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comprehensive exam question bank Multiple Choice Identify the choice that best completes the statement or answers the question. ____ 1. What would the future value of $100 be after 5 years at 10% compound interest? a. $161.05 b. $134.54 c. $127.84 d. $151.29 e. $143.65 ____ 2. Suppose a U.S. government bond promises to pay $2,249.73 three years from now. If the going interest rate on 3-year government bonds is 6%, how much is the bond worth today? a. $2,011.87 b. $2,591.45 c. $2,324.89 d. $1,888.92 e. $2,854.13 ____ 3. Sims Inc. earned $1.00 per share in 2000. Five years later, in 2005, it earned $2.00. What was the growth rate in Sims' earnings per share (EPS) over the 5-year period? a. 10.82% b. 14.87% c. 13.61% d. 14.28% e. 12.17% ____ 4. Addico Corp's 2005 earnings per share were $2, and its growth rate during the prior 5 years was 11.0% per year. If that growth rate were maintained, how long would it take for Addico's EPS to double? a. 6.64 years b. 6.81 years c. 6.99 years d. 7.13 years e. 7.28 years ____ 5. What is the PV of an annuity due with 5 payments of $1,000 at an interest rate of 5%? a. $11,110.34 b. $13,637.85 c. $12,513.68 d. $14,976.84 e. $15,349.15 ____ 6. Your father has $500,000 invested at 8%, and he now wants to retire. He wants to withdraw $50,000 at the beginning of each year, beginning immediately. How many years will it take to exhaust his funds, i.e., run the account down to zero? a. 11.34 years b. 18.49 years c. 17.54 years d. 13.91 years e. 15.27 years ____ 7. What's the present value of a 6-year ordinary annuity of $1,000 per year plus an additional $1,500 at the end of Year 6 if the interest rate is 6%? a. $5,324.89 b. $5,591.45 c. $5,974.77 d. $6,011.87 e. $4,854.13 ____ 8. If a bank pays a 6% nominal rate, with monthly compounding, on deposits, what effective annual rate does the bank pay? a. 6.17% b. 6.71% c. 5.10% d. 6.59% e. 5.91% ____ 9. You are buying your first house for $220,000, and are paying $30,000 as a down payment. You have arranged to finance the remaining $190,000 30-year mortgage with a 7% nominal interest rate and monthly payments. What are the equal monthly payments you must make? a. $1,513 b. $1,110 c. $1,264 d. $1,976 e. $1,349 ____ 10. Companies generate income from their "regular" operations and from things like interest on securities they hold, which is called non-operating income. Mitel Metals recently reported $9,000 of sales, $6,000 of operating costs other than depreciation, and $1,500 of depreciation. The company had no amortization charges and no non-operating income. It had issued $4,000 of bonds that carry a 7% interest rate, and its federal-plus-state income tax rate was 40%. What was the firm's operating income, or EBIT? a. $1,100 b. $1,200 c. $1,300 d. $1,400 e. $1,500 ____ 11. Madison Metals recently reported $9,000 of sales, $6,000 of operating costs other than depreciation, and $1,500 of depreciation. The company had no amortization charges and no non-operating income. It had issued $4,000 of bonds that carry a 7% interest rate, and its federal-plus-state income tax rate was 40%. What was the firm's taxable, or pre-tax, income? a. $1,180 b. $1,220 c. $1,260 d. $1,300 e. $1,340 ____ 12. Fine Breads Inc. paid out $26,000 common dividends during 2005, and it ended the year with $150,000 of retained earnings. The prior year's retained earnings were $145,500. What was the firm's 2005 net income? a. $30,000 b. $31,000 c. $32,000 d. $33,000 e. $34,000 ____ 13. Cox Corporation reported EBITDA of $22.5 million and $5.4 million of net income. The company has a $6 million interest expense and