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Myron Gordon and John Lintner believe that the required return on equity increases as the dividend payout ratio is decreased. Their argument is based on the assumption that
a. Investors are indifferent between dividends and capital gains.
b. Investors require that the dividend yield and capital gains yield equal a constant.
c. Capital gains are taxed at a higher rate than dividends.
d. Investors view dividends as being less risky than potential future capital gains.
e. Investors value a dollar of expected capital gains more highly than a dollar of
expected dividends because of the lower tax rate on capital gains.

d. Investors view dividends as being less risky than potential future capital gains.

Which of the following statements best describes the theories of investors' preferences for dividends?
a.Modigliani and Miller argue that investors prefer dividends to capital gains.
b. The bird-in-hand theory suggests that a company can reduce its cost of equitycapital
by reducing its dividend payout ratio.
c. The tax preference theory suggests that a company can increase its stock price by
increasing its dividend payout ratio.
d. One key advantage of a residual distribution policy (with all distributions as
dividends) is that it enables a company to follow a stable dividend policy.
e. The clientele effect suggests that companies should follow a stable dividend policy.

e. The clientele effect suggests that companies should follow a stable dividend policy.

Which of the following statements is most correct?
a. The bird-in-the-hand theory implies that a company can reduce its WACC by
reducing its dividend payout.
b. The bird-in-the-hand theory implies that a company can increase its stock price by
reducing its dividend payout.
c. One problem with following a residual distribution policy (with all distributions in the
form of dividends) is that it can lead to erratic dividend payouts that may prevent the
firm from establishing a reliable clientele of investors who prefer a particular dividend policy.
d. Statements a and c are correct.
e. All of the statements above are correct.

c. One problem with following a residual distribution policy (with all distributions in the
form of dividends) is that it can lead to erratic dividend payouts that may prevent the
firm from establishing a reliable clientele of investors who prefer a particular dividend policy.

Which of the following would not have an influence on the optimal distribution policy?
a. The possibility of accelerating or delaying investment projects.
b. A strong shareholders' preference for current income versus capital gains.
c. Bond indenture constraints.
d. The costs associated with selling new common stock.
e. All of the statements above can have an effect on dividend policy.

e. All of the statements above can have an effect on dividend policy.

In the real world, we find that dividends
a. Usually exhibit greater stability than earnings.
b. Fluctuate more widely than earnings.
c. Tend to be a lower percentage of earnings for mature firms.
d. Are usually changed every year to reflect earnings changes.
e. Are usually set as a fixed percentage of earnings

a. Usually exhibit greater stability than earnings.

A decrease in a firm's willingness to pay dividends is likely to result from an increase in its
a. Earnings stability.
b. Access to capital markets.
c. Profitable investment opportunities.
d. Collection of accounts receivable.
e. Stock price.

c. Profitable investment opportunities.

A stock split will cause a change in the total dollar amounts shown in which of the
following balance sheet accounts?
a. Cash.
b. Common stock.
c. Paid-in capital.
d. Retained earnings.
e. None of the above

e. None of the above

You currently own 100 shares of stock in Beverly Brothers Inc. The stock currently
trades at $120 a share. The company is contemplating a 2-for-1 stock split. Which of the
following best describes your position after the proposed stock split takes place?
a. You will have 200 shares of stock, and the stock will trade at or near $120 a share.
b. You will have 200 shares of stock, and the stock will trade at or near $60 a share.
c. You will have 100 shares of stock, and the stock will trade at or near $60 a share.
d. You will have 50 shares of stock, and the stock will trade at or near $120 a share.
e. You will have 50 shares of stock, and the stock will trade at or near $60 a share.

b. You will have 200 shares of stock, and the stock will trade at or near $60 a share.

Which of the following statements is most correct?
a. One advantage of stock repurchases is that they are generally taxed more favorably than dividend payments.
b. One advantage of dividend reinvestment plans is that they enable investors to avoid paying taxes on the dividends they receive.
c. Stock repurchases make sense if a company is interested in increasing its equity ratio.
d. Stock repurchases make sense if a company believes that its stock is overvalued and
that it has a lot of profitable projects to fund over the next year.
e. One advantage of an open market dividend reinvestment plan is that it increases the
number of shares the company has outstanding.

a. One advantage of stock repurchases is that they are generally taxed more favorably than dividend payments.

Which of the following statements is most correct?
a. In general, stock repurchases are taxed the same way as dividends.
b. One nice feature of dividend reinvestment plans is that they enable investors to
reduce the taxes paid on their dividends.
c. On average, companies send a negative signal to the marketplace when they
announce an increase in their dividend.
d. If a company is interested in issuing new equity capital, a new stock dividend reinvestment plan probably makes more sense than an open market dividend reinvestment plan.
e. Statements b and d are correct.

d. If a company is interested in issuing new equity capital, a new stock dividend reinvestment plan probably makes more sense than an open market dividend reinvestment plan.

Which of the following statements is most correct?
a. One reason that companies tend to avoid stock repurchases is that dividend payments
are taxed more favorably than stock repurchases.
b. One advantage of dividend reinvestment plans is that they allow shareholders to avoid
paying taxes on the dividends that they choose to reinvest.
c. If a company announces a 2-for-1 stock split and the overall value of the firm remains
unchanged, the company's stock price must have doubled.
d. All of the statements above are correct.
e. None of the statements above is correct.

e. None of the statements above is correct.

Which of the following statements is most correct?
a. If a company puts in place a 2-for-1 stock split, its stock price should roughly double.
b. Share repurchases are taxed less favorably than dividends; this explains why companies typically pay dividends and avoid share repurchases.
c. On average, a company's stock price tends to rise when it announces that it is initiating a share repurchase program.
d. Statements a and b are correct.
e. All of the statements above are correct.

c. On average, a company's stock price tends to rise when it announces that it is initiating a share repurchase program.

Which of the following statements is most correct?
a. The tax preference hypothesis suggests that companies can reduce their costs of
capital by increasing their dividend payout ratios.
b. One advantage of the residual distribution policy (with all distributions as dividends)
is that it leads to a stable dividend payout, which is desired by investors.
c. Firms with a large number of investment opportunities and a relatively small amount
of cash tend to have above average dividend payouts.
d. Answers a and b are correct.
e. None of the answers above is correct.

e. None of the answers above is correct.

If the MM hypothesis about dividends is correct, and if one found a group of companies
that differed only with respect to dividend policy, which of the following statements
would be most correct?
a. The residual distribution model should not be used, because it is inconsistent with the
MM dividend hypothesis.
b. The total expected return, which in equilibrium is also equal to the required return,
would be higher for those companies with lower payout ratios because of the greater
risk associated with capital gains versus dividends.
c. If the expected total return of each of the sample companies were divided into a
dividend yield and a growth rate, and then a scatter diagram (or regression) analysis
were undertaken, then the slope of the regression line (or b in the equation D1/P0 = a
+ b(g)) would be equal to +1.0.
d. None of the statements above is true.
e. All of the statements above are true.

d. None of the statements above is true.

Which of the following statements is most correct?
a. If the dividend irrelevance theory (which is associated with the names Modigliani and Miller) were exactly correct, and if this theory could be tested with "clean" data, then we would find, in a regression of dividend yield and capital gains, a line with a slope of -1.0.
b. The tax preference and bird-in-the-hand theories lead to identical conclusions as to
the optimal dividend policy.
c. If a company raises its dividend by an unexpectedly large amount, the announcement
of this new and higher dividend is generally accompanied by an increase in the stock
price. This is consistent with the bird-in-the-hand theory, and Modigliani and Miller
used these findings to support their position on dividend theory.
d. If it could be demonstrated that a clientele effect exists, this would suggest that firms
could alter their dividend payment policies from year to year to take advantage of
investment opportunities without having to worry about the effects of changing
dividends on capital costs.
e. Each of the statements above is false.

a. If the dividend irrelevance theory (which is associated with the names Modigliani and Miller) were exactly correct, and if this theory could be tested with "clean" data, then we would find, in a regression of dividend yield and capital gains, a line with a slope of -1.0.

