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FIN 350 MINI TEST 1 CHAPTER 2

A

1.      A firm has notes payable of $1,546,000, long-term debt of $13,000,000, and total interest expense of $1,300,000. If the firm pays 8 percent interest on its long-term debt, what interest rate does it pay on its notes payable?

·        16.8%

 

2.      A start-up firm is making an initial investment in new plant and equipment. Currently, equipment is depreciated on a straight-line basis over 10 years. Assume that Congress is considering legislation that will allow the corporation to depreciate the equipment over 7 years. If the legislation becomes law, and the firm implements the 7-year depreciation basis, which of the following will occur?

·        The firm's net cash flow will increase.

 

3.      A stock analyst has acquired the following information for Palmer Products:

Ø      Retained earnings on the year-end 2001 balance sheet was $700,000.

Ø      Retained earnings on the year-end 2002 balance sheet was $320,000.

Ø      The company does not pay dividends.

Ø      The company's depreciation expense is its only non-cash expense.

Ø      The company has no non-cash revenues.

Ø      The company's net cash flow for 2002 was $150,000.

On the basis of this information, which of the following statements is most correct?

·        Palmer Products had negative net income in 2002.

 

4.      A stock market analyst has forecasted the following year-end numbers for Raedebe Technology:

Ø      Sales                 $70 million

Ø      EBITDA             $20 million

Ø      Depreciation     $ 7 million

Ø      Amortization     $ 0

The company's tax rate is 40 percent. The company does not expect any changes in its net operating working capital. This year the company's planned gross capital expenditures will total $12 million. (Gross capital expenditures represent capital expenditures before deducting depreciation.) What is the company's forecasted free cash flow for the year?

·        $  2.8 million

 

5.      All else equal, which of the following actions will increase the amount of cash on a company's balance sheet?

·        The company issues new common stock.

 

6.      An analyst has acquired the following information regarding Company A and Company B:

Ø      Company A has a higher net cash flow than Company B.

Ø      Company B has higher net income than Company A.

Ø      Company B has a higher operating cash flow than Company A.

Ø      The companies have the same tax rate, investor-supplied operating capital, and cost of capital (WACC).

Assume that non-cash revenues equal zero for both companies, and depreciation is the only non-cash expense for both companies. Which of the following statements is most correct?

·        All of the statements above are correct.

 

7.      An analyst has collected the following information regarding Gilligan Grocers:

Ø      Earnings before interest and taxes (EBIT) = $700 million.

Ø      Earnings before interest, taxes, depreciation and amortization (EBITDA) = $850 million.

Ø      Interest expense = $200 million.

Ø      The corporate tax rate is 40 percent.

Ø      Depreciation is the company's only non-cash expense or revenue.

What is the company's net cash flow?

·        $450 million

 

8.      Analysts who follow Cascade Technology recently noted that, relative to the previous year, the company's operating income (EBIT) and net income had declined but its operating cash flow had increased. What could explain these changes?

·        The company's depreciation and amortization expenses increased.

 

9.      Analysts who follow Sierra Nevada Inc. recently noted that, relative to the previous year, the company's net cash flow was larger but cash on the firm's balance sheet had declined. What factors could explain these changes?

·        The company made a large investment in new plant and equipment.

 

10. Armstrong Inc. is a profitable corporation with a 40 percent corporate tax rate. The company is deciding between depreciating the equipment it purchased this year on a straight-line basis over five years or over three years. Changing the depreciation schedule will have no impact on the equipment's economic value. If Armstrong chooses to depreciate the equipment over three years, which of the following will occur next year, relative to what would have happened, if it had depreciated the equipment over five years?

·        Statements a and b are correct.

 

11. Assume that a company currently depreciates its fixed assets over 7 years. Which of the following would occur if a tax law change forced the company to depreciate its fixed assets over 10 years instead?

·        Statements a and c are correct.

 

12. Assume that the depreciation level used for tax and accounting purposes equals the true economic depreciation. Which of the following statements is most correct?

·        A firm can increase its EVA even if its operating income falls.

 

13. At the beginning of the year, Gonzales Corporation had $100,000 in cash. The company undertook a major expansion during this same year. Looking at its statement of cash flows, you see that the net cash provided by its operations was $300,000 and the company's investing activities required cash expenditures of $800,000. The company's cash position at the end of the year was $50,000. What was the net cash provided by the company's financing activities?

·        $450,000

 

14. At the end of 2001, Lehnhoff Inc. had $75 million in cash on its balance sheet. During 2002, the following events occurred:

Ø      The cash flow from Lehnhoff's operating activities totaled $325 million.

Ø      Lehnhoff issued $500 million in common stock.

Ø      Lehnhoff's notes payable decreased by $100 million.

Ø      Lehnhoff purchased fixed assets totaling $600 million.

How much cash did Lehnhoff Inc. have on its balance sheet at the end of 2002?

·        $   200 million

 

15. At the end of 2001, Scaringe Medical Supply had $275 million of retained earnings on its balance sheet. During 2002, Scaringe paid a per-share dividend of $0.25 and produced earnings per share of $0.75. Scaringe has 20 million shares of stock outstanding. What was the level of retained earnings that Scaringe had on its balance sheet at the end of 2002?

·        $285 million

B

Beckham Broadcasting Company
Beckham Broadcasting Company (BBC) has operating income (EBIT) of $2,500,000. The company's depreciation expense is $500,000 and it has no amortization expense. The company is 100 percent equity financed (that is, its interest expense is zero). The company has a 40 percent tax rate, and its net investment in operating capital is $1,000,000.

 

16. Refer to Beckham Broadcasting Company. What is BBC's net income?

·        $1,500,000

 

17. Refer to Beckham Broadcasting Company. What is BBC's net operating profit after taxes (NOPAT)?

·        $1,500,000

 

18. Below are the 2001 and 2002 year-end balance sheets for Kewell Boomerangs:

Assets:

2002

2001

Cash

$  100,000

$   85,000

Accounts receivable

432,000

350,000

Inventories

1,000,000

   700,000

   Total current assets

$1,532,000

$1,135,000

Net fixed assets

3,000,000

2,800,000

Total assets

$4,532,000

$3,935,000

 

 

 

Liabilities and equity:

 

 

Accounts payable

$  700,000

$  545,000

Notes payable

800,000

   900,000

   Total current liabilities

$1,500,000

$1,445,000

Long-term debt

1,200,000

1,200,000

Common stock

1,500,000

1,000,000

Retained earnings

   332,000

   290,000

   Total common equity

$1,832,000

$1,290,000

Total liabilities and equity

$4,532,000

$3,935,000

 

 

 


Kewell Boomerangs has never paid a dividend on its common stock. Kewell issued $1,200,000 of long-term debt in 1997. This debt was non-callable and is scheduled to mature in 2027. As of the end of 2002, none of the principal on this debt has been repaid. Assume that 2001 and 2002 sales were the same in both years. Which of the following statements is most correct?

·        Kewell issued new common stock in 2002.

 

19. Below is the equity portion (in millions) of the year-end balance sheet that Glenn Technology has reported for the last two years:

 

2002

2001

Preferred stock

$   80

$   80

Common stock

2,000

1,000

Retained earnings

2,000

2,340

Total equity

$4,080

$3,420

Glenn does not pay a dividend to its common stockholders. Which of the following statements is most correct?

·        Glenn issued common stock in 2002.

 

20. Brooks Sisters' operating income (EBIT) is $500,000. The company's tax rate is 40 percent, and its operating cash flow is $450,000. The company's interest expense is $100,000. What is the company's net cash flow? (Assume that depreciation is the only non-cash item in the firm's financial statements.)

·        $   390,000

 

21. Byrd Lumber has 2 million shares of common stock outstanding and its stock price is $15 a share. On the balance sheet, the company has $40 million of common equity. What is the company's Market Value Added (MVA)?

·        -$10,000,000

C

22. Casey Motors recently reported the following information:

Ø      Net income = $600,000.

Ø      Tax rate = 40%.

Ø      Interest expense = $200,000.

Ø      Total investor-supplied operating capital employed = $9 million.

Ø      After-tax cost of capital = 10%.

What is the company's EVA?

·        -$180,000

 

23. Cochrane, Inc. had $75,000 in cash on the balance sheet at the end of 2001. At year-end 2002, the company had $155,000 in cash. We know cash flow from operating activities totaled $1,250,000 and cash flow from long-term investing activities totaled -$1,000,000. Furthermore, Cochrane issued $250,000 in long-term debt last year to fund new projects, increase liquidity, and to buy back some common stock. If dividends paid to common stockholders equaled $25,000, how much common stock did Cochrane repurchase last year? (Assume that the only financing activities in which Cochrane engaged involved long-term debt, payment of common dividends, and common stock.)

·        $395,000

 

24. Congress recently passed a provision that will enable Piazza Cola to double its depreciation expense for the upcoming year. The new provision will have no effect on the company's sales revenue. Prior to the new provision, Piazza's net income was forecasted to be $4 million. The company's tax rate is 40 percent. Which of the following best describes the impact that this provision will have on Piazza's financial statements?

·        None of the statements above is correct.

 

25. Coolidge Cola is forecasting the following income statement:

Sales

$30,000,000

Operating costs excluding depreciation and amortization

20,000,000

EBITDA

$10,000,000

Depreciation and amortization

  5,000,000

Operating income (EBIT)

$ 5,000,000

Interest expense

  2,000,000

Taxable income (EBT)

$ 3,000,000

Taxes (40%)

  1,200,000

Net income

$ 1,800,000

 

 


Assume that, with the exception of depreciation, all other non-cash revenues and expenses sum to zero.

Congress is considering a proposal that will allow companies to depreciate their equipment at a faster rate. If this provision were put in place, Coolidge's depreciation expense would be $8,000,000 (instead of $5,000,000). This proposal would have no effect on the economic value of the company's equipment, nor would it affect the company's tax rate, which would remain at 40 percent. If this proposal were to be implemented, what would be the company's net cash flow?

·        $8,000,000

 

26. Cox Corporation recently reported an EBITDA of $22.5 million and $5.4 million of net income. The company has $6 million interest expense and the corporate tax rate is 35 percent. What was the company's depreciation and amortization expense?

·        $  8,192,308

E

27. Edge Brothers recently reported net income of $385,000. The tax rate is 40 percent. The company's interest expense was $200,000. What would have been the company's net income if it would have been able to double its operating income (EBIT), assuming that the company's tax rate and interest expense remain unchanged?

·        $   890,000

G

Garfield Industries is expanding its operations throughout the Southeast United States. Garfield anticipates that the expansion will increase sales by $1,000,000 and increase operating costs (excluding depreciation and amortization) by $700,000. Depreciation and amortization expenses will rise by $50,000, interest expense will increase by $150,000, and the company's tax rate will remain at 40 percent. If the company's forecast is correct, how much will net income increase or decrease, as a result of the expansion?

·        $  60,000 increase

H

28. Haskell Motors' common equity on the balance sheet totals $700 million, and the company has 35 million shares of common stock outstanding. Haskell has significant growth opportunities. Its headquarters has a book value of $5 million, but its market value is estimated to be $10 million. Over time, Haskell has issued outstanding debt that has a book value of $10 million and a market value of $5 million. Which of the following statements is most correct?

·        Statements a and c are correct.

 

29. Hayes Corporation has $300 million of common equity on its balance sheet and 6 million shares of common stock outstanding. The company's Market Value Added (MVA) is $162 million. What is the company's stock price?

·        $  77

 

30. Holmes Aircraft recently announced an increase in its net income, yet its net cash flow declined relative to last year. Which of the following could explain this performance?

·        The company's depreciation and amortization expenses declined.

 

31. Hebner Housing Corporation has forecast the following numbers for this upcoming year:

Ø      Sales = $1,000,000.

Ø      Cost of goods sold = 600,000.

Ø      Interest expense = 100,000.

Ø      Net income = 180,000.

The company is in the 40 percent tax bracket. Its cost of goods sold always represents 60 percent of its sales. That is, if the company's sales were to increase to $1.5 million, its cost of goods sold would increase to $900,000.

The company's CEO is unhappy with the forecast and wants the firm to achieve a net income equal to $240,000. In order to achieve this level of net income, what level of sales will the company have to achieve? Assume that Hebner's interest expense remains constant.

·        $1,250,000

I

32. In its recent income statement, Smith Software Inc. reported $25 million of net income, and in its year-end balance sheet, Smith reported $405 million of retained earnings. The previous year, its balance sheet showed $390 million of retained earnings. What were the total dividends paid to shareholders during the most recent year?

·        $10,000,000

K

33. Keaton Enterprises is a very profitable company, which recently purchased some equipment. It plans to depreciate the equipment on a straight-line basis over the next 10 years. Congress, however, is considering a change in the Tax Code that would allow Keaton to depreciate the equipment on a straight-line basis over 5 years instead of 10 years.

If Congress were to change the law, and Keaton does decide to depreciate the equipment over 5 years, what effect would this change have on the company's financial statements for the coming year? (Note that the change in the law would have no effect on the economic or physical value of the equipment.)

·        Statements a and c are correct.

 

34. Kramer Corporation recently announced that its net income was lower than last year. However, analysts estimate that the company's net cash flow increased. What factors could explain this discrepancy?

·        The company's depreciation and amortization expenses increased.

L

35. Last year Aldrin Co. had negative net cash flow, yet its cash on the balance sheet increased. What could explain these events?

·        Statements a and c are correct.

 

36. Last year, Blanda Brothers had positive net cash flow, yet cash on the balance sheet decreased. Which of the following could explain the company's financial performance?

·        The company purchased a lot of new fixed assets.

 

37. Last year, Sewickley Shoes had negative net cash flow; however, cash on its balance sheet increased. Which of the following could explain this?

·        The company issued a large amount of long-term debt.

 

Laiho Industries
Laiho Industries recently reported the following information in its annual report:

Ø      Net income = $7.0 million.

Ø      NOPAT = $60 million.

Ø      EBITDA = $120 million.

Ø      Net profit margin = 5.0%.

Laiho has depreciation expense, but it does not have amortization expense. Laiho has $300 million in operating capital, its after-tax cost of capital is 10 percent (that is, its WACC = 10%), and the firm's tax rate is 40 percent.

 

38. Refer to Laiho Industries. What is Laiho's depreciation expense?

·        $20.0 million

 

39. Refer to Laiho Industries. What is Laiho's EVA?

·        $30.0 million

 

40. Refer to Laiho Industries. What is Laiho's interest expense?

·        $88.3 million

 

41. Refer to Laiho Industries. What is Laiho's sales?

·        $140.0 million

 

42. Last year, Owen Technologies reported negative net cash flow and negative free cash flow. However, its cash on the balance sheet increased. Which of the following could explain these changes in its cash position?

·        The company issued new common stock.

M

43. McGwire Aerospace expects to have net cash flow of $12 million. The company forecasts that its operating costs excluding depreciation and amortization will equal 75 percent of the company's sales. Depreciation and amortization expenses are expected to be $5 million and the company has no interest expense. All of McGwire's sales will be collected in cash, costs other than depreciation and amortization will be paid in cash during the year, and the company's tax rate is 40 percent. What is the company's expected sales?

·        $  66.67 million

N

44. New Mexico Lumber recently reported that its earnings per share were $3.00. The company has 400,000 shares of common stock outstanding, its interest expense is $500,000, and its corporate tax rate is 40 percent. What is the company's operating income (EBIT)?

·        $2,500,000

 

45. New Hampshire Services reported $2.3 million of retained earnings on its 2001 balance sheet. In 2002, the company lost money--its net income was -$500,000 (negative $500,000). Despite the loss, the company still paid a $1.00 per share dividend. The company's earnings per share for 2002 were -$2.50 (negative $2.50). What was the level of retained earnings on the company's 2002 balance sheet?

·        $1.6 million

O

46. On its 2001 balance sheet, Sherman Books had retained earnings equal to $510 million. On its 2002 balance sheet, retained earnings were also equal to $510 million. Which of the following statements is most correct?

·        If the company's net income in 2002 was $200 million, dividends paid must have also equaled $200 million.

 

47. Ozark Industries reported net income of $75 million in 2002. The company's corporate tax rate was 40 percent and its interest expense was $25 million. The company had $500 million in sales and its cost of goods sold was $350 million. Ozark's goal is for its net income to increase by 20 percent (to $90 million) in 2003. It forecasts that the tax rate will remain at 40 percent, interest expense will increase by 40 percent, and cost of goods sold will remain at 70 percent of sales. What level of sales (to the closest million) will Ozark have to produce in 2003 in order to meet its goal for net income?

·        $617 million

S

48. Sanguillen Corp. had retained earnings of $400,000 on its 2001 balance sheet. In 2002, the company’s earnings per share (EPS) were $3.00 and its dividends paid per share (DPS) were $1.00. The company has 200,000 shares of common stock outstanding. What will be the level of retained earnings on the company’s 2002 balance sheet?

·        $800,000

 

49. Scranton Shipyards has $20 million in total investor-supplied operating capital. The company’s WACC is 10 percent. The company has the following income statement:

Sales                                                    $10.0 million

Operating costs                                       6.0 million

Operating income (EBIT)                   $  4.0 million

Interest expense                                      2.0 million

Earnings before taxes (EBT)             $  2.0 million

Taxes (40%)                                             0.8 million

Net income                                           $  1.2 million

What is Scranton’s EVA?

·        $   400,000

 

Sebring Corporation
You have just obtained financial information for the past 2 years for Sebring Corporation.

SEBRING CORPORATION: INCOME STATEMENTS
FOR YEAR ENDING DECEMBER 31
(MILLIONS OF DOLLARS)

 

2002

2001

Sales

$3,600.0

$3,000.0

Operating costs (excluding depreciation and amortization)

3,060.0

2,550.0

   EBITDA

$  540.0

$  450.0

Depreciation and amortization

    90.0

    75.0

   Earnings before interest and taxes

$  450.0

$  375.0

Interest

    65.0

    60.0

   Earnings before taxes

$  385.0

$  315.0

Taxes (40%)

   154.0

   126.0

Net income available to common stockholders

$  231.0

$  189.0

Common dividends

$  181.5

$   13.2

 

 

 

 

SEBRING CORPORATION: BALANCE SHEETS
FOR YEAR ENDING DECEMBER 31
(MILLIONS OF DOLLARS)

 

2002

2001

Assets:

 

 

Cash and marketable securities

$   36.0

$   30.0

Accounts receivable

540.0

450.0

Inventories

   540.0

   600.0

   Total current assets

$1,116.0

$1,080.0

Net plant and equipment

   900.0

   750.0

Total assets

$2,016.0

$1,830.0

 

 

 

Liabilities and equity:

 

 

Accounts payable

$  324.0

$  270.0

Notes payable

201.0

155.0

Accruals

   216.0

   180.0

   Total current liabilities

$  741.0

$  605.0

Long-term bonds

   450.0

   450.0

   Total debt

$1,191.0

$1,055.0

Common stock (50 million shares)

150.0

150.0

Retained earnings

   675.0

   625.0

   Total common equity

$  825.0

$  775.0

Total liabilities and equity

$2,016.0

$1,830.0

 

 

 

 

50. Refer to Sebring Corporation. What is Sebring's amount of total investor-supplied operating capital for 2002?

·        $1,476,000,000

 

51. Refer to Sebring Corporation. What is Sebring's free cash flow for 2002?

·        $174,000,000

 

52. Refer to Sebring Corporation. What is Sebring's net operating profit after taxes (NOPAT) for 2002?

·        $270,000,000

 

53. Refer to Sebring Corporation. What is Sebring's net operating working capital for 2002?

·        $   576,000,000

 

Sharpe Radios
Last year, Sharpe Radios had a net operating profit after-taxes (NOPAT) of $7.8 million. Its EBITDA was $15.5 million and net income amounted to $3.8 million. During the year, Sharpe Radios made $5.5 million in net capital expenditures (that is, capital expenditures net of depreciation). Finally, Sharpe Radios' finance staff has concluded that the firm's total after-tax capital costs were $5.9 million and its tax rate was 40 percent.

