1. If you invest $8,000 at 12% interest, how much will you have in 7 years?
FV = PV x FV if (n=7, i=12)
FV = 8,000 x 2.211 = 17,688
2. The concept of time value of money is important to financial decision making
a. it emphasizes earnings of return on invested capital
b. it recognizes that earning a return makes $1 worth more today than $1 received in
c. It can be applied to future cash flows in order to compare different streams of
d. All of the above.
3. An annuity may be defined as:
a. a payment at a fixed interest rate.
b. A series of payments of unequal amount.
c. A series of yearly payments.
d. A series of consecutive payments of equal amounts
4. You are to receive $12,000 at the end of 5 years. The available yield on
investments is 6%. Which table would you use to determine the value of that sum
a. Present value of an annuity of $1
b. Future value of an annuity
c. Present value of $1
d. Future value of $1
5. As the interest rate increases, the present value of an amount to be received at the
end of a fixed period:
c. remains the same
d. not enough information to tell
6. To save for her new born son’s college education, Lea Wilson will invest $1,000
at the beginning of each year for the next 18 years. The interest rate is 12%.
What is the future value?
7. Sharon Smith will receive $1 million in 50 years. The discount rate is 14%. As
an alternative, she can receive $2,000 today. Which should she choose?
a. the $1 million dollars in 50 years.
b. $2,000 today.
c. She should be indifferent.
d. Need more information.
8-13 match the following with the items below:
b. future value
c. future value of an annuity
d. discount rate
e. interest factor (IF)
f. present value
g. semi-annual compounding
____ 8. The interest or return is accumulated every six months.
____ 9. The discounted value of a future sum or annuity as of today’s value.
__A_ 10. A series of consecutive payments or receipts of an equal amounts.
____ 11. The percentage rate at which future sums or annuities are brought back to their
____ 12. It is based on the number of periods (n) and how the interest rate (i) and whether
Or not there is more than one cash flow
____ 13. The interest rate that equates a future value of an annuity to a given present
14. Which of the following financial assets is likely to have the highest required rate of
return based on risk?
a. Corporate bond
b. Treasury bill.
c. Certificate of Deposit
d. Common stock
15. A bond which has a yield to maturity greater than its coupon interest rate will sell for
a. below par
b. at par
c. above par
d. what is equal to the face value of the bond plus the value of all interest payments.
16. Which of the following is not one of the components that makes up the required rate
of return on a bond?
a. Risk premium
b. Real rate of return
c. Inflation premium
d. maturity payment
17. A 20-year bond pays 12% on a face value of $1,000. If similar bonds are currently
yielding 9%, what is the market value of the bond? Use annual analysis.
b. under $1,000
c. over $1,200
d. not enough information given to tell
18. The relationship between a bond’s price and the yield to maturity:
a. changes at a constant level for each percentage change of yield to maturity.
b. is an inverse relationship
c. is a linear relationship
d. a and b
19. Preferred stock has all but which of the following characteristics?
a. no stated maturity
b. a fixed dividend payment that carries a higher precedence than common stock
c. the same binding contractual obligation as debt
d. preferred lacks the ownership privilege of common stock
20. Financial capital does not include
c. preferred stock
d. working capital
21. The overall weighted average cost of capital is used instead of costs for specific
sources of funds because:
a. use the cost for specific sources of capital would make investment decisions
b. a project with the highest return would always be accepted under the specific cost
c. investments funded by low cost debt have an advantage over other investments
d. both a and c are both correct.
