# Practice Questions Practice Questions 1 Scanlon Inc s CFO hired

Document Sample

```					                            Practice Questions

1. Scanlon Inc.'s CFO hired you as a consultant to help her estimate the cost
of capital. You have been provided with the following data: rRF = 5.00%; RPM
= 6.00%; and b = 0.90. Based on the CAPM approach, what is the cost of
equity from retained earnings?

a. 9.21%
b. 9.49%
c. 9.79%
d. 10.09%
e. 10.40%

2. Assume that you are a consultant to Broske Inc., and you have been
provided with the following data: D1 = \$1.30; P0 = \$42.50; and g = 7.00%
(constant). What is the cost of equity from retained earnings based on the
DCF approach?

a.    9.08%
b.    9.56%
c.    10.06%
d.    10.56%
e.    11.09%

3. Lanser Inc. hired you as a consultant to help them estimate its cost of
capital. You have been provided with the following data: D1 = \$0.80; P0 =
\$22.50; and g = 5.00% (constant). Based on the DCF approach, what is the
cost of equity from retained earnings?

a.    7.34%
b.    7.72%
c.    8.13%
d.    8.56%
e.    8.98%

4. Which of the following statements is CORRECT?

a. If the underlying stock does not pay a dividend, it makes good
economic sense to exercise a call option as soon as the
stock’s price exceeds the strike price by about 10%, because
this permits the option holder to lock in an immediate profit.
b. Call options generally sell at a price less than their
exercise value.
c. If a stock becomes riskier (more volatile), call options on
the stock are likely to decline in value.
d. Call options generally sell at prices above their exercise
value, but for an in-the-money option, the greater the
exercise value in relation to the strike price, the lower the
premium on the option is likely to be.
e. Because of the put-call parity relationship, under equilibrium
conditions a put option on a stock must sell at exactly the
same price as a call option on the stock.

5. Call options on XYZ Corporation’s common stock trade in the market.
Which of the following statements is most correct, holding other
things constant?

a. The price of these call options is likely to rise if XYZ’s
stock price rises.
b. The higher the strike price on XYZ’s options, the higher the
option’s price will be.
c. Assuming the same strike price, an XYZ call option that
expires in one month will sell at a higher price than one that
expires in three months.
d. If XYZ’s stock price stabilizes (becomes less volatile), then
the price of its options will increase.
e. If XYZ pays a dividend, then its option holders will not
receive a cash payment, but the strike price of the option
will be reduced by the amount of the dividend.

6. Which of the following statements is CORRECT?

a.   Generally, debt-to-total-assets ratios do not vary much among different
industries, although they do vary among firms within a given industry.
b.   Electric utilities generally have very high common equity ratios because
their revenues are more volatile than those of firms in most other
industries.
c.   Drug companies (prescription, not illegal!) generally have high debt-to-
equity ratios because their earnings are very stable and, thus, they can
cover the high interest costs associated with high debt levels.
d.   Wide variations in capital structures exist both between industries and
among individual firms within given industries. These differences are
caused by differing business risks and also managerial attitudes.
e.   Since most stocks sell at or very close to their book values, book value
capital structures are almost always adequate for use in estimating
firms' costs of capital.

7. Elephant Books sells paperback books for \$7 each. The variable cost per
book is \$5. At current annual sales of 200,000 books, the publisher is just
breaking even. It is estimated that if the authors' royalties are reduced,
the variable cost per book will drop by \$1. Assume authors' royalties are
reduced and sales remain constant; how much more money can the publisher put
into advertising (a fixed cost) and still break even?

\$600,000
\$466,667
\$333,333
\$200,000
None of the above
8. DeLong Inc. has fixed operating costs of \$470,000, variable costs of \$2.80
per unit produced, and its products sell for \$4.00 per unit. What is the
company's breakeven point, i.e., at what unit sales volume would income equal
costs?

a.   391,667
b.   411,250
c.   431,813
d.   453,403
e.   476,073

9. Senbet Ventures is considering starting a new company to produce stereos.
The sales price would be set at 1.5 times the variable cost per unit; the
VC/unit is estimated to be \$2.50; and fixed costs are estimated at \$120,000.
What sales volume would be required in order to break even, i.e., to have an
EBIT of zero for the stereo business?

a.   86,640
b.   91,200
c.   96,000
d.   100,800
e.   105,840

10. The Congress Company has identified two methods for producing playing
cards. One method involves using a machine having a fixed cost of \$10,000
and variable costs of \$1.00 per deck of cards. The other method would use a
less expensive machine (fixed cost = \$5,000), but it would require greater
variable costs (\$1.50 per deck of cards). If the selling price per deck of
cards will be the same under each method, at what level of output will the
two methods produce the same net operating income (EBIT)?

a.   5,000 decks
b.   10,000 decks
c.   15,000 decks
d.   20,000 decks
e.   25,000 decks