its corporate tax rate is 35%. What was Cox's depreciation and amortization expense? a. $ 4,333,650 b. $ 8,192,308 c. $ 9,427,973 d. $11,567,981 e. $14,307,692 ____ 14. Garfield Inc. is expanding throughout the Southeast United States, and it expects sales to increase by $1 million and operating costs (excluding depr and amort) by $700,000. Depreciation and amortization expenses will rise by $50,000 and interest expense by $150,000, while the company's tax rate will remain at 40%. If the company's forecast is correct, how much will net income change, as a result of the expansion? a. No change b. $ 40,000 increase c. $ 60,000 increase d. $100,000 increase e. $180,000 increase ____ 15. Hebner Housing Corporation has forecast the following numbers for the upcoming year: • Sales = $1,000,000. • Cost of goods sold = 600,000. • Interest expense = 100,000. • Net income = 180,000. The company is in the 40% tax bracket, and its cost of goods sold always represents 60% of its sales. The company's CEO is unhappy with the forecast and wants the firm to achieve a net income equal to $240,000. Assuming interest expense is unchanged, what level of sales will the company have to achieve? a. $ 400,000 b. $ 500,000 c. $ 750,000 d. $1,000,000 e. $1,250,000 ____ 16. Swann Systems has forecast this income statement for the upcoming year: Sales $5,000,000 Operating costs (excluding depr and amort) 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 unsatisfied with the forecast and wants to see higher sales and a forecasted net income of $2,000,000. Assume that operating costs are always 60% of sales, and that depreciation and amortization, interest expense, and the company's tax rate (40%), will remain the same even if sales change. How much in sales would Swann have to obtain to generate $2,000,000 in net income? a. $ 5,800,000 b. $ 6,000,000 c. $ 7,200,000 d. $ 8,300,000 e. $10,833,333 ____ 17. 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 If the discount rate is 8%, what is the investment's present value? a. $103,799 b. $ 96,110 c. $ 95,353 d. $120,000 e. $ 77,592 ____ 18. 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%. What is the future value of the investment after 2.5 years? a. $520.61 b. $541.63 c. $542.07 d. $543.98 e. $547.49 ____ 19. The Wilson Corporation has the following results: Sales/Total assets 2.0× Return on assets (ROA) 4.0% Return on equity (ROE) 6.0% What is Wilson's profit margin and debt ratio? a. 2%; 0.33 b. 4%; 0.33 c. 4%; 0.67 d. 2%; 0.67 e. 4%; 0.50 ____ 20. 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? a. $20.00 b. $30.00 c. $40.00 d. $50.00 e. $60.00 ____ 21. Humphrey Hotels' operating income (EBIT) is $40 million. The company's times interest earned (TIE) ratio is 8.0, its tax rate is 40%, and its basic earning power (BEP) ratio is 10%. What is the company's return on assets (ROA)? a. 6.45% b. 5.97% c. 4.33% d. 8.56% e. 5.25% ____ 22. Assume Meyer Corporation is 100% equity financed. Calculate the return on equity (ROE), given the following information: Earnings before taxes $1,500 Sales $5,000 Dividend payout ratio 60% Total assets turnover 2.0 Tax rate 30% a. 25% b. 30% c. 35% d. 42% e. 50% ____ 23. Moss Motors has $8 billion in assets, and its tax rate is 40%. The company's basic earning power (BEP) ratio is 12%, and its return on assets (ROA) is 3%. What is Moss' times interest earned (TIE) ratio? a. 2.25 b. 1.71 c. 1.00 d. 1.33 e. 2.50 ____ 24. Last year, Kansas Office Supply had $400,000 of net income on $24,000,000 of sales, its total assets turnover was 6.0, and the company's ROE was 15%. If the company only finances with debt and equity, what is the company's debt ratio? a. 0.20 b. 0.30 c. 0.33 d. 0.60 e. 0.66 ____ 25. 