22. For a firm paying 7% for new debt, the higher the firm’s tax rate
a. the higher the after-tax cost of debt
b. the lower the after-tax cost of debt
c. after-tax cost is unchanged
d. not enough information to judge
23. A firm’s cost of financing, in an overall sense, is equal to its:
a. weighted average cost of capital
b. required yield that investors seek for various kinds of securities
c. required rate of return that investors seek for various kinds of securities
d. all of the above
24. The after-tax cost of preferred stock to the issuing corporation
a. is the same as the before-tax cost
b. is usually lower than the cost of debt
c. is depend on the firm’s tax bracket
d. none of the above
25. The cost of equity capital in the form of new common stock will be higher than the
cost of retained earnings because of:
a. the existence of taxes
b. the existence of flotation costs
c. investors’ unwillingness to purchase additional shares of common stock
d. the existence of financial leverage
26. Why is the cost of debt normally lower than the cost of preferred stock?
a. preferred stock dividends are tax deductions
b. interest is tax deductible
c. preferred stock dividends must be paid before common stock dividends
d. common stock dividends are not tax deductible
27. Retained earnings has a cost associated with it because:
a. new funds must be raised
b. there is an opportunity cost associated with stockholders funds
c. Ke > g
d. flotation cost increase the cost of fundings
28. A firm in a stable industry should use:
a. a large amount of debt to lower the cost of capital
b. no debt at all
c. preferred stock in place of debt
29. Although debt financing is usually the cheapest component of capital, it cannot be
used to excess because:
a. interest rate may change
b. the firm’s stock price will increase and raise the cost of equity financing
the financial risk of the firm may increase and thus drive up the cost of all sources of
c underwriting costs may change
30. Marginal cost of capital
a. recognizes that cost of capital does not stay constant as more funds are raised.
b. usually provides the same capital budgeting choices as the use of weighted average
cost of capital
c. can be defined as the cost of capital when no retained earnings are available for
d. none of the above apply.
31-36. Match the following with the items below:
a. capital asset pricing model b. cost of capital
c. dividend valuation model d. financial capital
e. flotation costs f. marginal cost of capital
g. optimal capital structure h. weighted average cost of capital
_____ 31. The distribution expense involved in selling securities to the public
_____ 32. The result of multiplying the cost of each item in the capital structure by
Its corresponding representation in the overall capital structure and
Summing the results.
_____ 33. Features the best possible mix of debt, preferred stock, retained earnings and
new common stock
_____ 34. Determines the value of a share of stock by taking the present value of the
Expected future stream of dividends
_____ 35. The cost of the next dollar of funds raised
_____ 36. Appears on the balance sheet under long-term liabilities and equity
37. The reason cash flow is used in capital budgeting is because:
a. cash rather than income is used to purchase new machines
b. cash outlays need to be evaluated in terms of the present value of the resultant cash
c. to ignore the tax shield provided from depreciation ignores the cash flow provided by
the machine which should be reinvested to replace old worn out machine
d. all of the above.
38. Capital budgeting is primarily concerned with
a. capital formation in the economy
b. planning future financing needs
c. evaluating investment alternatives
d. minimizing the cost of capital
39. Assume a corporation has earnings before depreciation and taxes of $100,000,
depreciation of $40,000, and that it has a 30% tax bracket. What are the after-tax cash
flows for the company?
a. $82,000 b. $110,000
c. $42,000 d. none of the above
40. Which of the following statements about the “payback method” is true?
a. The payback method considers cash flows after the payback has been reached
b. the payback method does not consider the time value of money
c. The payback method uses discounted cash-flow techniques
d. The payback method generally leads to the same decision as other investment selection
41. The Dammon Corp. has the following investment opportunities:
Machine A Machine B Machine C
($15,000) ($22,500) ($37,500)
Inflows Inflows Inflows
Year 1 $6,000 Year 1 $12,000 Year 1 $-0-
Year 2 $9,000 Year 2 $12,000 Year 2 $30,000
Year 3 $3,000 Year 3 $10,500 Year 3 $30,000
Year 4 $-0- Year 4 $10,500 Year 4 $15,000
Year 5 $-0- Year 5 $-0- Year 5 $15,000
Under the payback method and assuming these machines are mutually exclusive, which
machine(s) would Dammon Corp. choose?
