TestIII-FINN3120-090Fall2009(2.5PTSPERQUESTION.

MAX100PTS)

TypeA

Name___________________________________ID
PRINTYOURNAMEANDIDONTHETEST,ANSWERSHEETANDFORMULASHEET.
TURNINTHETEST,OPSCANANSWERSHEETANDFORMULASHEET.
STUDENTCANHAVEONELETTERSIZEFORMULASHEETPREPAREDBYSTUDENTHIM/HERSELF.
FINANCIALCALCULATOR/TI-83ORTHEIREQUIVALENCESAREALLOWED.
MULTIPLECHOICE.Choosetheonealternativethatbestcompletesthestatementoranswersthequestion.
1) Preferredstockissimilartocommonstockinthefollowingway:
A) asequity,botharesubordinatetobondholdersintheeventofbankruptcy.
B) bothpreferredstockandcommonstockprovideequalperiodicdividends.
C) bothcontainadividendgrowthfactor.
D) bothinvestmentshaveafinalmaturityvaluesetbytheissuingagreement.

1)

2) ABCCorp.commonstockpaid$2.50individendslastyear(D 0 ).Dividendsareexpectedtogrow

2)

ata12-percentannualrateforever.IfABCscurrentmarketpriceis$70.00,whatisthestocks
expectedrateofreturn(nearest.01percent)?
A) 16.00%
B) 5.50%
C) 18.25%
D) 19.00%
3) YantiCorp.preferredstockhasa5%stateddividendpercentage,anda$100parvalue.Whatisthe
valueofthestockifyourrequiredrateofreturnis6%peryear?
A) $30.00
B) $100.00
C) $94.05
D) $83.33

3)

4) Preferredstockissimilartoabondinthefollowingway:
A) bothprovideinterestpayments.
B) preferredstockalwayscontainsamaturitydate.
C) bothinvestmentsprovideastatedincomestream.
D) bothcontainagrowthfactorsimilartocommonstock.

4)

5) YouobserveGoldenFlashesCommonStocksellingfor$40.00pershare.Thenextdividendis
expectedtobe$4.00,andisexpectedtogrowata2%annualrateforever.Ifyourrequiredrateof
returnis14%,shouldyoupurchasethestock?
A) Yes,becausethepresentvalueoftheexpectedfuturecashflowsislessthan$40.
B) No,becausethepresentvalueoftheexpectedfuturecashflowsislessthan$40.
C) No,becausethepresentvalueoftheexpectedfuturecashflowsisgreaterthan$40.
D) Yes,becausethepresentvalueoftheexpectedfuturecashflowsisgreaterthan$40.

5)

6) GreenlandAirlineshasnetincomeof$1millionthisyear.ThebookvalueofGreenlandAirlines
commonequityis$5milliondollars.Thecompanysdividendpayoutratiois70%andisexpected
toremainthisway.WhatisGreenlandAirlinesinternalgrowthrate?
A) 15%
B) 5.7%
C) 6.0%
D) 9%

6)

7) Whichofthefollowingstatementsconcerningtherequiredrateofreturnonstocksistrue?
A) Ifriskisreduced,therequiredreturnwilldecreasebecausemoreinvestorsarerisk-averse.
B) Thehigheraninvestorsrequiredrateofreturn,thehigherthevalueofthestock.
C) Therequiredreturnonpreferredstockisgenerallyhigherthantherequiredreturnon
commonstock.
D) Thehighertherisk,thehighertherequiredreturn,otherthingsbeingequal.

7)

8) Youareconsideringthepurchaseofacommonstockthatpaidadividendof$2.00yesterday.You
expectthisstocktohaveagrowthrateof10percentforthenext3years.Thelong -runnormal
growthrateafteryear3isexpectedtobe5percent(thatis,aconstantgrowthrateafteryear3of
5%peryearforever).Ifyourequirea15percentrateofreturn,howmuchshouldyoubewillingto
payforthisstock?
A) $26.89
B) $18.65
C) $36.24
D) $23.87

8)

9) NogrowthCorporationexpectstheirdividendtostayat$1.50pershareeachyearintothe
foreseeablefuture.Therefore,
A) Thestockwillbevaluedat$1.50timesthenumberofyearsaninvestorplanstokeepit.
B) Thevalueofthestockcanbeestimatedas$1.50dividedbyaninvestorsrequiredrateof
return.
C) Thevalueofthestockcannotbedeterminedusingthedividendvaluationmodelbecausethe
growthrateiszero.
D) Thefreecashflowmodelwillyieldahigherstockvalueiffreecashflowisgreaterthan$1.50
pershare.

