1. The specified date on which the principal amount of a bond is payable is referred to as which one of the following? A. coupon date B. yield date C. maturity D. dirty date E. clean date 2. A bond has a market price that exceeds its face value. Which of the following features currently apply to this bond? I. discounted price II. premium price III. yield-to-maturity that exceeds the coupon rate IV. yield-to-maturity that is less than the coupon rate A. III only B. I and III only C. I and IV only D. II and III only E. II and IV only 3. The secondary market is best defined by which one of the following? A. market in which subordinated shares are issued and resold B. market conducted solely by brokers C. market dominated by dealers D. market where outstanding shares of stock are resold E. market where warrants are offered and sold 4. The dividend growth model: I. assumes that dividends increase at a constant rate forever. II. can be used to compute a stock price at any point in time. III. can be used to value zero-growth stocks. IV. requires the growth rate to be less than the required return. A. I and III only B. II and IV only C. I, III, and IV only D. I, II, and IV only E. I, II, III, and IV 5.
Miller Brothers Hardware paid an annual dividend of $1.15 per share last month. Today, the company announced that future dividends will be increasing by 2.6 percent annually. If you require a 12 percent rate of return, how much are you willing to pay to purchase one share of this stock today? A. $12.23
B. $12.55 C. $12.67 D. $12.72 E. $12.88 Answer:
6. The two-stage dividend growth model evaluates the current price of a stock based on the assumption a stock will: A. pay an increasing dividend for a period of time and then cease paying dividends altogether. B. increase the dividend amount every other year. C. pay a constant dividend for the first two quarters of each year and then increase the dividend the last two quarters of each year. D. grow at a fixed rate for a period of time after which it will grow at a different rate indefinitely. E. pay increasing dividends for a fixed period of time, cease paying dividends for a period of time, and then commence paying increasing dividends for an indefinite period of time. 7. The current dividend yield on Clayton's Metals common stock is 2.5 percent. The company just paid a $1.48 annual dividend and announced plans to pay $1.54 next year. The dividend growth rate is expected to remain constant at the current level. What is the required rate of return on this stock? A. 6.55 percent B. 6.82 percent C. 7.08 percent D. 7.39 percent E. 7.75 percent
8. Hightower Pharmacy just paid a $3.10 annual dividend. The company has a policy of increasing the dividend by 3.8 percent annually. You would like to purchase 100 shares of stock in this firm but realize that you will not have the funds to do so for another four years. If you require a 16 percent rate of return, how much will you be willing to pay per share for the 100 shares when you can afford to make this investment? A. $29.50 B. $30.62 C. $31.12 D. $31.78 E. $32.47
9. Two IPOs will commence trading next week. Scott places an order to buy 300 shares of IPO A. Steve places an order to purchase 300 shares of IPO A and 300 shares of IPO B. Both IPOs are priced at $20 a share. Scott is allocated 100 shares of IPO A. Steve is allocated 100 shares of IPO A and 300 shares of IPO B. At the end of the first day of trading, IPO A is selling for $22.70 a share and IPO B is selling for $18.60 a share. What is the difference in the total profits or losses that Scott and Steve have as of the end of the first day of trading? A. $120 B. $240 C. $360 D. $420 E. $580 Scott's profit = 100 ($22.70 - $20) = $270 Steve's profit = [100 ($22.70 - $20)] + [300 ($18.60 - $20)] = -$150 Difference = $270 - (-$150) = $420 10. Bruce & Co. expects its EBIT to be $100,000 every year forever. The firm can borrow at 11 percent. Bruce currently has no debt, and its cost of equity is 18 percent. The tax rate is 31 percent. Bruce will borrow $61,000 and use the proceeds to repurchase shares. What will the WACC be after recapitalization? A. 16.30 percent B. 16.87 percent C. 17.15 percent D. 18.29 percent E. 18.86 percent VU = $100,000(1 - 0.31)/0.18 = $383,333.33 VL = $383,333.33 + 0.31($61,000) = $402,243.33 RE = 0.18 + (0.18 - 0.11)($61,000/$402,243.33 - $61,000)(1 - 0.31) = 0.1886
WACC = 0.1886($402,243.33 - $61,000)/$402,243.33 + 0.11($61,000/$402,243.33) (1 - 0.31) = 17.15 percent 11. New Schools, Inc. expects an EBIT of $7,000 every year forever. The firm currently has no debt, and its cost of equity is 17 percent. The firm can borrow at 8 percent and the corporate tax rate is 34 percent. What will the value of the firm be if it converts to 50 percent debt? A. $29,871.17 B. $31,796.47 C. $32,407.16 D. $34,552.08 E. $37,119.30 VU = $7,000 (1 - 0.34)/0.17 = $27,176.47 VL = $27,176.47 + 0.34 (0.50) ($27,176.47) = $31,796.47 Note: When levered, the value of debt is equal to one-half of the unlevered value of the firm. 12. Which one of the following bonds is the least sensitive to interest rate risk? A. 3-year; 4 percent coupon B. 3-year; 6 percent coupon C. 5-year; 6 percent coupon D. 7-year; 6 percent coupon E. 7-year; 4 percent coupon 13. The Fisher Effect primarily emphasizes the effects of _____ on an investor's rate of return. A. default B. market C. interest rate D. inflation E. maturity
14. Roadside Markets has a 6.75 percent coupon bond outstanding that matures in 10.5 years. The bond pays interest semiannually. What is the market price per bond if the face value is $1,000 and the yield to maturity is 6.69 percent? A. $999.80 B. $999.85 C. $1,003.42 D. $1,004.47 E. $1,007.52
15. The Corner Grocer has a 7-year, 6 percent annual coupon bond outstanding with a $1,000 par value. The bond has a yield to maturity of 5.5 percent. Which one of the following statements is correct if the market yield suddenly increases to 6.5 percent? A. The bond price will increase by $57.14. B. The bond price will increase by 5.29 percent. C. The bond price will decrease by $53.62. D. The bond price will decrease by 5.43 percent. E. The bond price will decrease by 5.36 percent.
