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Exam2 FIN470 Spring 2009 Key 1. Glassparts, Inc. uses machines to manufacture windshields for automobiles. One machine costs $142,000 and lasts about 5 years before it needs replaced. The operating cost per machine is $7,000 a year. What is the equivalent annual cost of one machine if the required rate of return is 11 percent? (Round your answer to whole dollars) a. $33,574 b. $35,400 c. $30,811 D. $45,421 e. $37,267 AACSB TOPIC: ANALYTIC Ross - Chapter 010 #79 SECTION: 10.6 TOPIC: EQUIVALENT ANNUAL COST TYPE: PROBLEMS 2. If a stock portfolio is well diversified, then the portfolio variance: A. may be less than the variance of the least risky stock in the portfolio. b. will be an arithmetic average of the variance of the individual securities in the portfolio. c. will be a weighted average of the variances of the individual securities in the portfolio. d. must be equal to or greater than the variance of the least risky stock in the portfolio. e. will equal the variance of the most volatile stock in the portfolio. Ross - Chapter 013 #20 SECTION: 13.2 TOPIC: PORTFOLIO VARIANCE TYPE: CONCEPTS 3. A business entity which taxes it owners like partners while providing those owners with limited liability is called a: a. general partnership. B. limited liability company. c. corporation. d. sole proprietorship. e. limited proprietorship. Ross - Chapter 001 #13 SECTION: 1.2 TOPIC: LIMITED LIABILITY COMPANY TYPE: DEFINITIONS 4. Tracie deposits $5,000 into an account that pays 3 percent interest compounded annually. Chris deposits $5,000 into an account that pays 3 percent simple interest. Both deposits were made this morning. Which of the following statements are true concerning these two accounts? I. At the end of one year, both Tracie and Chris will have the same amount in their accounts. II. At the end of five years, Tracie will have more money in her account than Chris has in his. III. Chris will never earn any interest on interest. IV. All else equal, Chris made the better investment. a. I and II only b. III and IV only C. I, II, and III only d. II, III, and IV only e. I, III, and IV only Ross - Chapter 005 #13 SECTION: 5.1 TOPIC: SIMPLE VERSUS COMPOUND INTEREST TYPE: CONCEPTS 5. A project has a contribution margin of $6, projected fixed costs of $14,000, projected variable cost per unit of $14, and a projected financial break-even point of 6,000 units. What is the operating cash flow at this level of output? a. $34,000 b. $46,000 c. $62,000 D. $22,000 e. $70,000 Operating cash flow at the financial break-even point = (6,000 $6) $14,000 = $22,000 AACSB TOPIC: ANALYTIC Ross - Chapter 011 #81 SECTION: 11.4 TOPIC: FINANCIAL BREAK-EVEN TYPE: PROBLEMS 6. The number of shares of stock received for each bond that is converted is called the: a. conversion price. b. straight bond value. c. conversion value. d. conversion premium. E. conversion ratio. Ross - Chapter 014 #19 SECTION: 14.7 TOPIC: CONVERSION RATIO TYPE: DEFINITIONS 7. As the discount rate increases, the present value of $2,000 to be received four years from now: a. will vary but the direction of the change is unknown. b. also increases. c. becomes negative. d. remains constant. E. decreases. Ross - Chapter 005 #11 SECTION: 5.2 TOPIC: PRESENT VALUE AND DISCOUNT RATE TYPE: CONCEPTS 8. The Smith Co., which is currently operating at full capacity, has sales of $3,000, current assets of $800, current liabilities of $400, net fixed assets of $1,900, and a 6 percent profit margin. The firm has no long-term debt and does not plan on acquiring any. The firm does not pay any dividends. Sales are expected to increase by 9 percent next year. If all