 

54. Refer to Sharpe Radios. What is Sharpe Radios' depreciation and amortization expense?

·        $2.5 million

 

55. Refer to Sharpe Radios. What is Sharpe Radios' EVA?

·        $1.9 million

 

56. Refer to Sharpe Radios. What is Sharpe Radios' free cash flow?

·        $2.3 million

 

57. Refer to Sharpe Radios. What is Sharpe Radios' interest expense?

·        $  6.67 million

 

58. Solo Company has been depreciating its fixed assets over 15 years. It is now clear that these assets will only last a total of 10 years. Solo's accountants have encouraged the firm to revise its annual depreciation to reflect this new information. Which of the following would occur as a result of this change?

·        Statements a and b are correct.

 

59. Swann Systems is forecasting the following income statement for the upcoming year:

Sales

$5,000,000

Operating costs (excluding depreciation and amortization)

3,000,000

EBITDA

$2,000,000

Depreciation and amortization

   500,000

EBIT

$1,500,000

Interest

   500,000

EBT

$1,000,000

Taxes (40%)

   400,000

Net income

$  600,000

The company's president is disappointed with the forecast and would like to see Swann generate higher sales and a forecasted net income of $2,000,000.

Assume that operating costs (excluding depreciation and amortization) are always 60 percent of sales. Also, assume that depreciation and amortization, interest expense, and the company's tax rate, which is 40 percent, will remain the same even if sales change. What level of sales would Swann have to obtain to generate $2,000,000 in net income?

·        $10,833,333

T

60. The Campbell Corporation just purchased an expensive piece of equipment. Which of the following will occur as a result of this Congressional action?

·        All of the statements above are correct.

 

61. The Campbell Corporation just purchased an expensive piece of equipment. Originally, the firm was planning on depreciating the equipment over 5 years on a straight-line basis. However, Congress just passed a provision that will force the company to depreciate its equipment over 7 years on a straight-line basis. Which of the following will occur as a result of this Congressional action?

·        All of the statements above are correct.

 

62. The CFO of Mulroney Brothers has suggested that the company should issue $300 million worth of common stock and use the proceeds to reduce some of the company's outstanding debt. Assume that the company adopts this policy, and that total assets and operating income (EBIT) remain the same. The company's tax rate will also remain the same. Which of the following will occur?

·        The company's net income will increase.

W

63. Which of the following are likely to occur if Congress passes legislation that forces Carter Manufacturing to depreciate their equipment over a longer time period?

·        The company's cash position would decline.

 

64. Which of the following factors could explain why last year Cleaver Energy had negative net cash flow, but the cash on its balance sheet increased?

·        The company issued new debt.

 

65. Which of the following items is included as part of a company's current assets?

·        Statements b and c are correct.

 

66. Which of the following items can be found on a firm's balance sheet listed as a current asset?

·        Accounts receivable.

 

67. Which of the following statements is most correct?

·        One way to increase EVA is to maintain the same operating income with less capital.

 

·        If a company pays more in dividends than it generates in net income, its balance of retained earnings reported on the balance sheet will fall.

 

68. Whitehall Clothiers had $5,000,000 of retained earnings on its balance sheet at the end of 2001. One year later, Whitehall had $6,000,000 of retained earnings on its balance sheet. Whitehall has one million shares of common stock outstanding, and it paid a dividend of $0.80 per share in 2002. What was Whitehall's earnings per share in 2002?

·        $1.80

FIN 350 MINI TEST 2 CHAPTER 3

A

1.      A firm has a debt/equity ratio of 50 percent. Currently, it has interest expense of $500,000 on $5,000,000 of total debt outstanding. Its tax rate is 40 percent. If the firm's ROA is 6 percent, by how many percentage points is the firm's ROE greater than its ROA?

·        3.0%

 

2.      A firm has a profit margin of 15 percent on sales of $20,000,000. If the firm has debt of $7,500,000, total assets of $22,500,000, and an after-tax interest cost on total debt of 5 percent, what is the firm's ROA?

·        13.3%

 

3.      A firm that has an equity multiplier of 4.0 will have a debt ratio of

·        0.75

 

4.      A fire has destroyed a large percentage of the financial records of the Carter Company. You have the task of piecing together information in order to release a financial report. You have found the return on equity to be 18 percent. If sales were $4 million, the debt ratio was 0.40, and total liabilities were $2 million, what would be the return on assets (ROA)?

·        10.80%

 

5.      Aaron Aviation recently reported the following information:

Net income

$500,000

ROA

10%

Interest expense

$200,000

 

 


The company's average tax rate is 40 percent. What is the company's basic earning power (BEP)?

·        20.67%

 

6.      All else being equal, which of the following will increase a company's current ratio?

·        An increase in accounts receivable.

 

7.      Alumbat Corporation has $800,000 of debt outstanding, and it pays an interest rate of 10 percent annually on its bank loan. Alumbat's annual sales are $3,200,000, its average tax rate is 40 percent, and its net profit margin on sales is 6 percent. If the company does not maintain a TIE ratio of at least 4 times, its bank will refuse to renew its loan, and bankruptcy will result. What is Alumbat's current TIE ratio?

·        5.0

 

8.      Amazon Electric wants to increase its debt ratio, which will also increase its interest expense. Assume that the higher debt ratio will have no effect on the company's operating income, total assets, or tax rate. Also, assume that the basic earning power ratio exceeds the before-tax cost of debt financing. Which of the following will occur if the company increases its debt ratio?

·        All of the statements above are correct.

 

9.      An analyst has obtained the following information regarding two companies, Company X and Company Y

Ø      Company X and Company Y have the same total assets.

Ø      Company X has a higher interest expense than Company Y.

Ø      Company X has a lower operating income (EBIT) than Company Y.

Ø      Company X and Company Y have the same return on equity (ROE).

Ø      Company X and Company Y have the same total assets turnover (TATO).

Ø      Company X and Company Y have the same tax rate.

On the basis of this information, which of the following statements is most correct?

·        Company X has a lower profit margin.

 

10. As a short-term creditor concerned with a company's ability to meet its financial obligation to you, which one of the following combinations of ratios would you most likely prefer?

Current ratio; TIE; Debt ratio

·        1.5;         1.5;    0.50

 

11. Assume Meyer Corporation is 100 percent equity financed. Calculate the return on equity, given the following information:

Earnings before taxes

$1,500

Sales

$5,000

Dividend payout ratio

60%

Total assets turnover

2.0

Tax rate

30%

·        42%

 

12. Aurillo Equipment Company (AEC) projected that its ROE for next year would be just 6 percent. However, the financial staff has determined that the firm can increase its ROE by refinancing some high interest bonds currently outstanding. The firm's total debt will remain at $200,000 and the debt ratio will hold constant at 80 percent, but the interest rate on the refinanced debt will be 10 percent. The rate on the old debt is 14 percent. Refinancing will not affect sales, which are projected to be $300,000. EBIT will be 11 percent of sales and the firm's tax rate is 40 percent. If AEC refinances its high interest bonds, what will be its projected new ROE?

·        15.6%

 

13. Austin & Company has a debt ratio of 0.5, a total assets turnover ratio of 0.25, and a profit margin of 10 percent. The Board of Directors is unhappy with the current return on equity (ROE), and they think it could be doubled. This could be accomplished (1) by increasing the profit margin to 12 percent and (2) by increasing debt utilization. Total assets turnover will not change. What new debt ratio, along with the new 12 percent profit margin, would be required to double the ROE?

·        70%

B

14. Bedford Hotels and Breezewood Hotels both have $100 million in total assets and a 10 percent return on assets (ROA). Each company has a 40 percent tax rate. Bedford, however, has a higher debt ratio and higher interest expense. Which of the following statements is most correct?

·        Bedford has a higher return on equity (ROE).

 

15. Bichette Furniture Company recently issued new common stock and used the proceeds to reduce its short-term notes payable and accounts payable. This action had no effect on the company's total assets or operating income. Which of the following effects did occur as a result of this action?

·        The company's equity multiplier decreased.

 

16. Blair Company has $5 million in total assets. The company's assets are financed with $1 million of debt and $4 million of common equity. The company's income statement is summarized below:

Operating income (EBIT)

$1,000,000

Interest

   100,000

Earnings before taxes (EBT)

$  900,000

Taxes (40%)

   360,000

Net income

$  540,000

The company wants to increase its assets by $1 million, and it plans to finance this increase by issuing $1 million in new debt. This action will double the company's interest expense but its operating income will remain at 20 percent of its total assets, and its average tax rate will remain at 40 percent. If the company takes this action, which of the following will occur:

·        Statements a and b are correct.

C

17. Cannon Company has enjoyed a rapid increase in sales in recent years, following a decision to sell on credit. However, the firm has noticed a recent increase in its collection period. Last year, total sales were $1 million, and $250,000 of these sales were on credit. During the year, the accounts receivable account averaged $41,096. It is expected that sales will increase in the forthcoming year by 50 percent, and, while credit sales should continue to be the same proportion of total sales, it is expected that the days sales outstanding will also increase by 50 percent. If the resulting increase in accounts receivable must be financed externally, how much external funding will Cannon need? Assume a 365-day year.

·        $  51,370

 

18. Cartwright Brothers has the following balance sheet (all numbers are expressed in millions of dollars):

Cash

$  250

 

Accounts payable

$  300

Accounts receivable

250

 

Notes payable

300

Inventories

250

 

Long-term debt

600

Net fixed assets

1,250

 

Common stock

   800

Total assets

$2,000

 

Total claims

$2,000

 

 

 

 

 


Cartwright's average daily sales are $10 million. Currently, Cartwright's days sales outstanding (DSO) is well above the industry average of 15. Cartwright is implementing a plan that is designed to reduce its DSO to 15 without reducing its sales. If successful the plan will free up cash, half of which will be used to reduce notes payable and the other half will be used to reduce accounts payable. What will be the current ratio if Cartwright fully succeeds in implementing this plan?

·        1.30

 

19. Cleveland Corporation has 100,000 shares of common stock outstanding, its net income is $750,000, and its P/E is 8. What is the company's stock price?

·        $60.00

 

20. Collins Company had the following partial balance sheet and complete income statement information for 2002:

Partial Balance Sheet:

Cash

$   20

A/R

1,000

Inventories

2,000

Total current assets

$3,020

Net fixed assets

2,980

Total assets

$6,000

 

Income Statement:

Sales

$10,000

Cost of goods sold

  9,200

EBIT

$   800

Interest (10%)

    400

EBT

$   400

Taxes (40%)

    160

Net income

$   240


The industry average DSO is 30 (assuming a 365-day year). Collins plans to change its credit policy so as to cause its DSO to equal the industry average, and this change is expected to have no effect on either sales or cost of goods sold. If the cash generated from reducing receivables is used to retire debt (which was outstanding all last year and has a 10 percent interest rate), what will Collins' debt ratio (Total debt/Total assets) be after the change in DSO is reflected in the balance sheet?

·        65.65%

 

21. Companies A and B have the same profit margin and debt ratio. However, Company A has a higher return on assets and a higher return on equity than Company B. Which of the following can explain these observed ratios?

·        Company A must have a higher total assets turnover than Company B.

 

22. Company A and Company B have the same tax rate, total assets, and basic earning power. Both companies have positive net incomes. Company A has a higher debt ratio, and therefore, higher interest expense than Company B. Which of the following statements is true?

·        Company A pays less in taxes than Company B.

 

23. Company A and Company B have the same total assets, return on assets (ROA), and profit margin. However, Company A has a higher debt ratio and interest expense than Company B. Which of the following statements is most correct?

·        Statements a and c are correct.

 

24. Company A and Company B have the same total assets, tax rate, and net income. Company A, however, has a lower profit margin than Company B. Company A also has a higher debt ratio and, therefore, higher interest expense than Company B. Which of the following statements is most correct?

·        All of the statements above are correct.

 

25. Company A has sales of $1,000, assets of $500, a debt ratio of 30 percent, and an ROE of 15 percent. Company B has the same sales, assets, and net income as Company A, but its ROE is 30 percent. What is B's debt ratio? (Hint: Begin by looking at the Du Pont equation.)

·        65.0%

 

26. Company A's ROE is 20 percent, while Company B's ROE is 15 percent. Which of the following statements is most correct?

·        None of the statements above is correct.

 

27. company has just been taken over by new management that believes it can raise earnings before taxes (EBT) from $600 to $1,000, merely by cutting overtime pay and reducing cost of goods sold. Prior to the change, the following data applied:

Total assets

$8,000

Debt ratio

45%

Tax rate

35%

BEP ratio

13.3125%

EBT

$600

Sales

$15,000

These data have been constant for several years, and all income is paid out as dividends. Sales, the tax rate, and the balance sheet will remain constant. What is the company's cost of debt? (Hint: Work only with old data.)

·        12.92%

 

28. Company J and Company K each recently reported the same earnings per share (EPS). Company J's stock, however, trades at a higher price. Which of the following statements is most correct?

·        Company J must have a higher P/E ratio

 

29. Company X has a higher ROE than Company Y, but Company Y has a higher ROA than Company X. Company X also has a higher total assets turnover ratio than Company Y; however, the two companies have the same total assets. Which of the following statements is most correct?

·        Statements b and c are correct.

 

30. Culver Inc. has earnings after interest but before taxes of $300. The company's times interest earned ratio is 7.00. Calculate the company's interest charges.

·        $50.00

D

31. Daggy Corporation has the following simplified balance sheet:

           

Cash

$ 25,000

 

Current liabilities

$200,000

Inventories

190,000

 

 

 

Accounts receivable

125,000

 

Long-term debt

300,000

Net fixed assets

360,000

 

Common equity

200,000

Total assets

$700,000

 

Total claims

$700,000

The company has been advised that their credit policy is too generous and that they should reduce their days sales outstanding to 36 days (assume a 365-day year). The increase in cash resulting from the decrease in accounts receivable will be used to reduce the company's long-term debt. The interest rate on long-term debt is 10 percent and the company's tax rate is 30 percent. The tighter credit policy is expected to reduce the company's sales to $730,000 and result in EBIT of $70,000. What is the company's expected ROE after the change in credit policy?

·        15.86%

 

32. Dean Brothers Inc. recently reported net income of $1,500,000. The company has 300,000 shares of common stock, and it currently trades at $60 a share. The company continues to expand and anticipates that one year from now its net income will be $2,500,000. Over the next year the company also anticipates issuing an additional 100,000 shares of stock, so that one year from now the company will have 400,000 shares of common stock. Assuming the company's price/earnings ratio remains at its current level, what will be the company's stock price one year from now?

·        $75

 

33. Devon Inc. has a higher ROE than Berwyn Inc. (17 percent compared to 14 percent), but it has a lower EVA than Berwyn. Which of the following factors could explain the relative performance of these two companies?

·        Devon is riskier, has a higher WACC, and a higher cost of equity.

 

34. Division A has a higher ROE than Division B, yet Division B creates more value for shareholders and has a higher EVA than Division A. Both divisions, however, have positive ROEs and EVAs. What could explain these performance measures?

·        Division A is riskier than Division B.

 

Dokic, Inc.
Dokic, Inc. reported the following balance sheets for year-end 2001 and 2002 (dollars in millions):

 

2002

2001

Cash

$  650

$  500

Accounts receivable

450

700

Inventories

   850

   600

Total current assets

$1,950

$1,800

Net fixed assets

2,450

2,200

Total assets

$4,400

$4,000

 

 

 

Accounts payable

$  680

$  300

Notes payable

200

600

Wages payable

   220

   200

Total current liabilities

$1,100

$1,100

Long-term bonds

1,000

1,000

Common stock

1,500

1,200

Retained earnings

   800

   700

Total common equity

$2,300

$1,900

Total liabilities and equity

$4,400

$4,000

 

35. Refer to Dokic, Inc. The total dividends paid to the company's common stockholders during 2002 was $50 million. What was the company's net income during the year 2002?

·        $150 million

 

36. Refer to Dokic, Inc. When reviewing the company's performance for 2002, its CFO observed that the company's inventory turnover ratio was below the industry average inventory turnover ratio of 6.0. In addition, the company's DSO (days sales outstanding, calculated on a 365-day basis) was less than the industry average of 50 (that is, DSO < 50). On the basis of this information, what is the most likely estimate of the company's sales (in millions of dollars) for 2002?

·        $  5,038

 

37. Refer to Dokic, Inc. Which of the following statements is most correct?

·        Statements a and c are correct.

 

38. Drysdale Financial Company and Commerce Financial Company have the same total assets, the same total assets turnover, and the same return on equity. However, Drysdale has a higher return on assets than Commerce. Which of the following can explain these ratios?

·        Drysdale has a higher profit margin and a lower debt ratio than Commerce.

F

Fama’s French Bakery
Fama's French Bakery has a return on assets (ROA) of 10 percent and a return on equity (ROE) of 14 percent. Fama's total assets equal total debt plus common equity (that is, there is no preferred stock). Furthermore, we know that the firm's total assets turnover is 5.

 

1.      Refer to Fama’s French Bakery. What is Fama's debt ratio?

·        28.57%

G

39. Georgia Electric reported the following income statement and balance sheet for the previous year:

Balance Sheet:

Cash

$  100,000

 

 

 

Inventories

1,000,000

 

 

 

Accounts receivable

   500,000

 

 

 

Current assets

$1,600,000

 

 

 

 

 

 

Total debt

$4,000,000

Net fixed assets

4,400,000

 

Total equity

2,000,000

Total assets

$6,000,000

 

Total claims

$6,000,000

 

Income Statement:

Sales

$3,000,000

Operating costs

1,600,000

Operating income (EBIT)

$1,400,000

Interest

   400,000

Taxable income (EBT)

$1,000,000

Taxes (40%)

   400,000

Net income

$  600,000


The company's interest cost is 10 percent, so the company's interest expense each year is 10 percent of its total debt.

