Multiple Choice Study Guide. I want to be sure I have the right

| June 3, 2016

Question
The concept of time value of money is important to nancial decision making because
A.in uncertain times, future cash ow expectations are more valuable than current cash.
B. portfolio theory allows us to mitigate all risks.
C. many nancial decisions involve cash ows at different points in time.
D. all of the above

As the interest rate increases, the benet of receiving cash ows earlier
A. increases.
B. decreases.
C. remains the same.
D. Not enough information to tell.

Which of the following has the greatest impact on the present value of a sum to be received
sometime in the future
A. risk premium.
B. ination premium.
C. utility premium (real rate of return).
D. Not enough information to tell.

To save for her newborn son’s college education, Lea Wilson will invest $1,000 at the
BEGINNING of each year for the next 12 years. The interest rate is 18 percent. What is the
future value?
A. $7,690.
B. $34,931.
C. $41,219.
D. $55,750.

Mr. Nailor invests $5,000 in a certicate of deposit at his local bank. He receives annual interest
of 5% for 6 years. How much interest will his investment earn during this time period?
A. $1,700
B. $2,095
C. $5,254
D. $7,095

Based on a recent investment, Ambrin Corp. expects to receive $5,000 per year for 10 years and

$2,500 per year for the next 20 years (years 11 through 30). What is the present value of this 30
year cash ow. Use a 10% discount rate.
A. $15,362
B. $23,567
C. $31,417
D. $38,930

Mr. Fish wants to build a house in 5 years. He estimates that the total cost will be $249,000. If he
can put aside $40,000 at the end of each year (for the next 5 years), what rate of return must he
earn in order to have the amount needed?
A. Between 10% and 12%
B. Between 12% and 14%
C. Greater than 14%
D. None of the above

Decreasing the number of periods will increase
A. the present value of an annuity.
B. the present value of $1.
C. the future value of $1.
D. the future value of an annuity.

Which of the following nancial assets is likely to have its value impacted the most be a change
in the ination premium?
A. corporate bond.
B. short term treasury bill.
C. preferred stock.
D. common stock.

A bond which has a yield to maturity equal to its coupon interest rate will sell for a price
A. below par.
B. at par.
C. above par.
D. what is equal to the face value of the bond plus the value of all interest payments.

An increase in the riskiness of a particular security would NOT affect
A. the risk premium for that security.

B. the premium for expected ination.
C. the total required return for the security.
D. investors’ willingness to buy the security.

If the risk premium for a stock goes down (all other things being the same)
A. the stocks dividend will increase.
B. the price of the stock will decrease.
C. debt nancing will become more attractive.
D. none of the above.

A ten-year bond pays 10% annual interest on a $1000 face value. If it currently sells for $950,
what is its approximate yield to maturity?
A. 9.33%
B. 7.94%
C. 10.75%
D. 8.10%

The longer the time to maturity:
A. the greater the price decrease from an increase in interest rates.
B. the less the price increase from an increase in interest rates.
C. both A and B.
D. the higher the annual ination premium.

An issue of preferred stock is paying an annual dividend of $10. The growth rate for the rm’s
common stock dividend is 13%. What is the preferred stock price if the required rate of return
(Kp) is 12%?
A. $83.33
B. $76.92
C. $108.33
D. none of the above

Which type of security carries no ownership interest, and also does not impose an absolute
obligation on the part of the issuing company to make regular payments to the holder of the
security?
A. municipal bonds
B. common stock

C. treasury bills
D. preferred stock

A common stock does not pay any current dividend. It is however, expected to pay a $2.00
dividend at the end of the fourth year, at which point it is expected to pay an annual dividend,
which will increase by 5% per year. If the stocks current price is $30.04, what is the required
rate of return (Ke) of the stock?
A. 5% or less.
B. between 5 and 8%.
C. between 8 and 11%.
D. greater than 11%.

An issue of common stock has just paid a dividend of $2.00. Its dividend growth rate is equal to
5%. If the required rate of return is 15%, what is its current price?
A. $19
B. $20
C. $21
D. none of the above

US Steel has a capital structure that is comprised of 60% debt, 10% preferred stock, and 30%
common equity. US Steels pretax cost of debt is 8%. It’s pretax cost of preferred equity is 9%,
and it’s pretax cost of common equity is 14%. If the corporate tax rate is 50%, what is the
weighted average cost of capital?
A. between 7% and 8%
B. between 8% and 9%
C. between 9% and 10%
D. between 10% and 12%

If a rm’s bonds are currently yielding 8% in the marketplace, why would the rm’s cost of debt
be lower?
A. Interest rates have changed.
B. Additional debt can be issued more cheaply than the original debt.
C. There should be no difference; cost of debt is the same as the bond’s market yield.

D. Interest is tax-deductible.

The coupon rate on a debt issue (20 years to maturity) is 7%. If the yield to maturity on the debt
is 9%. The face amount of the bonds is $1,000. What is the after-tax cost of debt if the rm’s tax
rate is 30%?
A. 6.30%
B. 7.51%
C. 6.16%
D. 7.92%

A rm is paying an annual dividend of $6.50 for its preferred stock which is selling for $75.00.
There is a selling (oatation) cost of $3.30. What is the after-tax cost of preferred stock if the
rm’s tax rate is 33%?
A. 8.67%
B. 4.09%
C. 9.07%
D. 6.08%

If the otation costs of Preferred Stock go up (all other things being the same), the cost of
retained earnings will
A. go up.
B. go down.
C. stay the same.
D. slowly increase.

A rm’s common stock is selling for $100. The dividend yield is 6%. A 5% growth rate is
expected for the common stock. The rm’s tax rate is 40%. What is the rm’s cost of common
equity?
A. 8.25%
B. 11.00%
C. 9.11%
D. cannot be determined.

Which of the following are likely to be true of WalMart, relative to Facebook.
A. WalMart is likely to have more stable and predictable cash ows

B. WalMart is likely to benet from have a greater reliance on equity in its capital structure
C. WalMart is likely to benet from greater nancial leverage
D. A and C

The payback method has several disadvantages, among them:
A. payback identies the best time value of money adjusted returns.
B. payback emphasizes liquidity.
C. payback is relatively simple to calculate.
D. all of the above.

With non-mutually exclusive projects.
A. the payback method will select the best project.
B. the net present value method will always select the best project.
C. the internal rate of return method will always select the best project.
D. the net present value and the internal rate of return methods will accept or reject the same
project.

You require an IRR of 10% to accept a project. If the project will yield $100,000 per year for 4
years, what is the maximum amount that you would be willing to invest in the project?
A. less than $250,000
B. more than $250,000 and less than $300,000
C. more than $300,000 and less than $350,000
D. more than $350,000

Please show your work for the following problem:

You buy a new piece of equipment for $40,000, and you receive a cash inows of:

$10,000 in year 1 / $15,000 in year 2 / and $30,000 in year 3

What is the approximate internal rate of return for the project (within a range of 2%)?

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