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DAVENPORT FINC620 FINAL EXAM

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Question;Question 1;Which;of the following statements is CORRECT?;A. Although;its stockholders are insulated by limited legal liability, the legal status of;the corporation does not protect the firm?s managers in the same way, i.e.;bondholders can sue its managers if the firm defaults on its debt, even if the;default is the result of poor economic conditions.;B. Unlimited;liability and limited life are two key advantages of the corporate form over;other forms of business organization.;C. Limited;liability of its stockholders is an advantage of the corporate form of;organization, but corporations have more trouble raising money in financial;markets because of the complexity of this form of organization.;D. A;corporation is a legal entity that is generally created by a state, and it has;a life and existence that is separate from the lives of its individual owners;and managers.;Question 2;Below;is the common equity section (in millions) of Teweles Technology?s last two;year-end balance sheets;2007;2006;CommonStock;$2000 $1000;RetainedEarnings;2000 2340;Total;Common Equity $4000 $3340;Teweles;has never paid a dividend to its common stockholders. Which of the following;statements is CORRECT?;A.;The;market price of Teweles' stock doubled in 2007.;B.;The;company has more equity than debt on its balance sheet.;C.;The;company?s net income in 2007 was higher than in 2006.;D.;Teweles;had positive net income in both 2006 and 2007, but the company?s net income in;2007 was lower than it was in 2006.;E.;Teweles;issued common stock in 2007.;Question 3;Suppose;firms follow similar financing policies, face similar risks, have equal access;to capital, and operate in competitive product and capital markets. Under these;conditions, then firms that have high profit margins will tend to have high;asset turnover ratios, and firms with low profit margins will tend to have low;turnover ratios.;A.;True;B.;False;Question 4;Companies;E and P each reported the same earnings per share (EPS), but Company E's stock;trades at a higher price. Which of the following statements is CORRECT?;A.;Company;E must pay alowerdividend.;B.;Company;E is probably judged by investors to beriskier.;C.;Company;E trades at ahigherP/E ratio.;D.;Company;E must have a higher market-to-book ratio.;E.;Company E probably hasfewergrowth opportunities.;Question 5;Which;of the following statements isNOTCORRECT?;A.;Under;Chapter 11 of the Bankruptcy Act, the assets of a firm that declares bankruptcy;must be liquidated, and the sale proceeds must be used to pay off its debt;according to the seniority of the debt as spelled out in the Act.;B.;All;else equal, secured debt is less risky than unsecured debt.;C.;A;company?s bond rating is affected by its financial ratios and provisions in its;indenture.;D.;The;expected return on a corporate bond must be less than its promised return if;the probability of default is greater than zero.;E. All else equal;senior debt has less default risk than subordinated debt.;Question 6;Which;of the following statements is CORRECT?;A.;If;inflation is expected to increase in the future, and if the maturity risk;premium (MRP) is greater than zero, then the yield curve will have an upward;slope.;B.;The;yield curve can never be downward sloping.;C.;Because;long-term bonds are riskier than short-term bonds, yields on long-term Treasury;bonds will always be higher than yields on short-term T-bonds.;D.;If;the maturity risk premium (MRP) is greater than zero, then the yield curve must;have an upward slope.;E. If the maturity;risk premium (MRP) equals zero, the yield curve must be flat.;Question 7;A;highly risk-averse investor is considering adding one additional stock to a;3-stock portfolio, to form a 4-stock portfolio. The three stocks currently held;all have b = 1.0 and a perfect positive correlation with the market. Potential;new Stocks A and B both have expected returns of 15%, and both are equally;correlated with the market, with r = 0.75.However, Stock A's standard deviation;of returns is 12% versus 8% for Stock B. Which stock should this investor add;to his or her portfolio, or does the choice matter?;Neither;A nor B, as neither has a return sufficient to compensate for risk.;A.;Stock;B.;B.;Stock;A.;C.;Add;A, since its beta must be lower.;D. Either A or B;i.e., the investor should be indifferent between the two.;Question;8;If;two firms have the same current dividend and the same expected dividend growth;rate, their stocks must sell at the same current price or else the market will;not be in equilibrium.;A. True;B. False;Question;9;Stock;X has a required return of 10%, while Stock Y has a required return of 12%.;Which of the following statements is CORRECT?;A. If;Stock Y and Stock X have the same dividend yield, then Stock Y must have a;lower expected capital gains yield than Stock X.;B. Stock;Y must have a higher dividend yield than Stock X.;C. If;the market is in equilibrium, and if Stock Y has thelowerexpected;dividend yield, then it must have thehigherexpected growth rate.;D. The;stocks