Unit 2 Multiple Choice Questions (Enter your answers on the enclosed answer sheet)

 

1. What is the present value of an annuity of $120 received at the end of each year for 11 years? Assume a discount rate of 7%. The rst payment will be received one year from today (round to nearest $1).

 

a. $570 b. $250 c. $400 d. $900

 

1. You bought a racehorse that has had a winning streak for six years, bringing in $250,000 at the end of each year before dying of a heart attack. If you paid $1,155,720 for the horse 4 years ago, what was your annual return over this 4-year period?

 

a. 12% b. 8% c. 18% d. 33%

 

1. How much money do I need to place into a bank account that pays a 1.08% rate in order to have $500 at the end of 7 years?

 

a. $751.81 b. $463.78 c. $629.51 d. $332.54

 

1. Your daughter is born today and you want her to be a millionaire by the time she is 40 years old. You open an investment account that promises to pay 11.5% per year. How much money must you deposit today so your daughter will have $1,000,000 by her 35th birthday?

 

a. $20,100 b. $18,940 c. $28,575 d. $22,150

 

1. If you want to have $3,575 in 29 months, how much money must you put in a savings account today? Assume that the savings account pays 12% and it is compounded monthly (round to nearest $1).

 

a. $2,438 b. $2,679 c. $3,147 d. $3,008

 

Unit 2 Examination

 

BAM 313 Introduction to Financial Management

 

1. U.S. Savings Bonds are sold at a discount. The face value of the bond represents its value on its future maturity date. Therefore:
1. The current price of a $50 face value bond that matures in 10 years will be greater than the current price of a $50 face value bond that matures in 5 years.
2. The current prices of all $50 face value bonds will be the same, regardless of their maturity dates because they will all be worth $50 in the future.
3. The current price of a $50 face value bond will be higher if interest rates increase.
4. The current price of a $50 face value bond that matures in 10 years will be less than the

 

current price of a $50 face value bond that matures on 5 years.

 

1. Stock A has the following returns for various states of the economy:

 

State of the Economy

 

Recession Below Average Average
Above Average Boom

 

Probability Stock A’s Return 9% -72% 16% -15%

 

51% 16% 14% 35% 10% 85%

 

Unit 2 Examination

 

97

 

Stock A’s expected return is

 

a. 9.9%. b. 13.8% c. 12.7%. d. 16.5%.

 

8. Beginning with an investment in one company’s securities, as we add securities of other companies to our portfolio, which type of risk declines?

 

1. unsystematic risk
2. market risk
3. systematic risk
4. non-diversi able risk

 

BAM 313 Introduction to Financial Management

 

Unit 2 Examination

 

Project 1
Probability	Return	Standard Deviation	Beta
50% chance	22%	12%	1.1
50% chance	– 4%

 

 

 

Project 2
Probability	Return	Standard Deviation	Beta
30% chance	36%	19.5%	0.8
40% chance	10.5%
30% chance	– 20%

 

 

 

Project 3
Probability	Return	Standard Deviation	Beta
10% chance	28%	12%	2.0
70% chance	18%
20% chance	– 8%

 

98

 

1. Assume the risk-free rate of return is 2% and the market risk premium is 8%. If you are a risk averse investor, which project should you choose?
1. Project 3
2. Project 2
3. Project 1
4. Either Project 2 or Project 3 because the higher expected return on project 3 offsets its

 

higher risk.

 

1. Stock A has a beta of 1.2 and a standard deviation of returns of 14%. Stock B has a beta of 1.8 and a standard deviation of returns of 18%. If the risk-free rate of return increases and the market risk premium remains constant, then:
1. the required returns on stocks A and B will not change
2. the required returns on stocks A and B will both increase by the same amount
3. the required return on stock A will increase more than the required return on stock B
4. the required return on stock B will increase more than the required return on stock A

 

BAM 313 Introduction to Financial Management

 

99

 

1. Suppose interest rates have been at historically low levels the past two years. A reasonable strategy for bond investors during this time period would be to:
1. buy only junk bonds which have higher interest rates
2. invest in long-term bonds to reduce interest rate risk
3. invest in short-term bonds to reduce interest rate risk
4. invest in long-term bonds to lock in a bond position for when interest rates increase in the

 

future

 

1. Fred and Ethel are both considering buying a corporate bond with a coupon rate of 8%, a face value of $1,000, and a maturity date of January 1, 2025. Which of the following statements is MOST correct?
1. Fred and Ethel will only buy the bonds if the bonds are rated BBB or above.
2. Because both Fred and Ethel will receive the same cash ows if they each buy a bond,

 

they both must assign the same value to the bond.

