MCQs

Your uncle, who has a second home in Bethany Beach, Delaware, is planning to sell it in the next few weeks. You are interested in buying this beachside property, so your agent negotiates a price for the house with your uncle’s agent. This transaction is an example of

the assumption of arm’s-length transactions

the matching principle.

the cost principle.

the realization principle.

the going-concern assumption.

Dell Computer Corporation has receivables of $2.5 million and inventory worth $1.8 million. The firm plans to borrow $2 million for working capital purposes from Austin First National Bank. In evaluating the loan request, the bank should place the most emphasis on

the matching principle.

the assumption of arm’s-length transactions.

the realization principle.

the going-concern assumption.

Tyson Corporation bought raw materials on April 23, 2008 and also on July 2, 2008. Products produced in the months of May were sold in July. The firm uses FIFO to value its inventory. According to the matching principle, the firm’s accountant should associate

Neither of these dates is valid because the products were sold in July.

the inventory acquired on July 2 with the products sold.

the inventory acquired on April 23 with the products sold.

none of these

The time value of money refers to the issue of

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why a dollar received tomorrow is worth the same as a dollar received today.

 

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none of these.

 

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what the value of the stream of future cash flows is today.

 

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why a dollar received tomorrow is worth more than a dollar received today.

Using higher discount rates will   [removed] none of these.   [removed] not affect the present value of the future cash flow.   [removed] increase the present value of any future cash flow.   [removed] decrease the present value of any future cash flow. Your aunt is looking to invest a certain amount today. Which of the following choices should she opt for?   [removed] three-year CD at 6.25% annual rate   [removed] three-year CD at 6.5% annual rate   [removed] three-year CD at 7% annual rate   [removed] three-year CD at 6.75% annual rate Which ONE of the following statements is true about amortization?   [removed] A loan amortization schedule is just a table that shows the loan balance at the beginning and end of each period, the payment made during that period, and how much of that payment represents interest and how much represents repayment of principal.   [removed] All of these are true.   [removed] With an amortized loan, each loan payment contains some payment of principal and an interest payment.   [removed] Amortization refers to the way the borrowed amount (principal) is paid down over the life of the loan. Which one of the following statements is TRUE about the effective annual rate (EAR)?   [removed] The effective annual interest rate (EAR) is defined as the annual growth rate that takes compounding into account.   [removed] The EAR conversion formula accounts for the number of compounding periods and, thus, effectively adjusts the annualized interest rate for the time value of money.   [removed] The EAR is the true cost of borrowing and lending.   [removed] All of these are true. The true cost of lending is the   [removed] quoted interest rate.   [removed] none of these.   [removed] effective annual rate.   [removed] annual percentage rate. Which one of the following statements is NOT true?   [removed] The APR is the annualized interest rate using simple interest.   [removed] The correct way to annualize an interest rate is to compute the annual percentage rate (APR).   [removed] You can find the interest rate per period by dividing the quoted annual rate by the number of compounding periods.   [removed] The correct way to annualize an interest rate is to compute the effective annual interest rate (EAR).

If you are dealing with percentage returns, then which of the following is generally true?

 

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The variance of the return distribution is generally larger than the standard deviation.

 

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None of these is generally true.

 

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The variance of the return distribution is measured in the same units as expected return.

 

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The variance of the return distribution is generally smaller than the standard deviation.

The return distribution for an asset is as shown in the following table. What are the missing values if the expected return is 10 percent?

Return	Probability
0.1	0.25
X	0.5
X	0.25

 

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0.20

 

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0.15

 

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0.10

 

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None of these

Moshe purchased a stock for $30 last year. He found out today that he had a –100 percent return on his investment. Which of the following must be true?

 

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a) The stock is worth $30 today.

 

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b) The stock is worth $0 today.

 

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c) The stock paid no dividends during the year.

 

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d) Both b and c must be true.

Which of the following investment classes had the greatest variability in returns for recent historical data?

 

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Large U.S. Stocks

 

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Small U.S. Stocks

 

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Intermediate-Term Government Bonds

 

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Long-Term Government Bonds

If a bond’s coupon rate is equal to the market rate, then the bond will sell

 

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none of these are true.

 

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at a price less than its face value.

 

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at a price equal to its face value.

 

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at a price greater than its face value.

Bonds sell at a discount off the par value when market rates for similar bonds are

 

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less than the bond’s coupon rate.

 

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greater than the bond’s coupon rate.

 

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equal to the bond’s coupon rate.

 

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Market rates are irrelevant in determining a bond’s price.

hich of the following statements is most true about zero coupon bonds?

 

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They are always convertible to common stock.

 

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They typically sell at a premium over par when they are first issued.

 

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They typically sell at a deep discount below par when they are first issued.

 

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They typically sell for a higher price than similar coupon bonds.

The expected return on Kiwi Computers stock is 16.6 percent. If the risk-free rate is 4 percent and the expected return on the market is 10 percent, then what is Kiwi’s beta?