must sell for the same price.;E. If;Stock X and Stock Y have the same current dividend and the same expected;dividend growth rate, then Stock Y must sell for a higher price.;Question;10;Deeble Construction Co.?s stock is;trading at $30 a share. Call options on the company?s stock are also available;some with a strike price of $25 and some with a strike price of $35. Both;options expire in three months. Which of the following best describes the value;of these options?;A.;The options with the $25 strike price will sell for less;than the options with the $35 strike price.;B.;The options with the $35 strike price have an exercise;value greater than $0.;C.;The options with the $25 strike price will sell for $5.;D.;The options with the $25 strike price have an exercise;value greater than $5.;E.;If Deeble?s stock price rose by $5, the exercise value;of the options with the $25 strike price would also increase by $5.;Question 11;Which;of the following isNOTa capital component when calculating the weighted;average cost of capital (WACC)?;A. Retained;earnings.;B. Common;stock.;C. Accounts;payable.;D. Preferred;stock.;E. Long-term;debt.;Question;12;When;working with the CAPM, which of the following factors can be determined with;the most precision?;A. The;market risk premium (RPM).;B. The;expected rate of return on the market, rM.;C. The;beta coefficient of ?the market,? which is the same as the beta of an average;stock.;D. The;beta coefficient, bi, of a relatively safe stock.;E. The;most appropriate risk-free rate, rRF.;Question;13;You;are on the staff of Camden Inc. The CFO believes project acceptance should be;based on the NPV, but Steve Camden, the president, insists that no project can;be accepted unless its IRR exceeds the project?s risk-adjusted WACC. Now you;must make a recommendation on a project that has a cost of $15,000 and two cash;flows: $110,000 at the end of Year 1 and -$100,000 at the end of Year 2. The;president and the CFO both agree that the appropriate WACC for this project is;10%.At 10%, the NPV is $2,355.37, but you find two IRRs, one at 6.33% and one;at 527%, and a MIRR of 11.32%. Which of the following statements best describes;your optimal recommendation, i.e., the analysis and recommendation that is best;for the company and least likely to get you in trouble with either the CFO or;the president?;A. You;should recommend that the project be rejected because, although its NPV is;positive, it has an IRR that is less than the WACC.;B. You;should recommend that the project be rejected because its NPV is negative and;its IRR is less than the WACC.;C. You;should recommend that the project be rejected because (1) although its NPV is;positive and (2) it has two IRRs, one of which is less than the WACC, which;indicates that the firm?s value will decline if the project is accepted.;D. You;should recommend that the project be rejected because, although its NPV is;positive, its MIRR is less than the WACC, and that indicates that the firm?s;value will decline if it is accepted.;E. You;should recommend that the project be accepted because (1) its NPV is positive;and (2) although it has two IRRs, in this case it would be better to focus on;the MIRR, which exceeds the WACC. You should explain this to the president and;tell him that that the firm?s value will increase if the project is accepted.;Question;14;Edmondson;Electric Systems is considering a project that has the following cash flow and;WACC data. What is the project's NPV?Note that if a project's projected NPV is;negative, it should be rejected.;WACC;10.00%;Year;0 1 2 3;Cash;flows: -$1000 $500 $500 $500;A. $281.80;B. $268.38;C. $243.43;D. $295.89;E. $255.60;Question;15;Which;of the following statements is CORRECT?;A. A;sunk cost is any cost that must be expended in order to complete a project and;bring it into operation.;B. Sunk;costs were formerly hard to deal with, but once the NPV method came into wide;use, it became possible to simply include sunk costs in the cash flows and then;calculate the PV.;C. A;sunk cost is any cost that was expended in the past but can be recovered if the;firm decides not to go forward with the project.;D. A;sunk cost is a cost that was incurred and expensed in the past and cannot be;recovered if the firm decides not to go forward with the project.;E. A;good example of a sunk cost is a situation where a retailer opens a new store;and that leads to a decline in sales of some of the firm?s existing stores.;Question;16;Which;of the following statements is CORRECT?;A. Using;MACRS depreciation rather than straight line normally has the effect of slowing;down cash flows and thus reducing a project?s forecasted NPV.;B. Corporations;must use MACRS depreciation for both stockholder reporting and tax purposes.;C. Under;current laws and regulations, corporations must use straight-line depreciation;for all assets whose lives are 5 years or longer.;D. Using;MACRS depreciation rather than straight line normally has the effect of;speeding up cash flows and thus increasing a project?s forecasted NPV.;E. Since;depreciation is a cash expense, the faster an asset is depreciated, the lower;the projected NPV from investing in