Which of the following statements is most correct?
a. The bird-in-the-hand theory would predict that companies could decrease their cost of equity financing by raising their dividend payout.
b. The clientele effect can explain why firms often change their dividend policies.
c. One advantage of adopting a residual distribution policy (with all distributions in the
form of dividends) is that it makes it easier for corporations to maintain dividend
clienteles.
d. Answers a and c are correct.
e. None of the answers above is correct.

a. The bird-in-the-hand theory would predict that companies could decrease their cost of equity financing by raising their dividend payout.

Modigliani and Miller (MM) argued that dividend policy is irrelevant. On the other hand,
Gordon and Lintner (GL) argued that dividend policy does matter. GL's argument rests
on the contention that
a. rs = D1/P0 + g is constant for any dividend policy.
b. Because of perceived differences in risk, investors value a dollar of dividends more highly than a dollar of expected capital gains.
c. Investors, because of tax differentials, value a dollar of expected capital gains more
highly than a dollar of dividends.
d. Most investors will reinvest rather than spend dividends, so it would save investors
money (taxes) if corporations simply reinvested earnings rather than paid them out as
dividends.
e. None of the answers above.

b. Because of perceived differences in risk, investors value a dollar of dividends more highly than a dollar of expected capital gains.

Which of the following statements is most correct?
a. The tax preference theory states that, all else equal, investors prefer stocks that pay low dividends because retained earnings can lead to capital gains that are taxed preferentially.
b. An increase in the cost of equity capital (rs) when a company announces an increase in its dividend per share would be consistent with the bird-in-the-hand theory.
c. An increase in the stock price when a company decreases its dividend is consistent with the signaling theory.
d. A dividend policy that involves paying a consistent percentage of net income is the best policy if the "clientele effect" is correct.
e. Both statements a and d are correct.

a. The tax preference theory states that, all else equal, investors prefer stocks that pay low dividends because retained earnings can lead to capital gains that are taxed preferentially.

Which of the following statements is most correct?
a. Companies can repurchase shares either (1) to change their capital structures or (2) to distribute cash to stockholders without paying cash dividends. In the second situation, tax considerations will probably play a key role in the decision to repurchase stock versus to pay more cash dividends.
b. Stock dividends provide investors with additional shares of stock, not cash, yet many investors must pay cash in the form of taxes on the value of the stock dividends. For this reason, stock dividends are rarely used today.
c. The bird-in-the-hand theory of dividend policy could be rejected immediately if personal income taxes were abolished.
d. If the curve relating the WACC and the debt ratio looks like a sharp 'V', this would make it more feasible for a firm to follow the residual dividend policy than if the curve looks like a shallow bowl (or a shallow 'U').
e. The open market type of dividend reinvestment plan is the best type for firms that need to bring in new equity capital.

a. Companies can repurchase shares either (1) to change their capital structures or (2) to distribute cash to stockholders without paying cash dividends. In the second situation, tax considerations will probably play a key role in the decision to repurchase stock versus to pay more cash dividends.

If a firm adheres strictly to the residual distribution policy (with all distributions in the
form of dividends), a sale of new common stock by the company would suggest that
a. The dividend payout ratio has remained constant.
b. The dividend payout ratio is increasing.
c. No dividends were paid for the year.
d. The dividend payout ratio is decreasing.
e. The dollar amount of investments has decreased.

c. No dividends were paid for the year.

If a firm adheres strictly to the residual distribution policy with all distributions in the
form of dividends), then if its optimal capital budget requires the use of all earnings for
that year (along with new debt according to the optimal debt/total assets ratio), the firm
should pay
a. No dividends except out of past retained earnings.
b. No dividends to common stockholders.
c. Dividends, in effect, out of a new issue of common stock.
d. Dividends by borrowing the money (debt).
e. Either c or d above could be used.

b. No dividends to common stockholders.

Which of the following statements is most correct?
a. "New-stock" dividend reinvestment plans are similar to stock dividends because they
both increase the number of shares outstanding but don't change the total equity of a firm.
b. Investors receiving stock dividends must pay taxes on the new shares at the time the stock dividends are received.
c. Stockholders pay no income tax on dividends reinvested in a dividend reinvestment plan.
d. Both statements a and b are correct.
e. None of the statements above is correct.

e. None of the statements above is correct.

Which of the following statements is most correct?
a. The tax code encourages companies to pay large dividends to their shareholders.
b. If your company has established a clientele of investors who prefer large dividends, the company is unlikely to adopt a residual dividend policy.
c. If a firm follows a residual distribution policy (with all distributions in the form of dividends), holding all else constant, its dividend payout will tend to rise whenever the firm's investment opportunities improve.
d. All of the statements above are correct.
e. Answers b and c are correct.

b. If your company has established a clientele of investors who prefer large dividends, the company is unlikely to adopt a residual dividend policy.

Which of the following statements is most correct?
a. If a firm repurchases its stock in the open market, the shareholders that tender are subject to capital gains taxes.
b. If you own 100 shares in a company's stock, and the company does a 2- for-1 stock split, you will own 200 shares in the company following the split.
c. Some dividend reinvestment plans increase the amount of equity capital available to the firm.
d. All of the statements above are correct.
e. Answers a and b are correct.

d. All of the statements above are correct.

Which of the following statements is most correct?
a. An open-market dividend reinvestment plan is likely to be attractive to companies that are looking to issue additional shares of common stock.
b. Stock repurchases have the effect of reducing financial leverage.
c. If a company does a 2-for-1 stock split, its stock price will roughly double.
d. All of the answers above are correct.
e. None of the answers above is correct

e. None of the answers above is correct

Which of the following statements is most correct?
a. If a company wants to issue new shares of common stock and also wants to implement a dividend reinvestment plan, then it should implement a new-stock dividend reinvestment plan, rather than an open-market purchase plan.
b. If a company undertakes a 3-for-1 stock split, then the number of shares outstanding should fall, and the stock price should rise.
c. If a company wants to reduce its debt ratio, then it should repurchase some of its common stock.
d. Answers a and c are correct.
e. Answers b and c are correct.

a. If a company wants to issue new shares of common stock and also wants to implement a dividend reinvestment plan, then it should implement a new-stock dividend reinvestment plan, rather than an open-market purchase plan.

Which of the following statements is most correct?
a. If you were testing dividend theories and found that a dividend increase resulted in higher stock prices, then you could rule out all other theories and conclude that the bird-in-the-hand theory was most consistent with the evidence you found.
b. The clientele effect suggests that investors choose their investments based on firms'
past dividend policies and changes to established dividend policies may be costly to investors.
c. Dividends paid under a residual dividend policy might send conflicting signals to investors.
d. Both statements b and c are correct.
e. All of the statements above are correct

d. Both statements b and c are correct.

Which of the following actions will enable a company to raise additional equity capital
(that is, which of the following will raise the total book value of equity)?
a. The establishment of a new-stock dividend reinvestment plan.
b. A stock split.
c. The establishment of an open-market purchase dividend reinvestment plan.
d. A stock repurchase.
e. Answers a and d are correct

a. The establishment of a new-stock dividend reinvestment plan.

Which of the following statements is most correct?
a. Stock repurchases can be used by firms to defend against hostile takeovers since they
increase the proportion of debt in a firm's capital structure.
b. After a 3-for-1 stock split, a company's price per share will fall and its number of shares outstanding will rise.
c. Investors can interpret a stock repurchase by a firm as a signal that the firm's managers believe the stock is underpriced.
d. Both statements a and b are correct.
e. All of the statements above are correct.

e. All of the statements above are correct.

Firm M is a mature firm in a mature industry. Its annual net income and net cash flow are both consistently high and very stable. The company's growth prospects are quite limited; therefore, the company's capital budget is small relative to its net income. Firm N is a relatively new firm in a new industry. Its annual operating income fluctuates
considerably, but the company has substantial growth opportunities. Its capital budget is expected to be large relative to its net income for the foreseeable future. Which of the following statements is most correct?
a. Firm M probably has a lower debt ratio than Firm N.
b. Firm M probably has a higher distribution ratio (the total of dividend payout ratio and stock repurchase ratio) than Firm N.
c. If the corporate tax rate increases, the debt ratio of both firms is likely to fall.
d. Statements a and b are correct.
e. Statements b and c are correct.

b. Firm M probably has a higher distribution ratio (the total of dividend payout ratio and stock repurchase ratio) than Firm N.

