FIN 534 Midterm Exam Part 1 & 2 (Latest) 100% Answer

Part 1
1. Which of the following statements is CORRECT?
The New York Stock Exchange is an auction market with a physical location.
Capital market transactions involve only the purchase and sale of equity securities i.e. common stocks.
If an investor sells shares of stock through a broker then this would be a primary market transaction.
Consumer automobile loans are evidenced by legal documents called promissory notes and these individual notes are traded in the money market.
While the distinctions are blurring as investment banks are today buying commercial banks and vice versa investment banks generally specialize in lending money whereas commercial banks generally help companies raise capital from other parties.
2. Which of the following statements is CORRECT?
It is usually easier to transfer ownership in a corporation than it is to transfer ownership in a sole proprietorship.
Corporate shareholders are exposed to unlimited liability.
Corporations generally face fewer regulations than sole proprietorships.
Corporate shareholders are exposed to unlimited liability and this factor may be compounded by the tax disadvantages of incorporation.
Shareholders in a regular corporation (not an S corporation) pay higher taxes than owners of an otherwise identical proprietorship.
3. Which of the following statements is CORRECT?
While the distinctions are blurring investment banks generally specialize in lending money whereas commercial banks generally help companies raise capital from other parties.
A security whose value is derived from the price of some other underlying asset is called a liquid security.
Money market mutual funds usually invest most of their money in a well-diversified portfolio of liquid common stocks.
Money markets are markets for common stocks and long-term debt.
The NYSE operates as an auction market whereas the Nasdaq is a dealer market.
4. Which of the following statements is CORRECT?
Capital market instruments include both long-term debt and common stocks.
An example of a primary market transaction would be your uncle transferring 100 shares of Wal-Mart stock to you as a birthday gift.
The NYSE does not exist as a physical location; rather it represents a loose collection of dealers who trade stocks electronically.
If your uncle in New York sold 100 shares of Microsoft through his broker to an investor in Los Angeles this would be a primary market transaction.
While the two frequently perform similar functions investment banks generally specialize in lending money whereas commercial banks generally help companies raise large blocks of capital from investors.
5. Which of the following could explain why a business might choose to operate as a corporation rather than as a sole proprietorship or a partnership?
Corporations generally find it relatively difficult to raise large amounts of capital.
Less of a corporation’s income is generally subjected to taxes than would be true if the firm were a partnership.
Corporate shareholders escape liability for the firm’s debts but this factor may be offset by the tax disadvantages of the corporate form of organization.
Corporate investors are exposed to unlimited liability.
Corporations generally face relatively few regulations.
6. You recently sold 100 shares of your new company XYZ Corporation to your brother at a family reunion. At the reunion your brother gave you a check for the stock and you gave your brother the stock certificates. Which of the following statements best describes this transaction?
This is an example of an exchange of physical assets.
This is an example of a primary market transaction.
This is an example of a direct transfer of capital.
This is an example of a money market transaction.
This is an example of a derivatives market transaction
7. Money markets are markets for
Foreign stocks.
Consumer automobile loans.
U.S. stocks.
Short-term debt securities.
Long-term bonds.
8. Which of the following statements is CORRECT?
If Apple issues additional shares of common stock through an investment banker this would be a secondary market transaction.
If you purchased 100 shares of Apple stock from your sister-in-law this would be an example of a primary market transaction.
The IPO market is a subset of the secondary market.
Only institutions and not individuals can participate in derivatives market transactions.
As they are generally defined money market transactions involve debt securities with maturities of less than one year.
9. DeYoung Devices Inc. a new high-tech instrumentation firm is building and equipping a new manufacturing facility. Assume that currently its equipment must be depreciated on a straight-line basis over 10 years but Congress is considering legislation that would require the firm to depreciate the equipment over 7 years. If the legislation becomes law which of the following would occur in the year following the change?
The firm’s reported net income would increase.
The firm’s operating income (EBIT) would increase.
The firm’s taxable income would increase.
The firm’s net cash flow would increase.
The firm’s tax payments would increase.
10. Which of the following factors could explain why Regal Industrial Fixtures had a negative net cash flow last year even though the cash on its balance sheet increased?
The company repurchased 20% of its common stock.
The company sold a new issue of bonds.
The company made a large investment in new plant and equipment.
The company paid a large dividend.
The company had high amortization expenses.