 

1. If Fred decides to buy the bond, then Ethel will also decide to buy the bond if markets are

 

ef cient.

 

1. Fred may determine a different value for a bond than Ethel because each investor may

 

have a different level of risk aversion, and hence a different required return.

 

1. Which of the following statements is true?
1. Short-term bonds have greater interest rate risk than do long-term bonds.
2. Long-term bonds have greater interest rate risk than do short-term bonds.
3. Interest rate risk is highest during periods of high interest rates.
4. All bonds have equal interest rate risk.
2. Crandle’s common stock is currently selling for $79.00. It just paid a dividend of $4.60 and dividends are expected to grow at a rate of 5% inde nitely. What is the required rate of return on Crandle’s stock?

 

a. 11.76% b. 11.11% c. 12.2% d. 14.21%

 

1. An example of the growth factor in common stock is:
1. retaining pro ts in order to reinvest into the rm
2. two strong companies merging together to increase their economies of scale
3. acquiring a loan to fund an investment in Asia
4. issuing new stock to provide capital for future growth

 

Unit 2 Examination

 

BAM 313 Introduction to Financial Management

 

100

 

1. Waterfront Solutions, Inc. paid a dividend of $5.00 per share on its common stock yesterday. Dividends are expected to grow at a constant rate of 4% for the next two years, at which point the stock is expected to sell for $56.00. If investors require a rate of return on Waterfront’s common stock of 18%, what should the stock sell for today?

 

a. $40.22 b. $50.22 c. $44.76 d. $48.51

 

1. Andre’s parents established a college savings plan for him when he was born. They deposited $50 into the account on the last day of each month. The account has earned 10.9% compounded monthly, tax-free. How much can they withdraw on his 18th birthday to spend on his education?

 

a. $33,307 b. $30,028 c. $43,730 d. $27,560

 

1. Charlie wants to retire in 15 years, and he wants to have an annuity of $50,000 a year for
   20 years after retirement. Charlie wants to receive the rst annuity payment the day he retires. Using an interest rate of 8%, how much must Charlie invest today in order to have his retirement annuity (round to nearest $10).

 

a. $167,130 b. $315,240 c. $256,890 d. $200,450

 

An investor currently holds the following portfolio:

 

4,000 shares of Stock H 7,500 shares of Stock I 12,500 shares of Stock J

 

19. The beta for the portfolio is:

 

a. 1.45 b. 1.27 c. 1.99 d. 1.77

 

Amount
Invested
$8,000 Beta = 1.3 $24,000 Beta = 1.8 $48,000 Beta = 2.2

 

Unit 2 Examination

 

BAM 313 Introduction to Financial Management

 

101

 

1. Which of the following will cause the value of a bond to increase, if other things held the same?
1. interest rates decrease
2. the company’s debt rating drops from AAA to BBB
3. investors’ required rate of return increases
4. the bond is callable
2. A small biotechnology research corporation has been experiencing losses for the rst three years of its existence, and thus has a negative balance in retained earnings. The corporation’s stock price, however, is $1 per share. Which of the following statements is MOST correct?
1. The required return on the stock will be small because the company has very few assets.
2. Investors believe the stock is worth $1 per share because future earnings (and cash ows)

 

are expected to be positive.

 

1. The corporation’s accountants must have made a mistake because retained earnings may

 

not be negative.

 

1. Investors are irrational to pay $1 per share when earnings per share have been negative for

 

three years.