 

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3.15

 

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2.10

 

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1.26

 

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2.80

Payback: Binder Corp. has invested in new machinery at a cost of $1,450,000. This investment is expected to produce cash flows of $640,000, $715,250, $823,330, and $907,125 over the next four years. What is the payback period for this project?

 

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1.88 years

 

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3.00 years

 

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4.00 years

 

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2.12 years

Payback: Elmer Sporting Goods is getting ready to produce a new line of gold clubs by investing $1.85 million. The investment will result in additional cash flows of $525,000, $812,500, and 1,200,000 over the next three years. What is the payback period for this project?

 

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2.43 years

 

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3 years

 

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1.57 years

 

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More than 3 years

Payback: Kathleen Dancewear Co. has bought some new machinery at a cost of $1,250,000. The impact of the new machinery will be felt in the additional annual cash flows of $375,000 over the next five years. What is the payback period for this project? If their acceptance period is three years, will this project be accepted?

 

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2.67 years; yes

 

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2.67 years; no

 

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3.33 years; yes

 

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3.33 years; no

Payback: Carmen Electronics bought new machinery for $5 million. This is expected to result in additional cash flows of $1.2 million over the next seven years. What is the payback period for this project? If their acceptance period is five years, will this project be accepted?

 

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4.17 years; no

 

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3.83 years; yes

 

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3.83 years; no

 

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4.17 years; yes

Discounted payback: Carmen Electronics bought new machinery for $5 million. This is expected to result in additional cash flows of $1.2 million over the next seven years. The firm’s cost of capital is 12 percent. What is the discounted payback period for this project? If the firm’s acceptance period is five years, will this project be accepted?

 

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6.1 years; no

 

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4.6 years; yes

 

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5.4 years; no

 

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4.2 years; yes

Stillwater Drinks is trying to determine when to harvest the water from the fountain of youth that it currently owns. If it harvests the water in year 1, the NPV of the project would increase over an immediate harvest by 18 percent. A year 2 harvest would create an NPV increase of 12 percent over that of year 1 and year 3 would create an NPV increase of 8 percent over that of year 2. If the cost of capital is 17 percent for Stillwater, then which harvest year would maximize the NPV for the firm? Assume that all NPVs are calculated from the perspective of today.

 

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Harvest in year 1.

 

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Harvest immediately.

 

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Harvest in year 3.

 

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Harvest in year 2.

The proper time to harvest an asset is when

 

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the percentage NPV increase of harvesting a project at a future point in time is at the last date where the increase is greater than the cost of capital.

 

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the percentage NPV increase of harvesting a project at a future point in time is at the first date where the increase is less than the cost of capital.

 

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the percentage NPV increase of harvesting a project at a future point in time is at the first date where the increase is greater than the cost of capital.

 

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None of the above.

Norman, Inc., is considering two mutually exclusive projects. Project A is a six-year project with a NPV of $3,000 and Project B is a four-year project with an NPV of $2,278. Project A has an equivalent annual cash flow of $730 and Project B has an equivalent annual cash flow of $750. Which project should the firm select?

 

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Choose Project B because it has the lower NPV.

 

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Choose Project B because it has the higher equivalent annual cash flow.

 

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Choose Project A because it has the lower equivalent annual cash flow.

 

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Choose Project A because it has the higher NPV.

Champagne, Inc., had revenues of $12 million, cash operating expenses of $8 million, and depreciation and amortization of $1.5 million during 2008. The firm purchased $700,000 of equipment during the year while increasing its inventory by $500,000 (with no corresponding increase in current liabilities). The marginal tax rate for Champagne is 30 percent.

Free cash flow: What are Champagne’s cash flows associated with investments for 2008?

 

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$500,000

 

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$700,000

 

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$1,200,000

 

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None of these

Calculating operating leverage. Swan’s Bicycle Boats had a degree of accounting operating leverage equal to 1.50 during the most recent period. If the firm’s EBITDA was $5,000 and its fixed costs were equal to $1,750, then what was Swan’s depreciation and amortization expense during the same period?

 

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$1,500

 

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$2,833

 

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$500

 

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$1,000

Break-even analysis. IronVerks Ribshack has total fixed costs of $8,500 per month. It sells rib plates for $15 each, and the variable cost of providing each plate is $10. What is the pretax operating cash flow break-even point for IronVerks?

 

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8,500 plates.

 

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567 plates.

 

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1,700 plates.

 

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None of these

Break-even analysis. Monochrome Sun Glasses has found that its pretax operating cash flow basis break-even number of glasses sold is 770,000 pairs. If each pair is sold for $25 and the variable cost per unit is $15, then what is the amount of Monochrome’s fixed costs?

 

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$11,550,000

 

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$77,000

 

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$7,700,000

 

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$1,155,000

Capital rationing. You are considering a project that has an initial cost of $1,200,000. If you take the project, it will produce net cash flows of $300,000 per year for the next six years. If the appropriate discount rate for the project is 10 percent, what is the profitability index of the project?

 

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2.18

 

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1.09

 

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2.09

 

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0.09

Overall cost of capital: If the market risk premium is currently 6 percent and the risk-free rate of return is 4 percent, then what is the expected return on a common share with a beta equal to 2?