a. Machine A b. Machine B
c. Machine C d. Machine A and B
42. Stone Inc. is evaluating a project with an initial cost of $8,450. Cash inflows are
expected to be $1,000, $1,000 and $10,000 in three years over which the project will
produce cash flows. If the discount rate is 13%, what is the net present value of the
a. less than $0 b. between $0 and $400
c. between $400 and $800 c. more that $800
43. If projects are mutually exclusive
a. they can only be accepted under capital rationing
b. the selection of one alternative precludes the selection of other alternatives
c. the payback method should be used
d. the net present-value should be used
44. A characteristic of capital budgeting is
a. a large amount of money is always involves
b. the internal rate of return must be less than the cost of capital
c. the internal rate of return must be greater than the cost of capital
d. the time horizon is at least five years
45. The____________ assumes returns are reinvested at the cost of capital
a. payback method b. internal rate of return
c. net present value d. capital rationing
46. As the cost of capital increases
a. fewer projects are accepted b. more projects are accepted
c. project selection remains unchanged d. none of the above
47. MACRS depreciation is beneficial to corporation because it
a. increases total depreciation
b. lengthens the lives of assets for depreciation purposes
c. shortens the lives of assets for depreciation purposes
d. classifies assets into specific, well-understood groups for depreciation
48. At higher tax rates, depreciation is
a. more beneficial b. less beneficial
c. unaffected d. none of the above
49-56. Match the following with the items below:
a. modified accelerated cost recovery system depreciation (MACRS)
b. capital rationing
c. cash flow
d. internal rate of return (IRR)
e. net present value profile
f. normal recovery period
g. payback period
h. planning horizon
i. reinvestment assumption
_____49. Concerns the rate of return that can be earned on the cash flow generated by
capital budgeting projects,
_____ 50. Occurs when a corporation has more dollars of capital budgeting projects with
Positive net present values than it has money to invest in them
_____ 51. has defined assets lives of 3 to 39 years for different categories of assets
_____ 52. Equals cash inflows minus cash expenses
_____ 53. A discounted cash flow method for evaluating capital budgeting projects
Where the present value of the cash inflows are equal to the present
Value of the cash outflows.
_____ 54. The time it takes to depreciate an asset under the accelerated cost recovery
_____ 55. Indicates the length of time required to recoup as initial investment
_____ 56. A graphical presentation of the potential net present values of a project at
Different discount rates.
57. The term “risk averse” means that
a. an individual refuses to take risk
b. most investors and businessmen seek risk
c. an individual will seek to avoid risk or be compensated with a higher return
d. only investment proposals with no risk should be accepted
58. Firm X is considering a project and its analysis have projected the following
outcomes and their probabilities
Outcome Probability of Outcome Assumptions
$5,250 25% pessimistic
$7,800 45% moderately successful
$13,500 30% optimistic
What is the expected value of the outcomes?
a. $3,123 b. $8,460 c. $8,873
d. Cannot determined/depends upon which prediction is correct.
59. Which of the following is a characteristic of beta?
a. Beta measures only the volatility of returns on an individual bond relative to a bond
b. A beta of 1.0 is of equal risk with the market
c. A beta of greater than 1.0 has less risk than the market
d. Two of the above are true.
60. Risk may be integrated into capital budgeting decisions by
a. adjusting the standard deviation of possible outcomes
b. determining the expected value
c. adjusting the discount rate
d. adjusting the time horizon
61. In order to evaluate risk, management may also set qualitative risk classes. Rank
these four projects from the least to the most risky
1. Completely new market in United States
2. Completely new market in South America
3. Addition to normal product line
4. Repair to old machinery
a. 4, 3, 1, 2
b. 1, 2, 3, 4
c, 3, 4, 1, 2
d. 2, 3, 4, 1
62. An example of negative correlation may exist between the
a. forest products and housing industries
b. jewelry and discount furniture industries
c. steel and aluminum industries
d. oil and auto industries
63. The greater use of debt by corporation since the late 1960s is best shown by the
a. declining interest coverage ratio
b. small amount of common stock sold.
c. rising cost of interest
d. inability of earnings to keep up with the inflation
64. The term debenture refers to
a. long-term, secured debt
b. long-term, unsecured debt
c. the after-acquired property clause
d. a 100-page document covering the specific terms of the offering
65. Which of the following is the lowest in priority of claims against a bankrupt firm?
a. A junior mortgage bond b. a senior debenture
c. Common stock d. A subordinated debenture
66. A call provision, which allows the corporation to force an early maturity on a bond
issue, usually contains all but which of the following characterisctics?
