21. Which of the following is usually cited as a disadvantage of issuing new common stock as a method of financing?
a. Common stock does not have a maturity date, thus it is an open-end commitment of the firm’s earnings.
b. Since sale of common stock increases the number of owners and the amount of capital at risk, the firm’s bond rating is usually negatively affected and its cost of debt rises.
c. If the firm currently has more equity than its optimal capital structure dictates and it issues more equity, then the average cost of capital will most likely rise.
d. Common stock is not an attractive option if the firm seeks to increase its reserve borrowing capacity.
22. You have determined the profitability of a planned project by finding the present value of all the cash flows form that project. Which of the following would cause the project to look more appealing in terms of the present value of those cash flows?
a. The discount rate decreases.
b. The cash flows are extended over a longer period of time, but the total amount of the cash flows remains the same.
c. The discount rate increases.
d. Answers b and c above.
e. Answers a and b above.
23. Which of the following statements is correct?
a. For all positive values of k and n, FVIFr, n ? 1.0 and PVIFAr, n ? n.
b. You may use the PVIF tables to find the present value of an uneven series of payments. However, the PVIFA tables can never be of use, even if some of the payments constitute an annuity (for example, $100 each year for Years 3, 4, and 5), because the entire series does not constitute an annuity.
c. If a bank uses quarterly compounding for saving accounts, the simple rate will be greater than the effective annual rate.
d. The present value of a future sum decreases as either the simple interest rate or the number of discount periods per year increases.
e. All of the above statements are false.
Problems:
31. The Amer Company has the following characteristics:
Sales: $1,000
Total Assets: $1,000
Total Debt/Total Assets: 35%
EBIT: $ 200
Tax rate: 40%
Interest rate on total debt: 4.57%
What is Amer’s ROE? (5 points)
32. The Meryl Corporation’s common stock currently is selling at $100 per share, which represents a P/E ratio of 10. If the firm has 100 shares of common stock outstanding, a return on equity of 20 percent, and a debt ratio of 60 percent, what is its return on total assets (ROA)? (5 points)
33. You deposited $1,000 in a savings account that pays 8 percent interest, compounded quarterly, planning to use it to finish your last year in college. Eighteen months later, you decide to go to the Rocky Mountains to become a ski instructor rather than continue in school, so you close out your account. How much money will you receive? (5 points)
34. Assume that you can invest to earn a stated annual rate of return of 12 percent, but where interest is compounded semiannually. If you make 20 consecutive semiannual deposits of $500 each, with the first deposit being made today, what will your balance be at the end of Year 20? (5 points)
35. In its first year of operations, 1999, the Gourmet Cheese Shoppe had earnings per share (EPS) of $0.26. Four years later, in 2003, EPS was up to $0.38, and 7 years after that, in 2010, EPS was up to $0.535. It appears that the first 4 years represented a supernormal growth situation and since then a more normal growth rate has been sustained. What are the rates of growth for the earlier period and for the later period? (5 points)
36. Treasury securities that mature in 6 years currently have an interest rate of 8.5%. Inflation is expected to be 5% each of the next three years and 6% each year after the third year. The maturity risk premium is estimated to be 0.1%(t – 1), where t is equal to the maturity of the bond (i.e., the maturity risk premium of a one-year bond is zero). The real risk-free rate is assumed to be constant over time. What is the real risk-free rate of interest? (5 points)
37. Assume that you wish to purchase a 20-year bond that has a maturity value of $1,000 and makes semiannual interest payments of $40. If you require a 10 percent simple yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond? (5 points)
38. Blow Glass Corporation has 100,000 shares of stock outstanding, each with a par value of $2.50 per share. Blow Glass also has another 400,000 shares of stock that are shelf registered. Blow Glass has retained earnings of $9,000,000 and additional paid-in capital of $1,000,000. What is Blow Glass’s book value per share? (5 points)