While the company's financial performance is quite strong, its CFO (Chief Financial Officer) is always looking for ways to improve. The CFO has noticed that the company's inventory turnover ratio is considerably weaker than the industry average, which is 6.0. As an exercise, the CFO asks what would the company's ROE have been last year if the following had occurred:

Ø      The company maintained the same sales, but was able to reduce inventories enough to achieve the industry average inventory turnover ratio.

Ø      The cash that was generated from the reduction in inventories was used to reduce part of the company's outstanding debt. So, the company's total debt would have been $4 million less the freed-up cash from the improvement in inventory policy. The company's interest expense would have been 10 percent of new total debt.

Ø      Assume equity does not change. (The company pays all net income as dividends.)

Under this scenario, what would have been the company's ROE last year?

·        31.5%

 

40. Given the following information, calculate the market price per share of WAM Inc.:

Net income

$200,000.00

Earnings per share

$2.00

Stockholders' equity

$2,000,000.00

Market/Book ratio

0.20

·        $  4.00

H

41. Harte Motors and Mills Automotive each have the same total assets, the same level of sales, and the same return on equity (ROE). Harte Motors, however, has less equity and a higher debt ratio than does Mills Automotive. Which of the following statements is most correct?

·        All of the statements above are correct.

 

42. Humphrey Hotels' operating income (EBIT) is $40 million. The company's times interest earned (TIE) ratio is 8.0, its tax rate is 40 percent, and its basic earning power (BEP) ratio is 10 percent. What is the company's return on assets (ROA)?

·        5.25%

 

43. Huxtable Medical's CFO recently estimated that the company's EVA for the past year was zero. The company's cost of equity capital is 14 percent, its cost of debt is 8 percent, and its debt ratio is 40 percent. Which of the following statements is most correct?

·        The company's ROE was 14 percent.

I

44. Iken Berry Farms has $5 million in current assets, $3 million in current liabilities, and its initial inventory level is $1 million. The company plans to increase its inventory, and it will raise additional short-term debt (that will show up as notes payable on the balance sheet) to purchase the inventory. Assume that the value of the remaining current assets will not change. The company's bond covenants require it to maintain a current ratio that is greater than or equal to 1.5. What is the maximum amount that the company can increase its inventory before it is restricted by these covenants?

·        $1.00 million

J

45. Jefferson Co. has $2 million in total assets and $3 million in sales. The company has the following balance sheet:

Cash

$  100,000

 

Accounts payable

$  200,000

Accounts receivable

200,000

 

Accruals

100,000

Inventories

500,000

 

Notes payable

200,000

Net fixed assets

1,200,000

 

Long-term debt

700,000

 

 

 

Common equity

   800,000

 

 

 

Total liabilities

 

Total assets

$2,000,000

 

   and equity

$2,000,000

 

 

 

 

 


Jefferson wants to improve its inventory turnover ratio so that it equals the industry average of 10.0e. The company would like to accomplish this goal without reducing sales. If successful, the company would take the freed-up cash from the reduction in inventories and use half of it to reduce notes payable and the other half to reduce common equity. What will be Jefferson's current ratio, if it is able to accomplish its goal of improving its inventory management?

·        1.50

K

46. Kansas Office Supply had $24,000,000 in sales last year. The company's net income was $400,000, its total assets turnover was 6.0, and the company's ROE was 15 percent. The company is financed entirely with debt and common equity. What is the company's debt ratio?

·        0.33

 

Kewell Boomerangs
Below are the 2001 and 2002 year-end balance sheets for Kewell Boomerangs:

 

2002

2001

Cash

$  100,000

$   85,000

Accounts receivable

432,000

350,000

Inventories

1,000,000

   700,000

Total current assets

$1,532,000

$1,135,000

Net fixed assets

3,000,000

2,800,000

Total assets

$4,532,000

$3,935,000

 

 

 

Accounts payable

$  700,000

$  545,000

Notes payable

   800,000

   900,000

Total current liabilities

$1,500,000

$1,445,000

Long-term debt

1,200,000

1,200,000

Common stock

1,500,000

1,000,000

Retained earnings

   332,000

   290,000

Total common equity

$1,832,000

$1,290,000

Total liabilities and equity

$4,532,000

$3,935,000


Kewell Boomerangs has never paid a dividend on its common stock. Kewell issued $1,200,000 of long-term debt in 1997. This debt was non-callable and is scheduled to mature in 2027. As of the end of 2002, none of the principal on this debt has been repaid. Assume that 2001 and 2002 sales were the same in both years.

 

47. Refer to Kewell Boomerangs. During 2002, Kewell's days sales outstanding (DSO) was 40 days. The industry average DSO was 30 days. Assume instead that in 2002, Kewell had been able to achieve the industry-average DSO without reducing its sales, and that the freed-up cash would have been used to reduce accounts payable. If this reduction in DSO had successfully occurred, what would have been Kewell's new current ratio in 2002? (Assume Kewell uses a 365-day accounting year.)

·        1.023

 

48. Refer to Kewell Boomerangs. Which of the following statements is most correct?

·        Kewell's current ratio in 2002 was higher than it was in 2001.

L

49. Lancaster Co. and York Co. both have the same return on assets (ROA). However, Lancaster has a higher total assets turnover and a higher equity multiplier than York. Which of the following statements is most correct?

·        Statements a and c are correct.

 

50. Lancaster Motors has total assets of $20 million. Its basic earning power is 25 percent, its return on assets (ROA) is 10 percent, and the company's tax rate is 40 percent. What is Lancaster's TIE ratio?

·        3.0

 

51. Lombardi Trucking Company has the following data:

Assets

$10,000

Profit margin

3.0%

Tax rate

40%

Debt ratio

60.0%

Interest rate

10.0%

Total assets turnover

2.0

 

 


What is Lombardi's TIE ratio?

·        2.67

 

52. Lone Star Plastics has the following data:

Assets

$100,000

Profit margin

6.0%

Tax rate

40%

Debt ratio

40.0%

Interest rate

8.0%

Total assets turnover

3.0

 

 

What is Lone Star's EBIT?

·        $33,200

M

53. Meyersdale Office Supplies has common equity of $40 million. The company's stock price is $80 per share and its market/book ratio is 4.0. How many shares of stock does the company have outstanding?

·        2,000,000

 

Miller Technologies
Miller Technologies recently reported the following balance sheet in its annual report (all numbers are in millions of dollars):

Cash

$  100

 

Accounts payable

$  300

Accounts receivable

300

 

Notes payable

   500

Inventory

   500

 

Total current liabilities

$  800

Total current assets

$  900

 

Long-term debt

1,500

 

 

 

Total debt

$2,300

 

 

 

Common stock

500

 

 

 

Retained earnings

   400

Net fixed assets

2,300

 

Total common equity

$  900

Total assets

$3,200

 

Total liabilities and equity

$3,200

 

 

 

 

 


Miller also reported sales revenues of $4.5 billion and a 20 percent ROE for this same year.

 

54. Refer to Miller Technologies. Miller Technologies is always looking for ways to expand their business. A plan has been proposed that would entail issuing $300 million in notes payable to purchase new fixed assets (for this problem, ignore depreciation). If this plan were carried out, what would Miller's current ratio be immediately following the transaction?

·        0.818

 

55. Refer to Miller Technologies. What is Miller's ROA?

·        5.625%

 

56. Moss Motors has $8 billion in assets, and its tax rate is 40 percent. The company's basic earning power (BEP) ratio is 12 percent, and its return on assets (ROA) is 3 percent. What is Moss' times interest earned (TIE) ratio?

·        1.71

N

57. Nelson Company is thinking about issuing new common stock. The proceeds from the stock issue will be used to reduce the company's outstanding debt and interest expense. The stock issue will have no effect on the company's total assets, EBIT, or tax rate. Which of the following is likely to occur if the company goes ahead with the stock issue?

·        All of the above statements are correct.

P

58. Parcells Jets has the following balance sheet (in millions):

Cash

$  100

 

Notes payable

$  100

Inventories

300

 

Accounts payable

200

Accounts receivable

   400

 

Accruals

   100

Total current assets

$  800

 

Total current liabilities

$  400

Net fixed assets

1,200

 

Long-term bonds

   600

 

 

 

Total debt

$1,000

 

______

 

Total common equity

1,000

Total assets

$2,000

 

Total liabilities and equity

$2,000

 

 

 

 

 


Parcells' DSO (on a 365-day basis) is 40, which is above the industry average of 30. Assume that Parcells is able to reduce its DSO to the industry average without reducing sales, and the company takes the freed-up cash and uses it to reduce its outstanding long-term bonds. If this occurs, what will be the new current ratio?

·        1.75

 

59. Pepsi Corporation's current ratio is 0.5, while Coke Company's current ratio is 1.5. Both firms want to "window dress" their coming end-of-year financial statements. As part of its window dressing strategy, each firm will double its current liabilities by adding short-term debt and placing the funds obtained in the cash account. Which of the statements below best describes the actual results of these transactions?

·        Only Pepsi Corporation's current ratio will be increased.

 

60. Peterson Packaging Corp. has $9 billion in total assets. The company's basic earning power (BEP) ratio is 9 percent, and its times interest earned ratio is 3.0. Peterson's depreciation and amortization expense totals $1 billion. It has $0.6 billion in lease payments and $0.3 billion must go towards principal payments on outstanding loans and long-term debt. What is Peterson's EBITDA coverage ratio?

·        2.06

R

61. Reeves Corporation forecasts that its operating income (EBIT) and total assets will remain the same as last year, but that the company's debt ratio will increase this year. What can you conclude about the company's financial ratios? (Assume that there will be no change in the company's tax rate.)

·        Statements b and c are correct.

 

62. Ricardo Entertainment recently reported the following income statement:

 

Sales

$12,000,000

Cost of goods sold

  7,500,000

EBIT

$ 4,500,000

Interest

  1,500,000

EBT

$ 3,000,000

Taxes (40%)

  1,200,000

Net income

$ 1,800,000

 

The company's CFO, Fred Mertz, wants to see a 25 percent increase in net income over the next year. In other words, his target for next year's net income is $2,250,000. Mertz has made the following observations:

Ø      Ricardo's operating margin (EBIT/Sales) was 37.5 percent this past year. Mertz expects that next year this margin will increase to 40 percent.

Ø      Ricardo's interest expense is expected to remain constant.

Ø      Ricardo's tax rate is expected to remain at 40 percent.

On the basis of these numbers, what is the percentage increase in sales that Ricardo needs in order to meet Mertz's target for net income?

·        9.38%

 

63. Roland & Company has a new management team that has developed an operating plan to improve upon last year's ROE. The new plan would place the debt ratio at 55 percent, which will result in interest charges of $7,000 per year. EBIT is projected to be $25,000 on sales of $270,000, it expects to have a total assets turnover ratio of 3.0, and the average tax rate will be 40 percent. What does Roland & Company expect its return on equity to be following the changes?

·        26.67%

 

64. Roll's Boutique currently has total assets of $3 million in operation. Over this year, its performance yielded a basic earning power (BEP) of 25 percent and a return on assets (ROA) of 12 percent. The firm's earnings are subject to a 35 percent tax rate. On the basis of this information, what is the firm's times interest earned (TIE) ratio?

·        3.82

 

65. Russell Securities has $100 million in total assets and its corporate tax rate is 40 percent. The company recently reported that its basic earning power (BEP) ratio was 15 percent and its return on assets (ROA) was 9 percent. What was the company's interest expense?

·        $0

 

66. Ruth Company currently has $1,000,000 in accounts receivable. Its days sales outstanding (DSO) is 50 days. The company wants to reduce its DSO to the industry average of 32 days by pressuring more of its customers to pay their bills on time. The company's CFO estimates that if this policy is adopted the company's average sales will fall by 10 percent. Assuming that the company adopts this change and succeeds in reducing its DSO to 32 days and does lose 10 percent of its sales, what will be the level of accounts receivable following the change? Assume a 365-day year.

·        $576,000

S

67. Samuels Equipment has $10 million in sales. Its ROE is 15 percent and its total assets turnover is 3.5e. The company is 100 percent equity financed. What is the company's net income?

·        $   428,571

 

68. Savelots Stores' current financial statements are shown below:

Balance Sheet:

Inventories

$  500

 

Accounts payable

$  100

Other current assets

400

 

Short-term notes payable

370

Fixed assets

   370

 

Common equity

   800

Total assets

$1,270

 

Total liab. and equity

$1,270

 

Income Statement:

Sales

$2,000

Operating costs

1,843

EBIT

$  157

Interest

    37

EBT

$  120

Taxes (40%)

    48

Net income

$   72

 

A recently released report indicates that Savelots' current ratio of 1.9 is in line with the industry average. However, its accounts payable, which have no interest cost and are due entirely to purchases of inventories, amount to only 20 percent of inventories versus an industry average of 60 percent. Suppose Savelots took actions to increase its accounts payable to inventories ratio to the 60 percent industry average, but it (1) kept all of its assets at their present levels (that is, the asset side of the balance sheet remains constant) and (2) also held its current ratio constant at 1.9. Assume that Savelots' tax rate is 40 percent, that its cost of short-term debt is 10 percent, and that the change in payments will not affect operations. In addition, common equity will not change. With the changes, what will be Savelots' new ROE?

·        10.5%

 

69. Selzer Inc. sells all its merchandise on credit. It has a profit margin of 4 percent, days sales outstanding equal to 60 days, receivables of $150,000, total assets of $3 million, and a debt ratio of 0.64. What is the firm's return on equity (ROE)? Assume a 365-day year.

·        3.4%

 

70. Some key financial data and ratios are reported in the table below for Hemmingway Hotels and for its competitor, Fitzgerald Hotels:

Ratio

Hemmingway Hotels

Fitzgerald Hotels

Profit margin

4%

3%

ROA

9%

8%

Total assets

$2.0 billion

$1.5 billion

BEP

20%

20%

ROE

18%

24%


On the basis of the information above, which of the following statements is most correct?

·        Hemmingway has higher net income than Fitzgerald.

 

71. Stennett Corp.'s CFO has proposed that the company issue new debt and use the proceeds to buy back common stock. Which of the following are likely to occur if this proposal is adopted? (Assume that the proposal would have no effect on the company's operating income.)

·        Statements a and c are correct.

 

72. Strack Houseware Supplies Inc. has $2 billion in total assets. The other side of its balance sheet consists of $0.2 billion in current liabilities, $0.6 billion in long-term debt, and $1.2 billion in common equity. The company has 300 million shares of common stock outstanding, and its stock price is $20 per share. What is Strack's market/book ratio?

·        5.00

T

73. Taft Technologies has the following relationships:

Annual sales

$1,200,000.00

Current liabilities

$  375,000.00

Days sales outstanding (DSO) (365-day year)

40.00

Inventory turnover ratio

4.80

Current ratio

1.20


The company's current assets consist of cash, inventories, and accounts receivable. How much cash does Taft have on its balance sheet?

·        $  68,493

 

74. Tapley Dental Supply Company has the following data:

Net income

$240

Sales

$10,000

Total assets

$6,000

Debt ratio

75%

TIE ratio

2.0

Current ratio

1.2

BEP ratio

13.33%

 

 

75. If Tapley could streamline operations, cut operating costs, and raise net income to $300 without affecting sales or the balance sheet (the additional profits will be paid out as dividends), by how much would its ROE increase?

·        4.00%

 

76. The Amer Company has the following characteristics:

Sales

$1,000

Total assets

$1,000

Total debt/Total assets

35.00%

Basic earning power (BEP) ratio

20.00%

Tax rate

40.00%

Interest rate on total debt

4.57%

What is Amer's ROE?

·        16.99%

 

77. The Charleston Company is a relatively small, privately owned firm. Last year the company had net income of $15,000 and 10,000 shares were outstanding. The owners were trying to determine the equilibrium market value for the stock prior to taking the company public. A similar firm that is publicly traded had a price/earnings ratio of 5.0. Using only the information given, estimate the market value of one share of Charleston's stock.

·        $  7.50

 

78. The Merriam Company has determined that its return on equity is 15 percent. Management is interested in the various components that went into this calculation. You are given the following information: total debt/total assets = 0.35 and total assets turnover = 2.8. What is the profit margin?

·        3.48%

 

79. The Wilson Corporation has the following relationships:

Sales/Total assets

2.0e

Return on assets (ROA)

4.0%

Return on equity (ROE)

6.0%

 

What is Wilson's profit margin and debt ratio?

·        2%; 0.33

V

80. Van Buren Company has a current ratio = 1.9. Which of the following actions will increase the company's current ratio?

·        All of the statements above are correct.

 

81. Victoria Enterprises has $1.6 million of accounts receivable on its balance sheet. The company's DSO is 40 (based on a 365-day year), its current assets are $2.5 million, and its current ratio is 1.5. The company plans to reduce its DSO from 40 to the industry average of 30 without causing a decline in sales. The resulting decrease in accounts receivable will free up cash that will be used to reduce current liabilities. If the company succeeds in its plan, what will Victoria's new current ratio be?

·        1.66

 

82. Viera Company has $500,000 in total assets. The company's basic earning power (BEP) is 10 percent, its times interest earned (TIE) ratio is 5, and the company's tax rate is 40 percent. What is the company's return on assets (ROA)?

·        4.8%

W

83. Which of the following actions can a firm take to increase its current ratio?

·        None of the statements above is correct.

 

84. Which of the following alternatives could potentially result in a net increase in a company's cash flow for the current year?

·        Reduce the days sales outstanding ratio.

 

85. Which of the following statements is most correct?

·        A firm with financial leverage has a larger equity multiplier than an otherwise identical firm with no debt in its capital structure.

 

·        An increase in a firm's debt ratio, with no changes in its sales and operating costs, could be expected to lower its profit margin on sales.

 

·        Firms A and B have the same net income, taxes paid, and total assets. If Firm A has a higher interest expense, its basic earnings power ratio (BEP) must be greater than that of Firm B.

 

·        If a company's ROE is greater than its cost of equity, its EVA is positive.

 

·        If a firm has positive EVA, this implies that its ROE exceeds its cost of equity.

 

86. Which of the following statements is most correct about Economic Value Added (EVA)?

·        None of the statements above is correct.

X

87. XYZ's balance sheet and income statement are given below:

Balance Sheet:

Cash

$   50

 

Accounts payable

$  100

A/R

150

 

Notes payable

0

Inventories

300

 

Long-term debt (10%)

700

Fixed assets

   500

 

Common equity (20 shares)

   200

Total assets

$1,000

 

Total liabilities and equity

$1,000


Income Statement:

Sales

$1,000

Cost of goods sold

   855

EBIT

$  145

Interest

    70

EBT

$   75

Taxes (33.333%)

    25

Net income

$   50


The industry average inventory turnover is 5, the interest rate on the firm's long-term debt is 10 percent, 20 shares are outstanding, and the stock sells at a P/E of 8.0. If XYZ changed its inventory methods so as to operate at the industry average inventory turnover, if it used the funds generated by this change to buy back common stock at the current market price and thus to reduce common equity, and if sales, the cost of goods sold, and the P/E ratio remained constant, by what dollar amount would its stock price increase?