9)

10) XYZcommonstockiscurrentlysellingfor$8.00.Itjustpaidadividendof$1.50anddividendsare
expectedtogrowatarateof6%indefinitely.WhatistherequiredrateofreturnonXYZsstock?
A) 33.00%
B) 26.00%
C) 20.60%
D) 18.00%

10)

11) Aprojectrequiresaninitialinvestmentof$50,000.Theprojectgeneratesfreecashflowof$80,000
attheendofyear2.Whatistheinternalrateofreturnfortheproject?
A) 34.16%
B) 44.08%
C) 19.66%
D) 26.44%

11)

12) TheKitchenInc.isconsideringthefollowing3mutuallyexclusiveprojects.Projectedcashflows
fortheseventuresareasfollows:

12)

PlanA
Initial
Outlay=$4,000,000
CashFlow:
Yr1=$-0Yr2=-0Yr3=-0Yr4=-0Yr5=$7,000,000

PlanB
Initial
Outlay=$5,000,000
CashFlow:
Yr1=$4,000,000
Yr2=3,000,000
Yr3=2,000,000
Yr4=-0Yr5=-0-

PlanC
Initial
Outlay=$1,750,000
CashFlow:
Yr1=$1,000,000
Yr2=-0Yr3=1,000,000
Yr4=1,000,000
Yr5=1,000,000

IftheKitchenhasa12%costofcapital,whatdecisionshouldbemaderegardingtheprojects
above?
A) AcceptplanA
B) AcceptplanB
D) AcceptPlansBandC
C) AcceptplanC
13) Palm,Inc.isconsideringtwomutuallyexclusiveprojects,AandB.ProjectAcosts$75,000andis
expectedtogenerate$48,000inyearoneand$45,000inyeartwo.ProjectBcosts$80,000andis
expectedtogenerate$34,000inyearone,$37,000inyeartwo,$26,000inyearthree,and$25,000in
yearfour.Zellars,Inc.srequiredrateofreturnfortheseprojectsis10%.Themodifiedinternalrate
ofreturnforProjectAandB,respectively,are:
A) 16.49%and15.74%.
B) 19.43%and13.40%.
C) 14.19%and15.74%.
D) 14.19%and13.40%.

13)

14) Youareconsideringinvestinginaprojectwiththefollowingyear-endafter-taxcashflows:

14)

Year1:$57,000
Year2:$72,000
Year3:$78,000
Year4:$20,000
Iftheinitialoutlayfortheprojectis$185,000,computetheprojectsinternalrateofreturn.
A) 10.89%
B) 5.54%
C) 9.61%
D) 6.98%
15) Whichofthefollowingmethodsofevaluatinginvestmentprojectscanproperlyevaluateprojects
ofunequallives?
A) Thepayback.
B) Theequivalentannualannuity.
C) Theinternalrateofreturn.
D) Thenetpresentvalue.

15)

16) Yourfirmisconsideringaninvestmentthatwillcost$750,000today.Theinvestmentwillproduce
cashflowsof$250,000inyear1,$300,000inyears2through4,and$100,000inyear5.Thediscount
ratethatyourfirmusesforprojectsofthistypeisforyear1throughyear4is13.25%.However,
youexpectthatyoucanreducethedicountrateto12.5%foryear5.Whatistheinvestmentsnet
presentvalue?
A) $147.544
B) $149,525
C) $147,613
D) $132,000

16)

17) ProjectAhasaninternalrateofreturn(IRR)of15percent.ProjectBhasanIRRof12percent.Both
projectshavearequiredreturnof14percent.Whichofthefollowingstatementsismostcorrect?
A) ProjectBhasahigherprofitabilityindexthanProjectA.
B) Bothprojectshaveapositivenetpresentvalue(NPV).
C) Iftherequiredreturnwerelessthan14percent,ProjectBwouldhaveahigherIRRthan
ProjectA.
D) ProjectAmusthaveahigherNPVthanprojectB.

17)

18) Wecomputetheprofitabilityindexofacapitalbudgetingproposalby
A) dividingthepresentvalueoftheannualaftertaxcashflowsbythecashinvestmentinthe
project.
B) multiplyingthecashinflowbytheinternalrateofreturn.
C) multiplyingtheinternalrateofreturnbythecostofcapital.
D) dividingthepresentvalueoftheannualaftertaxcashflowsbythecostofcapital.

18)

19) ThedisadvantageoftheIRRmethodisthat:
A) theIRRwillalwaysgivethesameprojectaccept/rejectdecisionastheNPV.
B) theIRRrequireslong,detailedcashflowforecasts.
C) theIRRgivesequalregardtoallreturnswithinaprojectslife.
D) theIRRdealswithcashflows.