Petersen Co. has a capital budget of $1,200,000. The company wants to maintain a target capital structure that is 60 percent debt and 40 percent equity. The company forecasts that its net income this year will be $600,000. If the company follows a residual distribution policy (with all distributions in the form of dividends), what will be its payout ratio?
a. 0% b. 20% c. 40% d. 60% e. 80%

b. 20%

Chandler Communications' CFO has provided the following information:
 The company's capital budget is expected to be $5,000,000.
 The company's target capital structure is 70 percent debt and 30 percent equity.
 The company's net income is $4,500,000.
If the company follows a residual distribution policy (with all distributions in the form of dividends), what portion of its net income should it pay out as dividends this year?
a. 33.33% b. 40.00% c. 50.00% d. 60.00% e. 66.67%

e. 66.67%

Strategic Systems Inc. expects to have net income of $800,000 during the next year. Its target, and current, capital structure is 40 percent debt and 60 percent common equity. The Director of Capital Budgeting has determined that the optimal capital budget for next year is $1.2 million. If Strategic uses the residual distribution model (with all distributions in the form of dividends) to determine next year's dividend payout, what is the expected dividend payout ratio?
a. 0% b. 10% c. 28% d. 42% e. 56%

b. 10%

Powell Products anticipates that its capital budget next year will be $3 million. The company expects to report net income of $5 million this year. The company's target capital structure is 65 percent common equity and 35 percent long-term debt. Assume the company follows a strict residual distribution policy (with all distributions in the form
of dividends). What is the expected dividend payout ratio this year?
a. 65% b. 39% c. 61% d. 56% e. 100%

c. 61%

Arden Manufacturing follows a strict residual distribution policy (with all distributions in the form of dividends). The company is forecasting that its net income will be $500 million this year. The company anticipates that its capital budget will be $250 million.
The company has a target capital structure that consists of 50 percent equity and 50 percent long-term debt. What is the company's anticipated dividend payout ratio?
a. 75% b. 55% c. 50% d. 25% e. 47%

a. 75%

Redwood Systems follows a strict residual distribution policy (with all distributions in the
form of dividends). The company estimates that its capital expenditures this year will be $40 million, its net income will be $30 million, and its target capital structure is 60 percent equity and 40 percent debt. What will be the company's dividend payout ratio?
a. 80% b. 60% c. 40% d. 20% e. 15%

d. 20%

Wolfpack Multimedia follows a strict residual distribution policy (with all distributions
in the form of dividends). Wolfpack forecasts that its net income will be $12 million this year. The company has no depreciation expense so its net cash flow is $12 million, and its target capital structure consists of 70 percent equity and 30 percent debt. Wolfpack's capital budget is $10
million. What is the company's dividend payout ratio?
a. 16.67% b. 41.67% c. 11.67% d. 0.00% e. 58.30%

b. 41.67%

Albany Motors recently completed a 3-for-1 stock split. Prior to the split, the company had 10 million shares outstanding and its stock price was $150 per share. After the split, the total market value of the company's stock equaled $1.5 billion. What was the price of the company's stock following the stock split?
a. $ 15
b. $ 45
c. $ 50
d. $150
e. $450

c. $ 50

Loiselle Graphics recently announced a 3-for-1 stock split. Prior to the split, the company's stock was trading at $90 per share. The split had no effect on the wealth of the company's investors. What will be the new stock price?
a. $270 b. $ 45 c. $180 d. $ 60 e. $ 30

e. $ 30

Tarheel Computing's stock was trading at $150 per share before its recent 3-for-1 stock split. The 3-for-1 split led to a 5 percent increase in Tarheel's market capitalization. (Market capitalization equals the stock price times the number of shares.) What was Tarheel's price after the stock split?
a. $472.50 b. $ 50.00 c. $ 47.62 d. $428.57 e. $ 52.50

e. $ 52.50

Flavortech Inc. expects EBIT of $2,000,000 for the current year. The firm's capital structure consists of 40 percent debt and 60 percent equity, and its marginal tax rate is 40 percent. The cost of equity is 14 percent, and the company pays a 10 percent rate on its $5,000,000 of long-term debt. One million shares of common stock are outstanding. For
the next year, the firm expects to fund one large positive NPV project costing $1,200,000,
and it will fund this project in accordance with its target capital structure. If the firm follows a residual distribution policy (with all distributions in the form of dividends) and has no other projects, what is its expected dividend payout ratio?
a. 100% b. 60% c. 40% d. 20% e. 0%

d. 20%

Driver Corporation has plans calling for a capital budget of $60 million. Its optimal capital structure is 60 percent equity and 40 percent debt. Its earnings before interest and taxes (EBIT) were $98 million for the year. The firm has $200 million in assets, pays an average of 10 percent on all its debt, and faces a marginal tax rate of 35 percent. If the firm maintains a residual distribution policy (with all distributions in the form of dividends) and will keep its optimal capital structure intact, what will be the amount of
the dividends it pays out after financing its capital budget?
a. $22.5 million
b. $59.4 million
c. $60.0 million
d. $30.0 million
e. $ 0

a. $22.5 million

Your company has decided that its capital budget during the coming year will be $20 million. Its optimal capital structure is 60 percent equity and 40 percent debt. Its earnings before interest and taxes (EBIT) are projected to be $34.667 million for the year. The
company has $200 million of assets; its average interest rate on outstanding debt is 10 percent; and its tax rate is 40 percent. If the company follows the residual distribution policy (with all distributions in the form of dividends) and maintains the same capital
structure, what will its dividend payout ratio be?
a. 15% b. 20% c. 25% d. 30% e. 35%

c. 25%

Plato Inc. expects to have net income of $5,000,000 during the next year. Plato's target capital structure is 35 percent debt and 65 percent equity. The company's director of capital budgeting has determined that the optimal capital budget for the coming year is $6,000,000. If Plato follows a residual distribution policy (with all distributions in the
form of dividends) to determine the coming year's dividend, then what is Plato's payout ratio?
a. 38% b. 42% c. 58% d.33% e. None of the answers above is correct.

e. None of the answers above is correct.

Brock Brothers wants to maintain its capital structure that is 30 percent debt, and 70 percent equity. The company forecasts that its net income this year will be $1,000,000. The company follows a residual distribution policy (with all distributions in the form of dividends), and anticipates a dividend payout ratio of 40 percent. What is the size of the company's capital budget?
a. $ 600,000 b. $ 857,143 c.$1,000,000 d. $1,428,571 e. $2,000,000

b. $ 857,143

The following facts apply to your company:
Target capital structure: 50% debt; 50% equity.
EBIT: $200 million.
Assets:$500 million.
Tax rate: 40%.
Cost of new and old debt: 8%.
Based on the residual distribution policy (with all distributions in the form of dividends), the payout ratio is 60 percent. How large (in millions of dollars) will the capital budget be?
a. $ 43.2 b. $ 50.0 c. $ 64.8 d. $ 86.4 e. $108.0

d. $ 86.4

Which of the following is generally NOT true and an advantage of going public?
a. Facilitates stockholder diversification.
b. Increases the liquidity of the firm's stock.
c. Makes it easier to obtain new equity capital.
d. Establishes a market value for the firm.
Which of the following is generally NOT true and an advantage of going public?
e. Makes it easier for owner-managers to engage in profitable self-dealings.

e. Makes it easier for owner-managers to engage in profitable self-dealings.

Which of the following statements about listing on a stock exchange is most CORRECT?
a. Listing is a decision of more significance to a firm than going public.
b. Any firm can be listed on the NYSE as long as it pays the listing fee.
c. Listing provides a company with some "free" advertising, and it may enhance the firm's prestige and help it do more business.
d. Listing reduces the reporting requirements for firms, because listed firms file reports with
the exchange rather than with the SEC.
e. The OTC is the second largest market for listed stock, and it is exceeded only by the NYSE.

c. Listing provides a company with some "free" advertising, and it may enhance the firm's prestige and help it do more business.

Which of the following statements is most CORRECT?
a. In a private placement, securities are sold to private (individual) investors rather than to institutions.
b. Private placements occur most frequently with stocks, but bonds can also be sold in a private placement.
c. Private placements are convenient for issuers, but the convenience is offset by higher flotation costs.
d. The SEC requires that all private placements be handled by a registered investment banker.
e. Private placements can generally bring in funds faster than is the case with public offerings.

e. Private placements can generally bring in funds faster than is the case with public offerings.

