Multiple Choice Answers

Both Projects A and B are acceptable as independent projects. However, the selection of either one of these projects eliminates the option of selecting the other project. Which one of the following terms best describes the relationship between Project A and Project B?
Mutually exclusive
Multiple choice
Dual return
Any changes to a firm’s projected future cash flows that are caused by adding a new project are referred to as which one of the following?
Eroded cash flows
Deviated projections
Incremental cash flows
Directly impacted flows
Assumed flows

A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions. By doing so, the firm:
automatically gives preferential treatment in the allocation of funds to its riskiest division.
encourages the division managers to only recommend their most conservative projects.
maintains the current risk level and capital structure of the firm.
automatically maximizes the total value created for its shareholders.
allocates capital funds evenly amongst its divisions

A pro forma financial statement is a financial statement that:
expresses all values as a percentage of either total assets or total sales.
compares actual results to the budgeted amounts.
compares the performance of a firm to its industry.
projects future years’ operations.
values all assets based on their current market values.

Sensitivity analysis:
looks at the most reasonably optimistic and pessimistic results for a project.
helps identify the variable within a project that presents the greatest forecasting risk.
is used for projects that cannot be analyzed by scenario analysis because the cash flows are unconventional.
is generally conducted prior to scenario analysis just to determine if the range of potential outcomes is acceptable.
illustrates how an increase in operating cash flow caused by changing both the revenue and the costs simultaneously will change the net present value for a project.

The rate of return on which one of the following is used as the risk-free rate?
Long-term government bonds
Long-term corporate bonds
Inflation, as measured by the Consumer Price Index
U.S. Treasury bill
Large-company stocks

Which one of the following measures the amount of systematic risk present in a particular risky asset relative to that in an average risky asset?
Squared deviation
Beta coefficient
Standard deviation

Systematic risk is:
totally eliminated when a portfolio is fully diversified.
defined as the total risk associated with surprise events.
risk that affects a limited number of securities.
measured by beta.
measured by standard deviation

Lester lent money to The Corner Store by purchasing bonds issued by the store. The rate of return that he and the other lenders require is referred to as the:
pure play cost.
cost of debt.
weighted average cost of capital.
subjective cost.
cost of equity.

Ted is trying to decide what cost of capital he should assign to a project. Which one of the following should be his primary consideration in this decision?
Amount of debt used to finance the project
Use, or lack thereof, of preferred stock to finance the project
Mix of funds used to finance the project
Risk level of the project
Length of the project’s life

Old Town Industries has three divisions. Division X has been in existence the longest and has the most stable sales. Division Y has been in existence for five years and is slightly less risky than the overall firm. Division Z is the research and development side of the business. When allocating funds, the firm should probably:
require the highest rate of return from division X since it has been in existence the longest.
assign the highest cost of capital to division Z because it is most likely the riskiest of the three divisions.
use the firm’s WACC as the cost of capital for division Z as it provides analysis for the entire firm.
use the firm’s WACC as the cost of capital for divisions A and B because they are part of the revenue-producing operations of the firm.
allocate capital funds evenly amongst the divisions to maintain the current capital structure of the firm.

Moore & Moore has just finished projecting its expected cash receipts and expenditures for next year. What is this projection called?
Operating projection
Receivables schedule
Balance sheet
Cash budget
Compromise policy

Baxter’s, Inc. generally holds $125,000 in cash in case an unexpected investment opportunity arises. Which one of the following refers to holding cash for this type of purpose?
Precautionary motive
Opportunistic motive
Speculative motive
Reserve motive
Transaction motive

Which one of the following is the need to hold cash simply as a financial reserve?
Precautionary motive
Opportunistic motive
Speculative motive
Activity motive
Transaction motive

The transaction motive for holding cash refers to the need to have cash for which one of the following purposes?
Safety margin
Investment opportunities
Daily operations
Financial reserve
Bargain opportunities

A firm offers terms of 2/5, net 30. What effective annual interest rate does the firm earn when a customer does not take the discount?
21.69 percent
24.42 percent
28.97 percent
31.08 percent
34.31 percent

Jamie is analyzing the estimated net present value of a project under various what if scenarios. The type of analysis that Jamie is doing is best described as:
A. sensitivity analysis.
B. erosion planning.
C. scenario analysis.
D. benefit planning.
E. opportunity evaluation.

Mark is analyzing a proposed project to determine how changes in the variable costs per unit would affect the project’s net present value. What type of analysis is Mark conducting?
A. Sensitivity analysis
B. Erosion planning
C. Scenario analysis
D. Cost-benefit analysis
E. Opportunity cost analysis

Which one of the following portfolios will have a beta of zero?
A. A portfolio that is equally as risky as the overall market.
B. A portfolio that consists of a single stock.
D. A portfolio with a zero variance of returns.
E. No portfolio can have a beta of zero.

