1. The prices of financial assets are based on the expected value of future cash flows, discount rate, and past dividends. A. True B. False
2. By using different discount rates, the market allocates capital to companies based on their risk, efficiency, and expected returns. A. True B. False
3. As time to maturity increases, bond price sensitivity decreases. A. True B. False
4. Valuation of a common stock with no dividend growth potential is treated in the same manner as preferred stock. A. True B. False
5. Valuation of financial assets requires knowledge of A. future cash flows. B. appropriate discount rate. C. past asset performance. D. future cash flows and appropriate discount rate.
6. Which of the following financial assets is likely to have the highest required rate of return based on risk? A. corporate bond B. Treasury bill C. preferred share D. common share
7. A bond which has a yield to maturity less than its coupon interest rate will sell for a price A. below par. B. at par. C. above par. D. that is
equal to the face value of the bond plus the value of all interest payments.
8. A 10-year bond pays 12% interest on a $1,000 face value annually. If it currently sells for $1,100, what is its approximate yield to maturity? A. 10.35% B. 10.91% C. 11.00% D.
9. Companies prefer to maintain some financing flexibility in order to choose the lowest cost source of funds at a single point in time. A. True B. False
10. A firm that does not earn the cost of capital in the long run will not maximize shareholder
wealth. A. True B. False
11. The use of the optimum capital structure minimizes the cost of capital. A. True B. False
12. The discount rate that equates a future stream of expected dividends to the current price is a good approximation of the cost of common
shares. A. True B. False
13. Retained earnings has a cost associated with it because A. new funds must be raised. B. there is an opportunity cost associated with shareholder funds. C. Ke > g. D. flotation costs increase the cost of funding.
14. Each project should be judged against A. the specific means of financing used to support its implementation. B. the going interest rate at that point in time. C. the cost of new common stock equity. D. the weighted average cost of capital
15. When both the tax deductibility of debt and the present value of potential bankruptcy costs are included, the cost of capital for a firm tends to A. be constant regardless of the level of debt usage. B. decrease as the level of debt increases. C. increase as the level of debt increases.
D. decrease up to some debt-value ratio, then increase as bankruptcy costs become significant.
16. A firm’s debt to equity ratio varies at times because A. a firm will want to sell common stock when prices are low and bonds when interest rates are high. B.
a firm will want to take advantage of timing its fund-raising in order to minimize costs over the long run. C. the market allows extensive leeway in the debt to equity ratio before penalizing the firm with a higher cost of capital. D. all of the above answers are correct
17. The internal rate of return is the interest rate that equates the cash outflows of an investment with the subsequent inflows. A. True B. False
18. Under the net present value method, cash flows are assumed to be reinvested at the firm’s weighted
average cost of capital. A, True B. False
19. With nonmutually exclusive events and no capital rationing, we will usually arrive at the same conclusions using either the net present value or internal rate of return methods. A. True B. False
20. The payback period is easy to understand and places a heavy emphasis on liquidity. A. True B. False
21. The longer the life of an investment A. the more significant the discount rate. B. the less significant the discount rate. C. Makes no difference. D. None of these.
22. You buy a new piece of equipment for $7,360, and you receive a cash inflow of $1,000 per year for 10 years. What is the internal rate of return? A. 5% B. 6% C. 7% D. More than 7%
23. Assume a project has earnings before amortization and taxes of $15,000,
amortization of $25,000, and that the firm has a 30 percent tax bracket. What are the after-tax cash flows for the project? A. $18,000 B. $19,000 C. A loss of $21,000 D. None of these
24. The profitability index will give the same investment decision as A.
the payback period. B. the average accounting return. C. the net present value. D. It can be different from each of these techniques.
25. Risk is not only measured in terms of losses, but also in terms of variability. A. True B. False
26. Sensitivity analysis helps the financial planner to determine how sensitive shareholders will be to changes in investment strategy.
27. Choosing projects with returns equal to the company norm but having a higher level of risk will most likely lower the company’s share price.