Which of the following statements is most CORRECT?
a. If new debt is used to refund old debt, the correct discount rate to use in the refunding
analysis is the before-tax cost of new debt.
b. The key benefits associated with refunding debt are the reduction in the firm's debt ratio
and the creation of more reserve borrowing capacity.
c. The mechanics of finding the NPV of a refunding decision are fairly straightforward. However, the decision of when to refund is not always clear because it requires a forecast of future interest rates.
d. If a firm with a positive NPV refunding project delays refunding and interest rates rise, the firm can still obtain the entire NPV by locking in a low coupon rate when the rates are low, even though it actually refunds the debt after rates have risen.
e. Suppose a firm is considering refunding and interest rates rise during time when the analysis
is being done. The rise in rates would tend to lower the expected price of the new bonds,
which would make them cheaper to the firm and thus increase the expected interest
savings.

c. The mechanics of finding the NPV of a refunding decision are fairly straightforward. However, the decision of when to refund is not always clear because it requires a forecast of future interest rates.

Which of the following factors would increase the likelihood that a company would call its
outstanding bonds at this time?
a. The yield to maturity on the company's outstanding bonds increases due to a weakening of
the firm's financial situation.
b. A provision in the bond indenture lowers the call price on specific dates, and yesterday was one of those dates.
c. The flotation costs associated with issuing new bonds rise.
d. The firm's CFO believes that interest rates are likely to decline in the future.
e. The firm's CFO believes that corporate tax rates are likely to be increased in the future.

b. A provision in the bond indenture lowers the call price on specific dates, and yesterday was one of those dates.

Which of the following statements concerning common stock and the investment banking
process is NOT CORRECT?
a. The preemptive right gives each existing common stockholder the right to purchase his or her proportionate share of a new stock issue.
b. If a firm sells 1,000,000 new shares of Class B stock, the transaction occurs in the primary market.
c. Listing a large firm's stock is often considered to be beneficial to stockholders because the
increases in liquidity and reputation probably outweigh the additional costs to the firm.
d. Stockholders have the right to elect the firm's directors, who in turn select the officers who manage the business. If stockholders are dissatisfied with management's performance, an outside group may ask the stockholders to vote for it in an effort to take control of the business. This action is called a tender offer.
e. The announcement of a large issue of new stock could cause the stock price to fall. This loss is called "market pressure," and it is treated as a flotation cost because it is a cost to stockholders that is associated with the new issue.

d. Stockholders have the right to elect the firm's directors, who in turn select the officers who manage the business. If stockholders are dissatisfied with management's performance, an outside group may ask the stockholders to vote for it in an effort to take control of the business. This action is called a tender offer.

Which of the following statements is NOT CORRECT?
a. When a corporation's shares are owned by a few individuals who own most of the stock or are
part of the firm's management, we say that the firm is "closely, or privately, held."
b. "Going public" establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares.
c. Publicly owned companies have sold shares to investors who are not associated with
management, and they must register with and report to a regulatory agency such as the SEC.
d. When stock in a closely held corporation is offered to the public for the first time, the
transaction is called "going public," and the market for such stock is called the new issue market.
e. It is possible for a firm to go public and yet not raise any additional new capital.

b. "Going public" establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares.

Tuttle Buildings Inc. has decided to go public by selling $5,000,000 of new common stock. Its
investment bankers agreed to take a smaller fee now (6% of gross proceeds versus their normal
10%) in exchange for a 1-year option to purchase an additional 200,000 shares at $5.00 per
share. The investment bankers expect to exercise the option and purchase the 200,000 shares
in exactly one year, when the stock price is forecasted to be $6.50 per share. However, there is
a chance that the stock price will actually be $12.00 per share one year from now. If the $12
price occurs, what would the present value of the entire underwriting compensation be?
Assume that the investment banker's required return on such arrangements is 15%, and ignore
taxes.
a. $1,235,925
b. $1,300,973
c. $1,369,446
d. $1,441,522
e. $1,517,391

e. $1,517,391

Europa Corporation is financing an ongoing construction project. The firm will need $5,000,000
of new capital during each of the next 3 years. The firm has a choice of issuing new debt or
equity each year as the funds are needed, or issue only debt now and equity later. Its target
capital structure is 40% debt and 60% equity, and it wants to be at that structure in 3 years,
when the project has been completed. Debt flotation costs for a single debt issue would be
1.6% of the gross debt proceeds. Yearly flotation costs for 3 separate issues of debt would be
3.0% of the gross amount. Ignoring time value effects, how much would the firm save by raising
all of the debt now, in a single issue, rather than in 3 separate issues?
a. $79,425
b. $83,606
c. $88,006
d. $92,406
e. $97,027

c. $88,006

The City of Charleston issued $3,000,000 of 8% coupon, 30-year, semiannual payment, taxexempt muni bonds 10 years ago. The bonds had 10 years of call protection, but now the bonds can be called if the city chooses to do so. The call premium would be 6% of the face amount. New 20-year, 6%, semiannual payment bonds can be sold at par, but flotation costs on this issue would be 2% of the amount of bonds sold. What is the net present value of the refunding? Note that cities pay no income taxes, hence taxes are not relevant.
a. $453,443
b. $476,115
c. $499,921
d. $524,917
e. $551,163

a. $453,443

The State of Idaho issued $2,000,000 of 7% coupon, 20-year semiannual payment, tax-exempt
bonds 5 years ago. The bonds had 5 years of call protection, but now the state can call the
bonds if it chooses to do so. The call premium would be 5% of the face amount. Today 15-year,
5%, semiannual payment bonds can be sold at par, but flotation costs on this issue would be 2%.
What is the net present value of the refunding? Because these are tax-exempt bonds, taxes are
not relevant.
a. $278,606 b. $292,536 c. $307,163 d. $322,521 e. $338,647

a. $278,606

Thompson Enterprises has $5,000,000 of bonds outstanding. Each bond has a maturity value of $1,000, an annual coupon of 12.0%, and 15 years left to maturity. The bonds can be called at any time with a premium of $50 per bond. If the bonds are called, the company must pay flotation costs of $10 per new refunding bond. Ignore tax considerations--assume that the firm's tax rate is zero.The company's decision of whether to call the bonds depends critically on the current interest rate on newly issued bonds. What is the breakeven interest rate, the rate below which it would be profitable to call in the bonds?
a. 9.57% b. 10.07% c. 10.60% d. 11.16% e. 11.72%

d. 11.16%

Rainier Bros. has 12.0% semiannual coupon bonds outstanding that mature in 10 years. Each bond is now eligible to be called at a call price of $1,060. If the bonds are called, the company must replace them with new 10-year bonds. The flotation cost of issuing new bonds is estimated to be $45 per bond. How low would the yield to maturity on the new bonds have to be in order for it to be profitable to call the bonds today, i.e., what is the nominal annual
"breakeven rate"?
a. 9.29% b. 9.78% c. 10.29% d. 10.81% e. 11.35%

c. 10.29%

New York Waste (NYW) is considering refunding a $50,000,000, annual payment, 14% coupon, 30-year
bond issue that was issued 5 years ago. It has been amortizing $3 million of flotation costs on these
bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market. A call premium of 14% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NYW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called.What is the required after-tax refunding investment outlay, i.e., the cash outlay at the time of the refunding?
a. $5,049,939 b. $5,315,725 c. $5,595,500 d. $5,890,000 e. $6,200,000

e. $6,200,000

New York Waste (NYW) is considering refunding a $50,000,000, annual payment, 14% coupon, 30-year
bond issue that was issued 5 years ago. It has been amortizing $3 million of flotation costs on these
bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market. A call premium of 14% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NYW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called.What will the after-tax annual interest savings for NYW be if the refunding takes place?
a. $664,050 b. $699,000 c. $768,900 d. $845,790 e. $930,369

b. $699,000

New York Waste (NYW) is considering refunding a $50,000,000, annual payment, 14% coupon, 30-year
bond issue that was issued 5 years ago. It has been amortizing $3 million of flotation costs on these
bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market. A call premium of 14% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NYW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called. The amortization of flotation costs reduces taxes and thus provides an annual cash flow. What will the net increase or decrease in the annual flotation cost tax savings be if refunding takes
place?
a. $6,480 b. $7,200 c. $8,000 d. $8,800 e. $9,680

c. $8,000

New York Waste (NYW) is considering refunding a $50,000,000, annual payment, 14% coupon, 30-year
bond issue that was issued 5 years ago. It has been amortizing $3 million of flotation costs on these
bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market. A call premium of 14% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NYW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called. The amortization of flotation costs reduces taxes and thus provides an annual cash flow. What is the NPV if NYW refunds its bonds today?
a. $1,746,987 b. $1,838,933 c. $1,935,719 d. $2,037,599 e. $2,241,359

d. $2,037,599

From the lessee viewpoint, the riskiness of the cash flows, with the possible exception of the residual value, is about the same as the riskiness of the lessee's
a. equity cash flows.
b. capital budgeting project cash flows.
c. debt cash flows.
d. pension fund cash flows.
e. sales.