·        $  6.67

 

Y

88. You are an analyst following two companies, Company X and Company Y. You have collected the following information:

Ø      The two companies have the same total assets.

Ø      Company X has a higher total assets turnover than Company Y.

Ø      Company X has a higher profit margin than Company Y.

Ø      Company Y has a higher inventory turnover ratio than Company X.

Ø      Company Y has a higher current ratio than Company X.

Which of the following statements is most correct?

·        Company X must have a higher net income.

 

89. You are given the following information: Stockholders' equity = $1,250; price/earnings ratio = 5; shares outstanding = 25; and market/book ratio = 1.5. Calculate the market price of a share of the company's stock.

·        $  75.00

 

90. You have collected the following information regarding Companies C and D:

Ø      The two companies have the same total assets.

Ø      The two companies have the same operating income (EBIT).

Ø      The two companies have the same tax rate.

Ø      Company C has a higher debt ratio and interest expense than Company D.

Ø      Company C has a lower profit margin than Company D.

On the basis of this information, which of the following statements is most correct?

·        Company C must have a lower ROA.

 

91. You observe that a firm's profit margin is below the industry average, while its return on equity and debt ratio exceed the industry average. What can you conclude?

·        Total assets turnover must be above the industry average.

 

92. Your company had the following balance sheet and income statement information for 2002:

Balance Sheet:

Cash

$   20

 

 

 

A/R

1,000

 

 

 

Inventories

5,000

 

 

 

Total current assets

$6,020

 

Debt

$4,000

Net fixed assets

2,980

 

Equity

5,000

Total assets

$9,000

 

Total claims

$9,000


Income Statement:

Sales

$10,000

Cost of goods sold

  9,200

EBIT

$   800

Interest (10%)

    400

EBT

$   400

Taxes (40%)

    160

Net income

$   240


The industry average inventory turnover is 5. You think you can change your inventory control system so as to cause your turnover to equal the industry average, and this change is expected to have no effect on either sales or cost of goods sold. The cash generated from reducing inventories will be used to buy tax-exempt securities that have a 7 percent rate of return. What will your profit margin be after the change in inventories is reflected in the income statement?

·        4.5%

FIN 350 MINI TEST 3 CHAPTER 5

A

1.      A financial analyst is forecasting the expected return for the stock of Himalayan Motors. The analyst estimates the following probability distribution of returns:

Probability

Return

20%

-5%

40 

10 

20 

20 

10 

25 

10 

50 

On the basis of this analyst's forecast, what is the stock's coefficient of variation?

·        1.04

 

2.      A fund manager is holding the following stocks:

Stock

Amount Invested

Beta

1

$300 million 

1.2

2

560 million

1.4

3

320 million

0.7

4

230 million

1.8

The risk-free rate is 5 percent and the market risk premium is also 5 percent. If the manager sells half of her investment in Stock 2 ($280 million) and puts the money in Stock 4, by how many percentage points will her portfolio's required return increase?

·        0.40%

 

3.      A highly risk-averse investor is considering the addition of an asset to a 10-stock portfolio. The two securities under consideration both have an expected return, mc004-1.jpg, equal to 15 percent. However, the distribution of possible returns associated with Asset A has a standard deviation of 12 percent, while Asset B's standard deviation is 8 percent. Both assets are correlated with the market with r equal to 0.75. Which asset should the risk-averse investor add to his/her portfolio?

·        Asset B

 

4.      A money manager is holding a $10 million portfolio that consists of the following five stocks:

Stock

Amount Invested

Beta

A

$4 million 

1.2

B

2 million

1.1

C

2 million

1.0

D

1 million

0.7

E

1 million

0.5

The portfolio has a required return of 11 percent, and the market risk premium, kM - kRF, is 5 percent. What is the required return on Stock C?

·        10.9%

 

5.      A money manager is managing the account of a large investor. The investor holds the following stocks:

Stock

Amount Invested

Estimated Beta

A

$2,000,000 

0.80

B

5,000,000

1.10

C

3,000,000

1.40

D

5,000,000

????

The portfolio's required rate of return is 17 percent. The risk-free rate, kRF, is 7 percent and the return on the market, kM, is 14 percent. What is Stock D's estimated beta?

·        2.026

 

6.      A mutual fund manager has a $200,000,000 portfolio with a beta = 1.2. Assume that the risk-free rate is 6 percent and that the market risk premium is also 6 percent. The manager expects to receive an additional $50,000,000 in funds soon. She wants to invest these funds in a variety of stocks. After making these additional investments she wants the fund's expected return to be 13.5 percent. What should be the average beta of the new stocks added to the portfolio?

·        1.45

 

7.      A portfolio manager is holding the following investments:

Stock

Amount Invested

Beta

X

$10 million 

1.4

Y

20 million

1.0

Z

40 million

0.8

The manager plans to sell his holdings of Stock Y. The money from the sale will be used to purchase another $15 million of Stock X and another $5 million of Stock Z. The risk-free rate is 5 percent and the market risk premium is 5.5 percent. How many percentage points higher will the required return on the portfolio be after he completes this transaction?

·        0.39%

 

8.      A portfolio manager is holding the following investments in her portfolio:

Stock

Amount Invested

Beta

1

$300 million 

0.7

2

200 million

1.0

3

500 million

1.6

 

 

 


The risk-free rate, kRF, is 5 percent and the portfolio has a required return of 11.655 percent. The manager is thinking about selling all of her holdings of Stock 3, and instead investing the money in Stock 4, which has a beta of 0.9. If she were to do this, what would be the new portfolio's required return?

·        9.73%

 

9.      A portfolio manager is managing a $10 million portfolio. Currently the portfolio is invested in the following manner:

Investment

Dollar Amount Invested

Beta

Stock 1

$2 million  

0.6

Stock 2

3 million

0.8

Stock 3

3 million

1.2

Stock 4

2 million

1.4

Currently, the risk-free rate is 5 percent and the portfolio has an expected return of 10 percent. Assume that the market is in equilibrium so that expected returns equal required returns. The manager is willing to take on additional risk and wants to instead earn an expected return of 12 percent on the portfolio. Her plan is to sell Stock 1 and use the proceeds to buy another stock. In order to reach her goal, what should be the beta of the stock that the manager selects to replace Stock 1?

·        2.60

 

10. A stock market analyst estimates that there is a 25 percent chance the economy will be weak, a 50 percent chance the economy will be average, and a 25 percent chance the economy will be strong. The analyst estimates that Hartley Industries' stock will have a 5 percent return if the economy is weak, a 15 percent return if the economy is average, and a 30 percent return if the economy is strong. On the basis of this estimate, what is the coefficient of variation for Hartley Industries' stock?

·        0.54934

 

11. A stock has an expected return of 12.25 percent. The beta of the stock is 1.15 and the risk-free rate is 5 percent. What is the market risk premium?

·        6.30%

 

12. An analyst has estimated Williamsport Equipment's returns under the following economic states:

Economic State

Probability

Expected Return

Recession

0.20

-24%

Below average

0.30

-3

Above average

0.30

+15 

Boom

0.20

+50 

What is Williamsport's estimated coefficient of variation?

·        2.80

 

13. An analyst has estimated how a particular stock's return will vary depending on what will happen to the economy:


State of
the Economy


Probability of
State Occurring

Stock's Expected
Return if this
State Occurs

Recession

0.10

-60%

Below Average

0.20

-10 

Average

0.40

15

Above Average

0.20

40

Boom

0.10

90

What is the coefficient of variation on the company's stock?

·        2.472

 

14. An investor has $5,000 invested in a stock that has an estimated beta of 1.2, and another $15,000 invested in the stock of the company for which she works. The risk-free rate is 6 percent and the market risk premium is also 6 percent. The investor calculates that the required rate of return on her total ($20,000) portfolio is 15 percent. What is the beta of the company for which she works?

·        1.6

 

15. An investor is forming a portfolio by investing $50,000 in stock A that has a beta of 1.50, and $25,000 in stock B that has a beta of 0.90. The return on the market is equal to 6 percent and Treasury bonds have a yield of 4 percent. What is the required rate of return on the investor's portfolio?

·        6.6%

 

16. Assume a new law is passed that restricts investors to holding only one asset. A risk-averse investor is considering two possible assets as the asset to be held in isolation. The assets' possible returns and related probabilities (that is, the probability distributions) are as follows:

            Asset X             

            Asset Y             

   P  

   k   

   P  

   k   

0.10

-3%

0.05

-3%

0.10

2

0.10

2

0.25

5

0.30

5

0.25

8

0.30

8

0.30

10 

0.25

10 

Which asset should be preferred?

·        Asset Y, since its coefficient of variation is lower and its expected return is higher.

 

17. Assume that investors become increasingly risk averse, so that the market risk premium increases. Also, assume that the risk-free rate and expected inflation remain the same. Which of the following is most likely to occur?

·        None of the statements above is correct.

 

18. Assume that the risk-free rate, kRF, increases but the market risk premium, (kM - kRF) declines. The net effect is that the overall expected return on the market, kM, remains constant. Which of the following statements is most correct?

·        The required return will increase for stocks that have a beta less than 1.0 but will decline for stocks that have a beta greater than 1.0.

 

19. Assume that the risk-free rate, kRF, ot, (kM - kRF) declines. The net effect is that the overall expected return on the market, kM, remains constant. Which of the following statements is most correct?

·        The required return will increase for stocks that have a beta less than 1.0 but will decline for stocks that have a beta greater than 1.0.

 

20. Assume that the risk-free rate is 5 percent and that the market risk premium is 7 percent. If a stock has a required rate of return of 13.75 percent, what is its beta?

·        1.25

 

21. Assume that the risk-free rate is 5 percent. Which of the following statements is most correct?

·        If a stock has a negative beta, the stock's required return is less than 5 percent.

 

22. Assume that the risk-free rate is 5.5 percent and the market risk premium is 6 percent. A money manager has $10 million invested in a portfolio that has a required return of 12 percent. The manager plans to sell $3 million of stock with a beta of 1.6 that is part of the portfolio. She plans to reinvest this $3 million into another stock that has a beta of 0.7. If she goes ahead with this planned transaction, what will be the required return of her new portfolio?

·        10.38%

 

23. Assume that the risk-free rate remains constant, but that the market risk premium declines. Which of the following is likely to occur?

·        The required return on a stock with a beta < 1.0 will decline.

B

24. Below are the stock returns for the past five years for Agnew Industries:

Year

Stock Return

2002

22%

2001

33 

2000

1

1999

-12  

1998

10 

What was the stock's coefficient of variation during this 5-year period? (Use the population standard deviation to calculate the coefficient of variation.)

·        1.46

 

25. Bob has a $50,000 stock portfolio with a beta of 1.2, an expected return of 10.8 percent, and a standard deviation of 25 percent. Becky has a $50,000 portfolio with a beta of 0.8, an expected return of 9.2 percent, and a standard deviation of 25 percent. The correlation coefficient, r, between Bob's and Becky's portfolios is 0. Bob and Becky are engaged to be married. Which of the following best describes their combined $100,000 portfolio?

·        All of the statements above are correct.

 

26. Bradley Hotels has a beta of 1.3, while Douglas Farms has a beta of 0.7. The required return on an index fund that holds the entire stock market is 12 percent. The risk-free rate of interest is 7 percent. By how much does Bradley's required return exceed Douglas' required return?

·        3.0%

C

27. Calculate the required rate of return for Mercury Inc., assuming that investors expect a 5 percent rate of inflation in the future. The real risk-free rate is equal to 3 percent and the market risk premium is 5 percent. Mercury has a beta of 2.0, and its realized rate of return has averaged 15 percent over the last 5 years.

·        18%

 

CAPM Analysis
You have been asked to use a CAPM analysis to choose between Stocks R and S, with your choice being the one whose expected rate of return exceeds its required rate of return by the widest margin. The risk-free rate is 6 percent, and the required return on an average stock (or "the market") is 10 percent. Your security analyst tells you that Stock S's expected rate of return, nar002-1.jpg, is equal to 11 percent, while Stock R's expected rate of return, nar002-2.jpg, is equal to 12 percent. The CAPM is assumed to be a valid method for selecting stocks, but the expected return for any given investor (such as you) can differ from the required rate of return for a given stock. The following past rates of return are to be used to calculate the two stocks' beta coefficients, which are then to be used to determine the stocks' required rates of return:

Year

Stock R

Stock S

Market

1

-15%

0%

-5%

2

5

5

3

25 

10  

15 

Note: The averages of the historical returns are not needed, and they are generally not equal to the expected future returns.

 

28. Refer to CAPM Analysis. Calculate both stocks' betas. What is the difference between the betas? That is, what is the value of betaR - betaS? (Hint: The graphical method of calculating the rise over run, or (Y2 - Y1) divided by (X2 - X1) may aid you.)

·        1.5

 

29. Refer to CAPM Analysis. Set up the SML equation and use it to calculate both stocks' required rates of return, and compare those required returns with the expected returns given above. You should invest in the stock whose expected return exceeds its required return by the widest margin. What is the widest margin, or greatest excess return (mc047-1.jpg - k)?

·        3.0%

 

30. Certain firms and industries are characterized by consistently low or high betas, depending on the particular situation. On the basis of that notion, which of the following companies seems out of place with its stated beta? (That is, one of the following companies definitely could not have the indicated beta, while the other companies seem well matched with their stated betas.)

·        Florida Power & Light, Beta = 1.52

 

31. Company X has a beta of 1.6, while Company Y's beta is 0.7. The risk-free rate is 7 percent, and the required rate of return on an average stock is 12 percent. Now the expected rate of inflation built into kRF rises by 1 percentage point, the real risk-free rate remains constant, the required return on the market rises to 14 percent, and betas remain constant. After all of these changes have been reflected in the data, by how much will the required return on Stock X exceed that on Stock Y?

·        5.40%

 

Consider the following information for three stocks, Stock A, Stock B, and Stock C. The returns on each of the three stocks are positively correlated, but they are not perfectly correlated. (That is, all of the correlation coefficients are between 0 and 1.)


Stock

Expected
Return

Standard
Deviation


Beta

Stock A

10%

20%

1.0

Stock B

10 

20 

1.0

Stock C

12 

20 

1.4

 

32. Portfolio P has half of its funds invested in Stock A and half invested in Stock B. Portfolio Q has one third of its funds invested in each of the three stocks. The risk-free rate is 5 percent, and the market is in equilibrium. (That is, required returns equal expected returns.) What is the market risk premium (kM - kRF)?

·        5.0%

 

33. Portfolio P has half of its funds invested in Stock A and half invested in Stock B. Portfolio Q has one third of its funds invested in each of the three stocks. The risk-free rate is 5 percent, and the market is in equilibrium. (That is, required returns equal expected returns.) Which of the following statements is most correct?

·        Portfolio Q's expected return is 10.67 percent.

 

34. Currently, the risk-free rate is 5 percent and the market risk premium is 6 percent. You have your money invested in three assets: an index fund that has a beta of 1.0, a risk-free security that has a beta of 0, and an international fund that has a beta of 1.5. You want to have 20 percent of your portfolio invested in the risk-free asset, and you want your overall portfolio to have an expected return of 11 percent. What portion of your overall portfolio should you invest in the inter-national fund?

·        40%

 

35. Currently, the risk-free rate is 6 percent and the market risk premium is 5 percent. On the basis of this information, which of the following statements is most correct?

·        An index fund with beta = 1.0 has a required return of 11 percent.

 

36. Currently, the risk-free rate, kRF, is 5 percent and the required return on the market, kM, is 11 percent. Your portfolio has a required rate of return of 9 percent. Your sister has a portfolio with a beta that is twice the beta of your portfolio. What is the required rate of return on your sister's portfolio?

·        13.0%

G

37. Given the following information, determine which beta coefficient for Stock A is consistent with equilibrium:
mc006-1.jpg= 11.3%; kRF = 5%; kM = 10%

·        1.26

 

38. Given the following probability distribution, what are the expected return and the standard deviation of returns for Security J?

State

                 Pi

k J

1

0.2

10%

2

0.6

15 

3

0.2

20 

·        15%;   3.16%

 

39. Given the following returns on Stock J and "the market" during the last three years, what is the beta coefficient of Stock J? (Hint: Think rise over run.)

Year

Stock J

Market

1

-13.85%

-8.63%

2

22.90

12.37 

3

35.15

19.37 

·        1.75

 

40. Given the following returns on Stock Q and "the market" during the last three years, what is the difference in the calculated beta coefficient of Stock Q when Year 1-Year 2 data are used as compared to Year 2-Year 3 data? (Hint: Think rise over run.)

Year

Stock Q

Market

1

6.30%

6.10%

2

-3.70  

12.90  

3

21.71  

16.20  

·        9.17

H

41. Historical rates of return for the market and for Stock A are given below:

Year

Market

Stock A

1

6.0%

8.0%

2

-8.0  

3.0 

3

-8.0  

-2.0  

4

18.0  

12.0  

If the required return on the market is 11 percent and the risk-free rate is 6 percent, what is the required return on Stock A, according to CAPM/SML theory?

·        8.27%

I

42. In a portfolio of three different stocks, which of the following could not be true?

·        The beta of the portfolio is less than the beta of each of the individual stocks.

 

43. In general, which of the following will tend to occur if you randomly add additional stocks to your portfolio, which currently consists of only three stocks

·        The company-specific risk of your portfolio will usually decline, but the market risk will tend to remain the same.

 

44. In recent years, both expected inflation and the market risk premium (kM - kRF) have declined. Assume that all stocks have positive betas. Which of the following is likely to have occurred as a result of these changes?

·        The required returns on all stocks have fallen, but the decline has been greater for stocks with higher betas.

 

45. In the years ahead the market risk premium, (kM - kRF), is expected to fall, while the risk-free rate, kRF, is expected to remain at current levels. Given this forecast, which of the following statements is most correct?

·        The required return will fall for all stocks but will fall more for stocks with higher betas.

 

46. Inflation, recession, and high interest rates are economic events that are characterized as

·        Market risk.

J

47. Jane has randomly selected a portfolio of 20 stocks, and Dick has randomly selected a portfolio of two stocks. Which of the following statements is most correct?

·        None of the statements above is correct

 

48. Jane holds a large diversified portfolio of 100 randomly selected stocks and the portfolio's beta = 1.2. Each of the individual stocks in her portfolio has a standard deviation of 20 percent. Jack has the same amount of money invested in a single stock with a beta equal to 1.6 and a standard deviation of 20 percent. Which of the following statements is most correct?

·        Jane's portfolio has less market risk since it has a lower beta.

O

49. Oakdale Furniture Inc. has a beta coefficient of 0.7 and a required rate of return of 15 percent. The market risk premium is currently 5 percent. If the inflation premium increases by 2 percentage points, and Oakdale acquires new assets that increase its beta by 50 percent, what will be Oakdale's new required rate of return?

·        18.75%

 

50. Other things held constant, (1) if the expected inflation rate decreases, and (2) investors become more risk averse, the Security Market Line would shift

·        Down and have a steeper slope.