 

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8.0%

 

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10.0%

 

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12.0%

 

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16.0%

How firms estimate their cost of capital: The Diverse Co. has invested 40 percent of the firm’s assets in a project with a beta of 0.4 and the remaining assets in a project with a beta of 1.8. What is the beta of the firm?

 

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None of these

 

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1.28

 

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1.24

 

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0.96

The cost of equity: Oasis, Inc., has common shares with a price of $21.12 per share. The firm is expected to pay a dividend of $1.75 one year from today, and dividends are expected to grow at 10 percent for two years after that and then at 5 percent thereafter. What is the implied cost of common equity capital for Oasis?

 

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15%

 

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14%

 

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16%

 

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13%

The cost of preferred equity: Billy’s Goat Coats has a preferred share issue outstanding with a current price of $38.89. The firm last paid a dividend on the issue of $3.50 per share. What is the firm’s cost of preferred equity?

 

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7%

 

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10%

 

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8%

 

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9%

M&M Proposition 1: Dynamo Corp. produces annual cash flows of $150 and is expected to exist forever. The company is currently financed with 75 percent equity and 25 percent debt. Your analysis tells you that the appropriate discount rates are 10 percent for the cash flows, and 7 percent for the debt. You currently own 10 percent of the stock.

How much is Dynamo worth today?

 

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$2,143

 

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None of these.

 

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$1,765

 

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$1,500

M&M Proposition 2: Swirlpool, Inc., has a WACC of 11%, a cost of debt of 8%, and a cost of equity of 12%. What must the debt-to-equity ratio be?

 

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None of these.

 

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1/4

 

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1/6

 

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1/2

M&M Proposition 2: Melba’s Toast has a capital structure with 30% debt and 70% equity. Its pretax cost of debt is 6%, and its cost of equity is 10%. The firm’s marginal corporate income tax rate is 35%. What is the appropriate WACC?

 

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7.44%

 

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8.17%

 

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8.80%

 

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6.35%

The pecking order theory: A firm wishes to undertake a project that costs $150mm. It currently has $10mm in cash on hand and believes that it can raise $75mm in debt and $100mm in equity if needed. According to the pecking order theory of the capital structure, what percent of the project will be financed by debt?

 

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50%

 

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26.67%

 

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0%

 

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None of these

Break-even analysis: Jackson Electronics makes circuit boards and markets them to electronic goods manufacturers. The firm has nonsalary fixed costs of $212,000 and salary costs of $134,250. Each circuit board is sold at a price of $111.50 and involves variable costs of $81.73 per unit. What is the break-even point for Jackson?

 

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4,237

 

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3,714

 

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3,105

 

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11,631

Multiple Analysis: Turnbull Corp. had an EBIT of $247 million in the last fiscal year. Its depreciation and amortization expenses amounted to $84 million. The firm has 135 million shares outstanding and a share price of $12.80. A competing firm that is very similar to Turnbull has an enterprise value/EBITDA multiple of 5.40.

What is the enterprise value of Turnbull Corp.? Round to the nearest million dollars.

 

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$453.6 million

 

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$1,334 million

 

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$1,787 million

 

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$1,315 million

Multiple Analysis: Turnbull Corp. had an EBIT of $247 million in the last fiscal year. Its depreciation and amortization expenses amounted to $84 million. The firm has 135 million shares outstanding and a share price of $12.80. A competing firm that is very similar to Turnbull has an enterprise value/EBITDA multiple of 5.40.

What is the value of Turnbull Corp’s debt? Round to the nearest million dollars.

 

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$121 million

 

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$165 million

 

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$59 million

 

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$97 million

Income approaches: Quicksilver Software Co. is expected to grow rapidly in the next three years and then have no growth for the foreseeable future. The firm expects free cash flows of $9.1 million, $11.4 million, and $17.7 million over the next three years, and thereafter its cash flows will stay constant. The company has no nonoperating assets. If the appropriate WACC is 12 percent and debt of 44.5 million, what is the equity value of this business? Round to the nearest million.

 

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$135 million

 

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$105 million

 

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$45 million

 

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$90 million

Spot rate: Tantrix, Inc., purchased its inventory from an Indian manufacturer at a cost of Rs.5,325,000. The dollar cost of this payable is $125,634.07 at today’s spot rate. What is the spot rate today?

 

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Rs. 4.2385/$

 

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$4.2385/Rs

 

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Rs.42.3850/$

 

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$42.3850/Rs

Spot rate: If the spot rate is quoted as $0.009369/¥, what is the exchange rate in terms of yen per dollar?

 

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¥0.009369/$

 

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¥0.936900/$

 

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¥106.7350/$

 

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¥16.7350/$

Spot rate: Given that the spot rate is $1.5136/€ and the 90-day forward quote is $1.4974/€, we can say that

 

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the euro is at a forward premium against the U.S. dollar.

 

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the U.S. dollar is at a forward premium against the euro.

 

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the dollar is at neither a premium nor a discount against the euro.

 

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the U.S. dollar is at a forward discount against the euro.