Difference in prices = $972.58 - $1,028.41 = -$55.83
Percentage difference in prices =
16. A Treasury bond is quoted at a price of 101:14 with a current yield of 7.236 percent. What is the coupon rate? A. 7.20 percent B. 7.28 percent C. 7.30 percent D. 7.34 percent E. 7.39 percent Price = 101 and 14/32 percent of face = 1.014375 $1,000 = $1,014.375 Annual interest = 0.07236 $1,014.375 = $73.40 Coupon rate = $73.40/$1,000 = 7.34 percent
17. Kaiser Industries has bonds on the market making annual payments, with 14 years to maturity, and selling for $1,382.01. At this price, the bonds yield 7.5 percent. What is the coupon rate? A. 8.00 percent B. 8.50 percent C. 9.00 percent D. 10.50 percent E. 12.00 percent
Coupon rate = $120/$1,000 = 12 percent 18. Which of the following should be considered when selecting a venture capitalist? I. level of involvement II. past experiences III. termination of funding IV. financial strength A. I and III only B. II and IV only C. I, III, and IV only D. I, II, and IV only E. I, II, III, and IV 19. With firm commitment underwriting, the issuing firm: A. is unsure of the total amount of funds it will receive until after the offering is completed. B. is unsure of the number of shares it will actually issue until after the offering is completed. C. knows exactly how many shares will be purchased by the general public during the offer period. D. retains the financial risk associated with unsold shares. E. knows up-front the amount of money it will receive from the stock offering.
20. Wear Ever is expanding and needs $12.6 million to help fund this growth. The firm estimates it can sell new shares of stock for $32.50 a share. It also estimates it will cost an additional $340,000 for filing and legal fees related to the stock issue. The underwriters have agreed to a 7.5 percent spread. How many shares of stock must Wear Ever sell if it is going to have $12.6 million available for its expansion needs? A. 370,376 shares B. 419,127 shares C. 430,437 shares D. 454,209 shares E. 461,806 shares Total value of issue = ($12,600,000 + $340,000)/(1 - 0.075) = $13,989,189.19 Number of shares needed = $13,989,189.19/$32.50 = 430,437 shares 21. The proposition that a firm borrows up to the point where the marginal benefit of the interest tax shield derived from increased debt is just equal to the marginal expense of the resulting increase in financial distress costs is called: A. the static theory of capital structure. B. M&M Proposition I. C. M&M Proposition II. D. the capital asset pricing model. E. the open markets theorem. 22. A firm should select the capital structure that: A. produces the highest cost of capital. B. maximizes the value of the firm. C. minimizes taxes. D. is fully unlevered. E. equates the value of debt with the value of equity
23. The optimal capital structure has been achieved when the: A. debt-equity ratio is equal to 1. B. weight of equity is equal to the weight of debt. C. cost of equity is maximized given a pre-tax cost of debt. D. debt-equity ratio is such that the cost of debt exceeds the cost of equity. E. debt-equity ratio results in the lowest possible weighted average cost of capital. 24. The capital structure that maximizes the value of a firm also: A. minimizes financial distress costs. B. minimizes the cost of capital. C. maximizes the present value of the tax shield on debt. D. maximizes the value of the debt. E. maximizes the value of the unlevered firm.
