Test: Final Exam – Fall 1, 2013 Questions

Foundations of
Financial Management (10248) –

Test: Final Exam – Fall 1, 2013 Questions

Which of the following statements is CORRECT?

a. Call options generally sell at a price greater than their
exercise value, and the greater the exercise value, the higher the premium
on the option is likely to be.

b. Call options generally sell at a price below their
exercise value, and the lower the exercise value, the lower the premium on
the option is likely to be.

c. Call options generally sell at a price below their
exercise value, and the greater the exercise value, the lower the premium
on the option is likely to be.

d. If
the underlying stock does not pay a dividend, it does not make good
economic sense to exercise a call option prior to its expiration date, even
if this would yield an immediate profit.

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.

Which of the following statements is CORRECT?

a. Only institutions, and not individuals, can participate
in derivatives market transactions.

b. As
they are generally defined, money market transactions involve debt
securities with maturities of less than one year.

c. The IPO market is a subset of the secondary market.

d. If Disney issues additional shares of common stock
through an investment banker, this would be a secondary market transaction.

e. If you purchased 100 shares of Disney stock from your
brother-in-law, this would be an example of a primary market transaction.

Which of the following statements best describes what you should
expect if yourandomlyselect stocks and add them to your portfolio?

a. Adding more such stocks will reduce the portfolio’s beta
coefficient and thus its systematic risk.

b. Adding
more such stocks will reduce the portfolio’s unsystematic, or
diversifiable, risk.

c. Adding more such stocks will increase the portfolio’s
expected rate of return.

d. Adding more such stocks will reduce the portfolio’s
market risk but not its unsystematic risk.

e. Adding more such stocks will have no effect on the
portfolio’s risk.

Which of the following statements is CORRECT?

a. Corporations cannot buy the preferred stocks of other
corporations.

b. The
preferred stock of a given firm is generally less risky to investors than
the same firm’s common stock.

c. Preferred dividends are not generally cumulative.

d. Preferred stockholders have a priority over bondholders
in the event of bankruptcy to the income, but not to the proceeds in a
liquidation.

e. A big advantage of preferred stock is that dividends on
preferred stocks are tax deductible by the issuing corporation.

Which of the following statements is CORRECT?

a. The market value of a bond will always approach its par
value as its maturity date approaches. This holds true even if the firm has
filed for bankruptcy.

b. The yield to maturity for a coupon bond that sells at a
premium consists entirely of a positive capital gains yield; it has a zero
current interest yield.

c. On an expected yield basis, the expected capital gains
yield will always be positive because an investor would not purchase a bond
with an expected capital loss.

d. The
yield to maturity on a coupon bond that sells at its par value consists
entirely of a current interest yield; it has a zero expected capital gains yield.

e. Rising inflation makes the actual yield to maturity on a
bond greater than a quoted yield to maturity that is based on market
prices.

Which of the following statements regarding a 15-year
(180-month) $125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and
transactions costs.)

a. The remaining balance after three years will be $125,000
less one third of the interest paid during the first three years.

b. Because
it is a fixed-rate mortgage, the monthly loan payments (which include both
interest and principal payments) are constant.

c. Interest payments on the mortgage will increase steadily
over time, but the total amount of each payment will remain constant.

d. 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.

e. The outstanding balance declines at a slower rate in the
later years of the loan’s life.

Which of the following statements is CORRECT?

a. Hedge funds are legal in the United States, but they are
not permitted to operate in Europe or Asia.

b. Hedge funds are legal in Europe and Asia, but they are
not permitted to operate in the United States.

c. The
justification for the “light” regulation of hedge funds is that
only “sophisticated” investors with high net worths and high
incomes are permitted to invest in these funds, and such investors
supposedly can do the necessary “due diligence” on their own
rather than have it done by the SEC or some other regulator.

d. Hedge funds have more in common with commercial banks
than with any other type of financial institution.

e. Hedge funds have more in common with investment banks
than with any other type of financial institution

Companies E and P each reported the same earnings per share
(EPS), but Company E’s stock trades at a higher price. Which of the following statements
is CORRECT?

a. Company E must have a higher market-to-book ratio.

b. Company E is probably judged by investors to be riskier.

c. Company E must pay a lower dividend.

d. Company
E trades at a higher P/E ratio.

e. Company E probably has fewer growth
opportunities.