19)

20) Rent-to-OwnEquipmentCo.isconsideringanewinventorysystemthatwillcost$450,000.The
systemisexpectedtogeneratepositivecashflowsoverthenextfouryearsintheamountsof
$250,000inyearone,$125,000inyeartwo,$25,000inyearthree,and$100,000inyearfour.
Rent-to-Ownsrequiredrateofreturnis10%.Whatisthepaybackperiodofthisproject?
A) 3.50years
B) 4.00years
C) 2.68years
D) 2.50years

20)

21) Whichofthefollowingstatementsaboutthenetpresentvalueistrue?
A) Itproducesapercentageresultthatiseasytodescribe.
B) ItislikelythattherewillbemorethanoneNPVforaproject.
C) Ithasaninadequatereinvestmentassumption.
D) Itmaybeusedtoselectamongprojectsofdifferentsizes.

21)

22) TheadvantagesofNPVareallofthefollowingexcept:
A) itallowsthecomparisonofbenefitsandcostsinalogicalmannerthroughtheuseoftime
valueofmoneyprinciples.
B) itprovidestheamountbywhichpositiveNPVprojectswillincreasethevalueofthefirm.
C) itcanbeusedasaroughscreeningdevicetoeliminatethoseprojectswhosereturnsdonot
materializeuntillateryears.
D) itrecognizesthetimingofthebenefitsresultingfromtheproject.

22)

23) Allofthefollowingaresufficientindicationstoacceptaproject except (assumethatthereisno

capitalrationingconstraint,andnoconsiderationisgiventopaybackasadecisiontool):
A) Thenetpresentvalueofanindependentprojectispositive.
B) TheIRRofamutuallyexclusiveprojectexceedstherequiredrateofreturn.
C) Theprofitabilityindexofanindependentprojectexceedsone.
D) TheNPVofamutuallyexclusiveprojectispositiveandexceedsthatofallotherprojects.

23)

24) InitialOutlay

24)

$4,000,000

CashFlowinPeriod
1
$1,546,170

2
$1,546,170

3
$1,546,170

4
$1,546,170

TheInternalRateofReturn(tonearestwholepercent)is:
A) 24%.
B) 20%.
C) 18%.

D) 10%.

25) Theriskfreerateofreturnis4%andtheexpectedreturnonthemarketportfoliois12%.Afirmhas
abetaof1.8andastandarddeviationofreturnsof16%.Itsmarginaltaxrateis30%.Analysts
expectStarshipsnetincometogrowby8%peryearforthenext5years.Usingthecapitalasset
pricingmodel,whatisStarshipEnterprisescostofretainedearnings?
A) 22.2%
B) 18.2%
C) 18.4%
D) 16.6%

25)

26) TheABCCompanyisplanninga$100millionexpansion.Theexpansionistobefinancedby
selling$40millioninnewdebtand$60millioninnewcommonstock.Thebefore -taxrequiredrate
ofreturnondebtis10percentandtherequiredrateofreturnonequityis15percent.Ifthe
companyisinthe30percenttaxbracket,whatisthefirmscostofcapital?
A) 12.9%
B) 9.7%
C) 10.000%
D) 11.8%

26)

27) Acompanyhaspreferredstockwithacurrentmarketpriceof$26.5pershare.Thepreferredstock
paysanannualdividendof4%basedonaparvalueof$100.Flotationcostsassociatedwiththe
saleofpreferredstockequal$1.50pershare.Thecompanysmarginaltaxrateis40%.Therefore,
thecostofpreferredstockis:
A) 15.09%.
B) 22.22%.
C) 16.00%.
D) 4.00%.

27)

28) Costofcapitalis:
A) theaveragecostofthefirmsassets.
B) ahurdleratesetbytheboardofdirectors.
C) therateofreturnthatmustbeearnedonadditionalinvestmentiffirmvalueistoremain
unchanged.
D) thecouponrateofdebt.

28)

29) Whichofthefollowingcausesafirmscostofcapital(WACC)todifferfromaninvestorsrequired
rateofreturnonthecompanyscommonstock?
A) Themarketriskpremiumexceeds12%.
B) Thefactthattheriskfreerateofinteresthasincreased.
C) Theincurrenceofflotationcostswhennewsecuritiesareissued.
D) NoneoftheabovetheWACCandrequiredreturnarethesame

29)

30) Durocorphasatargetcapitalstructureof50%debtand50%equity.Durocorpisplanningtoinvest
inaprojectthatwillnecessitateraisingnewcapital.Newdebtwillbeissuedatabefore-taxyield
of15%,withacouponrateof10%.Theequitywillbeprovidedbyinternallygeneratedfundssono
newoutsideequitywillbeissued.Iftherequiredrateofreturnonthefirmsstockis20%andits
marginaltaxrateis40%,computethefirmscostofcapital.
A) 14.5%
B) 17.5%
C) 15.00%
D) 13.68%

30)

31) GiventhefollowinginformationonS&GInc.scapitalstructure,computethecompanys
weightedaveragecostofcapital.