 

1. How much money must be put into a bank account yielding 6.42% (compounded annually) in order to have $1,671 at the end of 11 years? (round to nearest $1)

 

a. $798 b. $886 c. $921 d. $843

 

1. Wendy purchased 800 shares of Robotics Stock at $3 per share on 1/1/09. Wendy sold the shares on 12/31/09 for $3.45. Genetics stock has a beta of 1.3, the risk-free rate of return is 3%, and the market risk premium is 8%. The required return on Genetics Stock is:

 

a. 21.1% b. 13.4% c. 16.5% d. 17.6%

 

Unit 2 Examination

 

BAM 313 Introduction to Financial Management

 

102

 

1. Bart’s Moving Company bonds have a 11% coupon rate. Interest is paid semiannually. The bonds have a par value of $1,000 and will mature 8 years from now. Compute the value of Bart’s Moving Company bonds if investors’ required rate of return is 9.5%.

 

a. $1,133.05 b. $1,098.99 c. $1,082.75 d. $1,197.27

 

1. Jackson Corp. common stock paid $2.50 in dividends last year (D0). Dividends are expected to grow at a 12-percent annual rate forever. If Jackson’s current market price is $40.00, what is the stock’s expected rate of return? (nearest .01 percent)

 

a. 18.25% b. 5.50% c. 11.00% d. 19.00%

 

Unit 3: Multiple Choice Questions (Enter your answers on the enclosed answer sheet)

 

1. The DEF Company is planning a $64 million expansion. The expansion is to be nanced by selling $25.6 million in new debt and $38.4 million in new common stock. The before-tax required rate of return on debt is 9 percent and the required rate of return on equity is 14 percent. If the company is in the 35 percent tax bracket, what is the rm’s cost of capital?

 

a. 8.92% b. 10.74% c. 11.50% d. 9.89%

 

Valley Flights, Inc. has a capital structure made up of 40% debt and 60% equity and a tax rate of 30%. A new issue of $1,000 par bonds maturing in 20 years can be issued with a coupon of 9% at a price of $1,098.18 with no otation costs. The rm has no internal equity available for investment at this time, but can issue new common stock at a price of $45. The next expected dividend on the stock is $2.70. The dividend for the rm is expected to grow at constant annual rate of 5% per year inde nitely. Flotation costs on new equity will be $7.00 per share. The company has the following independent investment projects available:

 

Project

 

Initial Outlay IRR

 

1.       1  $100,000 10%

 

2.       2  $10,000 8.5%

 

3.       3  $50,000 12.5%

 

2.       Which of the above projects should the company take on?

 

1.       Project 3 only

 

2.       Projects 1, 2 and 3

 

3.       Projects 1 and 3

 

4.       Projects 1 and 2

 

3.       PrimaCare has a capital structure that consists of $7 million of debt, $2 million of preferred stock, and $11 million of common equity, based upon current market values. The rm’s yield to maturity on its bonds is 7.4%, and investors require an 8% return on the rm’s preferred stock and a 14% return on PrimaCare’s common stock. If the tax rate is 35%, what is PrimaCare’s WACC?

 

a. 7.21% b. 10.18% c. 12.25% d. 8.12%

 

Unit 3 Examination

 

BAM 313 Introduction to Financial Management

 

136

 

4.       JPR Company is nanced 75 percent by equity and 25 percent by debt. If the rm expects to earn $30 million in net income next year and retain 40% of it, how large can the capital budget be before common stock must be sold?

 

1.       $15.5 million

 

2.       $7.5 million

 

3.       $16.0 million

 

4.       $12.0 million

 

5.       All else equal, an increase in beta results in:

 

1.       an increase in the cost of retained earnings

 

2.       an increase in the cost of common equity, whether or not the funds come from retained

 

earnings or newly issued common stock

 

3.       an increase in the cost of newly issued common stock

 

4.       an increase in the after-tax cost of debt

 

6.       Haroldson Inc. common stock is selling for $22 per share. The last dividend was $1.20, and dividends are expected to grow at a 6% annual rate. Flotation costs on new stock sales are 5% of the selling price. What is the cost of Haroldson’s retained earnings?