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%. What is the company's basic earning power (BEP)? a. 14.12% b. 16.67% c. 17.33% d. 20.67% e. 22.50% ____ 26. Suppose the interest rate on a 1-year T-bond is 5.0% and that on a 2-year T-bill is 6.0%. Assuming the pure expectations theory is correct, what is the market's forecast for 1-year rates 1 year from now? a. 6.65% b. 6.74% c. 6.83% d. 6.92% e. 7.01% ____ 27. The real risk-free rate is 3%. Inflation is expected to be 4% this coming year, jump to 5% next year, and increase to 6% the year after. According to the expectations theory, what should be the interest rate on 3-year, risk-free securities today? a. 18% b. 12% c. 6% d. 8% e. 10% ____ 28. One-year Treasury securities yield 5%, 2-year Treasury securities yield 5.5%, and 3-year Treasury securities yield 6%. Assume that the expectations theory holds. What does the market expect will be the yield on 1-year Treasury securities two years from now? a. 6.01% b. 6.51% c. 7.01% d. 7.51% e. 8.01% ____ 29. Given the following data, find the expected rate of inflation during the next year. Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. • r* = real risk-free rate = 3%. • Maturity risk premium on 10-year T-bonds = 2%. It is zero on 1-year bonds, and a linear relationship exists. • Default risk premium on 10-year, A-rated bonds = 1.5%. • Liquidity premium = 0%. • Going interest rate on 1-year T-bonds = 8.5%. a. 3.5% b. 4.5% c. 5.5% d. 6.5% e. 7.5% ____ 30. The real risk-free rate is expected to remain constant at 3%. Inflation is expected to be 2% a year for the next 3 years, and then 4% a year thereafter. The maturity risk premium is 0.1%(t − 1), where t equals the maturity of the bond. A 5-year corporate bond has a yield of 8.4%. What is the yield on a 7-year corporate bond that has the same default risk and liquidity premiums as the 5-year corporate bond? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. a. 8.73% b. 8.94% c. 8.65% d. 7.98% e. 9.24% ____ 31. Three-year Treasury securities currently yield 6%, while 4-year Treasury securities currently yield 6.5%. Assume that the expectations theory holds. What does the market believe the rate will be on 1-year Treasury securities three years from now? a. 8.01% b. 8.51% c. 9.01% d. 9.51% e. 10.01% ____ 32. The real risk-free rate is 3%. The market expects that inflation of 3% for each of the next 5 years, and 5% a year thereafter. The maturity risk premium is estimated to be MRPt = 0.1%(t − 1). What is the yield on a Treasury bond that matures in 12 years? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. a. 8.10% b. 8.27% c. 8.45% d. 8.53% e. 8.68% ____ 33. Brown Enterprises' bonds currently sell for $1,025. They have a 9-year maturity, an annual coupon of $80, and a par value of $1,000. What is their yield to maturity? a. 6.87% b. 7.03% c. 7.21% d. 7.45% e. 7.61% ____ 34. Brown Enterprises' bonds currently sell for $1,025. They have a 9-year maturity, an annual coupon of $80, and a par value of $1,000. What is their current yield? a. 7.80% b. 7.90% c. 9.00% d. 9.10% e. 9.20% ____ 35. Yest Corporation's bonds have a 15-year maturity, a 7% semiannual coupon, and a par value of $1,000. The going interest rate (rd) is 6%, based on semiannual compounding. What is the bond's price? a. $1,008.65 b. $1,024.67 c. $1,051.34 d. $1,098.00 e. $1,105.78 ____ 36. Moussawi Ltd's outstanding bonds have a $1,000 par value, and they mature in 5 years. Their yield to maturity is 9%, based on semiannual compounding, and the current market price is $853.61. What is the bond's annual coupon interest