a. most bonds must be outstanding at least 5 years before being called
b. After the call date, the call premium tends to decline over time
c. The provision typically calls for debt conversion into common stock
d. The corporation will pay a premium over par for the bonds
67. The dollar interest received dividend by the market place of the bond is called the
a. par value b. coupon rate c. current yield d. yield to maturity
68. The higher the bond rating
a. the higher the interest rate on a bond
b. the lower the interest rate on the bond
c. the higher the call premium
d. the lower the call premium
69. Solow Corp. has a bond with annual interest payment of $120 maturing in 15 years at
a value of $1,000 per bond. The current market price is $960. What will the nominal
a. 12.7% b. 12.5% c. 11.5% d. 12%
70. A bond’s rating can depend on all of the following except
a. the corporation’s debt-equity ratio
b. the corporation’s size
c. the ability of the firm to make interest payments
d. the coupon rate on the bond
71. The disadvantages of debt to the corporation include all but which of the following?
a. debt may have to be paid back with “cheaper dollars
b. interest and principal payments must be met
c. indenture agreements may place burdensome restrictions on the firm
d. Too much debt may depress the firm’s stock price
72. Leasing is a popular form of financing because
a. lease provisions are generally less restrictive than a bond indenture
b. the lessor likely has experience with the equipment being leased
c. the lessee may not be financially able to purchase
d. all of the above
73. Long-term financing leases currently
a. show up on the balance sheet
b. appear in the footnotes to the annual report
c. appear on the company’s statement of retained earnings
d. do not appear on any financial statement
74 – 78 match the following with the items below:
a. debenture bond b. indenture c. maturity date
d. mortgage agreement e. par value f. secured debt
g. after acquisition property clause h. serial payments i. sinking funds
j. subordinated payments k. unsecured debt l. zero-coupon bond
m. floating-rate bond
____ 74. A long-term unsecured corporate bond.
____ 75. A legal contract covering every detail of a bond issue
____ 76. The point at which the principle value of a bond is repaid to the lender
____ 77. Payment to the holder will take place only after the designated senior
Bondholders are satisfied
____ A loan based on the use of real property as collateral
____ Indicates the loan was obtained by pledging assets as collateral
____ The principal value of the bond
____ A method of retiring bonds in an orderly process over the life of the bond
____ 82. Arise when a bond issue has several different maturity dates as part of the
____ 83. A debt instrument which pays interest at a rate dependent on the market
____ 84. A debt instrument for which corporations incur only one cash outflow-the
Face values of the instrument as maturity.
Essays: Short, one paragraph
Choose 5 of the following essay questions. Do Not choose more than five. Number your
answers so that I know which questions you are addressing.
1. If, as an investor, you had a choice of daily, monthly, or quarterly
compounding, which would you choose? Why? Provide an example
2. Why might investors demand a lower rate of return for an investment in
Exxon Mobil as compared to United Airlines?
3. What are the three factors that influence the required rate of return by
4. What factors might influence a firm’s price-earnings ratio?
5. Why do we use the overall cost of capital for investment decisions even
when only one source of capital will be used (e.g., debt)?
6. Why is the cost of debt less than the cost of preferred stock if both
securities are priced to yield 10 percent in the market? Provide an
7. What effect would inflation have on a company’s cost of capital? (Hint:
Think about how inflation influences interest rates, stock prices, corporate
profits, and growth.)
8. Explain the concept of marginal cost of capital? Use an example
9. Discuss the concept of risk and how it might be measured
10. What is the purpose of serial repayments and sinking funds?
11. Explain how the zero-coupon rate bond provides return to the investor.
What are the advantages to the corporation?
12. Discuss the advantages of debt. (Explain at least 3 advantages)
13. Discuss the disadvantage of debt. (Explain at least 3 disadvantages)