Other things held constant, the value of an option depends on
the stock’s price, the risk-free rate, and the

a. Variability of the stock price.

b. Option’s time to maturity.

c. Strike price.

d. All of these.

e. None of these.

Under normal conditions, which of
the following would be most likely to increase the coupon rate
required to enable a bond to be issued at par?

a. The rating agencies change the bond’s rating from Baa to
Aaa.

b. Adding a sinking fund.

c. Adding additional restrictive covenants that limit
management’s actions.

d. Adding
a call provision.

e. Making the bond a first mortgage bond rather than a
debenture.

A firm wants to strengthen its financial position. Which of the
following actions wouldincreaseits current ratio?

a. Use cash to increase inventory holdings.

b. Issue
new stock and then use some of the proceeds to purchase additional
inventory and hold the remainder as cash.

c. Reduce the company’s days’ sales outstanding to the
industry average and use the resulting cash savings to purchase plant and
equipment.

d. Borrow using short-term debt and use the proceeds to
repay debt that has a maturity of more than one year.

e. Use cash to repurchase some of the company’s own stock.

Which of the following statements is CORRECT?

a. Long-term bonds have less interest rate price risk and
also less reinvestment rate risk than short-term bonds.

b. One advantage of a zero coupon Treasury bond is that no
one who owns the bond has to pay any taxes on it until it matures or is
sold.

c.
Relative to a coupon-bearing bond with the same maturity, a zero coupon
bond has more interest rate price risk but less reinvestment rate risk.

d. If interest rates increase, all bond prices will
increase, but the increase will be greater for bonds that have less
interest rate risk.

e. Long-term bonds have less interest rate price risk but
more reinvestment rate risk than short-term bonds.

Other things held constant, which of the following actions wouldincreasethe
amount of cash on a company’s balance sheet?

a. The company repurchases common stock.

b. The company gives customers more time to pay their bills.

c. The
company issues new common stock.

d. The company purchases a new piece of equipment.

e. The company pays a dividend.

Which of the following statements is CORRECT?

a. Typically, a firm’s EBIT should exceed its EBITDA.

b. If a firm is more profitable than most other firms, we
would normally expect to see its book value per share exceed its stock
price, especially after several years of high inflation.

c. Typically, a firm’s DPS should exceed its EPS.

d. The more depreciation a firm has in a given year, the
higher its EPS, other things held constant.

e. If a firm is more
profitable than average (e.g., Google), we would normally expect to see its
stock price exceed its book value per share.

Part 2

Pearson
Brothers recently reported an EBITDA of $6.5 million and net income of $1.95
million. It had $2.34 million of interest expense, and its corporate tax rate
was 35%. What was its charge for depreciation and amortization?

$

Problem 4-22
Expected Rate of return

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Washington-Pacific invests $4 million to buy a tract of land and
plant some young pine trees. The trees can be harvested in 15 years, at which
time W-P plans to sell the forest at an expected price of $8 million. What is
W-P’s expected rate of return? Round your answer to two decimal places.

%

Problem 4-5
Number of Periods for an Annuity

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You have $35,666.34 in a brokerage account, and you plan to
deposit an additional $4,000 at the end of every future year until your account
totals $450,000. You expect to earn 8.8% annually on the account. How many
years will it take to reach your goal? Round your answer to the nearest whole.

years

roblem 4-25
Repaying a Loan

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While Mary Corens was a student at the University of Tennessee,
she borrowed $12,000 in student loans at an annual interest rate of 10.80%. If
Mary repays $1,500 per year, how long (to the nearest year) will it take her to
repay the loan?

year(s)

Problem 8-4
Put – Call Parity

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The current price
of a stock is $36, and the annual risk-free rate is 3%. A call option with a
strike price of $32 and 1 year until expiration has a current value of $6.80.
What is the value of a put option written on the stock with the same exercise
price and expiration date as the call option? Round your answer to the nearest
cent.

$

roblem 5-5
Default Risk Premium

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A Treasury bond that matures in 10 years has a yield of 3%. A
10-year corporate bond has a yield of 8%. Assume that the liquidity premium on
the corporate bond is 0.4%. What is the default risk premium on the corporate
bond? Round your answer to two decimal places.