c. debt cash flows

Operating leases often have terms that include
a. maintenance of the equipment by the lessor.
b. full amortization over the life of the lease.
c. very high penalties if the lease is cancelled.
d. restrictions on how much the leased property can be used.
e. much longer lease periods than for most financial leases.

a. maintenance of the equipment by the lessor.

Which of the following statements is most CORRECT?
a. Firms that use "off balance sheet" financing, such as leasing, would show lower debt ratios if
the effects of their leases were reflected in their financial statements.
b. Capitalizing a lease means that the firm issues equity capital in proportion to its current capital
structure, in an amount sufficient to support the lease payment obligation.
c. The fixed charges associated with a lease can be as high as, but never greater than, the fixed
payments associated with a loan.
d. Capital, or financial, leases generally provide for maintenance by the lessor.
e. A key difference between a capital lease and an operating lease is that with a capital lease, the lease payments provide the lessor with a return of the funds invested in the asset plus a return on the invested funds, whereas with an operating lease the lessor depends on the residual value to realize a full return of and on the investment.

e. A key difference between a capital lease and an operating lease is that with a capital lease, the lease payments provide the lessor with a return of the funds invested in the asset plus a return on the invested funds, whereas with an operating lease the lessor depends on the residual value to realize a full return of and on the investment.

Financial Accounting Standards Board (FASB) Statement #13 requires that for an unqualified audit
report, financial (or capital) leases must be included in the balance sheet by reporting the
a. residual value as a fixed asset.
b. residual value as a liability.
c. present value of future lease payments as an asset and also showing this same amount as an offsetting liability.
d. undiscounted sum of future lease payments as an asset and as an offsetting liability.
e. undiscounted sum of future lease payments, less the residual value, as an asset and as an
offsetting liability.

c. present value of future lease payments as an asset and also showing this same amount as an offsetting liability.

Heavy use of off-balance sheet lease financing will tend to
a. make a company appear more risky than it actually is because its stated debt ratio will be
increased.
b. make a company appear less risky than it actually is because its stated debt ratio will appear lower.
c. affect a company's cash flows but not its degree of risk.
d. have no effect on either cash flows or risk because the cash flows are already reflected in the
income statement.
e. affect the lessee's cash flows but only due to tax effects

b. make a company appear less risky than it actually is because its stated debt ratio will appear lower.

In the lease versus buy decision, leasing is often preferable
a. because it has no effect on the firm's ability to borrow to make other investments.
b. because, generally, no down payment is required, and there are no indirect interest costs.
c. because lease obligations do not affect the firm's risk as seen by investors.
d. because the lessee owns the property at the end of the least term.
e. because the lessee may have greater flexibility in abandoning the project in which the leased property is used than if the lessee bought and owned the asset.

e. because the lessee may have greater flexibility in abandoning the project in which the leased property is used than if the lessee bought and owned the asset.

A lease versus purchase analysis should compare the cost of leasing to the cost of owning,
assuming that the asset purchased
a. is financed with short-term debt.
b. is financed with long-term debt.
c. is financed with debt whose maturity matches the term of the lease.
d. is financed with a mix of debt and equity based on the firm's target capital structure, i.e., at the WACC.
e. is financed with retained earnings.

c. is financed with debt whose maturity matches the term of the lease.

Sutton Corporation, which has a zero tax rate due to tax loss carry-forwards, is considering a 5-
year, $6,000,000 bank loan to finance service equipment. The loan has an interest rate of 10%
and would be amortized over 5 years, with 5 end-of-year payments. Sutton can also lease the
equipment for 5 end-of-year payments of $1,790,000 each. How much larger or smaller is the
bank loan payment than the lease payment? Note: Subtract the loan payment from the lease
payment.
a. $177,169 b. $196,854 c. $207,215 d. $217,576 e. $228,455

c. $207,215

Kohers Inc. is considering a leasing arrangement to finance some manufacturing tools that it
needs for the next 3 years. The tools will be obsolete and worthless after 3 years. The firm will
depreciate the cost of the tools on a straight-line basis over their 3-year life. It can borrow
$4,800,000, the purchase price, at 10% and buy the tools, or it can make 3 equal end-of-year
lease payments of $2,100,000 each and lease them. The loan obtained from the bank is a 3-year
simple interest loan, with interest paid at the end of the year. The firm's tax rate is 40%. Annual
maintenance costs associated with ownership are estimated at $240,000, but this cost would be
borne by the lessor if it leases. What is the net advantage to leasing (NAL), in thousands?
(Suggestion: Delete 3 zeros from dollars and work in thousands.)
a. $96 b. $106 c. $112 d. $117 e. $123

b. $106

Dakota Trucking Company (DTC) is evaluating a potential lease for a truck with a 4-year life that
costs $40,000 and falls into the MACRS 3-year class. If the firm borrows and buys the truck, the
loan rate would be 10%, and the loan would be amortized over the truck's 4-year life, so the
interest expense for taxes would decline over time. The loan payments would be made at the
end of each year. The truck will be used for 4 years, at the end of which time it will be sold at an
estimated residual value of $10,000. If DTC buys the truck, it would purchase a maintenance
contract that costs $1,000 per year, payable at the end of each year. The lease terms, which
include maintenance, call for a $10,000 lease payment (4 payments total) at the beginning of
each year. DTC's tax rate is 40%. Should the firm lease or buy? (Note: MACRS rates for Years 1
to 4 are 0.33, 0.45, 0.15, and 0.07.)
a. $849 b. $896 c. $945 d. $997 e. $1,047

d. $997

Buster's Beverages is negotiating a lease on a new piece of equipment that would cost $100,000 if purchased. The equipment falls into the MACRS 3-year class, and it would be used for 3 years and then sold, because the firm plans to move to a new facility at that time. The estimated value of the equipment after 3 years is $30,000. A maintenance contract on the equipment would cost $3,000 per year, payable at the beginning of each year. Alternatively, the firm could lease the equipment for 3 years for a lease payment of $29,000 per year, payable at the beginning of each year. The lease would include maintenance. The firm is in the 20% tax bracket, and it could obtain a 3-year simple interest loan, interest payable at the end of the
year, to purchase the equipment at a before-tax cost of 10%. If there is a positive Net Advantage to Leasing the firm will lease the equipment. Otherwise, it will buy it. What is the NAL?
a. $5,736 b. $6,023 c. $6,324 d. $6,640 e. $6,972

a. $5,736

Helena Furnishings wants to sharply reduce its cash conversion cycle. Which of the following steps would reduce its cash conversion cycle?
a. The company increases its average inventory without increasing its sales.
b. The company reduces its DSO.
c. The company starts paying its bills sooner, which reduces its average accounts payable without reducing its sales.
d. Statements a and b are correct.
e. All of the statements above are correct.

b. The company reduces its DSO.

Other things held constant, which of the following will cause an increase in working capital?
a. Cash is used to buy marketable securities.
b. A cash dividend is declared and paid.
c. Merchandise is sold at a profit, but the sale is on credit.
d. Long-term bonds are retired with the proceeds of a preferred stock issue.
e. Missing inventory is written off against retained earnings.

c. Merchandise is sold at a profit, but the sale is on credit.