assets, liabilities, and costs vary directly with sales, how much additional equity financing is required for next year? a. $207.00 B. $10.80 c. $40.00 d. $196.20 e. $103.50 Projected assets = ($800 + $1,900) 1.09 = $2,943 Projected liabilities = $400 1.09 = $436 Current equity = $800 + $1,900 $400 = $2,300 Projected increase in retained earnings = $3,000 .06 1.09 = $196.20 Equity funding need = $2,943 $436 $2,300 $196.20 = $10.80 AACSB TOPIC: ANALYTIC Ross - Chapter 004 #45 SECTION: 4.2 TOPIC: PRO FORMA STATEMENTS TYPE: PROBLEMS 9. Swenson & Swenson just decided to save $2,200 a month for the next 6 years as a safety net for recessionary periods. The money will be set aside in a separate savings account which pays 5.5 percent interest compounded monthly. They deposit the first $2,200 today. If the company had wanted to deposit an equivalent lump sum today, how much would they have had to deposit? a. $138,001.14 b. $137,778.92 c. $134,656.34 d. $130,297.18 E. $135,273.51 AACSB TOPIC: ANALYTIC Ross - Chapter 006 #30 SECTION: 6.2 TOPIC: ANNUITY DUE AND PRESENT VALUE TYPE: PROBLEMS 10. Risk that affects a large number of assets is called _____ risk. a. asset-specific B. systematic c. idiosyncratic d. diversifiable e. total Ross - Chapter 013 #4 SECTION: 13.4 TOPIC: SYSTEMATIC RISK TYPE: DEFINITIONS 11. What is the cost of three August 35 call option contracts on BeTa stock given the following price quotes? a. $6.80 b. $1,230 c. $2,040 d. $0.60 E. $60.00 Cost = 3 100 $.20 = $60 AACSB TOPIC: ANALYTIC Ross - Chapter 014 #57 SECTION: 14.1 TOPIC: OPTION QUOTES TYPE: PROBLEMS 12. The Furniture Makers purchased some fixed assets three years ago for $52,000. The assets are classified as 5-year property for MACRS. The company is considering selling these assets now so they can buy some newer fixed assets which utilize the latest in technology. The company has been offered $15,500 for these old assets. What is the net cash flow from the salvage value if the tax rate is 34 percent? a. $15,500.00 b. $14,976.00 c. $12,283.60 d. $15,678.16 E. $15,321.84 Book value at the end of year 3 = $52,000 (1 .2 .32 Tax on sale = ($15,500 $14,976) .34 = $178.16 After-tax cash flow = $15,500 $178.16 = $15,321.84 .192) = $14,976 AACSB TOPIC: ANALYTIC Ross - Chapter 010 #68 SECTION: 10.4 TOPIC: SALVAGE VALUE TYPE: PROBLEMS 13. An analysis of what happens to the estimate of net present value when only one variable is changed is called _____ analysis. a. scenario b. forecasting c. simulation d. break-even E. sensitivity Ross - Chapter 011 #3 SECTION: 11.2 TOPIC: SENSITIVITY ANALYSIS TYPE: DEFINITIONS 14. Which one of the following correctly describes the dividend yield? a. the increase in next year's dividend over this year's dividend divided by the current stock price b. this year's annual dividend divided by today's stock price C. next year's annual dividend divided by today's stock price d. this year's annual dividend divided by next year's expected stock price e. the annual dividend amount divided by the face value of the stock Ross - Chapter 012 #10 SECTION: 12.1 TOPIC: DIVIDEND YIELD TYPE: CONCEPTS 15. The principle of diversification tells us that: a. concentrating an investment in three companies all within the same industry will greatly reduce the systematic risk. B. spreading an investment across many diverse assets will eliminate some of the total risk. c. concentrating an investment in two or three large stocks will eliminate all of the unsystematic risk. d. spreading an investment across many diverse assets will eliminate all of the systematic risk. e. spreading an investment across five diverse companies will not lower the total risk. Ross - Chapter 013 #6 SECTION: 