Which one of the following terms applies to a bond that initially sells at a deep discount and pays no interest payments?
A. Callable
B. Income
C. Zero coupon
D. Convertible
E. Tax-free

The payback method of analysis ignores which one of the following?
A. Initial cost of an investment
B. Arbitrary cutoff point
C. Cash flow direction
D. Time value of money
E. Timing of each cash inflow

Which one of the following methods of analysis is most appropriate to use when two investments are mutually exclusive?
A. Internal rate of return
B. Profitability index
C. Net present value
D. Modified internal rate of return
E. Average accounting return

You want to create a $100,000 portfolio that consists of three stocks. Currently, you own 40,000 shares of stock A, 20,000 shares of stock B and 40,000 shares of stock C. The expected return for stock A is 5 percent, stock B is 20 percent and stock C is 15 percent. What is the expected rate of return for the portfolio?
A. 9 percent
B. 10 percent
C. 12 percent
D. 13 percent

Which one of the following is a use of cash?
Issuing new shares of stock
Increasing accounts payable
Decreasing inventory
Decreasing fixed assts
Increasing accounts receivable

The weighted average cost of capital is defined as the weighted average of a firm’s:
return on its investments.
cost of equity and its aftertax cost of debt.
pretax cost of debt and equity securities.
bond coupon rates.
dividend and capital gains yields.

All else constant, an increase in a firm’s cost of debt will:
A. result in an increase in the firm’s cost of capital..
B. lower the firm’s weighted cost of capital.
C. lower the firm’s external cost of new equity.
D. increase the firm’s capital structure weight of debt.
E. increase the firm’s capital structure weight of debt.

Judy’s Boutique just paid an annual dividend of $1.65 on its common stock. The firm increases its dividend by 2.5 percent annually. What is the rate of return on this stock if the current stock price is $38.20 a share?
6.93 percent
7.37 percent
7.54 percent
8.19 percent

Winter Wear, Inc. has 6 percent bonds outstanding that mature in 13 years. The bonds pay interest semiannually and have a face value of $1,000. Currently, the bonds are selling for $993 each. What is the firm’s pre-tax cost of debt?
5.97 percent
6.08 percent
6.14 percent
6.31 percent
8.33 percent
The 7.5 percent preferred stock of Home Town Brews is selling for $43 a share. What is the firm’s cost of preferred stock if the tax rate is 34 percent and the par value per share is $100?
14.47 percent
15.92 percent
16.17 percent
16.52 percent
17.44 percent

If inflation is expected to steadily decrease in the future, the term structure of interest rates will most likely be:

Which one of the following indicates that a project is expected to create value for its owners?
Profitability index less than 1.0
Payback period greater than the requirement
Positive net present value
Positive average accounting rate of return
Internal rate of return that is less than the requirement

A bond has a $1,000 face value, a market price of $1,036, and pays interest payments of $70 every year. What is the coupon rate?
6.76 percent
7.00 percent
7.12 percent
13.51 percent
14.00 percent

The Pancake House pays a constant annual dividend of $1.25 per share. How much are you willing to pay for one share if you require a 15 percent rate of return?

A corporate bond pays 8.5 percent interest. You are in the 15 percent tax bracket. What is your after-tax yield on this bond?
1.28 percent
2.23 percent
7.23 percent
8.35 percent
9.78 percent

The 7 percent annual coupon bonds of TPO, Inc. are selling for $1,021. The bonds have a face value of $1,000 and mature in 6.5 years. What is the yield to maturity?
6.42 percent
6.59 percent
6.63 percent
6.68 percent
6.70 percent

Healthy Foods just paid its annual dividend of $1.45 a share. The firm recently announced that all future dividends will be increased by 2.8 percent annually. What is one share of this stock worth to you if you require a 14 percent rate of return?

Blackwell Ink is losing significant market share and thus its managers have decided to decrease the firm’s annual dividend. The last annual dividend was $0.90 a share but all future dividends will be decreased by 5 percent annually. What is a share of this stock worth today at a required return of 15 percent?
Which one of the following types of securities has no priority in a bankruptcy proceeding?
Convertible bond
Senior debt
Common stock
Preferred stock
Straight bond

Any person who owns a license to trade on the NYSE is called a:
floor trader.

The payback period is the length of time it takes an investment to generate sufficient cash flows to enable the project to:
produce a positive annual cash flow.
produce a positive cash flow from assets.
offset its fixed expenses.
offset its total expenses.
recoup its initial cost

Which one of the following defines the internal rate of return for a project?
Discount rate that creates a zero cash flow from assets
Discount rate which results in a zero net present value for the project
Discount rate which results in a net present value equal to the project’s initial cost
Rate of return required by the project’s investors
The project’s current market rate of return