 

51. Over the past 75 years, we have observed that investments with higher average annual returns also tend to have the highest standard deviations in their annual returns. This observation supports the notion that there is a positive correlation between risk and return. Which of the following lists correctly ranks investments from having the highest returns and risk to those with the lowest returns and risk?

·        Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills

P

52. Partridge Plastic's stock has an estimated beta of 1.4, and its required rate of return is 13 percent. Cleaver Motors' stock has a beta of 0.8, and the risk-free rate is 6 percent. What is the required rate of return on Cleaver Motors' stock?

·        10.0%

 

Portfolio Manager
A portfolio manager has a $10 million portfolio, which consists of $1 million invested in 10 separate stocks. The portfolio beta is 1.2. The risk-free rate is 5 percent and the market risk premium is 6 percent.

 

53. Refer to Portfolio Manager. What is the portfolio's required return?

·        12.20%

 

54. Refer to Portfolio Manager. The manager sells one of the stocks in her portfolio for $1 million. The stock she sold has a beta of 0.9. She takes the $1 million and uses the money to purchase a new stock that has

·        12.62%

 

55. Portfolio P has 30 percent invested in Stock X and 70 percent in Stock Y. The risk-free rate of interest is 6 percent and the market risk premium is 5 percent. Portfolio P has a required return of 12 percent and Stock X has a beta of 0.75. What is the beta of Stock Y?

·        1.39

R

56. Ripken Iron Works faces the following probability distribution:


State of
the Economy


Probability of
State Occurring

Stock's Expected
Return if this
State Occurs

Boom

0.25

25%

Normal

0.50

15 

Recession

0.25

5

What is the coefficient of variation on the company's stock?

·        0.47

S

57. Some returns data for the market and for Countercyclical Corp. are given below:

Year

Market

Countercyclical

1999

-2.0%

8.0%

2000

12.0 

3.0 

2001

-8.0 

18.0  

2002

21.0 

-7.0  


The required return on the market is 14 percent and the risk-free rate is 8 percent. What is the required return on Countercyclical Corp. according to CAPM/SML theory?

·        3.42%

 

58. Stock A and Stock B both have an expected return of 10 percent and a standard deviation of 25 percent. Stock A has a beta of 0.8 and Stock B has a beta of 1.2. The correlation coefficient, r, between the two stocks is 0.6. Portfolio P is a portfolio with 50 percent invested in Stock A and 50 percent invested in Stock B. Which of the following statements is most correct?

·        Portfolio P has more market risk than Stock A but less market risk than Stock B.

 

59. Stock A and Stock B each have an expected return of 12 percent, a beta of 1.2, and a standard deviation of 25 percent. The returns on the two stocks have a correlation of 0.6. Portfolio P has half of its money invested in Stock A and half in Stock B. Which of the following statements is most correct?

·        Statements a and c are correct.

 

60. Stock A and Stock B each have an expected return of 15 percent, a standard deviation of 20 percent, and a beta of 1.2. The returns of the two stocks are not perfectly correlated; the correlation coefficient is 0.6. You have put together a portfolio that consists of 50 percent Stock A and 50 percent Stock B. Which of the following statements is most correct?

·        The portfolio's expected return is 15 percent.

 

61. Stock X, and "the market" have had the following rates of returns over the past four years.

Year

Stock X

Market

1999

12%

14%

2000

5

2

2001

11 

14 

2002

-7 

-3 

60 percent of your portfolio is invested in Stock X, and the remaining 40 percent is invested in Stock Y. The risk-free rate is 6 percent and the market risk premium is also 6 percent. You estimate that 14 percent is the required rate of return on your portfolio. What is the beta of Stock Y?

·        1.91

 

62. Stocks A, B, and C all have an expected return of 10 percent and a standard deviation of 25 percent. Stocks A and B have returns that are independent of one another. (Their correlation coefficient, r, equals zero.) Stocks A and C have returns that are negatively correlated with one another (that is, r < 0). Portfolio AB is a portfolio with half its money invested in Stock A and half invested in Stock B. Portfolio AC is a portfolio with half its money invested in Stock A and half invested in Stock C. Which of the following statements is most correct?

·        Statements a and c are correct.

 

63. Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is most correct?

·        If market participants become more risk averse, the required return on Stock B will increase more than the required return for Stock A.

 

64. Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50 percent invested in both Stocks A and B. Which of the following would occur if the market risk premium increased by 1 percentage point? (Assume that the risk-free rate remains constant.)

·        The required return for Portfolio P would increase by 1 percentage point

 

65. Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has equal amounts invested in each of the three stocks. Each of the stocks has a standard deviation of 25 percent. The returns of the three stocks are independent of one another (i.e., the correlation coefficients all equal zero). Assume that there is an increase in the market risk premium, but that the risk-free rate remains unchanged. Which of the following statements is most correct?

·        The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium.

 

66. Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has equal amounts invested in each of the three stocks. Each of the stocks has a standard deviation of 25 percent. The returns of the three stocks are independent of one another (i.e., the correlation coefficients all equal zero). Which of the following statements is most correct?

·        Statements a and b are correct.

 

67. Stock A has a beta of 0.8 and Stock B has a beta of 1.2. 50 percent of Portfolio P is invested in Stock A and 50 percent is invested in Stock B. If the market risk premium (kM - kRF) were to increase but the risk-free rate (kRF) remained constant, which of the following would occur?

·        The required return will increase for both stocks but the increase will be greater for Stock B than for Stock A.

 

68. Stock A has a beta of 1.2 and a standard deviation of 25 percent. Stock B has a beta of 1.4 and a standard deviation of 20 percent. Portfolio P was created by investing in a combination of Stocks A and B. Portfolio P has a beta of 1.25 and a standard deviation of 18 percent. Which of the following statements is most correct?

·        Portfolio P's required return is greater than Stock A's required return.

 

69. Stock A has a beta of 1.2 and a standard deviation of 20 percent. Stock B has a beta of 0.8 and a standard deviation of 25 percent. Portfolio P is a $200,000 portfolio consisting of $100,000 invested in Stock A and $100,000 invested in Stock B. Which of the following statements is most correct? (Assume that the required return is determined by the Security Market Line.)

·        Portfolio P has a beta equal to 1.0.

 

70. Stock A has a beta of 1.5 and Stock B has a beta of 0.5. Which of the following statements must be true about these securities? (Assume the market is in equilibrium.)

·        The expected return on Stock A will be greater than that on Stock B.

 

71. Stock A has an expected return of 10 percent and a beta of 1.0. Stock B has a beta of 2.0. Portfolio P is a two-stock portfolio, where part of the portfolio is invested in Stock A and the other part is invested in Stock B. Assume that the risk-free rate is 5 percent, that required returns are determined by the CAPM, and that the market is in equilibrium so that expected returns equal required returns. Portfolio P has an expected return of 12 percent. What proportion of Portfolio P consists of Stock B?

·        40%

 

72. Stock A has an expected return of 10 percent and a standard deviation of 20 percent. Stock B has an expected return of 12 percent and a standard deviation of 30 percent. The risk-free rate is 5 percent and the market risk premium, kM - kRF, is 6 percent. Assume that the market is in equilibrium. Portfolio P has 50 percent invested in Stock A and 50 percent invested in Stock B. The returns of Stock A and Stock B are independent of one another. (That is, their correlation coefficient equals zero.) Which of the following statements is most correct?

·        Statements a and b are correct.

 

73. Stock A has an expected return of 12 percent, a beta of 1.2, and a standard deviation of 20 percent. Stock B has an expected return of 10 percent, a beta of 1.2, and a standard deviation of 15 percent. Portfolio P has $900,000 invested in Stock A and $300,000 invested in Stock B. The correlation between Stock A's returns and Stock B's returns is zero (that is, r = 0). Which of the following statements is most correct?

·        Portfolio P's expected return is 11.5 percent.

 

74. Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements is most correct?

·        If expected inflation increases (but the market risk premium is unchanged), the required returns on the two stocks will increase by the same amount.

 

75. Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is most correct?

·        If the market risk premium decreases (but expected inflation is unchanged), the required return on both stocks will decrease but the decrease will be greater for Stock Y.

 

76. Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock's returns is 20 percent. The returns are independent of each other. (In other words, the correlation coefficient, r, between Stock X and Stock Y is zero.) Portfolio P has 50 percent of its wealth invested in Stock X and the other 50 percent is invested in Stock Y. Given this information, which of the following statements is most correct?

·        The required return on Portfolio P is the same as the required return on the market (kM).

 

77. Stock X has a beta of 1.5 and Stock Y has a beta of 0.5. The market is in equilibrium (that is, required returns equal expected returns). Which of the following statements is most correct?

·        None of the statements above is correct.

T

78. The CFO of Brady Boots has estimated the rates of return to Brady's stock, depending on the state of the economy. He has also compiled analysts' expectations for the economy.

Economy

Probability

Return

Recession

0.1

-23%

Below average

0.1

-8

Average

0.4

 6

Above average

0.2

17

Boom

0.2

24

Given this data, what is the company's coefficient of variation? (Use the population standard deviation, not the sample standard deviation when calculating the coefficient of variation.)

·        1.84

 

79. The current risk-free rate is 6 percent and the market risk premium is 5 percent. Erika is preparing to invest $30,000 in the market and she wants her portfolio to have an expected return of 12.5 percent. Erika is concerned about bearing too much stand-alone risk; therefore, she will diversify her portfolio by investing in three different assets (two mutual funds and a risk-free security). The three assets she will be investing in are an aggressive growth mutual fund that has a beta of 1.6, an S&P 500 index fund with a beta of 1, and a risk-free security that has a beta of 0. She has already decided that she will invest 10 percent of her money in the risk-free asset. In order to achieve the desired expected return of 12.5 percent, what proportion of Erika's portfolio must be invested in the S&P 500 index fund?

·        23.33%

 

80. The combined portfolio's expected return is a simple average of the expected returns of the two individual portfolios (10%).

·        The combined portfolio's beta is a simple average of the betas of the two individual portfolios (1.0).

 

81. The following probability distributions of returns for two stocks have been estimated:

 

Returns

Probability

Stock A

Stock B

0.3

12%

5%

0.4

8

0.3

6

What is the coefficient of variation for the stock that is less risky, assuming you use the coefficient of variation to rank riskiness?

·        0.19

 

82. The realized returns for the market and Stock J for the last four years are given below:

Year

Market

Stock J

1

10%

5%

2

15 

3

-5 

14  

4

0

10  

An average stock has an expected return of 12 percent and the market risk premium is 4 percent. If Stock J's expected rate of return as viewed by a marginal investor is 8 percent, what is the difference between J's expected and required rates of return?

·        2.64%

 

83. The risk-free rate is 5 percent. Stock A has a beta = 1.0 and Stock B has a beta = 1.4. Stock A has a required return of 11 percent. What is Stock B's required return?

·        13.4%

 

84. The risk-free rate is 6 percent. Stock A has a beta of 1.0, while Stock B has a beta of 2.0. The market risk premium (kM - kRF) is positive. Which of the following statements is most correct?

·        If Stock A's required return is 11 percent, the market risk premium is 5 percent.

 

85. The risk-free rate of interest, kRF, is 6 percent. The overall stock market has an expected return of 12 percent. Hazlett, Inc. has a beta of 1.2. What is the required return of Hazlett, Inc. stock?

·        13.2%

 

86. The returns of United Railroad Inc. (URI) are listed below, along with the returns on "the market":

Year

URI

Market

1

-14%

-9%

2

16

11 

3

22

15 

4

 7

5

5

-2

-1 

If the risk-free rate is 9 percent and the required return on URI's stock is 15 percent, what is the required return on the market? Assume the market is in equilibrium. (Hint: Think rise over run.)

·        13%

 

87. The risk-free rate, kRF, is 6 percent and the market risk premium, (kM - kRF), is 5 percent. Assume that required returns are based on the CAPM. Your $1 million portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. Which of the following statements is most correct?

·        If the risk-free rate remains unchanged but the market risk premium increases by 2 percentage points, the required return on your portfolio will increase by more than 2 percentage points.

W

88. Walter Jasper currently manages a $500,000 portfolio. He is expecting to receive an additional $250,000 from a new client. The existing portfolio has a required return of 10.75 percent. The risk-free rate is 4 percent and the return on the market is 9 percent. If Walter wants the required return on the new portfolio to be 11.5 percent, what should be the average beta for the new stocks added to the portfolio?

·        1.80

 

89. Which of the following statements best describes what would be expected to happen as you randomly add stocks to your portfolio?

·        Adding more stocks to your portfolio reduces the portfolio's company-specific risk.

 

90. Which of the following statements is most correct?

·        A security's beta measures its nondiversifiable (systematic, or market) risk relative to that of an average stock

·        An increase in expected inflation could be expected to increase the required return on a riskless asset and on an average stock by the same amount, other things held constant.

·        All of the statements above are correct.

                                             Wrong ans. i.            Statements a and b are correct.

·        None of the statements above is correct.

                                             Wrong ans. i.            The slope of the security market line is beta.

                                            Wrong ans. ii.        If a stock has a beta equal to 1.0, its required rate of return will be unaffected by changes in the market risk premium.

                                          Wrong ans. iii.            A portfolio with a large number of randomly selected stocks will have less market risk than a single stock that has a beta equal to 0.5.

·        Statements a and c are correct

·        Statements a and b are correct.

                                             Wrong ans. i.            If investors became more risk averse, then the new security market line would have a steeper slope.

·        Statements b and c are correct.

                                             Wrong ans. i.            All of the statements above are correct.

·        Statements b and d are correct.

                                                             Ans . b.      If you formed a portfolio that included a large number of low-beta stocks (stocks with betas less than 1.0 but greater than -1.0), the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, so the portfolio would have a relatively low degree of risk.

                                                             Ans . d.      Diversifiable risk can be eliminated by forming a large portfolio, but normally even highly-diversified portfolios are subject to market risk.

·        Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis, while the other has a beta of -0.6. The returns on the stock with the negative beta will be negatively correlated with returns on most other stocks in the market

·        The slope of the security market line is the market risk premium, (kM - kRF).

·        The beta coefficient of a stock is normally found by running a regression of past returns on the stock against past returns on a stock market index. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta.

·        The beta coefficient used in the SML equation should reflect the expected volatility of a given stock's return versus the return on the market during some future period.

·        The SML relates required returns to firms' market risk. The slope and intercept of this line cannot be controlled by the financial manager.

 

91. Which of the following statements is most correct about a stock that has a beta = 1.2?

·        If expected inflation increases 3 percent, the stock's expected return will increase by 3 percent

 

92. Which of the following statements is incorrect?

·        The slope of the security market line is measured by beta.

 

93. Which of the following is not a difficulty concerning beta and its estimation?

·        The beta of an "average stock," or "the market," can change over time, sometimes drastically.

Y

94. You are an investor in common stocks, and you currently hold a well-diversified portfolio that has an expected return of 12 percent, a beta of 1.2, and a total value of $9,000. You plan to increase your portfolio by buying 100 shares of AT&E at $10 a share. AT&E has an expected return of 20 percent with a beta of 2.0. What will be the expected return and the beta of your portfolio after you purchase the new stock?

·        k_hat = 12.8%; bp = 1.28

 

95. You are holding a stock that has a beta of 2.0 and is currently in equilibrium. The required return on the stock is 15 percent, and the return on an average stock is 10 percent. What would be the percentage change in the return on the stock, if the return on an average stock increased by 30 percent while the risk-free rate remained unchanged?

·        +40%

 

96. You have been managing a $1 million portfolio. The portfolio has a beta of 1.6 and a required rate of return of 14 percent. The current risk-free rate is 6 percent. Assume that you receive another $200,000. If you invest the money in a stock that has a beta of 0.6, what will be the required return on your $1.2 million portfolio?

·        13.17%

 

97. You have been scouring The Wall Street Journal looking for stocks that are "good values" and have calculated expected returns for five stocks. Assume the risk-free rate (kRF) is 7 percent and the market risk premium (kM - kRF) is 2 percent. Which security would be the best investment? (Assume you must choose just one.)

Expected Return      Beta

·        7.06%            0.00

 

98. You have developed data that give (1) the average annual returns on the market for the past five years, and (2) similar information on Stocks A and B. If these data are as follows, which of the possible answers best describes the historical betas for A and B?

Years

Market

Stock A

Stock B

1

0.03

0.16

0.05

2

-0.05 

0.20

0.05

3

0.01

0.18

0.05

4

-0.10 

0.25

0.05

5

0.06

0.14

0.05

·        bA < 0; bB = 0

 

99. You have developed the following data on three stocks:

Stock

Standard Deviation

Beta

A

0.15

0.79

B

0.25

0.61

C

0.20

1.29

If you are a risk minimizer, you should choose Stock __________ if it is to be held in isolation and Stock __________ if it is to be held as part of a well-diversified portfolio.

·        A; B

 

100.         You hold a diversified portfolio consisting of a $10,000 investment in each of 20 different common stocks (that is, your total investment is $200,000). The portfolio beta is equal to 1.2. You have decided to sell one of your stocks that has a beta equal to 0.7 for $10,000. You plan to use the proceeds to purchase another stock that has a beta equal to 1.4. What will be the beta of the new portfolio?

·        1.235

 

101.         You hold a diversified portfolio consisting of a $5,000 investment in each of 20 different common stocks. The portfolio beta is equal to 1.15. You have decided to sell one of your stocks, a lead mining stock whose b is equal to 1.0, for $5,000 net and to use the proceeds to buy $5,000 of stock in a steel company whose b is equal to 2.0. What will be the new beta of the portfolio?

·        1.20

 

102.         You observe the following information regarding Company X and Company Y:

Ø      Company X has a higher expected mean return than Company Y.

Ø      Company X has a lower standard deviation than Company Y.

Ø      Company X has a higher beta than Company Y.

Given this information, which of the following statements is most correct?

·        Company X has a lower coefficient of variation than Company Y.

 

103.         Your portfolio consists of $100,000 invested in a stock that has a beta = 0.8, $150,000 invested in a stock that has a beta = 1.2, and $50,000 invested in a stock that has a beta = 1.8. The risk-free rate is 7 percent. Last year this portfolio had a required rate of return of 13 percent. This year nothing has changed except for the fact that the market risk premium has increased by 2 percent (two percentage points). What is the portfolio's current required rate of return?

·        15.33%

 

104.         Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15 percent, a beta of 1.6, and a standard deviation of 30 percent. The returns of the two stocks are independent--the correlation coefficient, r, is zero. Which of the following statements best describes the characteristics of your portfolio?

·        Your portfolio has a beta equal to 1.6 and its expected return is 15 percent.

FIN 350 MINI TEST 4 CHAPTER 6

A

1.      A $10,000 loan is to be amortized over 5 years, with annual end-of-year payments. Given the following facts, which of these statements is most correct?

·        The proportion of each payment that represents interest as opposed to repayment of principal would be higher if the interest rate were higher.

