate, r RF, is expected to remain the same. Given this forecast, which of

the following statements is CORRECT?

a. The required return for all stocks will fall by the same amount.

b. The required return will fall for all stocks, but it will fall more for stocks with

higher betas.

c. The required return will fall for all stocks, but it will fall less for stocks with

higher betas.

d. The required return will increase for stocks with a beta less than 1.0 and will

decrease for stocks with a beta greater than 1.0.

e. The required return on all stocks will remain unchanged.

Portfolio beta Answer: e EASY

xxxi. Tom Skinner has $45,000 invested in a stock with a beta of 0.8 and another $55,000 invested in a stock with a beta of 1.4. These are the only two

investments in his portfolio. What is his portfolio’s beta?

a. 0.93

b. 0.98

c. 1.03

d. 1.08

e. 1.13

Portfolio beta Answer: c HARD

xxxii. Assume that you manage a $10.00 million mutual fund that has a beta of 1.05 and

a 12.00% required return. The risk-free rate is 4.75%. You now receive another

$10.00 million, which you invest in stocks with an average beta of 0.65. What is the required rate of return on the new $20.00 million portfolio? (Hint: You must first find the market risk premium, then find the new portfolio beta.)

a. 10.02%

b. 10.54%

c. 10.62%

d. 11.31%

e. 12.62%

Coefficient of variation Answer: b

xxxiii. Ripken Iron Works faces the following probability distribution:

Stock’s Expected

State of Probability of Return if this

the Economy State Occurring State Occurs

Boom 0.25 25%

Normal 0.50 15

Recession 0.25 5

What is the coefficient of variation on the company’s stock?

a. 0.06

b. 0.47

c. 0.54

d. 0.67

e. 0.71

CAPM Answer: b MEDIUM xxxiv. Apex Roofing's stock has a beta of 1.50, its required return is 14.00%, and the risk-free rate is 5.00%. What is the required rate of return on the stock market?

(Hint: First find the market risk premium.)

a. 10.50%

b. 11.00%

c. 11.50%

d. 12.00%

e. 12.50%

i. Goal of firm Answer: d MEDIUM

The primary operating goal should be to maximize the long-run

stock price, or the intrinsic value.

ii. Firm organization Answer: c EASY iii. Dividends, retained earnings Answer: b EASY/MEDIUM

Current RE$150,000

Previous RE = Current RE + increment$145,000

Change in RE$5,000

Plus dividends paid$26,000

= Net income$31,000

iv. Statement of cash flows Answer: d MEDIUM v. Effect of reducing costs on ROE Answer: a MEDIUM

Assets$200,000

Debt ratio40%

Debt$80,000

Equity$120,000

Sales$300,000

Old net income$20,000

New net income$30,000

New ROE25.000%

Old ROE16.667%

Increase in ROE8.33%

vi. Du Pont equation: basic calculation Answer: b EASY Profit margin 5.1%

TATO 1.60

Equity multiplier 1.80

ROE14.69%

vii. Current ratio Answer: e EASY viii. Estimating the 1-year forward rate Answer: e MEDIUM

1-year rate today 5.0%

2-year rate today 6.0%

Ending return if buy the 2-year bond = needed return on series of 1-year bonds 1.1236

Rate of return, or yield, on a 1-year bond 1 year from now: X in (1.05)(1+X) = 1.1236

X = 1.1236/1.05 - 1 =7.01% ix. Default risk premium Answer: b EASY T bond yield 5.20%

Corporate yield7.50%

MRP 1.10%

LP0.20%

DRP 2.10%

x. Amortization Answer: a MEDIUM Statement a is false, because monthly payments will not decline over

time, they will stay the same. Statement b is true, because the

percentage paid toward interest declines over time. Statement c is

true, because interest due for every payment gets progressively

smaller, which means that the portion toward principal gets larger.

Statement d is true, because if the interest rate is lower, less is

paid toward interest. Statement e is true. Therefore, answer choice

a is the correct answer.

xi. PV of an annuity due Answer: a EASY

BGN mode

N20

I/YR 6.00%

PV$607,905.82

PMT-$50,000

FV$0.00

xii. Comparing the effective cost of two bank loans Answer: e MEDIUM/HARD Students must understand that "simple interest with interest paid monthly" means that the

bank gets the interest at the end of each month, hence it can invest it, presumably at the same

nominal rate. This results in the same effective rate as if it were stated as "6%, monthly

compounding." The problem can be worked most easily using the interest conversion feature

of a calculator. It could also be worked using the conversion formula. We applied the formula

using Excel.