13.5 TOPIC: PRINCIPLE OF DIVERSIFICATION TYPE: DEFINITIONS 16. The Burger Joint paid $420 in dividends and $611 in interest expense. The addition to retained earnings is $397.74 and net new equity is $750. The tax rate is 34 percent. Sales are $6,250 and depreciation is $710. What are the earnings before interest and taxes? a. $1,780.82 b. $1,582.16 c. $1,660.00 d. $1,576.67 E. $1,850.00 Net income = $420 + $397.74 = $817.74; Taxable income = $817.74 interest and taxes = $1,239 + $611 = $1,850 (1 .34) = $1,239; Earnings before AACSB TOPIC: ANALYTIC Ross - Chapter 002 #59 SECTION: 2.4 TOPIC: EARNINGS BEFORE INTEREST AND TAXES TYPE: PROBLEMS 17. Which one of the following is a source of cash? a. a purchase of inventory B. an increase in accounts payable c. an increase in cash d. the payoff of a loan e. a credit sale to a customer Ross - Chapter 003 #37 SECTION: 3.1 TOPIC: SOURCES OF CASH TYPE: CONCEPTS 18. If a project has a net present value equal to zero, then: a. the project is expected to produce cash inflows in an amount equal to the initial cash outflow. b. the project produces a rate of return in excess of the required return. c. the present value of the cash inflows must exceed the initial cost of the project. d. the cash inflows equal the project's initial cost given a positive discount rate. E. any delay in receiving the projected cash inflows will cause the project to have a negative net present value. Ross - Chapter 009 #14 SECTION: 9.1 TOPIC: NET PRESENT VALUE TYPE: CONCEPTS Ross - Chapter 004 19. Creative Analysis, Inc. is currently operating at 70 percent of capacity. All costs and net working capital vary directly with sales. The tax rate, the profit margin, and the dividend payout ratio will remain constant. How much additional debt is required if no new equity is raised and sales are projected to increase by 10 percent? A. $54.90 b. $23.68 c. $3.80 d. $21.70 e. $14.10 Projected current assets = $5,000 1.1 = $5,500 Projected fixed assets = $2,200 Projected accounts payable = $2,075 1.1 = $2,282.50 Current long-term debt = $425 Current common stock = $3,000 Projected retained earnings = $1,700 + ($216 1.1) = $1,937.60 Additional debt required = $5,500 + $2,200 $2,282.50 $425 $3,000 $1,937.60 = $54.90 AACSB TOPIC: ANALYTIC Ross - Chapter 004 #63 SECTION: 4.4 TOPIC: EXTERNAL FINANCING NEEDED AT LESS THAN MAXIMUM CAPACITY TYPE: PROBLEMS 20. The average compound return earned per year over a multi-year period is called the _____ average return. a. arithmetic b. standard C. geometric d. variant e. real Ross - Chapter 012 #5 SECTION: 12.5 TOPIC: GEOMETRIC AVERAGE RETURN TYPE: DEFINITIONS The Quick Producers Co. is analyzing a proposed project. The company expects to sell 10,000 units, give or take 5 percent. The expected variable cost per unit is $6 and the expected fixed cost is $29,000. The fixed and variable cost estimates are considered accurate within a plus or minus 4 percent range. The depreciation expense is $25,000. The tax rate is 34 percent. The sale price is estimated at $13 a unit, give or take 6 percent. Ross - Chapter 011 21. What is the net income under the best case scenario? a. $5,440.00 b. $15,846.60 c. $10,665.80 d. $24,696.80 E. $20,704.20 Net income for best case = {[10,000 {1 .34} = $20,704.20 1.05] [($13 1.06) ($6 .96)] ($29,000 .96) $25,000} AACSB TOPIC: ANALYTIC Ross - Chapter 011 #65 SECTION: 11.2 TOPIC: SCENARIO ANALYSIS TYPE: PROBLEMS 22. The sustainable growth rate will be equivalent to the internal growth rate when: a. the dividend payout ratio is zero. b. the projected growth rate is equal to the internal growth rate. C. a firm has no debt. d. the plowback ratio is positive but less than one. e. a