Which of the following is typically part of the cash budget?
a. Payments lag.
b. Payment for plant construction.
c. Cumulative cash.
d. Statements a and c are correct.
e. All of the statements above are correct.

e. All of the statements above are correct.

Which of the following statements concerning the cash budget is correct?
a. Depreciation expense is not explicitly included, but depreciation effects are implicitly included in estimated tax payments.
b. Cash budgets do not include financial expenses such as interest and dividend payments.
c.Cash budgets do not include cash inflows from long-term sources such as bond issues.
d. Statements a and b are correct.
e. Statements a and c are correct.

a. Depreciation expense is not explicitly included, but depreciation effects are implicitly included in estimated tax payments.

Which of the following items should a company explicitly include in its monthly cash budget?
a. Its monthly depreciation expense.
b. Its cash proceeds from selling one of its divisions.
c. Interest paid on its bank loans.
d. Statements b and c are correct.
e. All of the statements above are correct.

d. Statements b and c are correct.

Which of the following statements is most correct?
a. A cash management system which minimizes collections float and maximizes disbursement float is better than one with higher collections float and lower disbursement float.
b. A cash management system which maximizes collections float and minimizes disbursement float is better than one with lower collections float and higher disbursement float.
c. The use of a lockbox is designed to minimize cash theft losses. If the cost of the
lockbox is less than theft losses saved, then the lockbox should be installed.
d. Other things held constant, a firm will need an identical line of credit if it can arrange to pay its bills by the 5th of each month than if its bills come due uniformly during the month.
e. The statements above are all false.

a. A cash management system which minimizes collections float and maximizes disbursement float is better than one with higher collections float and lower disbursement float.

Which of the following statements is most correct?
a. A good cash management system would inimize disbursement float and maximize collections float.
b. If a firm begins to use a well-designed lockbox system, this will reduce its customers' net float.
c. In the early 1980's, the prime interest rate hit a high of 21 percent. In 1995 the prime rate was considerably lower. That sharp interest rate decline has increased firms' concerns about the efficiency of their cash management programs.
d. If a firm can get its customers to permit it to pay by wire transfers rather than having to write checks, this will increase its net float and thus reduce its required cash balances.
e. A firm which has such an efficient cash management system that it has positive net float can have a negative checkbook balance at most times and still not have its checks bounce.

e. A firm which has such an efficient cash management system that it has positive net
float can have a negative checkbook balance at most times and still not have its
checks bounce.

A lockbox plan is
a. A method for safe-keeping of marketable securities.
b. Used to identify inventory safety stocks.
c. A system for slowing down the collection of checks written by a firm.
d. A system for speeding up a firm's collections of checks received.
e. Not described by any of the statements above.

d. A system for speeding up a firm's collections of checks received.

Which of the following might be attributed to efficient inventory management?
a. High inventory turnover ratio.
b. Low incidence of production schedule disruptions.
c. High total assets turnover.
d. Statements a and c are correct.
e. All of the statements above are correct.

e. All of the statements above are correct.

Analyzing days sales outstanding (DSO) and the aging schedule are two common methods for monitoring receivables. However, they can provide erroneous signals to credit managers when
a. Customers' payments patterns are changing.
b. Sales fluctuate seasonally.
c. Some customers take the discount and others do not.
d. Sales are relatively constant, either seasonally or cyclically.
e. None of the statements above is correct.

b. Sales fluctuate seasonally.

Which of the following is not commonly regarded as being a credit policy variable?
a. Credit period.
b. Collection policy.
c. Credit standards.
d. Cash discounts.
e. All of the statements above are credit policy variables.

e. All of the statements above are credit policy variables.

If easing a firm's credit policy lengthens the collection period and results in a worsening
of the aging schedule, then why do firms take such actions?
a. It normally stimulates sales.
b. To meet competitive pressures.
c. To increase the firm's deferral period for payables.
d. Statements a and b are correct.
e. All of the statements above are correct.

d. Statements a and b are correct.

Firms generally choose to finance temporary net operating working capital with shortterm debt because
a. Matching the maturities of assets and liabilities reduces risk.
b. Short-term interest rates have traditionally been more stable than long-term interest rates.
c. A firm that borrows heavily long-term is more apt to be unable to repay the debt than a firm that borrows heavily short-term.
d. The yield curve has traditionally been downward sloping.
e. Sales remain constant over the year, and financing requirements also remain constant

a. Matching the maturities of assets and liabilities reduces risk.

Which of the following statements is most correct?
a. Trade credit is provided to a business only when purchases are made.
b. Commercial paper is a form of short-term financing that is primarily used by large,
financially stable companies.
c. Short-term debt, while often cheaper than long-term debt, exposes a firm to the
potential problems associated with rolling over loans.
d. Statements b and c are correct.
e. All of the statements above are correct.

e. All of the statements above are correct.

Which of the following statements is incorrect?
a. Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate.
b. Accruals are "free" in the sense that no explicit interest is paid on these funds.
c. A conservative approach to working capital will result in all permanent assets being financed using long-term securities.
d. The risk to the firm of borrowing with short-term credit is usually greater than with long-term debt. Added risk can stem from greater variability of interest costs on short-term debt.
e. Bank loans have a lower interest rate than commercial paper.

a. Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate.

Which of the following is not a situation that might lead a firm to hold marketable securities?
a. The firm has purchased a fixed asset that will require a large write-off of depreciable expense.
b. The firm must meet a known financial commitment, such as financing an ongoing construction project.
c. The firm must finance seasonal operations.
d. The firm has just sold long-term securities and has not yet invested the proceeds in earning assets.
e. None of the statements above is correct. (All of the situations might lead the firm to hold marketable securities.)

a. The firm has purchased a fixed asset that will require a large write-off of depreciable expense.

Which of the following statements concerning commercial paper is incorrect?
a. Commercial paper is generally written for terms less than 270 days.
b. Commercial paper generally carries an interest rate below the prime rate.
c. Commercial paper is sold to money market mutual funds, as well as to other financial
institutions and nonfinancial corporations.
d. Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate.
e. Commercial paper is a type of unsecured promissory note issued by large, strong
firms.

d. Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate.

Ignoring cost and other effects on the firm, which of the following measures would tend to reduce the cash conversion cycle?
a. Maintain the level of receivables as sales decrease.
b. Buy more raw materials to take advantage of price breaks.
c. Take discounts when offered.
d. Forgo discounts that are currently being taken.
e. Offer a longer deferral period to customers.

d. Forgo discounts that are currently being taken.

Which of the following actions are likely to reduce the length of a company's cash conversion cycle?
a. Adopting a new inventory system that reduces the inventory conversion period.
b. Reducing the average days sales outstanding (DSO) on its accounts receivable.
c. Reducing the amount of time the company takes to pay its suppliers.
d. Statements a and b are correct.
e. All of the statements above are correct.

d. Statements a and b are correct.

Which of the following statements is incorrect about working capital policy?
a. A company may hold a relatively large amount of cash if it anticipates uncertain sales levels in the coming year.
b. Credit policy has an impact on working capital since it has the potential to influence sales levels and the speed with which cash is collected.
c. The cash budget is useful in determining future financing needs.
d. Holding minimal levels of inventory can reduce inventory carrying costs and cannot lead to any adverse effects on profitability.
e. Managing working capital levels is important to the financial staff since it influences
financing decisions and overall profitability of the firm.

d. Holding minimal levels of inventory can reduce inventory carrying costs and cannot lead to any adverse effects on profitability.

Which of the following statements is most correct?
a. The cash balances of most firms consist of transactions, compensating, and precautionary balances. The total desired cash balance can be determined by calculating the amount needed for each purpose and then summing them together.
b. The easier a firm's access to borrowed funds, the higher its precautionary balances will be in order to protect against sudden increases in interest rates.
c. For some firms holding highly liquid marketable securities is a substitute for holding cash, because the marketable securities accomplish the same objective as cash.
d. All companies hold the same amount of funds for a transaction balance.
e. None of the statements above is correct.

c. For some firms holding highly liquid marketable securities is a substitute for holding cash, because the marketable securities accomplish the same objective as cash.