the asset.;Question;17;Which;of the following statements is CORRECT?;A. The;first, and perhaps the most critical, step in forecasting financial;requirements is to forecast future sales.;B. Pro;forma financial statements, as discussed in the text, are used primarily as a;part of the managerial compensation program, where management?s historical;performance is evaluated.;C. The;AFN equation method produces more accurate forecasts than the forecasted;financial statement method, especially if fixed assets are lumpy and economies;of scale exist.;D. The;capital intensity ratio gives us an idea of the physical condition of the;firm?s fixed assets.;E. Perhaps;the most important step when developing pro forma financial statements is to;determine the breakdown of common equity between common stock and retained;earnings.;Question;18;Based;on the corporate valuation model, Hunsader?s value of operations is $300;million. The balance sheet shows $20 million of short-term investments that are;unrelated to operations, $50 million of accounts payable, $90 million of notes;payable, $30 million of long-term debt, $40 million of preferred stock, and;$100 million of common equity. The company has 10 million shares of stock;outstanding. What is the best estimate of the stock?s price per share?;$16.80;$15.20;$14.14;$16.00;$13.72;Question;19;Which;of the followingdoesNOTalwaysincreaseacompany?s market value?;A. Increasing;the expected operating profitability (NOPAT/Sales).;B. Decreasing;the weighted average cost of capital.;C. Decreasing;the capital requirements (Capital/Sales).;D. Increasing;the expected growth rate of sales.;E. Increasing;the expected rate of return on invested capital.;Question;20;Firm;A has a higher degree of business risk than Firm B. Firm A can offset this by;using less financial leverage. Therefore, the variability of both firms;expected EBITs could actually be identical.;True;False;Question;21;Volga;Publishing is considering a proposed increase in its debt ratio, which would;also increase the company?s interest expense. The plan would involve issuing;new bonds and using the proceeds to buy back shares of its common stock. The;company?s CFO thinks the plan will not change total assets or operating income;but that it will increase earnings per share (EPS). Assuming the CFO?s;estimates are correct, which of the following statements is CORRECT?;A. Since;the plan is expected to increase EPS, this implies that net income is also;expected to increase.;B. Under;the plan there will be more bonds outstanding, and that will increase their;liquidity and thus lower the interest rate on the currently outstanding bonds.;C. If;the plan does increase the EPS, the stock price will automatically increase at;the same rate.;D. If;the plan reduces the WACC, the stock price is also likely to decline.;E. Since;the proposed plan increases Volga?s financial risk, the company?s stock price still;might fall even if EPS increases.;Question;22;Other;things held constant, which of the following will cause anincreasein net;working capital?;Long-term;bonds are retired with the proceeds of a preferred stock issue.;Merchandise;is sold at a profit, but the sale is on credit.;Missing;inventory is written off against retained earnings.;Cash;is used to buy marketable securities.;A;cash dividend is declared and paid.;Question;23;Which;of the following statements is most CORRECT?;A. Since;depreciation is a non-cash charge, it does not appear on nor have an effect on;the cash budget.;B. Shorter-term;cash budgets, in general, are used primarily for planning purposes, while;longer-term budgets are used for actual cash control.;C. The;target cash balance is set optimally such that it need not be adjusted for;seasonal patterns and unanticipated fluctuations in receipts, although it is;changed to reflect long-term changes in the firm?s operations.;D. The;typical actual cash budget will reflect interest on loans and income from;investment of surplus cash. These numbers are expected values and actual;results might vary from budgeted results.;E. The;cash budget and the capital budget are planned separately and although they are;both important to the firm, they are independent of each other.;Question;24;In;1985, a given Japanese imported automobile sold for 1,476,000 yen, or $8,200.;If the car still sold for the same amount of yen today but the current exchange;rate is 144 yen per dollar, what would the car be selling for today in U.S.;dollars?;A. $10,250;B. $13,525;C. $5,964;D. $8,200;Question;25;You;are negotiating to make a 7-year loan of $25,000 to Breck Inc. To repay you;Breck will pay $2,500 at the end of Year 1, $5,000 at the end of Year 2, and;$7,500 at the end of Year 3, plus a fixed but currently unspecified cash flow;X, at the end of Years 4 through 7. Breck is essentially riskless, so you are;confident the payments will be made, and you regard 8% as an appropriate rate;of return on low risk 7-year loans. What cash flow must the investment provide;at the end of each of the final 4 years, that is, what is X?;A. $4,733.15;B. $4,271.67;C. $4,969.81;D. $4,496.49;E. $5,218.30

 

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