11. Which of the following statements is CORRECT?
The statement of cash flows shows how much the firm’s cashthe total of currency bank deposits and short-term liquid securities (or cash equivalents)increased or decreased during a given year.
The statement of cash flows reflects cash flows from operations but it does not reflect the effects of buying or selling fixed assets.
The statement of cash flows shows where the firm’s cash is located; indeed it provides a listing of all banks and brokerage houses where cash is on deposit.
The statement of cash flows reflects cash flows from continuing operations but it does not reflect the effects of changes in working capital.
The statement of cash flows reflects cash flows from operations and from borrowings but it does not reflect cash obtained by selling new common stock.
12. Which of the following statements is CORRECT?
One way to increase EVA is to achieve the same level of operating income but with more investor-supplied capital.
If a firm reports positive net income its EVA must also be positive.
One drawback of EVA as a performance measure is that it mistakenly assumes that equity capital is free.
One way to increase EVA is to generate the same level of operating income but with less investor-supplied capital.
Actions that increase reported net income will always increase net cash flow.
13. The LeMond Corporation just purchased a new production line. Assume that the firm planned to depreciate the equipment over 5 years on a straight-line basis but Congress then passed a provision that requires the company to depreciate the equipment on a straight-line basis over 7 years. Other things held constant which of the following will occur as a result of this Congressional action? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes.
LeMond’s tax liability for the year will be lower.
LeMond’s taxable income will be lower.
LeMond’s net fixed assets as shown on the balance sheet will be higher at the end of the year.
LeMond’s cash position will improve (increase).
LeMond’s reported net income after taxes for the year will be lower.
14. Other things held constant which of the following actions would increase the amount of cash on a company’s balance sheet?
The company purchases a new piece of equipment.
The company repurchases common stock.
The company pays a dividend.
The company issues new common stock.
The company gives customers more time to pay their bills.
15. Which of the following statements is CORRECT?
All corporations other than non-profit corporations are subject to corporate income taxes which are 15% for the lowest amounts of income and 35% for the highest amounts of income.
The income of certain small corporations that qualify under the Tax Code is completely exempt from corporate income taxes. Thus the federal government receives no tax revenue from these businesses.
All businesses regardless of their legal form of organization are taxed under the Business Tax Provisions of the Internal Revenue Code.
Small businesses that qualify under the Tax Code can elect not to pay corporate taxes but then their owners must report their pro rata shares of the firm’s income as personal income and pay taxes on that income.
Congress recently changed the tax laws to make dividend income received by individuals exempt from income taxes. Prior to the enactment of that law corporate income was subject to double taxation where the firm was first taxed on the income and stockholders were taxed again on the income when it was paid to them as dividends.
16. Which of the following statements is CORRECT?
The primary difference between EVA and accounting net income is that when net income is calculated a deduction is made to account for the cost of common equity whereas EVA represents net income before deducting the cost of the equity capital the firm uses.
MVA gives us an idea about how much value a firm’s management has added during the last year.
MVA stands for market value added and it is defined as follows:
MVA = (Shares outstanding)(Stock price) + Book value of common equity.
EVA stands for economic value added and it is defined as follows:
EVA = EBIT(1 – T) – (Investor-supplied op. capital) x (A – T cost of capital).
EVA gives us an idea about how much value a firm’s management has added over the firm’s life.
17. Which of the following items cannot be found on a firm’s balance sheet under current liabilities?
Accrued payroll taxes.
Accounts payable.
Short-term notes payable to the bank.
Accrued wages.
Cost of goods sold.
18. Which of the following statements is CORRECT?
If a firm increases its sales and cost of goods sold while holding its inventories constant then other things held constant its inventory turnover ratio will decrease.
A reduction in inventories held would have no effect on the current ratio.
An increase in inventories would have no effect on the current ratio.
If a firm increases its sales and cost of goods sold while holding its inventories constant then other things held constant its inventory turnover ratio will increase.
A reduction in the inventory turnover ratio will generally lead to an increase in the ROE.
19. Which of the following would generally indicate an improvement in a company’s financial position holding other things constant?
The total assets turnover decreases.
The TIE declines.
The DSO increases.
The EBITDA coverage ratio increases.
The current and quick ratios both decline.
20. Cordelion Communications is considering issuing new common stock and using the proceeds to reduce its outstanding debt. The stock issue would have no effect on total assets the interest rate Cordelion pays EBIT or the tax rate. Which of the following is likely to occur if the company goes ahead with the stock issue?
The times interest earned ratio will decrease.
