1)Which of the following statements is CORRECT?

a.Corporations are at a disadvantage relative to partnerships because they have to file more reports to state and federal agencies, including the Securities and Exchange Administration, even if they are not publicly owned.

b.Partnerships have difficulty attracting capital in part because of their unlimited liability, the lack of impermanence of the organization, and difficulty in transferring ownership.

c.In a regular partnership, liability for the firm's debts is limited to the amount a particular partner has invested in the business.

d.A fast-growth company would be more likely to set up as a partnership for its business organization than would a slow-growth company.

e.A major disadvantage of a partnership relative to a corporation as a form of business organization is the high cost and practical difficulty of its formation.

2) Jane Doe, who has substantial personal wealth and income, is considering the possibility of starting a new business in the chemical waste management field. She will be the sole owner, and she has enough funds to finance the operation. The business will have a relatively high degree of risk, and it is expected that the firm will incur losses for the first few years. However, the prospects for growth and positive future income look good, and Jane plans to have the firm pay out all of its income as dividends to her once it is well established. Which of the legal forms of business organization would probably best suit her needs?

a.Proprietorship, because of ease of entry.

b.Regular corporation, because of the limited liability.

c.S corporation, to gain some tax advantages and also to obtain limited liability.

d.Partnership, but only if she needs additional capital.

e.In this situation, the various forms of organization seem equally desirable.

3) Which of the following statements is CORRECT?

a.Relative to sole proprietorships, corporations generally face fewer regulations, which makes raising capital easier for corporations.

b.Bondholders are generally more willing than stockholders to have managers invest in risky projects with high potential returns as opposed to safer projects with lower expected returns.

c.There is no good reason to expect a firm's bondholders and stockholders to react differently to the types of new asset investments a firm makes.

d.Stockholders are generally more willing than bondholders to have managers invest in risky projects with high potential returns as opposed to safer projects with lower expected returns.

e.One disadvantage of operating as a corporation rather than as a partnership is that corporate shareholders are exposed to more personal liability than partners.

4) Which of the following statements is CORRECT?

a.Because most stock ownership is concentrated in the hands of a relatively small segment of society, firms' actions to maximize their stock prices have little benefit to society.

b.Corporations and partnerships have an advantage over proprietorships because a sole proprietor is exposed to unlimited liability, but the liability of all investors in the other types of businesses is more limited.

c.Most business in the U.S. is conducted by corporations, and corporations' popularity results primarily from their favorable tax treatment.

d.The potential exists for agency conflicts between stockholders and managers.

e.A good goal for a firm's management is maximization of expected EPS.

5) Which of the following statements is CORRECT?

a.A firm can show a large amount of retained earnings on its balance sheet yet need to borrow cash to make required payments.

b.If a firm reports a loss on its income statement, then the retained earnings account as shown on the balance sheet will be negative.

c.The retained earnings account as shown on the balance sheet shows the amount of cash that is available for paying dividends.

d.Common equity includes common stock and retained earnings, less accumulated depreciation.

e.Since depreciation is a source of funds, the more depreciation a company has, the larger its retained earnings will be, other things held constant.

6) Which of the following statements is CORRECT?

a.People sometimes talk about the firm's net cash flow, which is shown as the lowest entry on the income statement, hence it is often called "the bottom line."

b.The more depreciation a firm reports, the higher its tax bill, other things held constant.

c.Depreciation and amortization are not cash charges, so neither of them has an effect on a firm's reported profits.

d.Depreciation reduces a firm's cash balance, so an increase in depreciation would normally lead to a reduction in the firm's net cash flow.

e.Net cash flow (NCF) is often defined as follows:

Net Cash Flow = Net Income + Depreciation and Amortization Charges.

7) Companies generate income from their "regular" operations and from other sources like interest earned on the securities they hold, which is called non-operating income. Lindley Textiles recently reported $12,500 of sales, $7,250 of operating costs other than depreciation, and $1,000 of depreciation. The company had no amortization charges and no non-operating income. It had $8,000 of bonds outstanding that carry a 7.5% interest rate, and its federal-plus-state income tax rate was 40%. How much was Lindley's operating income, or EBIT?

a.$3,836

b.$4,250

c.$3,644

d.$3,462

e.$4,038

8) Last year Swensen Corp. had sales of $303,225, operating costs of $267,500, and year-end assets of $195,000. The debt-to-total-assets ratio was 27%, the interest rate on the debt was 8.2%, and the firm's tax rate was 37%. The new CFO wants to see how the ROE would have been affected if the firm had used a 45% debt ratio. Assume that sales and total assets would not be affected, and that the interest rate and tax rate would both remain constant. By how much would the ROE change in response to the change in the capital structure?

a.2.32%

b.3.14%

c.2.08%

d.2.86%

e.2.57%

9) Emerson Inc.'s would like to undertake a policy of paying out 45% of its income. Its latest net income was $1,250,000, and it had 225,000 shares outstanding. What dividend per share should it declare?

a.$2.50

b.$2.14

c.$2.38

d.$2.26

e.$2.63

10) Suppose a State of North Carolina bond will pay $1,000 ten years from now. If the going interest rate on these 10-year bonds is 5.5%, how much is the bond worth today?

a.$711.59

b.$677.71

c.$645.44

d.$614.70

e.$585.43

11) Your bank offers to lend you $100,000 at an 8.5% annual interest rate to start your new business. The terms require you to amortize the loan with 10 equal end-of-year payments. How much interest would you be paying inYear 2?