rate? a. 5.10% b. 5.20% c. 5.30% d. 5.40% e. 5.50% ____ 37. Walker Industries has a bond outstanding with 12 years to maturity, a 9% coupon paid semiannually, and a $1,000 par value. The bond has a 7% nominal yield to maturity, but it can be called in 3 years at a price of $1,045. What is the bond's nominal yield to call? a. 4.43% b. 4.62% c. 4.82% d. 4.91% e. 4.99% ____ 38. You just purchased a $1,000 par value, 9-year, 7% semiannual coupon bond. The bond sells for $920. What is the nominal yield to maturity? a. 7.28% b. 8.28% c. 9.60% d. 8.67% e. 4.13% ____ 39. A 10-year, $1,000 face value bond sells for $1,075. The bond has a 9% semiannual coupon and is callable in 5 years and a call price is $1,035. What is the bond's nominal yield to call? a. 7.19% b. 7.75% c. 7.90% d. 8.00% e. 8.13% ____ 40. T. Martell Inc.'s stock has a 50% chance of producing a 30% return, a 25% chance of producing a 9% return, and a 25% chance of producing a -25% return. What is Martell's expected return? a. 14.4% b. 15.2% c. 16.0% d. 16.8% e. 17.6% ____ 41. Tom Skinner has $45,000 invested in a stock with a beta of 0.8 and another $55,000 invested in a stock with a beta of 1.4. These are the only two investments in his portfolio. What is his portfolio's beta? a. 0.93 b. 0.98 c. 1.03 d. 1.08 e. 1.13 ____ 42. Magee Company's stock has a beta of 1.20, the risk-free rate is 4.50%, and the market risk premium is 5.00%. What is Magee's required return? a. 10.25% b. 10.50% c. 10.75% d. 11.00% e. 11.25% ____ 43. Niendorf Corporation's stock has a required return of 13.00%, the risk-free rate is 7.00%, and the market risk premium is 4.00%. Now suppose there is a shift in investor risk aversion, and the market risk premium increases by 2.00%. What is Niendorf's new required return? a. 14.00% b. 15.00% c. 16.00% d. 17.00% e. 18.00% ____ 44. Apex Roofing's stock has a beta of 1.50, its required return is 14.00%, and the risk-free rate is 5.00%. What is the required rate of return on the stock market? (Hint: First find the market risk premium.) a. 10.50% b. 11.00% c. 11.50% d. 12.00% e. 12.50% ____ 45. Suppose you hold a diversified portfolio consisting of $10,000 invested equally in each of 10 different common stocks. The portfolio's beta is 1.120. Now suppose you decided to sell one of your stocks that has a beta of 1.000 and to use the proceeds to buy a replacement stock with a beta of 1.750. What would the portfolio's new beta be? a. 0.982 b. 1.017 c. 1.195 d. 1.246 e. 1.519 ____ 46. Assume the risk-free rate is 5% and that the market risk premium is 7%. If a stock has a required rate of return of 13.75%, what is its beta? a. 1.25 b. 1.35 c. 1.37 d. 1.60 e. 1.96 ____ 47. 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 market risk premium is equal to 2% and Treasury bonds have a yield of 4%. What is the required rate of return on the investor's portfolio? a. 6.6% b. 6.8% c. 5.8% d. 7.0% e. 7.5% ____ 48. Given the following probability distribution, what are the expected return and the standard deviation of returns for Security J? State Pi kJ 1 0.2 10% 2 0.6 15 3 0.2 20 a. 15%; 6.50% b. 12%; 5.18% c. 15%; 3.16% d. 15%; 10.00% e. 20%; 5.00% ____ 49. If D1 = $2.00, g (which is constant) = 6%, and P0 = $40, what is the stock's expected total return for the coming year? a. 10.8% b. 11.0% c. 11.2% d. 11.4% e. 11.6% ____ 50. A stock is expected to pay a dividend of $1 at the end of the year. The required rate of return is rs = 11%, and the expected constant growth rate is 5%. What is the current stock price? a. $16.67 b. $18.83 c. $20.00 d. $21.67 e. $23.33 ____ 51. Hahn Manufacturing is expected to pay a dividend of $1.00 per share at the