28. Combining assets that have highly correlated returns will reduce portfolio risk.
29. The concept of being risk averse means
A. for a given situation investors would prefer relative certainty to uncertainty.
B. investors would prefer investments with low standard deviations and greater opportunity for gain.
C. that the lower the risk the lower the expected return must be.
D. all of the above answers are correct
30. Using the risk-adjusted discount rate approach, the cost of capital is applied to projects with
A. normal risk.
B. high risk.
C. no risk.
D. low risk.
31. The firm’s highest risk-adjusted discount should be applied to
A. the repair of old machinery.
B. a new product in a related field.
C. a new product in a foreign market.
D. the purchase of new equipment.
32. Which investment has the least amount of risk?
A. standard deviation = $500, expected return = $5,000
B. standard deviation = $700, expected return = $500
C. standard deviation = $900, expected return = $800
D. standard deviation = $400, expected return = $350
33. Foreign exchange risk is the risk that a person or business will not be able to exchange currencies.
34. Multinational firms tend to have a lower level of portfolio risk than comparable Canadian firms.
35. Expected future value of a currency is reflected in its spot rate.
36. The purchasing power parity theory of exchange rates suggests that exchange rates will adjust until the cost of equivalent goods is approximately equal in each country.
37. If in 2011, the Canadian dollar’s exchange rate with the Sudanese pound was .38433 dollars per pound and in 2014, the exchange rate was .20068 dollars per pound, it would indicate that in the period from 2011 to 2014, the dollar
A. strengthened against the pound.
B. weakened against the pound.
C. was unrelated to the value of the pound.
D. the answer cannot be determined without knowing the number of pounds needed to buy a dollar
38. Eurodollars are
A. Canadian dollars deposited in foreign banks.
B. foreign dollars deposited in Canadian banks.
C. investments of common market countries.
D. none of the other answers are correct
39. A portfolio of international stocks in comparison to purely Canadian stocks generally shows
A. lower percentage risk for a given number of stocks.
B. higher percentage risk for a given number of stocks.
C. the same percentage risk for a given number of stocks.
D. lower percentage return for a given number of stocks.
40. If prices double in Vancouver while the prices in San Paulo remain the same, the purchasing power of the dollar relative to the real
A. should increase by 50%.
B. should increase by 100%.
C. should decrease by 50%.
D. should decrease by 100%.
41. In addition to comparison with industry ratios, it is also helpful to analyze ratios using
A. trend analysis.
B. historical comparisons.
C. both of the above answers are correct.
D. none of the above is correct; only industry ratios provide valid comparisons.
42. Investors and financial analysts wanting to evaluate the operating efficiency of a firm’s managers would probably look primarily at the firm’s
A. debt utilization ratios.
B. liquidity ratios.
C. asset utilization ratios.
D. profitability ratios.
47. (2 points) How long does it take $1,000 to quadruple in value if you have an 11% annual return? Assume annual compounding, and express your answer in years (to two decimals).
48. (4 points) Assume the following spot and forward rates for the euro ($/euro).
What is the dollar value of one euro in the spot market?
Suppose you issued a 120-day forward contract to exchange 200,000 euros into Canadian dollars. How many dollars are involved?
How many euros can you get for one dollar in the spot market?
What is the 120-day forward premium?
49. The MacHardee Plumbing Company has common stock outstanding. The stock paid a dividend of $2.00 per share last year, but the company expects that earnings and dividends will grow by 25% for the next two years before dropping to a constant 9% growth rate afterward. The required rate of return on similar common stocks is 13%.
What is the per-share value of the company’s common stock?
50 Defense Electronics Corporation is considering building an overseas manufacturing facility to produce radar detection systems. As a consultant to DEC, you have the contract to determine the appropriate discount rate for evaluating this project.
Current information regarding DEC includes:
Debt: 25,000 bonds outstanding, each with a coupon rate of 6.5% paid semi-annually, par value of $1,000, maturity of 20 years, and current value of 96% of par.
Common Stock: 400,000 shares outstanding with a current value of $89/share. An annual dividend of $4.74 has just been paid, and dividends are expected to grow by 9% annually into the foreseeable future.
Preferred Stock: 35,000 shares of 6.5% stock with a par value of $100/share, and a current value of $99/share.
Tax rate: DEC’s combined tax rate is 34%.
Other liabilities: DEC has the usual accounts payable and accruals on its balance sheet, but does not regularly utilize any interest-bearing debt other than the bonds described above.
Risk Adjustment: Since the new manufacturing facility is to be built overseas, management is suggesting an adjustment factor of +2% to account for the increased riskiness.