 

a. 12.09% b. 11.78% c. 11.45% d. 5.73%

 

7.       A company has preferred stock that can be sold for $21 per share. The preferred stock pays an annual dividend of 3.5% based on a par value of $100. Flotation costs associated with the sale of preferred stock equal $1.25 per share. The company’s marginal tax rate is 35%. Therefore, the cost of preferred stock is:

 

a. 14.26% b. 12.94% c. 18.87% d. 17.72%

 

8.       Which of the following should NOT be considered when calculating a rm’s WACC?

 

1.       after-tax YTM on a rm’s bonds

 

2.       cost of newly issued preferred stock

 

3.       after-tax cost of accounts payable

 

4.       cost of newly issued common stock

 

Unit 3 Examination

 

BAM 313 Introduction to Financial Management

 

137

 

9.       Your rm is considering an investment that will cost $920,000 today. The investment will produce cash ows of $450,000 in year 1, $270,000 in years 2 through 4, and $200,000 in year 5. The discount rate that your rm uses for projects of this type is 11.25%. What is the investment’s pro tability index?

 

a. 1.26 b. 1.69 c. 1.21 d. 1.43

 

10.    Your rm is considering investing in one of two mutually exclusive projects. Project A requires an initial outlay of $3,500 with expected future cash ows of $2,000 per year for the next three years. Project B requires an initial outlay of $2,500 with expected future cash ows of $1,500 per year for the next two years. The appropriate discount rate for your rm is 12% and it is not subject to capital rationing. Assuming both projects can be replaced with a similar investment at the end of their respective lives, compute the NPV of the two chain cycle for Project A and three chain cycle for Project B.

 

1.       $2,865 and $94

 

2.       $3,528 and $136

 

3.       $5,000 and $1,500

 

4.       $2,232 and $85

 

11.    The capital budgeting manager for XYZ Corporation, a very pro table high technology company, completed her analysis of Project A assuming 5-year depreciation. Her accountant reviews the analysis and changes the depreciation method to 3-year depreciation. This change will:

 

1.       increase the present value of the NCFs

 

2.       have no effect on the NCFs because depreciation is a non-cash expense

 

3.       only change the NCFs if the useful life of the depreciable asset is greater than 5 years

 

4.       decrease the present value of the NCFs

 

12.    Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.’s required rate of return for these projects is 10%. The modi ed internal rate of return for Project B is:

 

a. 18.52% b. 22.80% c. 19.75% d. 17.84%

 

Unit 3 Examination

 

BAM 313 Introduction to Financial Management

 

138

 

13.    A capital budgeting project has a net present value of $30,000 and a modi ed internal rate of return of 15%. The project’s required rate of return is 13%. The internal rate of return is:

 

1.       greater than $30,000

 

2.       greater than 15%

 

3.       between 13% and 15%

 

4.       less than 13%

 

14.    A new project is expected to generate $800,000 in revenues, $250,000 in cash operating expenses, and depreciation expense of $150,000 in each year of its 10-year life. The corporation’s tax rate is 35%. The project will require an increase in net working capital of $85,000 in year one and a decrease in net working capital of $75,000 in year ten. What is the free cash ow from the project in year one?

 

a. $410,000 b. $375,000 c. $380,000 d. $298,000

 

15.    A local restaurant owner is considering expanding into another rural area. The expansion project will be nanced through a line of credit with City Bank. The administrative costs of obtaining the line of credit are $500, and the interest payments are expected to be $1,000 per month. The new restaurant will occupy an existing building that can be rented for $2,500 per month. The incremental cash ows for the new restaurant include:

 

1.       $2,500 per month rent

 

2.       $500 administrative costs, $1,000 per month interest payments, $2,500 per month rent

 

3.       $1,000 per month interest payments, $2,500 per month rent

 

4.       $500 administrative costs, $2,500 per month rent

 

16.    Which of the following should be included in the initial outlay?

 

1.       increased investment in inventory and accounts receivable

 

2.       preexisting rm overhead reallocated to the new project

 