The ROA will decline.
Taxable income will decrease.
The tax bill will increase.
Net income will decrease.
21. Which of the following would indicate an improvement in a company’s financial position holding other things constant?
The current and quick ratios both increase.
The inventory and total assets turnover ratios both decline.
The debt ratio increases.
The profit margin declines.
The EBITDA coverage ratio declines.
22. The Cavendish Company recently issued new common stock and used the proceeds to pay off some of its short-term notes payable. This action had no effect on the company’s total assets or operating income. Which of the following effects would occur as a result of this action?
The company’s debt ratio increased.
The company’s current ratio increased.
The company’s times interest earned ratio decreased.
The company’s basic earning power ratio increased.
The company’s equity multiplier increased.
23. If a bank loan officer were considering a company’s request for a loan which of the following statements would you consider to be CORRECT?
Other things held constant the lower the current ratio the lower the interest rate the bank would charge the firm.
The lower the company’s EBITDA coverage ratio other things held constant the lower the interest rate the bank would charge the firm.
Other things held constant the higher the debt ratio the lower the interest rate the bank would charge the firm.
Other things held constant the lower the debt ratio the lower the interest rate the bank would charge the firm.
The lower the company’s TIE ratio other things held constant the lower the interest rate the bank would charge the firm.
24. Arshadi Corp.’s sales last year were $52000 and its total assets were $22000. What was its total assets turnover ratio (TATO)?
2.03
2.13
2.25
2.36
2.48
25. Companies A and C each reported the same earnings per share (EPS) but Company A’s stock trades at a higher price. Which of the following statements is CORRECT?
Company A trades at a higher P/E ratio.
Company A probably has fewer growth opportunities.
Company A is probably judged by investors to be riskier.
Company A must have a higher market-to-book ratio.
Company A must pay a lower dividend.
Part 2
1 Which of the following statements regarding a 20-year (240-month) $225000 fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.)
The outstanding balance declines at a slower rate in the later years of the loan’s life.
The remaining balance after three years will be $225000 less one third of the interest paid during the first three years.
Because it is a fixed-rate mortgage the monthly loan payments (which include both interest and principal payments) are constant.
Interest payments on the mortgage will increase steadily over time but the total amount of each payment will remain constant.
The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from now than it will be the first year.
2. Which of the following statements is CORRECT assuming positive interest rates and holding other things constant?
Banks A and B offer the same nominal annual rate of interest but A pays interest quarterly and B pays semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit.
The present value of a 5-year $250 annuity due will be lower than the PV of a similar ordinary annuity.
A 30-year $150000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage.
A bank loan’s nominal interest rate will always be equal to or less than its effective annual rate.
If an investment pays 10% interest compounded annually its effective annual rate will be less than 10%.
3. Ellen now has $125. How much would she have after 8 years if she leaves it invested at 8.5% with annual compounding?
$205.83
$216.67
$228.07
$240.08
$252.08
4. You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would increase the calculated value of the investment?
The discount rate increases.
The cash flows are in the form of a deferred annuity and they total to $100000. You learn that the annuity lasts for 10 years rather than 5 years hence that each payment is for $10000 rather than for $20000.
The discount rate decreases.
The riskiness of the investment’s cash flows increases.
The total amount of cash flows remains the same but more of the cash flows are received in the later years and less are received in the earlier years.
5. Which of the following statements is CORRECT?
An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%.
The present value of a 3-year $150 ordinary annuity will exceed the present value of a 3-year $150 annuity due.
If a loan has a nominal annual rate of 7% then the effective rate will never be less than 7%.
If a loan or investment has annual payments then the effective periodic and nominal rates of interest will all be different.
The proportion of the payment that goes toward interest on a fully amortized loan increases over time.
6. A $150000 loan is to be amortized over 6 years with annual end-of-year payments. Which of these statements is CORRECT?
The proportion of interest versus principal repayment would be the same for each of the 7 payments.
The annual payments would be larger if the interest rate were lower.
If the loan were amortized over 10 years rather than 6 years and if the interest rate were the same in either case the first payment would include more dollars of interest under the 6-year amortization plan.
The proportion of each payment that represents interest as opposed to repayment of principal would be higher if the interest rate were lower.
The proportion of each payment that represents interest versus repayment of principal would be higher if the interest rate were higher.
7. Which of the following statements is CORRECT?
If a 10-year $1000 par 10% coupon bond were issued at par and if interest rates then dropped to the point where rd = YTM = 5% we could be sure that the bond would sell at a premium above its $1000 par value.