end of the year (D1 = $1.00). The stock sells for $40 per share, and its required rate of return is 11%. The dividend is expected to grow at a constant rate, g, forever. What is Hahn's expected growth rate? a. 8.00% b. 8.50% c. 9.00% d. 9.50% e. 10.00% ____ 52. P. Daves Inc's stock is currently sells for $45 per share. The stock's dividend is projected to increase at a constant rate of 4% per year. The required rate of return on the stock, rs, is 12%. What is Daves' expected price 6 years from now? a. $52.68 b. $53.71 c. $54.41 d. $55.12 e. $56.94 ____ 53. The Lashgari Company is expected to pay a dividend of $1 per share at the end of the year, and that dividend is expected to grow at a constant rate of 5% per year in the future. The company's beta is 1.2, the market risk premium is 5%, and the risk-free rate is 3%. What is the company's current stock price? a. $15.00 b. $20.00 c. $25.00 d. $30.00 e. $35.00 ____ 54. Mack Industries just paid a dividend of $1.00 per share (D0 = $1.00). Analysts expect the company's dividend to grow 20% this year (D1 = $1.20) and 15% next year. After two years the dividend is expected to grow at a constant rate of 5%. The required rate of return on the company's stock is 12%. What should be the company's current stock price? a. $12.33 b. $16.65 c. $16.91 d. $18.67 e. $19.67 ____ 55. Klieman Company's perpetual preferred stock sells for $90 per share and pays a $7.50 annual dividend per share. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the price paid by investors. What is the company's cost of preferred stock? a. 7.50% b. 7.79% c. 8.21% d. 8.57% e. 8.77% ____ 56. Assume that you are a consultant to Thornton Inc., and you have been provided with the following data: rRF = 5.5%; RPM = 6.0%; and b = 0.8. What is the cost of equity from retained earnings based on the CAPM approach? a. 9.65% b. 9.91% c. 10.08% d. 10.30% e. 10.49% ____ 57. Assume that you are a consultant to Morton Inc., and you have been provided with the following data: D1 = $1.00; P0 = $25.00; and g = 6% (constant). What is the cost of equity from retained earnings based on the DCF approach? a. 9.79% b. 9.86% c. 10.00% d. 10.20% e. 10.33% ____ 58. You were hired as a consultant to Keys Company, and you were provided with the following data: Target capital structure: 40% debt, 10% preferred, and 50% common equity. The after-tax cost of debt is 4.00%, the cost of preferred is 7.50%, and the cost of retained earnings is 11.50%. The firm will not be issuing any new stock. What is the firm's WACC? a. 7.55% b. 7.73% c. 7.94% d. 8.10% e. 8.32% ____ 59. Wagner Lumber Company hired you to help them estimate their cost of capital. You were provided with the following data: D1 = $1.25; P0 = $40; g = 6% (constant); and F = 5%. The firm must issue new stock; what is the cost of equity raised by selling new common stock? a. 9.29% b. 9.40% c. 9.62% d. 9.85% e. 9.99% ____ 60. Hamilton Company has 20-year, 8% quarterly coupon bonds that currently sell for $686.86. The company's tax rate is 40%. What is the firm's nominal component cost of debt? a. 3.05% b. 7.32% c. 7.36% d. 12.20% e. 12.26% comprehensive exam question bank Answer Section MULTIPLE CHOICE 1. ANS: A PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems TOP: FV of a lump sum 2. ANS: D PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems TOP: PV of a lump sum 3. ANS: B PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems TOP: Simple growth rate 4. ANS: A PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems TOP: Number of periods 5. ANS: B PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems TOP: PV of an annuity due 6. ANS: C PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems TOP: Years to deplete an annuity due 7. ANS: C PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems TOP: PV of an ordinary annuity plus an ending payment 8. ANS: A PTS: 1 DIF: Medium OBJ: Part I TYPE: Problems TOP: Nominal vs. effective annual rate 9. ANS: C PTS: 1 DIF: Medium OBJ: Part I TYPE: Problems TOP: Mortgage payments 10. ANS: E PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems TOP: Income statement: EBIT 11. ANS: B PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems TOP: Income statement: Taxable income 12. ANS: B PTS: 1 DIF: Easy/Medium OBJ: Part I TYPE: Problems TOP: Dividends, retained earnings 13. ANS: B PTS: 1 DIF: Easy/Medium OBJ: Part II TYPE: Problems TOP: Income statement 14. ANS: C Set up an income statement: Sales $1,000,000 Operating costs 700,000 EBITDA $ 300,000 Depreciation and amortization 50,000 EBIT $ 250,000 Interest 150,000 EBT $ 100,000 Taxes (40%) 40,000 Taxes = 0.4($100,000) = $40,000. Net income $ 60,000 PTS: 1 DIF: Medium OBJ: Part II TYPE: Problems TOP: Calculating change in net income 15. ANS: E This question requires working backwards through the income statement from net income to sales. The income statement will look like this: Sales $1,250,000 $500,000/(1 − 0.6) CGS (60%) 750,000 $1,250,000 × 0.6 EBIT $ 500,000 $100,000 + $400,000 Interest 100,000 (Given) EBT $ 400,000 $240,000/(1 − 0.4) Tax (40%) 160,000 NI $ 240,000 PTS: 1 DIF: Medium OBJ: Part II TYPE: Problems TOP: Sales level 16. ANS: E Working up the income statement you calculate the new sales level should be $10,833,333. Sales $10,833,333 $4,333,333/(1 − 0.6) Operating costs (excl. depr. and amort.)(60%) 6,500,000 $10,833,333 × 0.6 EBITDA $ 4,333,333 $3,833,333 + $500,000 Depreciation and amortization 500,000 EBIT $ 3,833,333 $3,333,333 + $500,000 Interest 500,000 EBT $ 3,333,333 $2,000,000/0.6 Taxes (40%) 1,333,333 Net income $ 2,000,000 PTS: 1 DIF: Medium OBJ: Part II TYPE: Problems TOP: Sales level 17. ANS: B NPV = $10,000/1.08 + $25,000/(1.08)2 + $50,000/(1.08)3 + $35,000/(1.08)4 = $9,259.26 + $21,433.47 + $39,691.61 + $25,726.04 = $96,110.38 ≈ $96,110. Financial calculator solution (using the cash flow register): Inputs: CF0 = 0; CF1 = 10000; CF2 = 25000; CF3 = 50000; CF4 = 35000; I/YR = 8. Output: NPV = $96,110.39 ≈ $96,110. PTS: 1 DIF: Easy/Medium OBJ: Part II TYPE: Problems TOP: PV of an uneven CF stream 18. ANS: C The effective rate is given by: NOM% = 8; P/YR = 4; and solve for EFF% = 8.2432%. The nominal rate on a semiannual basis is given by: EFF% = 8.2432; P/YR = 2; and solve for NOM% = 8.08%. The future value is given by: N = 2.5 × 2 = 5; I/YR = 8.08/2 = 4.04; PV = 0; PMT = -100; and solve for FV = $542.07. PTS: 1 DIF: Medium OBJ: Part II TYPE: Problems TOP: FV under quarterly compounding 19. ANS: A First, calculate the profit margin, which equals NI/Sales: ROA = NI/TA = 0.04. Sales/TA = S/TA = 2. PM = (NI/TA)(TA/S) = 0.04(0.5) = 0.02. [TA/S = 1/2 = 0.5.] Next, find the debt ratio by finding the equity ratio: E/TA = (E/NI)(NI/TA). [ROE = NI/E and ROA = NI/TA.] E/TA = (1/ROE)(ROA) = (1/0.06)(0.04) = 0.667, or 66.7% equity. Therefore, D/TA must be 0.333 = 33.3%. PTS: 1 DIF: Medium OBJ: Part II TYPE: Problems TOP: Du Pont equation 20. ANS: E EPS = $750,000/100,000 = $7.50. P/E = Price/EPS = 8. Thus, Price = 8 × $7.50 = $60.00. PTS: 1 DIF: Medium OBJ: Part II TYPE: Problems TOP: P/E ratio and stock price 21. ANS: E Step 1: We must find TA. We are given BEP and EBIT. and . Therefore, TA = $40,000,000/0.1, or $400 million. Step 2: NI/TA = ROA, so now we need to find net income. Net income is found by working through the income