Nominal rate, Bank A6%

Nominal rate, Bank B7%

Periods/yr, A12

Periods/yr, B1

EFF% A 6.17%

EFF% B7.00%

Difference0.83%

xiii. Interest rate price risk Answer: b EASY/MEDIUM

Statement b is correct, because the longer-term, lowest coupon

bond will have the greatest price effect due to interest rates.

xiv. Determining the coupon rate Answer: c MEDIUM/HARD First use the data provided to find the dollar coupon payment per 6 months, multiply by 2 to get the

annual coupon, and then divide by the par value to find the coupon rate.

Par value$1,000.00

Maturity5

Periods/year2

N10

YTM9.00%

Periodic rate 4.50%Coupon rate = 5.30%

xv. Constant growth rate Answer: b EASY

Expected dividend (D1)$1.00

Stock price$40.00

xvi. Nonconstant growth stock price Answer: a HARD

Last dividend (D0)$2.00

Short-run growth rate 3.0%

Long-run growth rate8%

Required return12%

Year0123

Dividend$2.00$2.06$2.12$2.29

Terminal value57.29

Total CFs$2.06$59.41

PV of CFs$1.84$47.36

Stock price$49.20

xvii. WACC Answer: c MEDIUM Statement c is true, because if the tax rate increases the tax

deductibility benefits of debt financing increase, resulting in a

lower WACC. The other statements are false.

xviii. R isk and project selection Answer: b MEDIUM The project whose return is greater than its risk-adjusted cost of

capital should be selected. Only Project B meets this criterion.

xix. WACC Answer: a MEDIUM

Weights Rate AT Costs

Debt40%7.50% 4.50%

Preferred10%7.00%

Common50%11.50%

Tax rate40%

WACC8.25%

xx. Component cost of preferred stock Answer: e EASY Preferred stock price$90.00

Preferred dividend$7.50

Flotation cost 5.00%

r p8.77%

xxi. Component cost of debt Answer: a MEDIUM Coupon rate8.00%

Periods/year4

Maturity (yr)25

Bond price$900.90

Par value$1,000

Tax rate40%

Calculator inputs:

N100

PV-$900.90

PMT$20

xxii. Component cost of retained earnings: DCF, D0Answer: b MEDIUM

D0 $1.20

P0 $40.00

g7.00%

D1 $1.28

r s10.21%

xxiii.NPV, IRR, and MIRR Answer: a MEDIUM xxiv. Discounted payback (nonconstant cash flows; 4 years) Answer: d MEDIUM

WACC:10.00%

01234

Cash flows -$1,000$525$485$445$405Answer:PV of CFs -$1,000$477$401$334$277Cumulative CF -$1,000-$523-$122$212$489Payback = 2.36--- 2.36- xxv. IRR (uneven cash flows; 4 years) Answer: a EASY/MEDIUM

1234Cash flows

-$1,000$250$230$210$190

Answer:

IRR =

-5.15%

xxvi. NPV vs IRR (size differences)

Answer: c MEDIUM/HARD

WACC:12.00%01234CF S -$1,025$375$380$385$390CF L

-$2,153$750$759$768$777

Answer:IRR, L 15.5%IRR, S 18.1%NPV, L $162.16

S

L 0%505.0901.02%431.0753.44%362.5616.86%299.1490.38%240.3372.910%185.6263.812%134.6162.214%87.167.316%42.7-21.218% 1.2-104.120%-37.7-181.822%-74.2-254.624%

-108.6

-323.1

xxvii.Relevant cash flows Answer: e EASY

xxviii.

Sunk costs

Ans

xxix. Beta coefficient

Answer: d MEDIUM

xxx.Required return Answer: b MEDIUM

The easiest way to see this is to write out the CAPM: r s = r RF + (r M–

r RF)b. Clearly, a change in the market risk premium is going to have the

most effect on firms with high betas. Consequently, statement b is the

correct choice.

xxxi.Portfolio beta Answer: e EASY

Company Investment Port. weight Beta Weight x beta

0.80

Stock 2$55,0000.550 1.40

$100,000 1.00

xxxii.Portfolio beta Answer: c HARD Old funds (millions)$10.00

New funds (millions)$10.00

Total portfolio$20.00

Req'd return, old stocks

New portfolio

Old portfolio's beta 1.05

xxxiii.Coefficient of variation Answer: b The expected rate of return will equal 0.25(25%)+0.5(15%) + 0.25(5%)

= 15%. The variance of the expected return is:

0.25(25% - 15%)2 + 0.5(15% -15%)2 + 0.25(5% - 15%)2 = 0.0050.

The standard deviation is the square root of 0.0050 = 0.0707.

And, CV = 0.0707/0.15 = 0.47.

xxxiv. CAPMAnswer: b MEDIUM

Beta 1.50 Risk-free rate 5.00% Required return on stock14.00% Market risk premium 6.00% Required return on market11.00%