firm has a debt-equity ratio exactly equal to one. Ross - Chapter 004 #35 SECTION: 4.4 TOPIC: SUSTAINABLE GROWTH RATE TYPE: CONCEPTS 23. An efficient capital market defined as a market in which: a. investors earn a profit on a security equal to the current yield. b. investors earn a zero profit. c. trading is free for all participants. D. security prices reflect available information. e. taxes are irrelevant. Ross - Chapter 012 #7 SECTION: 12.6 TOPIC: EFFICIENT CAPITAL MARKET TYPE: DEFINITIONS 24. Huntington Manor would like to buy some additional land and build a new assisted living center. The anticipated total cost is $12.4 million. The CEO of the firm is quite conservative and will only do this when the company has sufficient funds to pay cash for the entire construction project. Management has decided to save $235,000 a month for this purpose. The firm earns 7 percent compounded monthly on the funds it saves. How long does the company have to wait before expanding its operations? a. 49.68 months b. 30.32 months C. 46.14 months d. 54.00 months e. 31.23 months AACSB TOPIC: ANALYTIC Ross - Chapter 006 #55 SECTION: 6.2 TOPIC: ORDINARY ANNUITY TIME PERIODS AND FUTURE VALUE TYPE: PROBLEMS 25. A call option is the _____ an asset at a fixed price during a stated period of time. a. right to sell b. obligation to sell c. obligation to trade D. right to buy e. obligation to buy Ross - Chapter 014 #7 SECTION: 14.1 TOPIC: CALL OPTION TYPE: DEFINITIONS 26. The most valuable investment given up if an alternative investment is chosen is a(n): A. opportunity cost. b. salvage value expense. c. erosion cost. d. net working capital expense. e. sunk cost. Ross - Chapter 010 #4 SECTION: 10.2 TOPIC: OPPORTUNITY COSTS TYPE: DEFINITIONS 27. The value of an option if it were about to expire is called the _____ value. a. strike b. time c. deadline d. upper E. intrinsic Ross - Chapter 014 #9 SECTION: 14.2 TOPIC: INTRINSIC VALUE TYPE: DEFINITIONS 28. A common-size statement is an accounting statement that expresses all of a firm's expenses as a percentage of: a. total assets. b. taxable income. C. sales. d. net income. e. total equity. Ross - Chapter 003 #3 SECTION: 3.2 TOPIC: COMMON-SIZE STATEMENTS TYPE: DEFINITIONS 29. You want your portfolio beta to be 1.10. Currently, your portfolio consists of $3,000 invested in stock A with a beta of 1.65 and $2,000 in stock B with a beta of .72. You have another $5,000 to invest and want to divide it between an asset with a beta of 1.48 and a risk-free asset. How much should you invest in the risk-free asset? a. $0 b. $3,115 c. $5,000 D. $1,885 e. $775 BetaPortfolio = 1.10 = ($3,000 / $10,000 1.65) + ($2,000 / $10,000 .72) + (x / $10,000 1.48) + (($5,000 x) / $10,000 0) = .495 + .144 + .000148x + 0; .461 = .000148x; x = $3,114.86; Risk-free asset = $5,000 $3,114.86 = $1,885.14 Ross - Chapter 013 #58 SECTION: 13.2 AND 13.6 TOPIC: ANALYZING A PORTFOLIO TYPE: PROBLEMS 30. The common stock of Trynor's, Inc. is currently priced at $37.90 a share. One year from now, the stock price is expected to be either $38 or $43 a share. The risk-free rate of return is 3.5 percent. What is the current value of one call option on this stock if the exercise price is $40? a. $0.64 B. $0.71 c. $0.82 d. $0.91 e. $0.77 Number of options needed = ($43 $38) (3 0) = 1.66667; $37.90 = (1.66667 $37.90 = 1.66667C0 + $36.71498; 1.66667C0 = 1.18502; C0 = $.71 C0) + [$38 (1 + .035)]; AACSB TOPIC: ANALYTIC Ross - Chapter 014 #76 SECTION: 14.3 TOPIC: CALL OPTION VALUE TYPE: PROBLEMS 31. Cellular Talk is a new firm in a rapidly growing industry. The company is planning on increasing its annual dividend by 25 percent a year for the next three years and then