3.       rst year depreciation expense on any new equipment purchased

 

4.       taxable gain on the sale of old equipment being replaced

 

Unit 3 Examination

 

BAM 313 Introduction to Financial Management

 

139

 

17.    QRW Corp. needs to replace an old lathe with a new, more ef cient model. The old lathe was purchased for $50,000 nine years ago and has a current book value of $5,000. (The old machine is being depreciated on a straight-line basis over a ten-year useful life.) The new machine costs $100,000. It will cost the company $10,000 to get the new lathe to the factory and get it installed. The old machine will be sold as scrap metal for $2,000. The new machine is also being depreciated on a straight-line basis over ten years. Sales are expected to increase by $8,000 per year while operating expenses are expected to decrease by $12,000 per year. QRW’s marginal tax rate is 40%. Additional working capital of $3,000 is required to maintain the new machine and higher sales level. The new lathe is expected to be sold for $5,000 at the end of the project’s ten-year life. What is the incremental free cash ow during year 1 of the project?

 

1.       $11,400

 

2.       $15,200

 

3.       $12,800

 

4.       $14,400

 

18.    The cost of retained earnings is less than the cost of new common stock because:

 

1.       dividends are not tax deductible

 

2.       otation costs are incurred when new stock is issued

 

3.       accounting rules allow a deduction when using retained earnings

 

4.       marginal tax brackets increase

 

19.    Beauty Inc. plans to maintain its optimal capital structure of 40 percent debt, 10 percent preferred stock, and 50 percent common equity inde nitely. The required return on each component source of capital is as follows: debt–8 percent; preferred stock–12 percent; common equity–16 percent. Assuming a 40 percent marginal tax rate, what after-tax rate of return must the rm earn on its investments if the value of the rm is to remain unchanged?

 

1.       12.00 percent

 

2.       11.12 percent

 

3.       12.40 percent

 

4.       10.64 percent

 

20.    Your rm is considering an investment that will cost $920,000 today. The investment will produce cash ows of $450,000 in year 1, $270,000 in years 2 through 4, and $200,000 in year 5. The discount rate that your rm uses for projects of this type is 11.25%. What is the investment’s internal rate of return?

 

a. 15.98% b. 27.28% c. 20.53% d. 21.26%

 

Unit 3 Examination

 

BAM 313 Introduction to Financial Management

 

140

 

21.    The advantages of NPV are all of the following EXCEPT:

 

1.       it provides the amount by which positive NPV projects will increase the value of the rm

 

2.       it allows the comparison of bene ts and costs in a logical manner through the use of time

 

value of money principles

 

3.       it recognizes the timing of the bene ts resulting from the project

 

4.       it can be used as a rough screening device to eliminate those projects whose returns do

 

not materialize until later years

 

22.    Which of the following are included in the terminal cash ow?

 

1.       recapture of any working capital increase included in the initial outlay

 

2.       the expected salvage value of the asset

 

3.       any tax payments or receipts associated with the salvage value of the asset

 

4.       all of the above

 

23.    Which of the following differentiates the cost of retained earnings from the cost of newly issued common stock?

 

1.       the larger dividends paid to the new common stockholders

 

2.       the otation costs incurred when issuing new securities

 

3.       the cost of the pre-emptive rights held by existing shareholders

 

4.       the greater marginal tax rate faced by the now-larger rm

 

24.    Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.’s required rate of return for these projects is 10%. The pro tability index for Project B is:

 

a. 1.55 b. 1.39 c. 1.33 d. 1.48

 

25.    When terminating a project for capital budgeting purposes, the working capital outlay required

 

at the initiation of the project will:

 

1.       increase the cash ow because it is recaptured

 

2.       decrease the cash ow because it is an outlay

 

3.       not affect the cash ow

 

4.       decrease the cash ow because it is a historical cost

 

Unit 4:

 

Multiple Choice Questions (Enter your answers on the enclosed answer sheet)

 

1.       A high degree of variability in a rm’s earnings before interest and taxes refers to:

 

a. business risk
b. nancial leverage c. operating leverage d. nancial risk

 

2.       If a rm has no operating leverage and no nancial leverage, then a 10% increase in sales will have what effect on EPS?