a.$8,323

b.$7,531

c.$8,740

d.$9,177

e.$7,927

12) You would like to travel in South America 5 years from now, and you can save $3,100 per year, beginning one year from today. You plan to deposit the funds in a mutual fund that you think will return 8.5% per year. Under these conditions, how much would you have just after you make the 5th deposit, 5 years from now?

a.$18,369

b.$20,251

c.$21,264

d.$19,287

e.$22,327

13) Which of the following statements is CORRECT?

a.Other things held constant, acallablebond would have a lower required rate of return than a noncallable bond.

b.Other things held constant, a corporation would rather issuenoncallablebonds than callable bonds.

c.If a 10-year, $1,000 par, 10% coupon bond were issued at par, and if interest rates then dropped to the point where r_d= YTM = 5%, we could be sure that the bond would sell at a premium above its $1,000 par value.

d.Reinvestment rate risk is worse from an investor's standpoint than interest rate price risk if the investor has a short investment time horizon.

e.If a 10-year, $1,000 par,zero coupon bondwere issued at a price that gave investors a 10% yield to maturity, and if interest rates then dropped to the point where r_d= YTM = 5%, the bond would sell at a premium over its $1,000 par value.

14) Which of the following statements is CORRECT?

a.The total yield on a bond is derived from dividends plus changes in the price of the bond.

b.Bonds are riskier than common stocks and therefore have higher required returns.

c.Bonds issued by larger companies always have lower yields to maturity (less risk) than bonds issued by smaller companies.

d.If the Federal Reserve unexpectedly announces that it expects inflation to increase, then we would probably observe an immediate increase in bond prices.

e.The market value of a bond will always approach its par value as its maturity date approaches, provided the bond's required return remains constant.

15) A 10-year bond pays an annual coupon, its YTM is 8%, and it currently trades at a premium. Which of the following statements is CORRECT?

a.The bond's current yield is less than 8%.

b.If the yield to maturity increases, then the bond's price will increase.

c.The bond's coupon rate is less than 8%.

d.If the yield to maturity remains at 8%, then the bond's price will decline over the next year.

e.If the yield to maturity remains at 8%, then the bond's price will remain constant over the next year.

16) Which of the following statements is CORRECT?

a.If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise.

b.If a company's beta were cut in half, then its required rate of return would also be halved.

c.If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rates of return on stocks with betas less than 1.0 will decline while returns on stocks with betas above 1.0 will increase.

d.Other things held constant, if investors suddenly become convinced that there will be deflation in the economy, then the required returns on all stocks should increase.

e.If a company's beta doubles, then its required rate of return will also double.

17) Your friend is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. She is highly risk averse and has asked for your advice. The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter?

a.Either A or B, i.e., the investor should be indifferent between the two.

b.Stock B.

c.Neither A nor B, as neither has a return sufficient to compensate for risk.

d.Add A, since its beta must be lower.

e.Stock A.

18)Burke Tires just paid a dividend of D₀= $1.32. Analysts expect the company's dividend to grow by 30% this year, by 10% in Year 2, and at a constant rate of 5% in Year 3 and thereafter. The required return on this low-risk stock is 9.00%. What is the best estimate of the stock's current market value?

a.$42.65

b.$41.59

c.$43.75

d.$44.87

e.$45.99

19) You, in analyzing a stock, find that its expected returnexceedsits required return. This suggests that you think

a.dividends are not likely to be declared.

b.the stock is a good buy.

c.the stock is experiencing supernormal growth.

d.the stock should be sold.

e.management is probably not trying to maximize the price per share.

20) A stock is expected to pay a year-end dividend of $2.00, i.e., D₁= $2.00. The dividend is expected to decline at a rate of 5% a year forever (g =5%). If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT?

a.The company's dividend yield 5 years from now is expected to be 10%.

b.The company's current stock price is $20.

c.The company's expected stock price at the beginning of next year is $9.50.

d.The company's expected capital gains yield is 5%.

e.The constant growth model cannot be used because the growth rate is negative.

21) Muscarella Inc. has the following balance sheet and income statement data:

Cash

$14,000

Accounts payable

$42,000

Receivables

70,000

Other current liabilities

28,000

Inventories

210,000

Total CL

$70,000

Total CA

$294,000

Long-term debt

70,000

Net fixed assets

126,000

Common equity

280,000

Total assets

$420,000

Total liab. and equity

$420,000

Sales

$280,000

Net income

$21,000

The new CFO thinks that inventories are excessive and could be lowered sufficiently to cause the current ratio to equal the industry average, 2.70, without affecting either sales or net income. Assuming that inventories are sold off and not replaced to get the current ratio to the target level, and that the funds generated are used to buy back common stock at book value, by how much would the ROE change?

a.

4.50%

b.

4.96%

c.

4.28%

d.

5.21%

e.

4.73%

22) Stuart Company's manager believes that economic conditions during the next year will be strong, normal, or weak, and she thinks that the firm's returns will have the probability distribution shown below. What's the standard deviation of the estimated returns? (Hint: Use the formula for the standard deviation of a population, not a sample.)

Economic

Conditions

Prob.

Return

Strong

30%

32.0%

Normal

40%

10.0%

Weak

30%

16.0%

a.

20.52%

b.

19.55%

c.

21.55%

d.

17.69%

e.

18.62%

23) Heath and Logan Inc. forecasts the free cash flows (in millions) shown below. The weighted average cost of capital is 13%, and the FCFs are expected to continue growing at a 5% rate after Year 3. Assuming that the ROIC is expected to remain constant in Year 3 and beyond, what is the Year 0 value of operations, in millions?

Year:

1

2

3

Free cash flow:

$15

$10

$40

a.

$348

b.

$331

c.

$386

d.

$315

e.

$367