31)

Typeof
Capital

Percentof
CapitalStructure

Bonds
PreferredStock
CommonStock(InternalOnly)

Before-Tax
ComponentCost

40%
10%
50%

10%
15%
20%

Thecompanysmarginaltaxrateis40%.
A) 15.5%
B) 10.6%

C) 13.9%

D) 15%

32) ACompanyhasacapitalstructuremadeupof40%debtand60%equityandataxrateof30%.A
newissueof$1,000parbondsmaturingin20yearscanbeissuedwithacouponof9%atapriceof
$1,098.18withnoflotationcosts.Thefirmhasnointernalequityavailableforinvestmentatthis
time,butcanissuenewcommonstockatapriceof$45.Thenextexpecteddividendonthestockis
$2.80.ThedividendforMarsCo.isexpectedtogrowataconstantannualrateof5%peryear
indefinitely.Flotationcostsonnewequitywillbe$5.00pershare.TheWACCforthefirmis:
A) 9.76%

B) 9.44%

C) 9.20%

32)

D) 14%

33) WhichofthefollowingshouldNOTbeconsideredwhencalculatingafirmsWACC?
A) After-taxcostofaccountspayable
B) Costofnewlyissuedpreferredstock
C) After-taxYTMonafirmsbonds
D) Costofnewlyissuedcommonstock

33)

34) BellCorp.hasapreferredstockthatpaysadividendof$2.40.Ifyouarewillingtopurchasethe
stockat$11,whatisyourrequiredrateofreturn(roundyouranswertothenearest.1%and
assumethattherearenotransactioncosts)?
A) 9.1%
B) 11.0%
C) 20.1%
D) 21.8%

34)

35) Thecostofnewpreferredstockisequalto:
A) thepreferredstockdividenddividedbythemarketprice.
B) thepreferredstockdividenddividedbyitsparvalue.
C) preferredstockdividenddividedbythenetsellingpriceofpreferred.
D) (1-taxrate)timesthepreferredstockdividenddividedbynetprice.

35)

36) NogrowthCorporationexpectstheirdividendtostayat$0.50pershareeachyearintothe
foreseeablefuture.Therefore,
A) Thestockwillbevaluedat$0.50timesthenumberofyearsaninvestorplanstokeepit.
B) Thevalueofthestockcanbeestimatedas$0.50dividedbyaninvestorsrequiredrateof
return.
C) Thefreecashflowmodelwillyieldahigherstockvalueiffreecashflowisgreaterthan$0.50
pershare.
D) Thevalueofthestockcannotbedeterminedusingthedividendvaluationmodelbecausethe
growthrateiszero.

36)

TRUE/FALSE.A.TrueB.False
37) Preferredstockandcommonstockissuedbythesamefirmwillhavethesamerequiredreturn
becausetheriskinessofthefirmscashflowsisthesameforbothsecurities.

37)

38) Undermajorityvotingamajority(>50%)shareholderwilljustbeabletoelectasimplemajorityof
theboardofdirectors.

38)

39) Anacceptableprojectshouldhaveanetpresentvaluegreaterthanorequaltozeroanda
profitabilityindexgreaterthanorequaltoone.

39)

40) Shareholders,asownersofthecorporation,faceunlimitedliabilityforthecorporationsdebts,
whilebondholders,ascreditors,mayonlylosethevalueoftheirinvestmentifthecompanygoes
bankrupt.

40)

41) Anopportunitycostisarelevantincrementalcostforcapitalbudgetingdecisions.

41)

42) Iftheexpectedgrowthratefordividendsiszero,thenthevalueofcommonstockwillbeequalto
thecurrentdividend.

42)

AnswerKey
Testname:TESTIII

1) A
2) A
3) D
4) C
5) B
6) C
7) D
8) D
9) B
10) B
11) D
12) D
13) C
14) C
15) B
16) C
17) D
18) A
19) B
20) A
21) D
22) C
23) B
24) B
25) C
26) D
27) C
28) C
29) C
30) A
31) C
32) B
33) A
34) D
35) C
36) B
37) FALSE
38) FALSE
39) TRUE
40) FALSE
41) TRUE
42) FALSE