Which of the following statements is most correct?
a. Compensating balance requirements apply only to businesses, not to individuals.
b. Compensating balances are essentially costless to most firms, because those firms would normally have such funds on hand to meet transactions needs anyway.
c. If the required compensating balance is larger than the transactions balance the firm would ordinarily hold, then the effective cost of any loan requiring such a balance is increased.
d. Banks are prohibited from earning interest on the funds they force businesses to keep
as compensating balances.
e. None of the statements above is correct.

c. If the required compensating balance is larger than the transactions balance the firm would ordinarily hold, then the effective cost of any loan requiring such a balance is increased.

Which of the following statements is most correct?
a. Shorter-term cash budgets, in general, are used primarily for planning purposes, while longer-term budgets are used for actual cash control.
b. The cash budget and the capital budget are planned separately and although they are both important to the firm, they are independent of each other.
c. Since depreciation is a non-cash charge, it does not appear on nor have an effect on the cash budget.
d. The target cash balance is set optimally such that it need not be adjusted for seasonal patterns and unanticipated fluctuations in receipts, although it is changed to reflect long-term changes in the firm's operations.
e. The typical actual cash budget will reflect interest on loans and income from investment of surplus cash. These numbers are expected values and actual results might vary from budgeted results.

e. The typical actual cash budget will reflect interest on loans and income from investment of surplus cash. These numbers are expected values and actual results might vary from budgeted results.

A lockbox plan is most beneficial to firms which
a. Send payables over a wide geographic area.
b. Have widely disbursed manufacturing facilities.
c. Have a large marketable securities account to protect.
d. Hold inventories at many different sites.
e. Make collections over a wide geographic area.

e. Make collections over a wide geographic area.

Which of the following statements is most correct?
a. Poor synchronization of cash flows which results in high cash management costs can be partially offset by increasing disbursement float and decreasing collections float.
b. The size of a firm's net float is primarily a function of its natural cash flow
synchronization and how it clears its checks.
c. Lockbox systems are used mainly for security purposes as well as to decrease the firm's net float.
d. If a firm can speed up its collections and slow down its disbursements, it will be able to reduce its net float.
e. A firm practicing good cash management and making use of positive net float will bring its check book balance as close to zero as possible, but must never generate a negative book balance.

a. Poor synchronization of cash flows which results in high cash management costs can be partially offset by increasing disbursement float and decreasing collections float.

Which of the following statements is most correct?
a. A firm that makes 90 percent of its sales on credit and 10 percent for cash is growing at a rate of 10 percent annually. If the firm maintains stable growth it will also be able to maintain its accounts receivable at its current level, since the 10 percent cash sales can be used to manage the 10 percent growth rate.
b. In managing a firm's accounts receivable it is possible to increase credit sales per day yet still keep accounts receivable fairly steady if the firm can shorten the length of its collection period.
c. If a firm has a large percentage of accounts over 30 days old, it is a sign that the firm's receivables management needs to be reviewed and improved.
d. Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio should also have a high payables-to-sales ratio.
e. None of the statements above is correct.

b. In managing a firm's accounts receivable it is possible to increase credit sales per day yet still keep accounts receivable fairly steady if the firm can shorten the length of its collection period.

Which of the following statements is most correct?
a. If a firm's volume of credit sales declines then its DSO will also decline.
b. If a firm changes its credit terms from 1/20, net 40 days, to 2/10, net 60 days, the impact on sales can't be determined because the increase in the discount is offset by the longer net terms, which tends to reduce sales.
c. The DSO of a firm with seasonal sales can vary. While the sales per day figure is usually based on the total annual sales, the accounts receivable balance will be high or low depending on the season.
d. An aging schedule is used to determine what portion of customers pay cash and what portion buy on credit.
e. Aging schedules can be constructed from the summary data provided in the firm's financial statements.

c. The DSO of a firm with seasonal sales can vary. While the sales per day figure is usually based on the total annual sales, the accounts receivable balance will be high or low depending on the season.

Which of the following statements is most correct?
a. Other things held constant, the higher a firm's days sales outstanding (DSO), the better its credit department.
b. If a firm that sells on terms of net 30 changes its policy and begins offering all customers terms of 2/10, net 30 days, and if no change in sales volume occurs, then the firm's DSO will probably increase.
c. If a firm sells on terms of 2/10, net 30 days, and its DSO is 30 days, then its aging schedule would probably show some past due accounts.
d. Statements a and c are correct.
e. None of the statements above is correct.

c. If a firm sells on terms of 2/10, net 30 days, and its DSO is 30 days, then its aging schedule would probably show some past due accounts.

Which of the following statements is most correct?
a. Depreciation is included in the estimate of cash flows (Cash flow = Net income + Depreciation), so depreciation is set forth on a separate line in the cash budget.
b. If cash inflows and cash outflows occur on a regular basis, such as the situation in which inflows from collections occur in equal amounts each day and most payments are made regularly on the 10th of each month, then it is not necessary to use a daily cash budget. A cash budget prepared at the end of the month will suffice.
c. Sound working capital policy is designed to maximize the time between cash expenditures on materials and the collection of cash on sales.
d. Statements b and c are correct.
e. None of the statements above is correct.

e. None of the statements above is correct.

Which of the following statements is most correct?
a. Net working capital may be defined as current assets minus current liabilities. Any increase in the current ratio will automatically lead to an increase in net working capital.
b. Although short-term interest rates have historically averaged less than long-term rates, the heavy use of short-term debt is considered to be an aggressive strategy because of the inherent risks of using short-term financing.
c. If a company follows a policy of "matching maturities," this means that it matches its use of common stock with its use of long-term debt as opposed to short-term debt.
d. All of the statements above are correct.
e. None of the statements above is correct.

e. None of the statements above is correct.

Which of the following statements is most correct?
a. Accruals are an expensive way to finance working capital.
b. A conservative financing policy is one in which the firm finances all of its fixed
assets with long-term capital and part of its permanent net operating working capital
with short-term, nonspontaneous credit.
c. If a company receives trade credit under the terms 2/10, net 30 days, this implies the company has 10 days of free trade credit.
d. Statements a and b are correct.
e. None of the answers above is correct

c. If a company receives trade credit under the terms 2/10, net 30 days, this implies the company has 10 days of free trade credit.

Which of the following statement completions is most correct? If the yield curve is
upward sloping, then a firm's marketable securities portfolio, assumed to be held for
liquidity purposes, should be
a. Weighted toward long-term securities because they pay higher rates.
b. Weighted toward short-term securities because they pay higher rates.
c. Weighted toward U.S. Treasury securities to avoid interest rate risk.
d. Weighted toward short-term securities to avoid interest rate risk.
e. Balanced between long- and short-term securities to minimize the effects of either an
upward or a downward trend in interest rates.

d. Weighted toward short-term securities to avoid interest rate risk.

Which of the following statements is most correct?
a. Under normal conditions, a firm's expected ROE would probably be higher if it financed with short-term rather than with long-term debt, but the use of short-term debt would probably increase the firm's risk.
b. Conservative firms generally use no short-term debt and thus have zero current liabilities.
c. A short-term loan can usually be obtained more quickly than a long-term loan, but the cost of short-term debt is likely to be higher than that of long-term debt.
d. If a firm that can borrow from its bank buys on terms of 2/10, net 30 days, and if it must pay by Day 30 or else be cut off, then we would expect to see zero accounts payable on its balance sheet.
e. If one of your firm's customers is "stretching" its accounts payable, this may be a nuisance but does not represent a real financial cost to your firm as long as the firm periodically pays off its entire balance.

a. Under normal conditions, a firm's expected ROE would probably be higher if it financed with short-term rather than with long-term debt, but the use of short-term debt would probably increase the firm's risk.

Which of the following statements is most correct?
a. Under normal conditions the shape of the yield curve implies that the interest cost of short-term debt is greater than that of long-term debt, although short-term debt has other advantages that make it desirable as a financing source.
b. Flexibility is an advantage of short-term credit but this is somewhat offset by the higher flotation costs associated with the need to repeatedly renew short-term credit.
c. A short-term loan can usually be obtained more quickly than a long-term loan but the penalty for early repayment of a short-term loan is significantly higher than for a long-term loan.
d. Statements about the flexibility, cost, and riskiness of short-term versus long-term credit are dependent on the type of credit that is actually used.
e. Short-term debt is often less costly than long-term debt and the major reason for this is that short-term debt exposes the borrowing firm to much less risk than long-term debt.

d. Statements about the flexibility, cost, and riskiness of short-term versus long-term credit are dependent on the type of credit that is actually used.

