# An income statement reports the firm’s revenues and expenses for a specific period of time such as one year

True/False

(1 point each). For each question,

enter (a) for True and (b) for False.

1.

An income statement reports the

firm’s revenues and expenses for a specific period of time such as one year.

2.

An example of a perpetuity is a

bond with an interest rate that remains constant over the life of the bond

(i.e., until the bond matures).

3.

A return of 12% compounded

annually is the same as a return of 1% per month.

4.

If a bond sells for its par

value, the coupon interest rate and yield to maturity are equal.

5.

An inverted yield curve implies

that the market expects interest rates to rise in the future.

6.

Preferred stock is less risky

than common stock, but more risky than debt.

7.

A general partnership, unlike a

limited partnership, is an entity that legally functions separate and apart

from its owners.

8.

Profit maximization is not the

goal of the firm because accounting profits do not accurately measure the

timing and uncertainty of a company’s cash flows.

9.

The corporation is a legal

entity separate from it owners; thus it is possible for the corporation to

continue even upon the death of one or more shareholders.

10.

If two companies have the same

revenues and operating expenses, their net incomes will still be different if

one company finances its assets with more debt and the other company with more

equity.

11.

Multiple

Choice (3 points each)

11. Company A and Company B both report the same level of sales and net

income. Therefore, ________.

a. both

A and B will report the same Earnings Per Share

b. both

A and B will report the same Gross Profit Margin

c. both A and B will report the same Net

Profit Margin

d. both A and C are true

12. Which of the following questions are

addressed by financial managers?

I. How

long will it take to produce a product?

II. How

long should customers be given to pay for their credit purchases?

III. Should

the firm borrow more money?

IV. Should

the firm build a new factory?

a. I and IV only

b. II and III only

c. I, II, and III only

d. II, III, and IV only

e. I, II, III, and IV

13. Which one of the following statements is correct?

a. Both partnerships and corporations incur

double taxation.

b. Both sole proprietorships and partnerships

are taxed in a similar fashion.

c. Partnerships are the most complicated type

of business to form.

d. All types of business formations have

limited lives.

14.

Which one of the following actions by a financial manager creates an

agency problem?

a. refusing to borrow money when doing so will

create losses for the firm

b. refusing to lower selling prices if doing

so will reduce the net profits

c. expanding the company resulting in a

decline in stockholders’ value

d. agreeing to pay bonuses based on the market

value of the company stock

e. increasing current costs in order to increase

the market value of the stockholders’

equity

15. Which of the following is a disadvantage to

organizing as a C Corporation?

a. Owners

are subject to unlimited liability for the firm’s debts

b. Changes

in ownership will not dissolve the firm

c. Earnings

are subject to taxation at the corporate and personal level

d. Owners

have no control over the actions of the manager

e. Corporations

have easy access to capital

16. Li Retailing reported the following items for

the current year: Sales = $2,000,000; Cost of Goods Sold = $1,200,000;

Depreciation Expense = $140,000; Administrative Expenses = $170,000; Interest

Expense = $40,000; Marketing Expenses = $60,000; and Taxes = $20,000. Li’s gross profit is equal to ________.

a. $800,000

b. $490,000

c. $430,000

d. $410,000

17. The

process of finding the present value of some future amount is often called:

a. growth.

b. discounting.

c. accumulation.

d. compounding.

e. reduction.

18. As

the discount rate increases, the present value of $500 to be received six years

from now:

a. remains constant.

b. also increases.

c. decreases.

d. becomes negative.

e. will vary but the direction of the change

is unknown.

19. You

hope to buy your dream house six years from now. Today your dream house costs

$189,900.

You expect housing prices to rise by an average of 4.5 percent per year over

the

next six years. How much will your dream house cost by the time you are ready

to

buy

it?

a. $240,284.08

b. $246,019.67

c. $246,396.67

d. $246,831.94

e. $247,299.20

20. Alpha, Inc. is saving money to

build a new factory. Six years ago they set aside

$250,000

for this purpose. Today, that account is worth $306,958. What rate of interest

is

Alpha earning on this money?

a. 3.36 percent

b. 3.42 percent

c. 3.48 percent

d. 3.55 percent

e. 3.60 percent

21.You are

comparing two annuities which offer monthly payments for ten years. Both

annuities are identical with the exception of the payment dates. Annuity A pays

on the first of each month while annuity B pays on the last day of each month.

Which one of the following statements is correct concerning these two

annuities?

a. Both annuities are of equal value today.

b. Annuity B is an annuity due.

c. Annuity A has a higher present value than

annuity B.

d. Annuity B has a higher present value than

annuity A.

e. Both annuities have the same future value

as of ten years from today.

22. You are the beneficiary of a life insurance

policy. The insurance company informs you that you have two options for

receiving the insurance proceeds. You can receive a lump sum of $50,000 today

or receive payments of $641 a month for ten years. You can earn 6.5 percent on

your money. Which option should you take and why?

a. You should accept the payments because they

are worth $56,451.91 today.

b. You should accept the payments because they

are worth $76,523.74 today.

c. You should accept the payments because they

are worth $126,737.08 today.

d. You should accept the $50,000 because the

payments are only worth $6,223.10 today.

e. You should accept the $50,000 because the

payments are only worth $47,808.17 today.