25. Sewer's Paradise is an all equity firm that has 5,000 shares of stock outstanding at a market price of $15 a share. The firm's management has decided to issue $30,000 worth of debt and use the funds to repurchase shares of the outstanding stock. The interest rate on the debt will be 10 percent. What are the earnings per share at the break-even level of earnings before interest and taxes? Ignore taxes. A. $1.46 B. $1.50 C. $1.67 D. $1.88 E. $1.94 Number of shares repurchased = $30,000/$15 = 2,000 EBIT/5,000 = [EBIT - ($30,000 .0.10)]/(5,000 - 2,000); EBIT = $7,500 EPS = [$7,500 - ($30,000 0.10)]/(5,000 - 2,000); EPS = $1.50 26. Winter's Toyland has a debt-equity ratio of 0.72. The pre-tax cost of debt is 8.7 percent and the required return on assets is 16.1 percent. What is the cost of equity if you ignore taxes? A. 19.31 percent B. 19.74 percent C. 20.29 percent D. 20.46 percent E. 21.43 percent RE = 0.161 + (0.161 - 0.087) 0.72 = 21.43 percent 27. Johnson Tire Distributors has debt with both a face and a market value of $12,000. This debt has a coupon rate of 6 percent and pays interest annually. The expected earnings before interest and taxes are $2,100, the tax rate is 30 percent, and the unlevered cost of capital is 11.7 percent. What is the firm's cost of equity? A. 22.46 percent B. 22.87 percent C. 23.20 percent D. 23.59 percent E. 25.14 percent VU = [$2,100 (1 - 0.30)]/0.117 = $12,564.10 VL = $12,564.10 + (0.30 $12,000) = $16,164.10 VE = $16,164.10 - $12,000 = $4,164.10 RE = 0.117 + [(0.117 - 0.06) ($12,000/$4,164.10) (1 - 0.30)] = 23.20 percent
28. Which one of the following favors a low dividend policy? A. the tax on capital gains is deferred until the gain is realized B. few, if any, positive net present value projects are available to a firm C. a majority of the shareholders has a low relevant tax rate D. a majority of the shareholders has better investment opportunities with similar risks E. corporate tax rates exceed personal tax rates 29. Which of the following tend to keep dividends low? I. shareholders desiring current income II. terms contained in bond indenture agreements III. the desire to maintain constant dividends over time IV. flotation costs A. II and III only B. I and IV only C. II, III, and IV only D. I, II, and III only E. I, II, III, and IV 30. You own 2,200 shares of Deltona Hardware. The company has stated that it plans on issuing a dividend of $0.42 a share at the end of this year and then issuing a final liquidating dividend of $2.90 a share at the end of next year. Your required rate of return on this security is 16 percent. Ignoring taxes, what is the value of one share of this stock to you today? A. $2.30 B. $2.43 C. $2.52 D. $2.92 E. $3.32 Value per share = ($0.42/1.161) + ($2.90/1.162) = $2.52
31. Consider the following information on Stocks I and II:
The market risk premium is 8 percent, and the risk-free rate is 3.6 percent. The beta of stock I is _____ and the beta of stock II is _____. A. 2.08; 2.47 B. 2.08; 2.76 C. 3.21; 3.84 D. 4.47; 3.89 E. 4.47; 4.26 E(RI) = 0.06(0.15) + 0.25(0.35) + 0.69(0.43) = 0.3932 BI: 0.3932 = 0.036 + BI (0.08); BI = 4.47 E(RII) = 0.06(-0.35) + 0.25(0.35) + 0.69(0.45) = 0.0377 BII: 0.0377 = 0.036 + BII (0.08); BII = 4.26 32. Suppose you observe the following situation:
Assume the capital asset pricing model holds and stock A's beta is greater than stock B's beta by 0.21. What is the expected market risk premium? A. 8.8 percent B. 9.5 percent C. 12.6 percent D. 17.9 percent E. 20.0 percent E(RA) = 0.22(-0.12) + 0.48(0.10) + 0.30(0.23) = .0906 E(RB) = 0.22(-0.27) + 0.48(0.05) + 0.30(0.28) = .0486 SlopeSML = (.0906 - 0.486)/0.21 = 20 percent
33. The common stock of Alpha Manufacturers has a beta of 1.47 and an actual expected return of 15.26 percent. The risk-free rate of return is 4.3 percent and the market rate of return is 12.01 percent. Which one of the following statements is true given this information? A. The actual expected stock return will graph above the Security Market Line. B. The stock is underpriced. C. To be correctly priced according to CAPM, the stock should have an expected return of 21.95 percent. D. The stock has less systematic risk than the overall market. E. The actual expected stock return indicates the stock is currently overpriced. E(r) = 0.043 + 1.47 (0.1201 - 0.043) = 15.63 percent The stock is overpriced because its actual expected return is less than the CAPM return. 34. The common stock of United Industries has a beta of 1.34 and an expected return of 14.29 percent. The risk-free rate of return is 3.7 percent. What is the expected market risk premium? A. 7.02 percent B. 7.90 percent C. 10.63 percent D. 11.22 percent E. 11.60 percent E(r) = 0.1429 = 0.037 + 1.34 Mrp; Mrp = 7.90 percent 35. The common stock of Jensen Shipping has an expected return of 16.3 percent. The return on the market is 10.8 percent and the risk-free rate of return is 3.8 percent. What is the beta of this stock? A. .92 B. 1.23 C. 1.33 D. 1.67 E. 1.79 E(r) = 0.163 = 0.038 + (0.108 - 0.038); = 1.79