 

2.      A 10-year security generates cash flows of $2,000 a year at the end of each of the next three years (t = 1, 2, and 3). After three years, the security pays some constant cash flow at the end of each of the next six years (t = 4, 5, 6, 7, 8, and 9). Ten years from now (t = 10) the security will mature and pay $10,000. The security sells for $24,307.85 and has a yield to maturity of 7.3 percent. What annual cash flow does the security pay for years 4 through 9?

·        $3,700

 

3.      A baseball player is offered a 5-year contract that pays him the following amounts:

Year 1:

$1.2 million

Year 2:

  1.6 million

Year 3:

  2.0 million

Year 4:

  2.4 million

Year 5:

  2.8 million

Under the terms of the agreement all payments are made at the end of each year.

Instead of accepting the contract, the baseball player asks his agent to negotiate a contract that has a present value of $1 million more than that which has been offered. Moreover, the player wants to receive his payments in the form of a 5-year annuity due. All cash flows are discounted at 10 percent. If the team were to agree to the player's terms, what would be the player's annual salary (in millions of dollars)?

·        $1.989

 

4.      A real estate investment has the following expected cash flows:

Year           

Cash Flows

1

$10,000 

2

25,000

3

50,000

4

35,000

The discount rate is 8 percent. What is the investment's present value?

·        96,110

 

5.      A financial planner has offered you three possible options for receiving cash flows. You must choose the option that has the highest present value.

(1)   $1,000 now and another $1,000 at the beginning of each of the 11 subsequent months during the remainder of the year, to be deposited in an account paying a 12 percent nominal annual rate, but compounded monthly (to be left on deposit for the year).

(2)   $12,750 at the end of the year (assume a 12 percent nominal interest rate with semiannual compounding).

(3)   A payment scheme of 8 quarterly payments made over the next two years. The first payment of $800 is to be made at the end of the current quarter. Payments will increase by 20 percent each quarter. The money is to be deposited in an account paying a 12 percent nominal annual rate, but compounded quarterly (to be left on deposit for the entire 2-year period).

Which one would you choose?

·        Choice 1

 

6.      A project with a 3-year life has the following probability distributions for possible end-of-year cash flows in each of the next three years:

Year 1

Year 2

Year 3

Prob

Cash Flow

Prob

Cash Flow

Prob

Cash Flow

0.30

$300 

0.15

$100 

0.25

$200 

0.40

500

0.35

200

0.75

800

0.30

700

0.35

600

 

 

0.15

900

 

 

 

 

Using an interest rate of 8 percent, find the expected present value of these uncertain cash flows. (Hint: Find the expected cash flow in each year, then evaluate those cash flows.)

·        $1,347.61

 

7.      A young couple is planning for the education of their two children. They plan to invest the same amount of money at the end of each of the next 16 years. The first contribution will be made at the end of the year and the final contribution will be made at the end of the year the older child enters college.

The money will be invested in securities that are certain to earn a return of 8 percent each year. The older child will begin college in 16 years and the second child will begin college in 18 years. The parents anticipate college costs of $25,000 a year (per child). These costs must be paid at the end of each year. If each child takes four years to complete their college degrees, then how much money must the couple save each year?

·        $  5,477.36

 

8.      An investment costs $3,000 today and provides cash flows at the end of each year for 20 years. The investment's expected return is 10 percent. The projected cash flows for Years 1, 2, and 3 are $100, $200, and $300, respectively. What is the annual cash flow received for each of Years 4 through 20 (17 years)? (Assume the same payment for each of these years.)

·        $417.87

 

9.      An investment pays $100 every six months (semiannually) over the next 2.5 years. Interest, however, is compounded quarterly, at a nominal rate of 8 percent. What is the future value of the investment after 2.5 years?

·        $542.07

 

10. An investment pays you $5,000 at the end of each of the next five years. Your plan is to invest the money in an account that pays 8 percent interest, compounded monthly. How much will you have in the account after receiving the final $5,000 payment in 5 years (60 months)?

·        $  29,508.98

 

11. An investment pays you 9 percent interest compounded semiannually. A second investment of equal risk, pays interest compounded quarterly. What nominal rate of interest would you have to receive on the second investment in order to make you indifferent between the two investments?

·        8.90%

 

12. Assume one bank offers you a nominal annual interest rate of 6 percent compounded daily while another bank offers you continuous compounding at a 5.9 percent nominal annual rate. You decide to deposit $1,000 with each bank. Exactly two years later you withdraw your funds from both banks. What is the difference in your withdrawal amounts between the two banks?

·        $  2.25

 

13. Assume that you will receive $2,000 a year in Years 1 through 5, $3,000 a year in Years 6 through 8, and $4,000 in Year 9, with all cash flows to be received at the end of the year. If you require a 14 percent rate of return, what is the present value of these cash flows?

·        $11,714

 

14. At an inflation rate of 9 percent, the purchasing power of $1 would be cut in half in 8.04 years. How long to the nearest year would it take the purchasing power of $1 to be cut in half if the inflation rate were only 4 percent?

·        18 years

B

Bill
Bill and Paula just purchased a car. They financed the car with a four-year (48-month) $15,000 loan. The loan is fully amortized after four years (i.e., the loan will be fully paid off after four years). Loan payments are due at the end of each month. The loan has a 12 percent nominal annual rate and the interest is compounded monthly.

 

15. Refer to Bill. What are the monthly payments on the loan

·        $395.01

 

16. Refer to Bill. What is the effective annual rate on the loan?

·        12.68%

 

17. Bill and Bob are both 25 years old today. Each wants to begin saving for his retirement. Both plan on contributing a fixed amount each year into brokerage accounts that have annual returns of 12 percent. Both plan on retiring at age 65, 40 years from today, and both want to have $3 million saved by age 65. The only difference is that Bill wants to begin saving today, whereas Bob wants to begin saving one year from today. In other words, Bill plans to make 41 total contributions (t = 0, 1, 2, ... 40), while Bob plans to make 40 total contributions (t = 1, 2, ... 40). How much more than Bill will Bob need to save each year in order to accumulate the same amount as Bill does by age 65?

·        $423.09

 

Bill plans to deposit $200 into a bank account at the end of every month. The bank account has a nominal interest rate of 8 percent and interest is compounded monthly. How much will Bill have in the account at the end of 2.5 years (30 months)?

$  6,617.77

 

Birthday
Today is your 21st birthday and your parents gave you a gift of $2,000. You just put this money in a brokerage account, and your plan is to add $1,000 to the account each year on your birthday, starting on your 22nd birthday.

 

18. Refer to Birthday. Assume that you want to have $1,000,000 in the account by age 60 (39 years from today). What annual rate of return will you need to earn on your investments in order to reach this goal?

·        12.57%

 

19. Refer to Birthday. If you earn 10 percent a year in the brokerage account, what is the minimum number of whole years it will take for you to have at least $1,000,000 in the account?

·        47

 

20. Bob is 20 years old today and is starting to save money, so that he can get his MBA. He is interested in a 1-year MBA program. Tuition and expenses are currently $20,000 per year, and they are expected to increase by 5 percent per year. Bob plans to begin his MBA when he is 26 years old, and since all tuition and expenses are due at the beginning of the school year, Bob will make his one single payment six years from today. Right now, Bob has $25,000 in a brokerage account, and he plans to contribute a fixed amount to the account at the end of each of the next six years (t = 1, 2, 3, 4, 5, and 6). The account is expected to earn an annual return of 10 percent each year. Bob plans to withdraw $15,000 from the account two years from today (t = 2) to purchase a used car, but he plans to make no other withdrawals from the account until he starts the MBA program. How much does Bob need to put in the account at the end of each of the next six years to have enough money to pay for his MBA?

·        $   580

C

21. Carla is interested in saving for retirement. Today, on her 40th birthday, she has $100,000 in her investment account. She plans to make additional contributions on each of her subsequent birthdays. Specifically, she plans to:

Ø      Contribute $10,000 per year each year during her 40's. (This will entail 9 contributions--the first will occur on her 41 st birthday and the 9th on her 49th birthday.)

Ø      Contribute $20,000 per year each year during her 50's. (This will entail 10 contributions--the first will occur on her 50th birthday and the 10th on her 59th birthday.)

Ø      Contribute $25,000 per year thereafter until age 65. (This will entail 6 contributions--the first will occur on her 60th birthday and the 6th on her 65th birthday.)

Assume that her investment account has an expected return of 11 percent per year. If she sticks to her plan, how much will Carla have in her account on her 65th birthday after her final contribution?

·        $2,934,143

E

22. Elizabeth has $35,000 in an investment account. Her goal is to have the account grow to $100,000 in 10 years without having to make any additional contributions to the account. What effective annual rate of interest would she need to earn on the account in order to meet her goal?

·        11.07%

 

23. Erika opened a savings account today and she immediately put $10,000 into it. She plans to contribute another $20,000 one year from now, and $50,000 two years from now. The savings account pays a 6 percent annual interest rate. If she makes no other deposits or withdrawals, how much will she have in the account 10 years from today?

·        $131,390.46

F

24. Find the present value of an income stream that has a negative flow of $100 per year for 3 years, a positive flow of $200 in the 4th year, and a positive flow of $300 per year in Years 5 through 8. The appropriate discount rate is 4 percent for each of the first 3 years and 5 percent for each of the later years. Thus, a cash flow accruing in Year 8 should be discounted at 5 percent for some years and 4 percent in other years. All payments occur at year-end.

·        $   792.49

 

25. For a 10-year deposit, what annual rate payable semiannually will produce the same effective rate as 4 percent compounded continuously?

·        4.04%

 

26. Foster Industries has a project that has the following cash flows:

Year

Cash Flow

0

-$300.00  

1

100.00

2

125.43

3

 90.12

4

 ?

What cash flow will the project have to generate in the fourth year in order for the project to have a 15 percent rate of return?

·        $103.10

 

27. Frank Lewis has a 30-year, $100,000 mortgage with a nominal interest rate of 10 percent and monthly compounding. Which of the following statements regarding his mortgage is most correct?

·        Statements b and c are correct.

G

28. Gilhart First National Bank offers an investment security with a 7.5 percent nominal annual return, compounded quarterly. Gilhart's competitor, Olsen Savings and Loan, is offering a similar security that bears the same risk and same effective rate of return. However, Olsen's security pays interest monthly. What is the nominal annual return of the security offered by Olsen?

·        7.45%

 

29. Gomez Electronics needs to arrange financing for its expansion program. Bank A offers to lend Gomez the required funds on a loan in which interest must be paid monthly, and the quoted rate is 8 percent. Bank B will charge 9 percent, with interest due at the end of the year. What is the difference in the effective annual rates charged by the two banks?

·        0.70%

H

30. Hillary is trying to determine the cost of health care to college students and parents' ability to cover those costs. She assumes that the cost of one year of health care for a college student is $1,000 today, that the average student is 18 when he or she enters college, that inflation in health care cost is rising at the rate of 10 percent per year, and that parents can save $100 per year to help cover their children's costs. All payments occur at the end of the relevant period, and the $100/year savings will stop the day the child enters college (hence 18 payments will be made). Savings can be invested at a nominal rate of 6 percent, annual compounding. Hillary wants a health care plan that covers the fully inflated cost of health care for a student for 4 years, during Years 19 through 22 (with payments made at the end of Years 19 through 22). How much would the government have to set aside now (when a child is born), to supplement the average parent's share of a child's college health care cost? The lump sum the government sets aside will also be invested at 6 percent, annual compounding.

·        $7,472.08

 

31. How much should you be willing to pay for an account today that will have a value of $1,000 in 10 years under continuous compounding if the nominal rate is 10 percent?

·        $368

 

House
Your family recently bought a house. You have a $100,000, 30-year mortgage with a 7.2 percent nominal annual interest rate. Interest is compounded monthly and all payments are made at the end of the month.

 

32. Refer to House. What is the monthly payment on the mortgage?

    • $678.79

I

33. If $100 is placed in an account that earns a nominal 4 percent, compounded quarterly, what will it be worth in 5 years?

·        $122.02

 

34. If a 5-year ordinary annuity has a present value of $1,000, and if the interest rate is 10 percent, what is the amount of each annuity payment?

·        $263.80

 

35. If it were evaluated with an interest rate of 0 percent, a 10-year regular annuity would have a present value of $3,755.50. If the future (compounded) value of this annuity, evaluated at Year 10, is $5,440.22, what effective annual interest rate must the analyst be using to find the future value?

·        8%

 

36. If you buy a factory for $250,000 and the terms are 20 percent down, the balance to be paid off over 30 years at a 12 percent rate of interest on the unpaid balance, what are the 30 equal annual payments?

·        $24,829

 

37. If you receive $15,000 today and can invest it at a 5 percent annual rate compounded continuously, what will be your ending value after 20 years?

·        -$40,774

 

38. In 1958 the average tuition for one year at an Ivy League school was $1,800. Thirty years later, in 1988, the average cost was $13,700. What was the growth rate in tuition over the 30-year period?

·        7%

 

39. In order to purchase your first home you need a down payment of $19,000 four years from today. You currently have $14,014 to invest. In order to achieve your goal, what nominal interest rate, compounded continuously, must you earn on this investment?

·        7.61%

 

40. In six years' time, you are scheduled to receive money from a trust established for you by your grandparents. When the trust matures there will be $100,000 in the account. If the account earns 9 percent compounded continuously, how much is in the account today?

·        $  58,275

J

41. Jerry plans to retire on the same day (which will be his 65th birthday); however, until now, he has saved nothing for retirement. Jerry's plan is to start contributing a fixed amount each year on his birthday; the first contribution will occur today. Jerry's 36th, and final, contribution will occur on his 65th birthday. Jerry's goal is to have the same amount when he retires at age 65 that Donald will have at age 60. Assume that both accounts have an expected annual return of 12 percent. How much does Jerry need to contribute each year in order to meet his goal?

·        $  9,838

 

42. Jill currently has $300,000 in a brokerage account. The account pays a 10 percent annual interest rate. Assuming that Jill makes no additional contributions to the account, how many years will it take for her to have $1,000,000 in the account?

·        12.63 years

 

43. Jim and Nancy just got married today. They want to start saving so they can buy a house five years from today. The average house in their town today sells for $120,000. Housing prices are expected to increase 3 percent a year. When they buy their house five years from now, Jim and Nancy expect to get a 30-year (360-month) mortgage with a 7 percent nominal interest rate. They want the monthly payment on their mortgage to be $500 a month.

Jim and Nancy want to buy an average house in their town. They are starting to save today for a down payment on the house. The down payment plus the mortgage will equal the expected price of the house. Their plan is to deposit $2,000 in a brokerage account today and then deposit a fixed amount at the end of each of the next five years. Assuming that the brokerage account has an annual return of 10 percent, how much do Jim and Nancy need to deposit at the end of each year in order to accomplish their goal?

·        $  9,949

 

44. Joe and Jane are interested in saving money to put their two children, John and Susy through college. John is currently 12 years old and will enter college in six years. Susy is 10 years old and will enter college in 8 years. Both children plan to finish college in four years.

College costs are currently $15,000 a year (per child), and are expected to increase at 5 percent a year for the foreseeable future. All college costs are paid at the beginning of the school year. Up until now, Joe and Jane have saved nothing but they expect to receive $25,000 from a favorite uncle in three years.

To provide for the additional funds that are needed, they expect to make 12 equal payments at the beginning of each of the next 12 years--the first payment will be made today and the final payment will be made on Susy's 21st birthday (which is also the day that the last payment must be made to the college). If all funds are invested in a stock fund that is expected to earn 12 percent, how large should each of the annual contributions be?

·        $  7,475.60

 

45. John and Jessica are saving for their child's education. Their daughter is currently eight years old and will be entering college 10 years from now (t = 10). College costs are currently $15,000 a year and are expected to increase at a rate of 5 percent a year. They expect their daughter to graduate in four years, and that all annual payments will be due at the beginning of each year (t = 10, 11, 12, and 13).

Right now, John and Jessica have $5,000 in their college savings account. Starting today, they plan to contribute $3,000 a year at the beginning of each of the next five years (t = 0, 1, 2, 3, and 4). Then their plan is to make six equal annual contributions at the end of each of the following six years (t = 5, 6, 7, 8, 9, and 10). Their investment account is expected to have an annual return of 12 percent. How large of an annual payment do they have to make in the subsequent six years (t = 5, 6, 7, 8, 9, and 10) in order to meet their child's anticipated college costs?

·        $4,411

 

46. John Keene recently invested $2,566.70 in a project that is promising to return 12 percent per year. The cash flows are expected to be as follows:

End of Year

Cash Flow

1

$325 

2

400

3

550

4

?

5

750

6

800

What is the cash flow at the end of the 4th year?

·        $1,157

 

Jordan
The Jordan family recently purchased their first home. The house has a 15-year (180-month), $165,000 mortgage. The mortgage has a nominal annual interest rate of 7.75 percent. All mortgage payments are made at the end of the month.

 

47. Refer to Jordan. What is the monthly payment on the mortgage?

·        $1,553.10

 

48. Refer to Jordan. What will be the remaining balance on the mortgage after one year (right after the 12th payment has been made)?

·        $158,937.91

 

49. Josh and John (2 brothers) are each trying to save enough money to buy their own cars. Josh is planning to save $100 from every paycheck. (He is paid every 2 weeks.) John plans to put aside $150 each month but has already saved $1,500. Interest rates are currently quoted at 10 percent. Josh's bank compounds interest every two weeks while John's bank compounds interest monthly. At the end of 2 years they will each spend all their savings on a car. (Each brother will buy a car.) What is the price of the most expensive car purchased?

·        $5,797.63

K

50. Karen
Karen and Keith have a $300,000, 30-year (360-month) mortgage. The mortgage has a 7.2 percent nominal annual interest rate. Mortgage payments are made at the end of each month.

·        $2,036.36

 

51. Karen and her twin sister, Kathy, are celebrating their 30th birthday today. Karen has been saving for her retirement ever since their 25th birthday. On their 25th birthday, she made a $5,000 contribution to her retirement account. Every year thereafter on their birthday, she has added another $5,000 to the account. Her plan is to continue contributing $5,000 every year on their birthday. Her 41st, and final, $5,000 contribution will occur on their 65th birthday.

So far, Kathy has not saved anything for her retirement but she wants to begin today. Kathy's plan is to also contribute a fixed amount every year. Her first contribution will occur today, and her 36th, and final, contribution will occur on their 65th birthday. Assume that both investment accounts earn an annual return of 10 percent. How large does Kathy's annual contribution have to be for her to have the same amount in her account at age 65, as Karen will have in her account at age 65?

·        $8,154.60

 

52. Katherine wants to open a savings account, and she has obtained account information from two banks. Bank A has a nominal annual rate of 9 percent, with interest compounded quarterly. Bank B offers the same effective annual rate, but it compounds interest monthly. What is the nominal annual rate of return for a savings account from Bank B?

·        8.933%

 

53. Kelly and Brian Johnson are a recently married couple whose parents have counseled them to start saving immediately in order to have enough money down the road to pay for their retirement and their children's college expenses. Today (t = 0) is their 25th birthday (the couple shares the same birthday).