statement (in millions): EBIT $40 Interest 5 (from TIE ratio: 8 = EBIT/Int) EBT $35 Taxes (40%) 14 NI $21 Step 3: ROA = $21/$400 = 0.0525 = 5.25%. PTS: 1 DIF: Medium OBJ: Part II TYPE: Problems TOP: ROA 22. ANS: D Profit margin = ($1,500(1 − 0.3))/$5,000 = 21%. Equity multiplier = 1.0 since firm is 100% equity financed. ROE = (Profit margin)(Assets turnover)(Equity multiplier) = (21%)(2.0)(1.0) = 42%. PTS: 1 DIF: Medium OBJ: Part II TYPE: Problems TOP: ROE 23. ANS: B TA = $8,000,000,000; T = 40%; EBIT/TA = 12%; ROA = 3%; TIE ? = $960,000,000 = $240,000,000 Now use the income statement format to determine interest so you can calculate the firm's TIE ratio. TIE = EBIT/INT = $960,000,000/$560,000,000 = 1.7143 ≈ 1.71. PTS: 1 DIF: Medium OBJ: Part II TYPE: Problems TOP: TIE ratio 24. ANS: C Debt ratio = Debt/Total assets. Sales/Total assets = 6 Total assets = $24,000,000/6 = $4,000,000. ROE = NI/Equity Equity = NI/ROE = $400,000/0.15 = $2,666,667. Debt = Total assets − Equity = $4,000,000 − $2,666,667 = $1,333,333. Debt ratio = $1,333,333/$4,000,000 = 0.3333. PTS: 1 DIF: Medium OBJ: Part II TYPE: Problems TOP: Debt ratio 25. ANS: D Given ROA = 10% and net income of $500,000, total assets must be $5,000,000. ROA = 10% = TA = $5,000,000. To calculate BEP, we still need EBIT. To calculate EBIT construct a partial income statement: EBIT $1,033,333 ($200,000 + $833,333) Interest 200,000 (Given) EBT $ 833,333 $500,000/0.6 Taxes (40%) 333,333 NI $ 500,000 BEP = = = 0.2067 = 20.67%. PTS: 1 DIF: Medium/Hard OBJ: Part II TYPE: Problems TOP: Basic earning power (BEP) 26. ANS: E PTS: 1 DIF: Medium OBJ: Part I TYPE: Problems TOP: Estimating the 1-year forward rate 27. ANS: D Average inflation = . rRF = r* + IP = 3% + 5% = 8%. PTS: 1 DIF: Easy/Medium OBJ: Part I TYPE: Problems TOP: Expected interest rates 28. ANS: C r2 = 2 year rate today r3 = 3 year rate today 2r 1 = 1 year rate, two years from now (1 + r3)3= (1 + r2)2(1 + 2r1) (1.06)3= (1.055)2(1 + 2r1) 2r1= 7.01% PTS: 1 DIF: Easy/Medium OBJ: Part I TYPE: Problems TOP: Expectations theory 29. ANS: C rNom = r* + IP + DRP + LP + MRP 8.5% = 3% + IP + 0 + 0 + 0 IP = 5.5%. PTS: 1 DIF: Easy/Medium OBJ: Part I TYPE: Problems TOP: Inflation rate 30. ANS: B The return on the 5-year corporate bond is calculated as follows: r5 = r* + IP + MRP + DRP + LP 8.4% = 3% + [(2% × 3) + (4% × 2)]/5 + 0.4% + DRP + LP DRP + LP = 2.2%. Now, calculate the 7-year corporate bond yield: r7 = 3% + [(2% × 3) + (4% × 4)]/7 + 0.6% + 2.2% = 3% + 3.1429% + 0.6% + 2.2% = 8.9429% ≈ 8.94%. PTS: 1 DIF: Medium OBJ: Part I TYPE: Problems TOP: Expected interest rates 31. ANS: A r3 = 3 year rate today 3r 1 = 1 year rate, three years from now r4 = 4 year rate today (1 + r4)4= (1 + r3)3(1 + 3r1) (1.065)4= (1.06)3(1 + 3r1) 3r1= 8.01% PTS: 1 DIF: Medium OBJ: Part I TYPE: Problems TOP: Expected interest rates 32. ANS: B r = r* + IP + MRP; DRP = LP = 0. IP = [(3%)5 + (5%)7]/12 = 4.1667%. MRP = 0.1%(12 − 1) = 1.1%. r12 = 3% + 4.17% + 1.1% = 8.27%. PTS: 1 DIF: Medium/Hard OBJ: Part I TYPE: Problems TOP: Expected interest rates 33. ANS: E PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems TOP: Yield to maturity 34. ANS: A PTS: 1 DIF: Easy/Medium OBJ: Part I TYPE: Problems TOP: Current yield 35. ANS: D PTS: 1 DIF: Medium OBJ: Part I TYPE: Problems TOP: Bond valuation--semiannual coupons 36. ANS: C PTS: 1 DIF: Medium/Hard OBJ: Part I TYPE: Problems TOP: Determining the coupon rate 37. ANS: B PTS: 1 DIF: Medium/Hard OBJ: Part I TYPE: Problems TOP: Yields to maturity and call 38. ANS: B Enter the following input data in the calculator: N = 18; PV = -920; PMT = 35; FV = 1000; and then solve for I/YR = 4.1391%. Convert