 

1.       EPS will increase by 10%

 

2.       EPS will remain the same

 

3.       EPS will increase by less than 10%

 

4.       EPS will decrease by 10%

 

3.       According to the moderate view of capital costs and nancial leverage, as the use of debt nancing increases:

 

1.       the cost of capital continuously increases

 

2.       there is an optimal level of debt nancing

 

3.       the cost of capital remains constant

 

4.       the cost of capital continuously decreases

 

4.       The primary weakness of EBIT-EPS analysis is that:

 

1.       it double counts the cost of debt nancing

 

2.       it applies only to rms with large amounts of debt in their capital structure

 

3.       it may only be used by rms that are pro table this year

 

4.       it ignores the implicit cost of debt nancing

 

5.       Potential applications of the break-even model include:

 

1.       optimizing the cash-marketable securities position of a rm

 

2.       replacement for time-adjusted capital budgeting techniques

 

3.       pricing policy

 

4.       All of the above.

 

Unit 4 Examination

 

BAM 313 Introduction to Financial Management

 

191

 

6.       The Modigliani and Miller hypothesis does NOT work in the “real world” because:

 

1.       interest expense is tax deductible, providing an advantage to debt nancing

 

2.       higher levels of debt increase the likelihood of bankruptcy, and bankruptcy has real costs

 

for any corporation

 

3.       both a and b

 

4.       dividend payments are xed and tax deductible for the corporation

 

7.       A corporation with very high growth prospects and many positive NPV projects to fund may want to increase its dividend based on the:

 

1.       very low agency costs of the corporation

 

2.       information effect

 

3.       tax bias against capital gains

 

4.       residual dividend theory

 

8.       Which of the following strategies may be used to alter a rm’s capital structure toward a higher percentage of debt compared to equity?

 

1.       stock split

 

2.       stock repurchase

 

3.       stock dividend

 

4.       maintain a low dividend payout ratio

 

9.       AFB, Inc.’s dividend policy is to maintain a constant payout ratio. This year AFB, Inc. paid out a total of $2 million in dividends. Next year, AFB, Inc.’s sales and earnings per share are expected to increase. Dividend payments are expected to:

 

1.       increase above $2 million only if the company issues additional shares of common stock

 

2.       decrease below $2 million

 

3.       increase above $2 million

 

4.       remain at $2 million

 

10.    Which of the following is true?

 

1.       In industries with volatile earnings, the residual dividend policy results in the most consistent dividend stream.

 

2.       If the clientele effect is correct, rms should follow a constant dividend payout ratio policy.

 

3.       In general, the higher the number of positive NPV investment opportunities for a rm, the

 

lower the dividend payout ratio.

 

4.       According to the informational content of dividends, an increase in dividends is always a

 

positive signal.

 

Unit 4 Examination

 

BAM 313 Introduction to Financial Management

 

192

 

11.    Which of the following is always a non-cash expense?

 

1.       salaries

 

2.       depreciation

 

3.       income taxes

 

4.       None of the above.

 

12.    Which of the following is a limitation of the “percent of sales method” of preparing pro forma nancial statements?

 

1.       Inventory levels are seldom affected by changes in sales volume.

 

2.       A rm’s investment in accounts receivable is seldom related to sales volume.

 

3.       Not all assets and liabilities increase or decrease as a constant percent of sales.

 

4.       The dividend payout ratio may change from one year to the next.

 

13.    Spontaneous sources of funds refer to all of the below EXCEPT:

 

1.       accounts payable

 

2.       accruals

 

3.       common stock

 

4.       a bank loan

 

14.    Selection of a source of short-term nancing should include all of the following EXCEPT:

 

1.       the effect of the use of credit from a particular source on the cost and availability of other sources of credit

 

2.       the oatation costs for debentures

 

3.       the effective cost of credit

 

4.       the availability of nancing in the amount and for the time needed

 

