Multiple Choice Questions:

1. Corporate managers are expected to make corporate decisions that are in the best interest of

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A) top corporate management.
B) the corporation’s board of directors.
C) the corporation’s shareholders.
D) all corporate employees.

2. Financial markets are used for trading:

A) both real assets and financial assets.
B) the goods and services produced by a firm.
C) securities, such as shares of IBM.
D) the raw materials used in manufacturing.

3. The best criterion for success in a capital budgeting decision would be to:

A) minimize the cost of the investment.
B) maximize the number of capital budgeting projects.
C) maximize the difference between cash inflows and cost.
D) finance all capital budgeting projects with debt.

4. The term “capital structure” refers to:

A) the manner in which a firm obtains its long-term sources of funding.
B) the length of time needed to repay debt.
C) whether the firm invests in capital budgeting projects.
D) which specific assets the firm should invest in.

5. Which of the following financial assets might be least likely to have an active secondary market?

A) Common stock of a large firm
B) Bank loans made to smaller firms
C) Bonds of a major, multinational corporation
D) Debt issued by the United States Treasury

6. How much can be accumulated for retirement if $2,000 is deposited annually, beginning one year from today, and the account earns 9% interest compounded annually for 40 years?

A) $ 87,200.00
B) $675,764.89
C) $736,583.73
D) $802,876.27

7. The present value of the following cash flows is known to be $6,939.91; $500 today, $2,000 in one year, and $5,000 in two years. What discount rate is being used?

A) 3%
B) 4%
C) 5%
D) 6%

8. How much should you pay for a $1,000 bond with 10% coupon, annual payments, and five years to maturity if the interest rate is 12%?

A) $ 927.90
B) $ 981.40
C) $1,000.00
D) $1,075.82

9. If an investor purchases a bond when its current yield is less than the coupon
rate, then the bond’s price will be expected to:

A) decline over time, reaching par value at maturity.
B) increase over time, reaching par value at maturity.
C) be less than the face value at maturity.
D) exceed the face value at maturity.

10. In the calculation of rates of return on common stock, dividends are ___ and capital gains are ____.

A) guaranteed; not guaranteed
B) guaranteed; guaranteed
C) not guaranteed; not guaranteed
D) not guaranteed; guaranteed

11. What should be the price for a common stock paying $3.50 annually in dividends if the growth rate is zero and the discount rate is 8%?

A) $22.86
B) $28.00
C) $42.00
D) $43.75

12. An increase in a firm’s financial leverage will:

A) increase the variability in earnings per share.
B) reduce the operating risk of the firm.
C) increase the value of the firm in a non-MM world.
D) increase the WACC.

13. How much could NPV be affected by a worst-case scenario of 25% reduction from the $3 million in expected annual cash flows on a five-year project with 10% cost of capital?

A) $2,843,090
B) $3,750,000
C) $4,578,825
D) $6,155,274

14. Projects that are calculated as having negative NPVs should be:

A) depreciated over a longer time period.
B) charged less in overhead costs.
C) discounted using lower rates.
D) rejected or abandoned.

15. If a project is expected to increase inventory by $15,000, increase accounts payable by $10,000, and decrease accounts receivable by $1,000, what effect does working capital have during the life of the project?

A) Increases investment by $4,000.
B) Increases investment by $5,000.
C) Increases investment by $6,000.
D) Working capital has no effect during the life of the project.

Problem 1:

Examine the following book-value balance sheet for University Products, Inc. The preferred stock currently sells for $15 per share and the common stock for $20 per share. There are one million common shares outstanding. (Provide all computations in addition to the solutions.)


Cash and short-term securities $ 1.0
Accounts receivable 3.0
Inventories 7.0
Plant and equipment 21.0
Total $32.0

Liabilities and Net Worth
Bonds, coupon = 8%, paid annually $10.0
(maturity = 10 years, current yield to maturity = 9%)
Preferred stock (par value $20 per share) 2.0
Common stock (par value $.10) 0.1
Additional paid in stockholders’ capital 9.9
Retained earnings 10.0
Total $32.0

a. What is the capital structure of the firm based on market values (V)?

b. If the preferred stock pays a dividend of $2 per share, the beta of the stock is .8,
the market risk premium is 10 percent, the risk-free rate is 6 percent, and the firm’s tax rate is 40 percent, what is University’s weighted-average cost of capital?

Problem 2:

Dominique, Inc. is considering an investment in a new shoe factory which will entail an immediate capital expenditure of $2 million. The plant is going to be depreciated on a straight line basis over 10 years with no expected salvage value. The operating income before deducting depreciation is expected to be $500,000 per year over the 10-year life of the project. If Dominique is in the 30 percent tax bracket and the required return is 15 percent, calculate

a) the after-tax cash flows of the project (NCF),

b) the payback period (PBP),

c) the net present value (NPV),

d) the net profitability index (PI),

e) the internal rate of return (IRR).

(Provide all computations for this problem in addition to the solutions.)

Bonus Problem:

Ms. Amidala Inflamada is celebrating today her birthday and 15th anniversary as the Executive Secretary for Mr. Num Bei Wan, President of Last Chance, Inc. During the day she was talking to her closest friends how turbulent where the first days she came in to work after her graduation from the University when she was only 22 years old. One of her friends asked her if she have planned for her retirement. She replied that she has to establish a retirement plan that should provide for her needs after her retirement, considering that probably she will be alone and maybe the Social Security will not be around any more.

For a female her age and ethnic group, the life expectancy is 85 years and according to new rules her retirement age should be 65. She thinks that she will do fine with a monthly pension payment of $3,500.00.

How much should Ms. Inflamada deposit every end of month starting this same month in order to accumulate the proper amount to fund her pension payments after her retirement? Assume that she can obtain a 9% average return on her deposits and on her funds accumulated on her retirement plan.

(Provide all computations for this problem in addition to the solution.)

Multiple Choice Questions & Problems.doc
Solution Summary
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