this semiannual periodic rate to a nominal annual rate, 4.1391% × 2 = 8.2782% ≈ 8.28%. PTS: 1 DIF: Easy/Medium OBJ: Part II TYPE: Problems TOP: Yield to maturity--semiannual bond 39. ANS: B Enter the following data as inputs in your calculator: N = 2 × 5 = 10; PV = -1075; PMT = 0.09/2 × 1,000 = 45; FV = 1035; and then solve for I/YR = rd/2 = 3.8743%. Since this is a 6-month rate, just multiply by 2 to solve for the nominal yield to call. I/YR = rd = 2 × 3.8743% = 7.7486% ≈ 7.75%. PTS: 1 DIF: Medium OBJ: Part II TYPE: Problems TOP: Yield to call--semiannual bond 40. ANS: A PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems TOP: Expected return 41. ANS: E PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems TOP: Portfolio beta 42. ANS: B PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems TOP: CAPM 43. ANS: C PTS: 1 DIF: Medium OBJ: Part I TYPE: Problems TOP: CAPM 44. ANS: B PTS: 1 DIF: Medium OBJ: Part I TYPE: Problems TOP: CAPM 45. ANS: C PTS: 1 DIF: Medium/Hard OBJ: Part I TYPE: Problems TOP: Portfolio beta 46. ANS: A 13.75% = 5% + 7%(b) 8.75% = 7%(b) b = 1.25. PTS: 1 DIF: Easy/Medium OBJ: Part II TYPE: Problems TOP: Beta coefficient 47. ANS: A The portfolio's beta is a weighted average of the individual security betas as follows: ($50,000/$75,000)1.5 + ($25,000/$75,000)0.9 = 1.3. The required rate of return is then simply: 4% + 2%(1.3) = 6.6%. PTS: 1 DIF: Medium OBJ: Part II TYPE: Problems TOP: Portfolio return 48. ANS: C J = (0.2)(0.10) + (0.6)(0.15) + (0.2)(0.20) = 0.15 = 15.0%. Expected return = 15.0%. = (0.2)(0.10 − 0.15)2 + 0.6(0.15 − 0.15)2 + (0.2)(0.20 − 0.15)2 = 0.001. Standard deviation = = 0.0316 = 3.16%. PTS: 1 DIF: Medium OBJ: Part II TYPE: Problems TOP: Expected return 49. ANS: B PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems TOP: Expected total return 50. ANS: A PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems TOP: Constant growth valuation 51. ANS: B PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems TOP: Constant growth rate 52. ANS: E PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems TOP: Future price of a constant growth stock 53. ANS: C PTS: 1 DIF: Medium OBJ: Part I TYPE: Problems TOP: Constant growth valuation; CAPM 54. ANS: D First, find the stock price after two years: D1 = $1.20. D2 = $1.20 × 1.15 = $1.38. D3 = $1.38 × 1.05 = $1.449. = D3/(rs − g) = $1.449/(0.12 − 0.05) = $20.70. Next, determine the dividends during the nonconstant growth period: D1 = $1.00 × 1.2 = $1.20. D2 = $1.20 × 1.15 = $1.38. Finally, determine the company's current stock price: Numerical solution: Financial calculator solution: Enter in CFLO register CF0 = 0, CF1 = 1.20, and CF2 = 22.08. Then enter I/YR = 12, and press NPV to get NPV = P0 = $18.67. PTS: 1 DIF: Medium/Hard OBJ: Part II TYPE: Problems TOP: Nonconstant growth stock 55. ANS: E PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems TOP: Component cost of preferred stock 56. ANS: D PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems TOP: Component cost of retained earnings: CAPM 57. ANS: C PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems TOP: Component cost of retained earnings: DCF, D 58. ANS: D PTS: 1 DIF: Easy OBJ: Part I TYPE: Problems TOP: WACC 59. ANS: A PTS: 1 DIF: Medium OBJ: Part I TYPE: Problems TOP: Component cost of new common stock, based on DCF, D 60. ANS: B Calculate the nominal YTM of bond: Inputs: N = 80; PV = -686.86; PMT = 20; FV = 1000. Output: I/YR = 3.05% periodic rate. Nominal annual rate = 3.05% × 4 = 12.20%. Calculate rd after-tax: rd,AT = 12.20(1 − T) = 12.20(1 − 0.4) = 7.32%. PTS: 1 DIF: Medium OBJ: Part II TYPE: Problems TOP: Component cost of debt