%

Problem 7-1
DPS Calculation

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Thress Industries just paid a dividend of $2.00 a share (i.e., D0= 2.00). The dividend is expected to grow 7% a year for the next
3 years and then at 11% a year thereafter. What is the expected dividend per
share for each of the next 5 years? Round your answers to the nearest cent.

a.
D1=
$

b.
D2=
$

c.
D3=
$

d.
D4=
$

e.
D5=
$

roblem 3-8
Profit Margin and Debt Ratio

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Assume you are given the following relationships for the Clayton
Corporation:

Sales/total assets

1.4

Return on assets (ROA)

4%

Return on equity (ROE)

5%

1.
Calculate Clayton’s profit margin. Round your answer to two
decimal places.
%

2.
Calculate Clayton’s debt ratio. Round your answer to two decimal
places.
%

Problem 6-11
Required Rate of Return

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Stock R has a beta of 2.2, Stock S has a beta of 0.75, the
expected rate of return on an average stock is 13%, and the risk-free rate is
7%. By how much does the required return on the riskier stock exceed the
required return on the riskier stock exceed that on the less risky stock? Round
your answer to two decimal places.

%

Problem 4-2
Present Value of a Single Payment

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What is the present value of a security that will pay $5,000 in
30 years if securities of equal risk pay 6.1% annually? Round your answer to
the nearest cent.

$

Problem 3-5
Price/Earnings Ratio

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Needham Pharmaceuticals has a profit margin of 4% and an equity
multiplier of 2.1. Its sales are $90 million and it has total assets of $44
million. What is its ROE? Round your answer to two decimal places.

%

roblem 7-11
Nonconstant Growth Stock Valuation

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Assume that the average firm in your company’s industry is
expected to grow at a constant rate of 7% and that its dividend yield is 5%.
Your company is about as risky as the average firm in the industry, but it has
just successfully completed some R&D work that leads you to expect that its
earnings and dividends will grow at a rate of 50% [D1= D0(1 + g) = D0(1.50)] this year and 25%
the following year, after which growth should return to the 7% industry
average. If the last dividend paid (D0) was $1.5, what is the value
per share of your firm’s stock? Round your answer to the nearest cent. Do not
round your intermediate computations.

$

Problem 7-8
Preferred Stock Rate of Return

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What will be the nominal rate of return on a perpetual preferred
stock with a $100 par value, a stated dividend of 12% of par, and a current
market price of (a) $60, (b) $81, (c) $100, and (d) $139? Round the answers to
two decimal places.

a. ?

b. ?

c. ?

d.
?

Problem 2-10
Cash Flows

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The Moore Corporation had operating income (EBIT) of $550,000.
The company’s depreciation expense is $165,000. Moore is 100% equity financed,
and it faces a 40% tax rate.

1. What is
the company’s net income?
$

2.
What is its net cash flow?
$

Problem 8-3
Black-Scholes Model

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Assume you have been given the following information on Purcell
Industries:

Current stock price = $18

Strike price of option = $12

Time to maturity of option = 4 months

Risk-free rate = 8%

Variance of stock return = 0.11

d1 = 0.24451

N(d1) = 0.40038

d2 = 0.0548

N(d2) = 0.49924

According to the Black-Scholes option pricing model, what is the
option’s value? Round your answer to the nearest cent.

$

Problem 5-2
Yield to Maturity for Annual Payments

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Wilson Wonders’s
bonds have 7 years remaining to maturity. Interest is paid annually, the bonds
have a $1,000 par value, and the coupon interest rate is 9%. The bonds sell at
a price of $1,095. What is their yield to maturity? Round your answer to two
decimal places.

%

Problem 6-2
Required Rate of Return

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Assume that the risk-free rate is 4% and that the expected
return on the market is 14%. What is the required rate of return on a stock
that has a beta of 1.3?

%

Problem 5-13
Yield to Maturity and Current Yield

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You just purchased a bond that matures in 15 years. The bond has
a face value of $1,000 and has an 8% annual coupon. The bond has a current
yield of 8.37%. What is the bond’s yield to maturity? Round your answer to two
decimal places.

%