Other things held constant a corporation would rather issue noncallable bonds than callable bonds.
Other things held constant a callable bond would have a lower required rate of return than a noncallable bond.
Reinvestment rate risk is worse from an investor’s standpoint than interest rate price risk if the investor has a short investment time horizon.
If a 10-year $1000 par zero coupon bond were issued at a price that gave investors a 10% yield to maturity and if interest rates then dropped to the point where rd = YTM = 5% the bond would sell at a premium over its $1000 par value.
8. A 10-year bond with a 9% annual coupon has a yield to maturity of 8%. Which of the following statements is CORRECT?
The bond is selling below its par value.
The bond is selling at a discount.
If the yield to maturity remains constant the bond’s price one year from now will be lower than its current price.
The bond’s current yield is greater than 9%.
If the yield to maturity remains constant the bond’s price one year from now will be higher than its current price.
9 Which of the following statements is NOT CORRECT?
All else equal bonds with longer maturities have more interest rate (price) risk than bonds with shorter maturities.
If a bond is selling at its par value its current yield equals its yield to maturity.
If a bond is selling at a premium its current yield will be greater than its yield to maturity.
All else equal bonds with larger coupons have greater interest rate (price) risk than bonds with smaller coupons.
If a bond is selling at a discount to par its current yield will be less than its yield to maturity.
10. A 10-year corporate bond has an annual coupon of 9%. The bond is currently selling at par ($1000). Which of the following statements is NOT CORRECT?
The bond’s yield to maturity is 9%.
The bond’s current yield is 9%.
If the bond’s yield to maturity remains constant the bond will continue to sell at par.
The bond’s current yield exceeds its capital gains yield.
The bond’s expected capital gains yield is positive.
11. Which of the following statements is CORRECT?
If a coupon bond is selling at a discount its price will continue to decline until it reaches its par value at maturity.
If interest rates increase the price of a 10-year coupon bond will decline by a greater percentage than the price of a 10-year zero coupon bond.
If a bond’s yield to maturity exceeds its annual coupon then the bond will trade at a premium.
If a coupon bond is selling at a premium its current yield equals its yield to maturity.
If a coupon bond is selling at par its current yield equals its yield to maturity.
12. A 10-year bond pays an annual coupon its YTM is 8% and it currently trades at a premium. Which of the following statements is CORRECT?
If the yield to maturity remains at 8% then the bond’s price will decline over the next year.
The bond’s coupon rate is less than 8%.
If the yield to maturity increases then the bond’s price will increase.
If the yield to maturity remains at 8% then the bond’s price will remain constant over the next year.
The bond’s current yield is less than 8%.
13. Bonds A and B are 15-year $1000 face value bonds. Bond A has a 7% annual coupon while Bond B has a 9% annual coupon. Both bonds have a yield to maturity of 8% which is expected to remain constant for the next 15 years. Which of the following statements is CORRECT?
One year from now Bond A’s price will be higher than it is today.
Bond A’s current yield is greater than 8%.
Bond A has a higher price than Bond B today but one year from now the bonds will have the same price.
Both bonds have the same price today and the price of each bond is expected to remain constant until the bonds mature.
Bond B has a higher price than Bond A today but one year from now the bonds will have the same price.
14. Which of the following statements is CORRECT?
The SML shows the relationship between companies’ required returns and their diversifiable risks. The slope and intercept of this line cannot be influenced by a firm’s managers but the position of the company on the line can be influenced by its managers.
Suppose you plotted the returns of a given stock against those of the market and you found that the slope of the regression line was negative. The CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor assuming investors expect the observed relationship to continue on into the future.
If investors become less risk averse the slope of the Security Market Line will increase.
If a company increases its use of debt this is likely to cause the slope of its SML to increase indicating a higher required return on the stock.
The slope of the SML is determined by the value of beta.
15. Which of the following statements is CORRECT?
A portfolio that consists of 40 stocks that are not highly correlated with the market will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market assuming the stocks all have the same standard deviations.
A two-stock portfolio will always have a lower beta than a one-stock portfolio.
If portfolios are formed by randomly selecting stocks a 10-stock portfolio will always have a lower beta than a one-stock portfolio.
A stock with an above-average standard deviation must also have an above-average beta.
A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio.