23. The Great Giant Corp. has a management contract with

their newly hired president. The contract requires a lump sum payment of $25

million be paid to the president upon the completion of her first ten years of

service. The company wants to set aside an equal amount of funds each year to

cover this anticipated cash outflow. The company can earn 6.5 percent on these

funds. How much must the company set aside each year for this purpose?

a. $1,775,042.93

b. $1,798,346.17

c. $1,801,033.67

d. $1,852,617.25

e. $1,938,018.22

24. You recently filed suit against a company.

Today, you received three settlement options as follows:

Option

A: $10,000 on the first day of

each year for 25 years

Option

B: $880 on the first day of each

month for 25 years

Option

C: $119,830 as a lump sum payment

today

You can earn 7.5 percent on your

investments. You do not care if you personally receive the funds or if they are

paid to your heirs should you die within the next 25 years. Which one of the

following statements is correct given this information?

a. Option C is clearly the best choice since

you can earn 7.5 percent on the entire lump sum starting immediately.

b. Option B is clearly the best choice since

it offers the largest number of payments.

c. Option A is clearly the best choice since

it has by far the largest future value.

d. Option B is clearly the best choice since

it has by far the largest present value.

e. You are relatively indifferent to the three

options as they are all approximately equal in value to you.

25. Marko, Inc. is considering the purchase of ABC Co. Marko

believes that ABC Co. can generate cash flows of $5,000, $9,000, and $15,000

over the next three years, respectively. After that time, they feel the

business will be worthless. Marko has determined that a 14 percent rate of

return is applicable to this potential purchase. What is Marko willing to pay

today to buy ABC Co.?

a. $19,201.76

b. $21,435.74

c. $23,457.96

d. $27,808.17

e. $31,758.00

26.You would like to establish a

trust fund that will provide $50,000 a year forever for your heirs. The trust fund

is going to be invested very conservatively so the expected rate of return is

only 2.75 percent. How much money must you deposit today to fund this gift for

your heirs?

a. $1,333,333.33

b. $1,375,000.00

c. $1,425,000.00

d. $1,666,666.67

e. $1,818,181.82

27.In the event of default, debt

holders are considered to have a more _____ claim on the firm than common

stockholders, and common stockholders have a more _____ claim than preferred

stockholders.

a. short-term; long-term

b. long-term; short-term

c. senior; junior

d. junior; senior

e. senior; senior

28.A bond with a 7 percent

coupon that pays interest semi-annually and is priced at a premium could have a

market price of _____ and will have interest payments in the amount of _____

each.

a. $934.58; $70

b. $1,070; $35

c. $1,070; $70

d. $934.58; $35

e. $1,000; $70

29.A General Co. bond has an 8

percent coupon and pays interest annually. The face value is $1,000 and the

current market price is $1,020.50. The bond matures in 20 years. What is the

yield to maturity?

a. 7.79 percent

b. 7.82 percent

c. 8.00 percent

d. 8.04 percent

e. 8.12 percent

30.Party Time, Inc. has a 6

percent coupon bond that matures in 11 years. The bond pays interest

semiannually. What is the market price of a $1,000 face value bond if the yield

to maturity is 12.9 percent?

a. $434.59

b. $580.86

c. $600.34

d. $605.92

e. $947.87

31. 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 of time.

III. states that the market price of a stock is

only affected by the amount of the dividend.

IV. considers capital gains but ignores the

dividend yield.

a. I only

b. II only

c. III and IV only

d. I and II only

e. I, II, and III only

32. Michael’s, Inc. just paid $1.40 to their shareholders as the

annual dividend. Simultaneously, the company announced that future dividends

will be increasing by 4.5 percent. If you require an 8 percent rate of return,

how much are you willing to pay to purchase one share of Michael’s stock?

a. $31.11

b. $32.51

c. $40.00

d. $41.80

e. $43.68

33.

Majestic Homes stock

traditionally provides an 8 percent rate of return (EAR). The company

just

paid a $2 dividend which is expected to increase by 1.5 percent per quarter. If

you

are planning on buying 1,000 shares of this stock next year, how much should

you

expect

to pay per share if the market rate of return for this type of security is 9

percent (EAR)

at

the time of your purchase?

a. $451.82

b. $26.67

c. $400.00

d. $295.06

e. $266.67

34.The

common stock of Grady Co. returned an 11.25 percent rate of return last year.

The dividend amount was $.70 a share which equated to a dividend yield of 1.5

percent. What was the capital gains yield on the stock?

a. 1.50 percent

b. 8.00 percent

c. 9.75 percent

d. 11.25 percent

e. 12.75 percent

35. The

Extreme Reaches Corp. last paid a $1.50 per share annual dividend. The company

is planning on paying $3.00, and $5.00 a share over the next two years,

respectively. After that the dividend will be a constant $2.50 per share per

year. What is the market price of this stock if the market rate of return is 15

percent?

a. $17.04

b. $18.99

c. $26.57

d. $29.08

e. $33.71

Short Answer (1.5 points

each)

1. What is the goal of the firm?

2. What is price (of a financial asset)?

Computational

Problem (Each part 3 points) –

Batman decides he wants to help Robin save for retirement. Robin is

currently 30 years old and wants to retire at age 62. He expects to live for 20

years after he retires. Batman plans to invest $25,000 at the end of each year

into a retirement account that earns an APR of 9%, compounded monthly.

a. What is the appropriate

discount rate.

b. Assume an answer of 10% to

part (a). How much will Robin have in his account at the time of his

retirement?

c. Assume an answer of 10% to

part (a) and 5,000,000 to part (b). Robin wants to withdraw funds monthly once

he retires so that he will have no money left in the account after 20 years.

What is the appropriate discount rate? How much can he withdraw per month?

d. Alternatively, Superman

is considering acquiring a new sidekick and knows Robin feels underappreciated

in his current employ. He has offered to fund a retirement account for Robin

with $350,000 today at an APR of 8% compounded annually. If Robin chooses

Batman’s option, what does foregoing this alternative represent? Why did Robin

choose Batman’s option (what is Superman’s option worth at his retirement)?

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