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

| October 22, 2018

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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