The couple plan to have two children (Dick and Jane). Dick is expected to enter college 20 years from now (t = 20); Jane is expected to enter college 22 years from now (t = 22). So in years t = 22 and t = 23 there will be two children in college. Each child will take 4 years to complete college, and college costs are paid at the beginning of each year of college.

College costs per child will be as follows:

Year

Cost per child

Children in college

20

$58,045 

Dick

21

62,108

Dick

22

66,456

Dick and Jane

23

71,108

Dick and Jane

24

76,086

Jane

25

81,411

Jane


Kelly and Brian plan to retire 40 years from now at age 65 (at t = 40). They plan to contribute $12,000 per year at the end of each year for the next 40 years into an investment account that earns 10 percent per year. This account will be used to pay for the college costs, and also to provide a nest egg for Kelly and Brian's retirement at age 65. How big will Kelly and Brian's nest egg (the balance of the investment account) be when they retire at age 65 (t = 40)?

·        $2,393,273

L

54. Linda needs a new car and she is deciding whether it makes sense to buy or lease the car. She estimates that if she buys the car it will cost her $17,000 today (t = 0) and that she would sell the car four years from now for $7,000 (at t = 4). If she were to lease the car she would make a fixed lease payment at the end of each of the next 48 months (4 years). Assume that the operating costs are the same regardless of whether she buys or leases the car. Assume that if she leases, there are no up-front costs and that there is no option to buy the car after four years. Linda estimates that she should use a 6 percent nominal interest rate to discount the cash flows. What is the breakeven lease payment? (That is, at what monthly lease payment would she be indifferent between buying and leasing the car?)

·        $269.85

M

Mortgage
A 30-year, $115,000 mortgage has a nominal annual rate of 7 percent. All payments are made at the end of each month.

 

55. Refer to Mortgage. What is the monthly payment on the mortgage?

·        $765.10

O

56. On its savings accounts, the First National Bank offers a 5 percent nominal interest rate that is compounded monthly. Savings accounts at the Second National Bank have the same effective annual return, but interest is compounded quarterly. What nominal rate does the Second National Bank offer on its savings accounts?

·        5.02%

R

57. Rachel wants to take a trip to England in 3 years, and she has started a savings account today to pay for the trip. Today (8/1/02) she made an initial deposit of $1,000. Her plan is to add $2,000 to the account one year from now (8/1/03) and another $3,000 to the account two years from now (8/1/04). The account has a nominal interest rate of 7 percent, but the interest is compounded quarterly. How much will Rachel have in the account three years from today (8/1/05)?

·        $6,744.78

S

58. Steaks Galore needs to arrange financing for its expansion program. One bank offers to lend the required $1,000,000 on a loan that requires interest to be paid at the end of each quarter. The quoted rate is 10 percent, and the principal must be repaid at the end of the year. A second lender offers 9 percent, daily compounding (365-day year), with interest and principal due at the end of the year. What is the difference in the effective annual rates (EFF%) charged by the two banks?

·        0.96%

 

59. Steve and Robert were college roommates, and each is celebrating their 30th birthday today. When they graduated from college nine years ago (on their 21st birthday), they each received $5,000 from family members for establishing investment accounts. Steve and Robert have added $5,000 to their separate accounts on each of their following birthdays (22nd through 30th birthdays). Steve has withdrawn nothing from the account, but Robert made one withdrawal on his 27th birthday. Steve has invested the money in Treasury bills that have earned a return of 6 percent per year, while Robert has invested his money in stocks that have earned a return of 12 percent per year. Both Steve and Robert have the same amount in their accounts today. How much did Robert withdraw on his 27th birthday?

·        $15,545.07

 

60. Steven just deposited $10,000 in a bank account that has a 12 percent nominal interest rate, and the interest is compounded monthly. Steven also plans to contribute another $10,000 to the account one year (12 months) from now and another $20,000 to the account two years from now. How much will be in the account three years (36 months) from now?

·        $49,542

 

61. South Penn Trucking is financing a new truck with a loan of $10,000 to be repaid in 5 annual end-of-year installments of $2,504.56. What annual interest rate is the company paying?

·        8%

 

62. Suppose someone offered you the choice of two equally risky annuities, each paying $10,000 per year for five years. One is an ordinary (or deferred) annuity, the other is an annuity due. Which of the following statements is most correct?

·        The present value of the annuity due exceeds the present value of the ordinary annuity, and the future value of the annuity due also exceeds the future value of the ordinary annuity.

 

63. Suppose you are deciding whether to buy or lease a car. If you buy the car, it will cost $17,000 today (t = 0). You expect to sell the car four years (48 months) from now for $6,000 (at t = 48). As an alternative to buying the car, you can lease the car for 48 months. All lease payments would be made at the end of the month. The first lease payment would occur next month (t = 1) and the final lease payment would occur 48 months from now (t = 48). If you buy the car, you would do so with cash, so there is no need to consider financing. If you lease the car, there is no option to buy it at the end of the contract. Assume that there are no taxes, and that the operating costs are the same regardless of whether you buy or lease the car. Assume that all cash flows are discounted at a nominal annual rate of 12 percent, so the monthly periodic rate is 1 percent. What is the breakeven lease payment? (That is, at what monthly payment would you be indifferent between buying and leasing the car?)

·        $349.67

 

64. Suppose you put $100 into a savings account today, the account pays a nominal annual interest rate of 6 percent, but compounded semiannually, and you withdraw $100 after 6 months. What would your ending balance be 20 years after the initial $100 deposit was made?

·        $    9.50

T

65. Terry Austin is 30 years old and is saving for her retirement. She is planning on making 36 contributions to her retirement account at the beginning of each of the next 36 years. The first contribution will be made today (t = 0) and the final contribution will be made 35 years from today (t = 35). The retirement account will earn a return of 10 percent a year. If each contribution she makes is $3,000, how much will be in the retirement account 35 years from now (t = 35)?

·        $897,380

 

66. The Florida Boosters Association has decided to build new bleachers for the football field. Total costs are estimated to be $1 million, and financing will be through a bond issue of the same amount. The bond will have a maturity of 20 years, a coupon rate of 8 percent, and has annual payments. In addition, the Association must set up a reserve to pay off the loan by making 20 equal annual payments into an account that pays 8 percent, annual compounding. The interest-accumulated amount in the reserve will be used to retire the entire issue at its maturity 20 years hence. The Association plans to meet the payment requirements by selling season tickets at a $10 net profit per ticket. How many tickets must be sold each year to service the debt (to meet the interest and principal repayment requirements)?

·        10,186

 

67. The future value of a lump sum at the end of five years is $1,000. The nominal interest rate is 10 percent and interest is compounded semiannually. Which of the following statements is most correct?

·        Statements b and c are correct.

 

68. The Martin family recently deposited $1,000 in a bank account that pays a 6 percent nominal interest rate. Interest in the account will be compounded daily (365 days = 1 year). How much will they have in the account after 5 years?

·        $1,349.82

 

69. To save money for a new house, you want to begin contributing money to a brokerage account. Your plan is to make 10 contributions to the brokerage account. Each contribution will be for $1,500. The contributions will come at the beginning of each of the next 10 years. The first contribution will be made at t = 0 and the final contribution will be made at t = 9. Assume that the brokerage account pays a 9 percent return with quarterly compounding. How much money do you expect to have in the brokerage account nine years from now (t = 9)?

·        $23,127.49

 

70. Today, Bruce and Brenda each have $150,000 in an investment account. No other contributions will be made to their investment accounts. Both have the same goal: They each want their account to reach $1 million, at which time each will retire. Bruce has his money invested in risk-free securities with an expected annual return of 5 percent. Brenda has her money invested in a stock fund with an expected annual return of 10 percent. How many years after Brenda retires will Bruce retire?

·        19.0

 

71. Today is Craig's 24th birthday, and he wants to begin saving for retirement. To get started, his plan is to open a brokerage account, and to put $1,000 into the account today. Craig intends to deposit $X into the account each year on his subsequent birthdays until the age of 64. In other words, Craig plans to make 40 contributions of $X. The first contribution will be made one year from now on his 25th birthday, and the 40th (and final) contribution will occur on his 64th birthday. Craig plans to retire at age 65 and he expects to live until age 85. Once he retires, Craig estimates that he will need to withdraw $100,000 from the account each year on his birthday in order to meet his expenses. (That is, Craig plans to make 20 withdrawals of $100,000 each--the first withdrawal will occur on his 65th birthday and the final one will occur on his 84th birthday.) Craig expects to earn 9 percent a year in his brokerage account. Given his plans, how much does he need to deposit into the account for each of the next 40 years, in order to reach his goal? (That is, what is $X?)

·        $2,608.73

 

72. Today is Janet's 23rd birthday. Starting today, Janet plans to begin saving for her retirement. Her plan is to contribute $1,000 to a brokerage account each year on her birthday. Her first contribution will take place today. Her 42nd and final contribution will take place on her 64th birthday. Her aunt has decided to help Janet with her savings, which is why she gave Janet $10,000 today as a birthday present to help get her account started. Assume that the account has an expected annual return of 10 percent. How much will Janet expect to have in her account on her 65th birthday?

·        $1,139,037.68

 

73. Today is your 20th birthday. Your parents just gave you $5,000 that you plan to use to open a stock brokerage account. Your plan is to add $500 to the account each year on your birthday. Your first $500 contribution will come one year from now on your 21st birthday. Your 45th and final $500 contribution will occur on your 65th birthday. You plan to withdraw $5,000 from the account five years from now on your 25th birthday to take a trip to Europe. You also anticipate that you will need to withdraw $10,000 from the account 10 years from now on your 30th birthday to take a trip to Asia. You expect that the account will have an average annual return of 12 percent. How much money do you anticipate that you will have in the account on your 65th birthday, following your final contribution?

·        $505,803

 

74. Today is your 21st birthday, and you are opening up an investment account. Your plan is to contribute $2,000 per year on your birthday and the first contribution will be made today. Your 45th, and final, contribution will be made on your 65th birthday. If you earn 10 percent a year on your investments, how much money will you have in the account on your 65th birthday, immediately after making your final contribution?

·        $1,437,809.67

 

75. Today is your 23rd birthday. Your aunt just gave you $1,000. You have used the money to open up a brokerage account. Your plan is to contribute an additional $2,000 to the account each year on your birthday, up through and including your 65th birthday, starting next year. The account has an annual expected return of 12 percent. How much do you expect to have in the account right after you make the final $2,000 contribution on your 65th birthday?

·        $2,045,442

 

76. Today is your 25th birthday. Your goal is to have $2 million by the time you retire at age 65. So far you have nothing saved, but you plan on making the first contribution to your retirement account today. You plan on making three other contributions to the account, one at age 30, age 35, and age 40. Since you expect that your income will increase rapidly over the next several years, the amount that you contribute at age 30 will be double what you contribute today, the amount at age 35 will be three times what you contribute today, and the amount at age 40 will be four times what you contribute today. Assume that your investments will produce an average annual return of 10 percent. Given your goal and plan, what is the minimum amount you need to contribute to your account today?

·        $10,145

 

77. Today is Rachel's 30th birthday. Five years ago, Rachel opened a brokerage account when her grandmother gave her $25,000 for her 25th birthday. Rachel added $2,000 to this account on her 26th birthday, $3,000 on her 27th birthday, $4,000 on her 28th birthday, and $5,000 on her 29th birthday. Rachel's goal is to have $400,000 in the account by her 40th birthday.

Starting today, she plans to contribute a fixed amount to the account each year on her birthday. She will make 11 contributions, the first one will occur today, and the final contribution will occur on her 40th birthday. Complicating things somewhat is the fact that Rachel plans to withdraw $20,000 from the account on her 35th birthday to finance the down payment on a home. How large does each of these 11 contributions have to be for Rachel to reach her goal? Assume that the account has earned (and will continue to earn) an effective return of 12 percent a year.

·        $11,743.95

 

78. Today you opened up a local bank account. Your plan is make five $1,000 contributions to this account. The first $1,000 contribution will occur today and then every six months you will contribute another $1,000 to the account. (So your final $1,000 contribution will be made two years from today). The bank account pays a 6 percent nominal annual interest, and interest is compounded monthly. After two years, you plan to leave the money in the account earning interest, but you will not make any further contributions to the account. How much will you have in the account 8 years from today?

·        $7,609

V

Victoria
Victoria and David have a 30-year, $75,000 mortgage with an 8 percent nominal annual interest rate. All payments are due at the end of the month.

 

79. Refer to Victoria. If Victoria and David were able to refinance their mortgage and replace it with a 7 percent nominal annual interest rate, how much (in dollars) would their monthly payment decline?

·        $  51.35

W

80. What is the future value of a 5-year ordinary annuity with annual payments of $200, evaluated at a 15 percent interest rate?

·        $1,348.48

 

81. Which of the following bank accounts has the highest effective annual return?

·        An account that pays 10 percent nominal interest with daily com-pounding.

 

82. Which of the following investments has the highest effective annual rate (EAR)? (Assume that all CDs are of equal risk.)

·        A bank CD that pays 10 percent monthly.

 

83. What is the present value of a 5-year ordinary annuity with annual payments of $200, evaluated at a 15 percent interest rate?

·        $   670.43

 

84. Which of the following investments will have the highest future value at the end of 5 years? Assume that the effective annual rate for all investments is the same.

·        E pays $100 at the beginning of every year for the next 5 years (a total of 5 payments).

 

85. Which of the following investments would provide an investor the highest effective annual rate of return?

·        An investment that has a 9 percent nominal rate with quarterly compounding.

 

86. Which of the following is most correct?

·        All of the statements above are correct.

                                 Wrong ans. i.     If there is annual compounding, then the effective, periodic, and nominal rates of interest are all the same.

                                Wrong ans. ii.     If a loan has a nominal rate of 10 percent, then the effective rate can never be less than 10 percent.

                              Wrong ans. iii.     If an investment pays 10 percent interest compounded annually, its effective rate will also be 10 percent.

                               Wrong ans. iv.     compounded annually, its effective rate will also be 10 percent.

·        Statements a and b are correct.

                                 Wrong ans. i.     The nominal interest rate will always be greater than or equal to the effective annual interest rate.

·        The proportion of the payment of a fully amortized loan that goes toward interest declines over time.

 

87. Which of the following securities has the largest present value? Assume in all cases that the annual interest rate is 8 percent and that there are no taxes.

·        A preferred stock issue that pays an $800 annual dividend in perpetuity. (Assume that the first dividend is received one year from today.)

 

88. Which one of the following investments provides the highest effective rate of return?

·        An investment that has a 9.9 percent nominal rate and quarterly annual compounding.

Y

89. You are considering an investment in a 40-year security. The security will pay $25 a year at the end of each of the first three years. The security will then pay $30 a year at the end of each of the next 20 years. The nominal interest rate is assumed to be 8 percent, and the current price (present value) of the security is $360.39. Given this information, what is the equal annual payment to be received from Year 24 through Year 40 (for 17 years)?

·        $40

 

90. You are considering buying a new car. The sticker price is $15,000 and you have $2,000 to put toward a down payment. If you can negotiate a nominal annual interest rate of 10 percent and you wish to pay for the car over a 5-year period, what are your monthly car payments?

·        $276.21

 

91. You are contributing money to an investment account so that you can purchase a house in five years. You plan to contribute six payments of $3,000 a year. The first payment will be made today (t = 0) and the final payment will be made five years from now (t = 5). If you earn 11 percent in your investment account, how much money will you have in the account five years from now (at t = 5)?

·        $23,739

 

92. You are currently investing your money in a bank account that has a nominal annual rate of 7 percent, compounded monthly. How many years will it take for you to double your money?

·        9.93

 

93. You are given the following cash flows. $1 at yr. 1, $2,000 at yr. 2, $2,000 at yr. 3, $2,000 at yr. 4, $0 at yr. 5, and -$2,000 at yr. 6. What is the present value (t = 0) if the discount rate is 12 percent?

·        $3,277

 

94. You are given the following cash flows. What is the present value (t = 0) if the discount rate is 12 percent?

·        $3,277

 

95. You are interested in investing your money in a bank account. Which of the following banks provides you with the highest effective rate of interest?

·        Bank 4; 8 percent with daily (365-day) compounding.

 

96. You are interested in saving money for your first house. Your plan is to make regular deposits into a brokerage account that will earn 14 percent. Your first deposit of $5,000 will be made today. You also plan to make four additional deposits at the beginning of each of the next four years. Your plan is to increase your deposits by 10 percent a year. (That is, you plan to deposit $5,500 at t = 1, and $6,050 at t = 2, etc.) How much money will be in your account after five years?

·        $44,873.90

 

97. You are saving for the college education of your two children. One child will enter college in 5 years, while the other child will enter college in 7 years. College costs are currently $10,000 per year and are expected to grow at a rate of 5 percent per year. All college costs are paid at the beginning of the year. You assume that each child will be in college for four years.

You currently have $50,000 in your educational fund. Your plan is to contribute a fixed amount to the fund over each of the next 5 years. Your first contribution will come at the end of this year, and your final contribution will come at the date when you make the first tuition payment for your oldest child. You expect to invest your contributions into various investments, which are expected to earn 8 percent per year. How much should you contribute each year in order to meet the expected cost of your children's education?

·        $3,712

 

98. You are willing to pay $15,625 to purchase a perpetuity that will pay you and your heirs $1,250 each year, forever. If your required rate of return does not change, how much would you be willing to pay if this were a 20-year annual payment, ordinary annuity instead of a perpetuity?

·        $12,273

 

99. You deposited $1,000 in a savings account that pays 8 percent interest, compounded quarterly, planning to use it to finish your last year in college. Eighteen months later, you decide to go to the Rocky Mountains to become a ski instructor rather than continue in school, so you close out your account. How much money will you receive?

·        $1,126

 

100.         You have $2,000 invested in a bank account that pays a 4 percent nominal annual interest with daily compounding. How much money will you have in the account at the end of July (in 132 days)? (Assume there are 365 days in each year.)

·        $2,029.14

 

101.         You have $5,438 in an account that has been paying an annual rate of 10 percent, compounded continuously. If you deposited some funds 10 years ago, how much was your original deposit?

·        $2,000

 

102.         You have been offered an investment that pays $500 at the end of every 6 months for the next 3 years. The nominal interest rate is 12 percent; however, interest is compounded quarterly. What is the present value of the investment?

·        $2,451.73

 

103.         You have determined the profitability of a planned project by finding the present value of all the cash flows from that project. Which of the following would cause the project to look more appealing in terms of the present value of those cash flows?

·        The discount rate decreases.

 

104.         You have just bought a security that pays $500 every six months. The security lasts for 10 years. Another security of equal risk also has a maturity of 10 years, and pays 10 percent compounded monthly (that is, the nominal rate is 10 percent). What should be the price of the security that you just purchased?

·        $6,175.82

 

105.         You have just taken out a 10-year, $12,000 loan to purchase a new car. This loan is to be repaid in 120 equal end-of-month installments. If each of the monthly installments is $150, what is the effective annual interest rate on this car loan?