15.    The terminal warehouse agreement differs from the eld warehouse agreement in that:

 

1.       the cost of the terminal warehouse agreement is lower due to the lower degree of risk

 

2.       the warehouse procedure differs for both agreements

 

3.       the terminal agreement transports the collateral to a public warehouse

 

4.       the borrower of the eld warehouse agreement can sell the collateral without the consent

 

of the lender

 

Unit 4 Examination

 

BAM 313 Introduction to Financial Management

 

193

 

16.    Your company buys supplies on credit terms of 2/10 net 45. Suppose the company makes a purchase of $20,000 today. Which of the following payment options makes the most sense as a general rule?

 

1.       pay the bill as soon as possible to keep the supplier happy

 

2.       pay the bill on day 10 to get the discount

 

3.       either pay the bill on day 10 to get the discount, or wait until day 45

 

4.       pay the bill on day 45 due to the time value of money

 

17.    Which of the following statements about nancial leverage is true?

 

1.       Financial leverage is the responsiveness of the rm’s EBIT to uctuations in sales.

 

2.       Financial leverage is the responsiveness of the rm’s EPS to uctuations in EBIT.

 

3.       Financial leverage involves the incurrence of xed operating costs in the rm’s income

 

stream.

 

4.       Financial leverage reduces a rm’s risk.

 

18.    Which of the following statements about combined (operating & nancial) leverage is true?

 

1.       Usage of both operating and nancial leverage reduces a rm’s risk.

 

2.       If a rm employs both operating and nancial leverage, any percent change in sales will

 

produce a larger percent change in earnings per share.

 

3.       High operating leverage and high nancial leverage offset one another, meaning that if

 

sales increase by 10%, then EPS will also increase by 10%.

 

4.       A rm that is in a capital-intensive industry should use a higher level of nancial leverage

 

than a rm that employs low levels of operating leverage.

 

19.    The “bird-in-the-hand dividend theory” supports which view of the effect of dividend policy on company value?

 

1.       constant dividends increase stock values

 

2.       high dividends increase stock values

 

3.       a rm’s dividend policy is irrelevant

 

4.       low dividends increase stock values

 

20.    All of the following will increase the discretionary nancing needed EXCEPT:

 

1.       decrease the dividend payout ratio

 

2.       decrease the spontaneous nancing

 

3.       decrease the sales growth rate

 

4.       decrease the net pro t margin

 

Unit 4 Examination

 

BAM 313 Introduction to Financial Management

 

194

 

21.    If a rm relies on short-term debt or current liabilities in nancing its asset investments, and all other things remain the same, what can be said about the rm’s liquidity?

 

1.       The liquidity of the rm will be unchanged.

 

2.       The rm will be relatively more liquid.

 

3.       The rm will be relatively less liquid.

 

4.       The rm will be more liquid only if interest rates are below the company’s weighted

 

average cost of capital.

 

22.    Dakota Oil, Inc. reported that its sales and EBIT increased by 10%, but its EPS increased by 30%. The much larger change in earnings per share could be the result of:

 

1.       high operating leverage

 

2.       high nancial leverage

 

3.       high xed costs of production

 

4.       a high percentage of credit sale collections from prior years

 

23.    Which of the following statements would be consistent with the bird-in-the-hand dividend theory?

 

1.       Dividends are less certain than capital gains.

 

2.       Investors are indifferent whether stock returns come from dividend income or capital gains

 

income.

 

3.       Wealthy investors prefer corporations to defer dividend payments because capital gains

 

produce greater after-tax income.

 

4.       Dividends are more certain than capital gains income.

 

24.    The term “lumpy asset” means:

 

1.       assets that have economies of scale but not economies of scope

 

2.       assets that must be purchased in discrete quantities

 

3.       the same thing as assets that exhibit scale economies

 

4.       assets that can be purchased in incremental units

 

25.    All of the following are potential advantages of commercial paper EXCEPT:

 

1.       ability to borrow very large amounts

 

2.       exible repayment terms

 

3.       no compensating balance requirements

 

4.       lower interest rates than comparable sources of short-term nancing