16. Stocks A and B each have an expected return of 15% a standard deviation of 20% and a beta of 1.2. The returns on the two stocks have a correlation coefficient of +0.6. Your portfolio consists of 50% A and 50% B. Which of the following statements is CORRECT?
The portfolio’s expected return is 15%.
The portfolio’s standard deviation is greater than 20%.
The portfolio’s beta is greater than 1.2.
The portfolio’s standard deviation is 20%.
The portfolio’s beta is less than 1.2.
17. Stock X has a beta of 0.7 and Stock Y has a beta of 1.7. Which of the following statements must be true according to the CAPM?
Stock Y’s realized return during the coming year will be higher than Stock X’s return.
If the expected rate of inflation increases but the market risk premium is unchanged the required returns on the two stocks should increase by the same amount.
Stock Y’s return has a higher standard deviation than Stock X.
If the market risk premium declines but the risk-free rate is unchanged Stock X will have a larger decline in its required return than will Stock Y.
If you invest $50000 in Stock X and $50000 in Stock Y your 2-stock portfolio would have a beta significantly lower than 1.0 provided the returns on the two stocks are not perfectly correlated.
18. Assume that the risk-free rate remains constant but the market risk premium declines. Which of the following is most likely to occur?
The required return on a stock with beta 1.0 will increase.
The return on the market will remain constant.
The return on the market will increase.
The required return on a stock with beta < 1.0 will decline. The required return on a stock with beta = 1.0 will not change. 19. Which of the following statements is CORRECT? The higher the correlation between the stocks in a portfolio the lower the risk inherent in the portfolio. An investor can eliminate almost all risk if he or she holds a very large and well diversified portfolio of stocks. Once a portfolio has about 40 stocks adding additional stocks will not reduce its risk by even a small amount. An investor can eliminate almost all diversifiable risk if he or she holds a very large well-diversified portfolio of stocks. An investor can eliminate almost all market risk if he or she holds a very large and well diversified portfolio of stocks. 20. Franklin Corporation is expected to pay a dividend of $1.25 per share at the end of the year (D1 = $1.25). The stock sells for $32.50 per share and its required rate of return is 10.5%. The dividend is expected to grow at some constant rate g forever. What is the equilibrium expected growth rate? 6.01% 6.17% 6.33% 6.49% 6.65% 21. A stock just paid a dividend of D0 = $1.50. The required rate of return is rs = 10.1% and the constant growth rate is g = 4.0%. What is the current stock price? $23.11 $23.70 $24.31 $24.93 $25.57 22. Stocks A and B have the same price and are in equilibrium but Stock A has the higher required rate of return. Which of the following statements is CORRECT? Stock B must have a higher dividend yield than Stock A. Stock A must have a higher dividend yield than Stock B. If Stock A has a higher dividend yield than Stock B its expected capital gains yield must be lower than Stock B's. Stock A must have both a higher dividend yield and a higher capital gains yield than Stock B. If Stock A has a lower dividend yield than Stock B its expected capital gains yield must be higher than Stock B's. 23. Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium which of the following statements is CORRECT? A B Price $25 $40 Expected growth 7% 9% Expected return 10% 12% The two stocks could not be in equilibrium with the numbers given in the question. A's expected dividend is $0.50. B's expected dividend is $0.75. A's expected dividend is $0.75 and B's expected dividend is $1.20. The two stocks should have the same expected dividend. 24. Which of the following statements is NOT CORRECT? The corporate valuation model discounts free cash flows by the required return on equity. The corporate valuation model can be used to find the value of a division. An important step in applying the corporate valuation model is forecasting the firm's pro forma financial statements. Free cash flows are assumed to grow at a constant rate beyond a specified date in order to find the horizon or terminal value. The corporate valuation model can be used both for companies that pay dividends and those that do not pay dividends. 25. Which of the following statements is CORRECT? Preferred stock is normally expected to provide steadier more reliable income to investors than the same firm's common stock and as a result the expected after-tax yield on the preferred is lower than the after-tax expected return on the common stock. The preemptive right is a provision in all corporate charters that gives preferred stockholders the right to purchase (on a pro rata basis) new issues of preferred stock. One of the disadvantages to a corporation of owning preferred stock is that 70% of the dividends received represent taxable income to the corporate recipient whereas interest income earned on bonds would be tax free. One of the advantages to financing with preferred stock is that 70% of the dividends paid out are tax deductible to the issuer. A major disadvantage of financing with preferred stock is that preferred stockholders typically have supernormal voting rights.