·        9.0438%

 

106.         You have the choice of placing your savings in an account paying 12.5 percent compounded annually, an account paying 12.0 percent compounded semiannually, or an account paying 11.5 percent compounded continuously. To maximize your return you would choose:

·        12.5% compounded annually

 

107.         You have the opportunity to buy a perpetuity that pays $1,000 annually. Your required rate of return on this investment is 15 percent. You should be essentially indifferent to buying or not buying the investment if it were offered at a price of

·        $6,666.67

 

108.         You just graduated, and you plan to work for 10 years and then to leave for the Australian "Outback" bush country. You figure you can save $1,000 a year for the first 5 years and $2,000 a year for the next 5 years. These savings cash flows will start one year from now. In addition, your family has just given you a $5,000 graduation gift. If you put the gift now, and your future savings when they start, into an account that pays 8 percent compounded annually, what will your financial "stake" be when you leave for Australia 10 years from now?

·        $31,148

 

109.         You just put $1,000 in a bank account that pays 6 percent nominal annual interest, compounded monthly. How much will you have in your account after 3 years?

·        $1,196.68

 

110.         You place $1,000 in an account that pays 7 percent interest compounded continuously. You plan to hold the account exactly three years. Simultaneously, in another account you deposit money that earns 8 percent compounded semiannually. If the accounts are to have the same amount at the end of the three years, how much of an initial deposit do you need to make now in the account that pays 8 percent interest compounded semiannually?

·        $   975.01

 

111.         You plan to invest $5,000 at the end of each of the next 10 years in an account that has a 9 percent nominal rate with interest compounded monthly. How much will be in your account at the end of the 10 years?

·        $  77,359

 

112.         You recently purchased a 20-year investment that pays you $100 at t = 1, $500 at t = 2, $750 at t = 3, and some fixed cash flow, X, at the end of each of the remaining 17 years. You purchased the investment for $5,544.87. Alternative investments of equal risk have a required return of 9 percent. What is the annual cash flow received at the end of each of the final 17 years, that is, what is X?

·        $675

 

113.         You recently received a letter from Cut-to-the-Chase National Bank that offers you a new credit card that has no annual fee. It states that the annual percentage rate (APR) is 18 percent on outstanding balances. What is the effective annual interest rate? (Hint: Remember these companies bill you monthly.)

·        19.56%

 

114.         Your bank account pays a nominal interest rate of 6 percent, but interest is compounded daily (on a 365-day basis). Your plan is to deposit $500 in the account today. You also plan to deposit $1,000 in the account at the end of each of the next three years. How much will you have in the account at the end of three years, after making your final deposit?

·        $3,788

 

115.         Your bank account pays an 8 percent nominal rate of interest. The interest is compounded quarterly. Which of the following statements is most correct?

·        The periodic rate of interest is 2 percent and the effective rate of interest is greater than 8 percent.

 

116.         Your employer has agreed to make 80 quarterly payments of $400 each into a trust account to fund your early retirement. The first payment will be made 3 months from now. At the end of 20 years (80 payments), you will be paid 10 equal annual payments, with the first payment to be made at the beginning of Year 21 (or the end of Year 20). The funds will be invested at a nominal rate of 8 percent, quarterly compounding, during both the accumulation and the distribution periods. How large will each of your 10 receipts be? (Hint: You must find the EAR and use it in one of your calculations.)

·        $10,789

 

117.         Your family recently obtained a 30-year (360-month) $100,000 fixed-rate mortgage. Which of the following statements is most correct? (Ignore all taxes and transactions costs.)

·        The proportion of the monthly payment that goes towards repayment of principal will be higher 10 years from now than it will be this year.

 

118.         Your father is 45 years old today. He plans to retire in 20 years. Currently, he has $50,000 in a brokerage account. He plans to make 20 additional contributions of $10,000 a year. The first of these contributions will occur one year from today. The 20th and final contribution will occur on his 65th birthday. Once he retires, your father plans to withdraw a fixed dollar amount from the account each year on his birthday. The first withdrawal will occur on his 66th birthday. His 20th and final withdrawal will occur on his 85th birthday. After age 85, your father expects you to take care of him. Your father also plans to leave you with no inheritance. Assume that the brokerage account has an annual expected return of 10 percent. How much will your father be able to withdraw from his account each year after he retires?

·        $106,785.48

 

119.         Your father, who is 60, plans to retire in 2 years, and he expects to live independently for 3 years. Suppose your father wants to have a real income of $40,000 in today's dollars in each year after he retires. His retirement income will start the day he retires, 2 years from today, and he will receive a total of 3 retirement payments.

Inflation is expected to be constant at 5 percent. Your father has $100,000 in savings now, and he can earn 8 percent on savings now and in the future. How much must he save each year, starting today, to meet his retirement goals?

·        $5,350

 

120.         Your lease calls for payments of $500 at the end of each month for the next 12 months. Now your landlord offers you a new 1-year lease that calls for zero rent for 3 months, then rental payments of $700 at the end of each month for the next 9 months. You keep your money in a bank time deposit that pays a nominal annual rate of 5 percent. By what amount would your net worth change if you accept the new lease? (Hint: Your return per month is 5%/12 = 0.4166667%.)

·        -$253.62

 

121.         Your subscription to Jogger's World Monthly is about to run out and you have the choice of renewing it by sending in the $10 a year regular rate or of getting a lifetime subscription to the magazine by paying $100. Your cost of capital is 7 percent. How many years would you have to live to make the lifetime subscription the better buy? Payments for the regular subscription are made at the beginning of each year. (Round up if necessary to obtain a whole number of years.)

·        15 years

FIN 350 MINI TEST 5 CHAPTER 4 & 7

12-Year Bond
A 12-year bond has an 8 percent annual coupon and a face value of $1,000. The bond has a yield to maturity of 7 percent.

 

1.      Refer to 12-Year Bond. If the yield to maturity remains at 7 percent, what will be the price of the bond three years from today?

·        $1,065.15

 

2.      Refer to 12-Year Bond. What is the price of the annual coupon bond today?

·        $1,079.43

 

3.      A 12-year bond pays an annual coupon of 8.5 percent. The bond has a yield to maturity of 9.5 percent and a par value of $1,000. What is the bond's current yield?

·        9.14%

 

4.      A 12-year bond has a 9 percent annual coupon, a yield to maturity of 8 percent, and a face value of $1,000. What is the price of the bond?

·        $1,075

A

5.      A company is planning to raise $1,000,000 to finance a new plant. Which of the following statements is most correct?

·        If debt is used to raise the million dollars, but $500,000 is raised as a first mortgage bond on the new plant and $500,000 as debentures, the interest rate on the first mortgage bonds would be lower than it would be if the entire $1 million were raised by selling first mortgage bonds.

 

6.      A 5-year corporate bond has an 8 percent yield. A 10-year corporate bond has a 9 percent yield. The two bonds have the same default risk premium and liquidity premium. The real risk-free rate, k*, is expected to remain constant at 3 percent. Inflation is expected to be 3 percent a year for the next five years. After five years, inflation is expected to be constant at some rate, X, which may or may not be 3 percent. The maturity risk premium equals 0.1%(t - 1), where t equals time until the bond's maturity. In other words, the maturity risk premium on the 5-year bond is 0.4 percent or 0.004. What is the market's expectation today of the average level of inflation for Years 6 through 10, that is, what is X?

·        4.0%

 

7.      A 6-year bond that pays 8 percent interest semiannually sells at par ($1,000). Another 6-year bond of equal risk pays 8 percent interest annually. Both bonds are noncallable and have face values of $1,000. What is the price of the bond that pays annual interest?

·        $992.64

 

8.      An 8 percent annual coupon, noncallable bond has 10 years until it matures and a yield to maturity of 9.1 percent. What should be the price of a 10-year noncallable bond of equal risk that pays an 8 percent semiannual coupon? Assume both bonds have a par value of $1,000.

·        $ 941.09

 

9.      A 10-year bond has a 10 percent annual coupon and a yield to maturity of 12 percent. The bond can be called in 5 years at a call price of $1,050 and the bond's face value is $1,000. Which of the following statements is most correct?

·        Statements a and c are correct.

 

10. A 10-year Treasury bond currently yields 7 percent. The real risk-free rate of interest, k*, is 3.1 percent. The maturity risk premium has been estimated to be 0.1%(t - 1), where t = the maturity of the bond. (For a 3-year bond the maturity risk premium is 0.2 percent or 0.002.) Inflation is expected to average 2.5 percent a year for each of the next five years. What is the expected average rate of inflation between years five and ten?

·        3.5%

 

11. A 10-year corporate bond has an annual coupon payment of 9 percent. The bond is currently selling at par ($1,000). Which of the following statements is most correct?

·        All of the statements above are correct.

 

12. A 10-year bond with a 9 percent annual coupon has a yield to maturity of 8 percent. Which of the following statements is most correct?

·        If the yield to maturity remains constant, the bond's price one year from now will be lower than its current price.

 

13. A 10-year bond with a 9 percent semiannual coupon is currently selling at par. A 10-year bond with a 9 percent annual coupon has the same risk, and therefore, the same effective annual return as the semiannual bond. If the annual coupon bond has a face value of $1,000, what will be its price?

·        $   987.12

 

14. A 10-year bond pays an annual coupon. The bond has a yield to maturity of 8 percent. The bond currently trades at a premium--its price is above the par value of $1,000. Which of the following statements is most correct?

·        If the yield to maturity remains at 8 percent, then the bond's price will decline over the next year.

 

15. A 12-year bond has an annual coupon rate of 9 percent. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7 percent. Which of the following statements is most correct?

·        If market interest rates remain unchanged, the bond's price one year from now will be lower than it is today.

 

16. A 12-year bond has an 8 percent semiannual coupon and a face value of $1,000. The bond pays a $40 coupon every six months. The bond has a nominal yield to maturity of 7 percent. What is the price of the bond?

·        $1,080.29

 

17. A 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is most correct?

·        The bond's yield to maturity is greater than its coupon rate.

 

18. A 15-year bond with an 8 percent annual coupon has a face value of $1,000. The bond's yield to maturity is 7 percent. What is the bond's current yield?

·        -7.33%

 

19. A 15-year bond with a 10 percent semiannual coupon and a $1,000 face value has a nominal yield to maturity of 7.5 percent. The bond, which may be called after five years, has a nominal yield to call of 5.54 percent. What is the bond's call price?

·        $1,040

 

20. A $1,000 par value bond pays interest of $35 each quarter and will mature in 10 years. If your nominal annual required rate of return is 12 percent with quarterly compounding, how much should you be willing to pay for this bond?

·        $1,115.57

 

21. A bond that matures in 12 years has a 9 percent semiannual coupon (i.e., the bond pays a $45 coupon every six months) and a face value of $1,000. The bond has a nominal yield to maturity of 8 percent. What is the price of the bond today?

·        $1,076.23

 

22. A bond with a $1,000 face value and an 8 percent annual coupon pays interest semiannually. The bond will mature in 15 years. The nominal yield to maturity is 11 percent. What is the price of the bond today?

·        $   781.99

 

23. A bond with 10 years to maturity has a face value of $1,000. The bond pays an 8 percent semiannual coupon, and the bond has a 9 percent nominal yield to maturity. What is the price of the bond today?

·        $934.96

 

24. A bond with a face value of $1,000 matures in 10 years. The bond has an 8 percent annual coupon and a yield to maturity of 10 percent. If market interest rates remain at 10 percent, what will be the price of the bond two years from today?

·        $   893.30

 

25. A fixed-income analyst has made the following assessments:

Ø      The real risk-free rate is expected to remain at 2.5 percent for the next 10 years.

Ø      Inflation is expected to be 3 percent this year, 4 percent next year, and 5 percent a year thereafter.

Ø      The maturity risk premium is 0.1%(t - 1), where t = the maturity of the bond (in years).

A 5-year corporate bond currently yields 8.5 percent. What will be the yield on the bond, one year from now, if the above assessments are correct, and the bond's default premium and liquidity premium remain unchanged?

·        8.75%

 

26. A Treasury bond has an 8 percent annual coupon and a yield to maturity equal to 7.5 percent. Which of the following statements is most correct?

·        Statements b and c are correct

 

27. All of the following may serve to reduce the coupon rate that would otherwise be required on a bond issued at par, except a

·        Call provision

 

28. All treasury securities have a yield to maturity of 7 percent--so the yield curve is flat. If the yield to maturity on all Treasuries were to decline to 6 percent, which of the following bonds would have the largest percentage increase in price?

·        15-year zero coupon Treasury bond.

 

29. An investor is considering buying one of two bonds issued by Carson City Airlines. Bond A has a 7 percent annual coupon, whereas Bond B has a 9 percent annual coupon. Both bonds have 10 years to maturity, face values of $1,000, and yields to maturity of 8 percent. Assume that the yield to maturity for both of the bonds will remain constant over the next 10 years. Which of the following statements is most correct?

·        One year from now, Bond A's price will be higher than it is today

 

30. Assume interest rates on long-term government and corporate bonds were as follows:

T-bond = 7.72%        A = 9.64%            AAA = 8.72%            BBB = 10.18%

The differences in rates among these issues were caused primarily by

·        Default risk differences.

 

31. Assume that a 3-year Treasury note has no maturity risk premium, and that the real risk-free rate of interest is 3 percent. If the T-note carries a yield to maturity of 13 percent, and if the expected average inflation rate over the next 2 years is 11 percent, what is the implied expected inflation rate during Year 3?

·        8%

 

32. Assume that a 10-year Treasury bond has a 12 percent annual coupon, while a 15-year Treasury bond has an 8 percent annual coupon. The yield curve is flat; all Treasury securities have a 10 percent yield to maturity. Which of the following statements is most correct?

·        If interest rates decline, the price of both bonds will increase, but the 15-year bond will have a larger percentage increase in price.

 

33. Assume that a 15-year, $1,000 face value bond pays interest of $37.50 every 3 months. If you require a nominal annual rate of return of 12 percent, with quarterly compounding, how much should you be willing to pay for this bond? (Hint: The PVIFA and PVIF for 3 percent, 60 periods are 27.6756 and 0.1697, respectively.)

·        $1,207.57

 

34. Assume that all interest rates in the economy decline from 10 percent to 9 percent. Which of the following bonds will have the largest percentage increase in price?

·        A 10-year zero coupon bond.

 

35. Assume that k* = 2.0%; the maturity risk premium is found as MRP = 0.1%(t - 1), where t = years to maturity; the default risk premium for corporate bonds is found as DRP = 0.05%(t - 1); the liquidity premium is 1 percent for corporate bonds only; and inflation is expected to be 3 percent, 4 percent, and 5 percent during the next three years and then 6 percent thereafter. What is the difference in interest rates between 10-year corporate and Treasury bonds?

·        1.45%

 

36. Assume that McDonald's and Burger King have similar $1,000 par value bond issues outstanding. The bonds are equally risky. The Burger King bond has an annual coupon rate of 8 percent and matures 20 years from today. The McDonald's bond has a coupon rate of 8 percent, with interest paid semiannually, and it also matures in 20 years. If the nominal required rate of return, kd, is 12 percent, semiannual basis, for both bonds, what is the difference in current market prices of the two bonds?

·        $17.53

 

37. Assume that today is January 1, 2003. A 5-year corporate bond maturing on January 1, 2008, has a yield to maturity of 7.5 percent. A 10-year corporate bond maturing on January 1, 2013, with the same liquidity and default risk premiums as the 5-year corporate bond has a yield to maturity of 8.2 percent. The annual real risk-free rate of interest, k*, is expected to remain constant at 2 percent. The maturity risk premium equals 0.1%(t - 1), where t = the bond's maturity in years. (For example, the maturity risk premium on a 5-year bond is 0.4 percent or 0.004.) Inflation is expected to average 2 percent per year for the next five years. What is the average annual expected inflation between January 2008 and January 2013?

·        2.4%

 

38. Assume that the City of Tampa sold an issue of $1,000 maturity value, tax exempt (muni), zero coupon bonds 5 years ago. The bonds had a 25-year maturity when they were issued, and the interest rate built into the issue was a nominal 10 percent, but with semiannual compounding. The bonds are now callable at a premium of 10 percent over the accrued value. What effective annual rate of return would an investor who bought the bonds when they were issued and who still owns them earn if they were called today?

·        12.37%

 

39. Assume that the State of Florida sold tax-exempt, zero coupon bonds with a $1,000 maturity value 5 years ago. The bonds had a 25-year maturity when they were issued, and the interest rate built into the issue was a nominal 8 percent, compounded semiannually. The bonds are now callable at a premium of 4 percent over the accrued value. What effective annual rate of return would an investor who bought the bonds when they were issued and who still owns them earn if they were called today?

·        9.01%

 

40. Assume that you are considering the purchase of a $1,000 par value bond that pays interest of $70 each six months and has 10 years to go before it matures. If you buy this bond, you expect to hold it for 5 years and then to sell it in the market. You (and other investors) currently require a nominal annual rate of 16 percent, but you expect the market to require a nominal rate of only 12 percent when you sell the bond due to a general decline in interest rates. How much should you be willing to pay for this bond?

·        $   966.99

 

41. Assume that you wish to purchase a 20-year bond that has a maturity value of $1,000 and makes semiannual interest payments of $40. If you require a 10 percent nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?

·        $828

B

Bond Matures
A bond that matures in 10 years sells for $925. The bond has a face value of $1,000 and an 8 percent annual coupon.

 

42. Refer to Bond Matures. Assume that the yield to maturity remains constant for the next three years. What will be the price of the bond three years from today?

·        $   941

 

43. Refer to Bond Matures. What is the bond's current yield?

·        8.65%

 

44. Bonds A, B, and C all have a maturity of 10 years and a yield to maturity equal to 7 percent. Bond A's price exceeds its par value, Bond B's price equals its par value, and Bond C's price is less than its par value. Which of the following statements is most correct?

·        If the yield to maturity on each bond increases to 8 percent, the price of all three bonds will decline.

 

45. Bond X has an 8 percent annual coupon, Bond Y has a 10 percent annual coupon, and Bond Z has a 12 percent annual coupon. Each of the bonds has a maturity of 10 years and a yield to maturity of 10 percent. Which of the following statements is most correct?

·        If market interest rates remain at 10 percent, Bond Z's price will be lower one year from now than it is today.

C

46. Chapter 7 of the Bankruptcy Act is designed to do which of the following?

·        Statements a and c are correct.

 

47. Cold Boxes Ltd. has 100 bonds outstanding (maturity value = $1,000). The nominal required rate of return on these bonds is currently 10 percent, and interest is paid semiannually. The bonds mature in 5 years, and their current market value is $768 per bond. What is the annual coupon interest rate?

·        4%

 

48. Consider a $1,000 par value bond with a 7 percent annual coupon. The bond pays interest annually. There are 9 years remaining until maturity. What is the current yield on the bond assuming that the required return on the bond is 10 percent?

·        8.46%