decreasing the growth rate to 6 percent per year. The company just paid its annual dividend in the amount of $0.80 per share. What is the current value of one share of this stock if the required rate of return is 17 percent? a. $11.17 b. $14.27 C. $12.14 d. $12.94 e. $15.06 AACSB TOPIC: ANALYTIC Ross - Chapter 008 #81 SECTION: 8.1 TOPIC: SUPERNORMAL GROWTH TYPE: PROBLEMS 32. An account managed by a bond trustee for early bond redemption payments is called a: a. deed in trust account. B. sinking fund. c. call provision account. d. collateral payment account. e. conversion fund. Ross - Chapter 007 #12 SECTION: 7.2 TOPIC: SINKING FUND TYPE: DEFINITIONS 33. You are trying to determine whether to accept project A or project B. These projects are mutually exclusive. As part of your analysis, you should compute the crossover point by determining the: a. internal rate of return for the cash flows of each project. b. discount rate that equates the discounted payback periods for each project. C. internal rate of return for the differences in the cash flows of the two projects. d. net present value of each project using the internal rate of return as the discount rate. e. discount rate that makes the net present value of each project equal to 1. Ross - Chapter 009 #37 SECTION: 9.5 TOPIC: CROSSOVER POINT TYPE: CONCEPTS 34. Last year, you purchased a stock at a price of $53.60 a share. Over the course of the year, you received $1.50 in dividends and inflation averaged 2.9 percent. Today, you sold your shares for $55.90 a share. What is your approximate real rate of return on this investment? a. 7.1 percent b. 7.9 percent c. 10.0 percent d. 8.6 percent E. 4.2 percent Nominal return = ($55.90 4.19 percent = 4.2 percent $53.60 + $1.50) / $53.60 = 7.09 percent; Real return = 7.09 percent 2.9 percent = AACSB TOPIC: ANALYTIC Ross - Chapter 012 #65 SECTION: 12.1 TOPIC: REAL RETURN TYPE: PROBLEMS 35. Which of the following are examples of erosion? I. the loss of current sales due to increased competition in the product market II. the loss of current sales because your chief competitor just opened a store across the street from your store III. the loss of current sales due to a new product which you recently introduced IV. the loss of current sales due to a new product recently introduced by your competitor a. II and IV only b. III and IV only C. III only d. I, II, III, and IV e. I, III, and IV only Ross - Chapter 010 #16 SECTION: 10.2 TOPIC: EROSION TYPE: CONCEPTS 36. The sales level that results in a project's net income exactly equaling zero is called the _____ break-even. a. operational b. financial c. leveraged d. cash E. accounting Ross - Chapter 011 #8 SECTION: 11.3 TOPIC: ACCOUNTING BREAK-EVEN TYPE: DEFINITIONS 37. Changes in the net working capital: a. are included in project analysis only if they represent cash outflows. b. only affect the initial cash flows of a project. c. affect the initial and the final cash flows of a project but not the cash flows of the middle years. d. are generally excluded from project analysis due to their irrelevance to the total project. E. can affect the cash flows of a project every year of the project's life. Ross - Chapter 010 #21 SECTION: 10.4 TOPIC: NET WORKING CAPITAL TYPE: CONCEPTS 38. What is the variance of a portfolio consisting of $5,500 in stock G and $4,500 in stock H? A. .000387 b. .000778 c. .019677 d. .001482 e. .038496 E(r)Boom = [$5,500 / ($5,500 + $4,500) .14)] + [$4,500 / ($5,500 + $4,500) .11) = .077 + .0495 = .1265 E(r)Normal = [$5,500 / ($5,500 + $4,500) .07)] + [$4,500 / ($5,500 + $4,500) .09) = .0385 + .0405 = .079 E(r)Portfolio = (.22 .1265) + (.78 .079) = .02783 + .06162 = .08945 VarPortfolio = [.22 (.1265 .08945)2] + [.78 (.079 .08945)2] = .000301995 + .000085178 = .000387173 = .000387 AACSB TOPIC: ANALYTIC Ross - Chapter 013 #76 SECTION: 13.2 TOPIC: PORTFOLIO VARIANCE TYPE: PROBLEMS 39. Milner's stock had annual returns of 11.4 percent, 2.6 percent, and 14.8 percent over the past three years. Which one of the following best describes the probability that this stock will produce a return of 25 percent or more next year? a. less than 2.5 percent b. less than 0.5 percent c. less than 5 percent D. less than 1.0 percent e. less than 0.1 percent Average return = (.114 + .026 + .148) / 3 = .096; Total squared deviation = (.114 .096)2 + (.026 .096)2 + (.148 .096)2 = .000324 + .0049 + .002704 = .007928; Standard deviation = (.007928) / (3 1) = .003964 = .0630 = 6.3 percent; Upper end of 95 percent probability range = 9.6 percent + (2)6.3 percent = 22.2 percent; Upper end of 99 percent probability range = 9.6 percent + (3)6.3 percent = 28.5 percent; Thus, a return of 25 percent or more has less than a 2.5 percent chance of occurring in any one year. AACSB TOPIC: ANALYTIC Ross - Chapter 012 #70 SECTION: 12.4 TOPIC: RETURN DISTRIBUTIONS TYPE: PROBLEMS 40. Operating leverage is the: a. percentage of the sales price which represents the contribution margin. b. dependence of a firm on variable costs. c. percentage of a sales price that is needed to cover variable costs. D. degree to which a firm relies on fixed costs. e. amount of debt used to finance a project. Ross - Chapter 011 #11 SECTION: 11.5 TOPIC: OPERATING LEVERAGE TYPE: DEFINITIONS Exam2 FIN470 Winter 2008 Summary Category AACSB TOPIC: ANALYTIC Ross - Chapter 001 Ross - Chapter 002 Ross - Chapter 003 Ross - Chapter 004 Ross - Chapter 005 Ross - Chapter 006 Ross - Chapter 007 Ross - Chapter 008 Ross - Chapter 009 Ross - Chapter 010 Ross - Chapter 011 Ross - Chapter 012 Ross - Chapter 013 Ross - Chapter 014 SECTION: 1.2 SECTION: 10.2 SECTION: 10.4 SECTION: 10.6 SECTION: 11.2 SECTION: 11.3 SECTION: 11.4 SECTION: 11.5 SECTION: 12.1 SECTION: 12.4 SECTION: 12.5 SECTION: 12.6 SECTION: 13.2 SECTION: 13.2 AND 13.6 SECTION: 13.4 SECTION: 13.5 SECTION: 14.1 SECTION: 14.2 SECTION: 14.3 SECTION: 14.7 SECTION: 2.4 SECTION: 3.1 SECTION: 3.2 SECTION: 4.2 SECTION: 4.4 SECTION: 5.1 SECTION: 5.2 SECTION: 6.2 # of Questions 15 1 1 2 4 2 2 1 1 2 5 6 5 5 5 1 2 2 1 2 1 1 1 2 1 1 1 2 1 1 1 2 1 1 1 1 1 1 1 2 1 1 2 SECTION: 7.2 SECTION: 8.1 SECTION: 9.1 SECTION: 9.5 TOPIC: ACCOUNTING BREAK-EVEN TOPIC: ANALYZING A PORTFOLIO TOPIC: ANNUITY DUE AND PRESENT VALUE TOPIC: CALL OPTION TOPIC: CALL OPTION VALUE TOPIC: COMMON-SIZE STATEMENTS TOPIC: CONVERSION RATIO TOPIC: CROSSOVER POINT TOPIC: DIVIDEND YIELD TOPIC: EARNINGS BEFORE INTEREST AND TAXES TOPIC: EFFICIENT CAPITAL MARKET TOPIC: EQUIVALENT ANNUAL COST TOPIC: EROSION TOPIC: EXTERNAL FINANCING NEEDED AT LESS THAN MAXIMUM CAPACITY TOPIC: FINANCIAL BREAK-EVEN TOPIC: GEOMETRIC AVERAGE RETURN TOPIC: INTRINSIC VALUE TOPIC: LIMITED LIABILITY COMPANY TOPIC: NET PRESENT VALUE TOPIC: NET WORKING CAPITAL TOPIC: OPERATING LEVERAGE TOPIC: OPPORTUNITY COSTS TOPIC: OPTION QUOTES TOPIC: ORDINARY ANNUITY TIME PERIODS AND FUTURE VALUE TOPIC: PORTFOLIO VARIANCE TOPIC: PRESENT VALUE AND DISCOUNT RATE TOPIC: PRINCIPLE OF DIVERSIFICATION TOPIC: PRO FORMA STATEMENTS TOPIC: REAL RETURN TOPIC: RETURN DISTRIBUTIONS TOPIC: SALVAGE VALUE TOPIC: SCENARIO ANALYSIS TOPIC: SENSITIVITY ANALYSIS TOPIC: SIMPLE VERSUS COMPOUND INTEREST TOPIC: SINKING FUND TOPIC: SOURCES OF CASH TOPIC: SUPERNORMAL GROWTH TOPIC: SUSTAINABLE GROWTH RATE TOPIC: SYSTEMATIC RISK TYPE: CONCEPTS TYPE: DEFINITIONS TYPE: PROBLEMS 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 1 1 1 1 1 1 1 1 1 1 1 1 1 1 10 14 16