Spartan Sporting Goods has $5 million in inventory and $2 million in accounts receivable. Its
average daily sales are $100,000. The company's payables deferral period (accounts payable divided
by daily purchases) is 30 days. What is the length of the company's cash conversion cycle?
a. 100 days
b. 60 days
c. 50 days
d. 40 days
e. 33 days

d. 40 days

For the Cook County Company, the average age of accounts receivable is 60 days, the average age of accounts payable is 45 days, and the average age of inventory is 72 days. Assuming a 365-day year, what is the length of the firm's cash conversion cycle?
a. 87 days
b. 90 days
c. 65 days
d. 48 days
e. 66 day

a. 87 days

The Danser Company expects to have sales of $30,000 in January, $33,000 in February, and $38,000 in March. If 20 percent of sales are for cash, 40 percent are credit sales paid in the month following the sale, and 40 percent are credit sales paid 2 months following the sale, what are the cash receipts from sales in March?
a. $55,000
b. $47,400
c. $38,000
d. $32,800
e. $30,000

d. $32,800

Jumpdisk Company writes checks averaging $15,000 a day, and it takes 5 days for these
checks to clear. The firm also receives checks in the amount of $17,000 per day, but the
firm loses three days while its receipts are being deposited and cleared. What is the
firm's net float in dollars?
a. $126,000
b. $ 75,000
c. $ 32,000
d. $ 24,000
e. $ 16,000

d. $ 24,000

Bowa Construction's days sales outstanding is 50 days (on a 365-day basis). The company's
accounts receivable equal $100 million and its balance sheet shows inventory equal to $125
million. What is the company's inventory turnover ratio?
a. 5.84
b. 4.25
c. 3.33
d. 2.75
e. 7.25

5.84

If Hot Tubs Inc. had sales of $2,027,773 per year (all credit) and its days sales
outstanding was equal to 35 days, what was its average amount of accounts receivable
outstanding? (Assume a 365-day year.)
a. $194,444
b. $ 57,143
c. $ 5,556
d. $ 97,222
e. $212,541

a. $194,444

A firm is offered trade credit terms of 3/15, net 45 days. The firm does not take the
discount, and it pays after 67 days. What is the nominal annual cost of not taking the
discount? (Assume a 365-day year.)
a. 21.71%
b. 22.07%
c. 22.95%
d. 23.48%
e. 24.52%

a. 21.71%

Dixie Tours Inc. buys on terms of 2/15, net 30 days. It does not take discounts, and it
typically pays 35 days after the invoice date. Net purchases amount to $720,000 per year.
What is the nominal annual cost of its non-free trade credit? (Assume a 365-day year.)
a. 17.2%
b. 23.6%
c. 26.1%
d. 37.2%
e. 50.6%

d. 37.2%

Your company has been offered credit terms on its purchases of 4/30, net 90 days. What will
be the nominal annual cost of trade credit if your company pays on the 35th day after
receiving the invoice? (Assume a 365-day year.)
a. 30%
b. 304%
c. 3%
d. 87%
e. 156%

b. 304%

Phillips Glass Company buys on terms of 2/15, net 30 days. It does not take discounts, and it
typically pays 30 days after the invoice date. Net purchases amount to $730,000 per year.
On average, how much "free" trade credit does Phillips receive during the year? (Assume a
365-day year.)
a. $30,000
b. $40,000
c. $50,000
d. $60,000
e. $70,000

a. $30,000

Wildthing Amusement Company's total assets fluctuate between $320,000 and $410,000,
while its fixed assets remain constant at $260,000. If the firm follows a maturity
matching or moderate working capital financing policy, what is the likely level of its
long-term financing?
a. $ 90,000
b. $260,000
c. $350,000
d. $410,000
e. $320,000

e. $320,000

Inland Oil arranged a $10,000,000 revolving credit agreement with a group of small banks. The firm paid an annual commitment fee of one-half of one percent of the unused balance of the loan commitment. On the used portion of the loan, Inland paid 1.5 percent above prime for the funds actually borrowed on an annual, simple interest basis. The
prime rate was at 9 percent for the year. If Inland borrowed $6,000,000 immediately after the agreement was signed and repaid the loan at the end of one year, what was the total dollar cost of the loan agreement for one year?
a. $560,000
b. $650,000
c. $540,000
d. $900,000
e. $675,000

b. $650,000

On average, a firm sells $2,000,000 in merchandise a month. It keeps inventory equal to one-half of its monthly sales on hand at all times. If the firm analyzes its accounts using a 365-day year, what is the firm's inventory conversion period?
a. 365.0 days
b. 182.5 days
c. 30.3 days
d. 15.2 days
e. 10.5 days

d. 15.2 days

Porta Stadium Inc. has annual sales of $80,000,000 and keeps average inventory of $20,000,000. On average, the firm has accounts receivable of $16,000,000. The firm buys all raw materials on credit, its trade credit terms are net 35 days, and it pays on time. The firm's managers are searching for ways to shorten the cash conversion cycle. If sales can be maintained at existing levels but inventory can be lowered by $4,000,000 and
accounts receivable lowered by $2,000,000, what will be the net change in the cash conversion cycle? Use a 365-day year. Round to the closest whole day.
a. +105 days
b. -105 days
c. +27 days
d. -27 days
e. -3 days

d. -27 days

You have recently been hired to improve the performance of Multiplex Corporation, which has been experiencing a severe cash shortage. As one part of your analysis, you want to determine the firm's cash conversion cycle. Using the following information and a 365-day year, what is your estimate of the firm's current cash conversion cycle?
 Current inventory = $120,000.
 Annual sales = $600,000.
 Accounts receivable = $157,808.
 Accounts payable = $25,000.
 Total annual purchases = $365,000.
 Purchases credit terms: net 30 days.
 Receivables credit terms: net 50 days.
a. 49 days
b. 193 days
c. 100 days
d. 168 days
e. 144 days

e. 144 days

Kolan Inc. has annual sales of $36,500,000 ($100,000 a day on a 365-day basis). On average, the company has $12,000,000 in inventory and $8,000,000 in accounts receivable. The company is looking for ways to shorten its cash conversion cycle, which is calculated on a 365-day basis. Its CFO has proposed new policies that would result in
a 20 percent reduction in both average inventories and accounts receivables. The company anticipates that these policies will also reduce sales by 10 percent. Accounts payable will remain unchanged. What effect would these policies have on the company's cash conversion cycle? Round to the nearest whole day.
a. -40 days
b. -22 days
c. -13 days
d. +22 days
e. +40 days

b. -22 days

Gaston Piston Corp. has annual sales of $50,735,000 and maintains an average inventory level of $15,012,000. The average accounts receivable balance outstanding is $10,008,000. The company makes all purchases on credit and has always paid on the 30th day. The company is now going to take full advantage of trade credit and pay its suppliers on the 40th day. If sales can be maintained at existing levels but inventory can be lowered by $1,946,000 and accounts receivable lowered by $1,946,000, what will be the net change in the cash conversion cycle? (Assume there are 365 days in the
year.)
a. -14.0 days
b. -18.8 days
c. -28.0 days
d. -25.6 days
e. -38.0 days

e. -38.0 days

Jarrett Enterprises is considering whether to pursue a restricted or relaxed current asset
investment policy. The firm's annual sales are $400,000; its fixed assets are $100,000;
debt and equity are each 50 percent of total assets. EBIT is $36,000, the interest rate on
the firm's debt is 10 percent, and the firm's tax rate is 40 percent. With a restricted
policy, current assets will be 15 percent of sales. Under a relaxed policy, current assets
will be 25 percent of sales. What is the difference in the projected ROEs between the
restricted and relaxed policies?
a. 0.0%
b. 6.2%
c. 5.4%
d. 1.6%
e. 3.8%

c. 5.4%

Chadmark Corporation's budgeted monthly sales are $3,000. Forty percent of its customers pay in the first month and take the 2 percent discount. The remaining 60 percent pay in the month following the sale and don't receive a discount. Chadmark's
bad debts are very small and are excluded from this analysis. Purchases for next month's sales are constant each month at $1,500. Other payments for wages, rent, and taxes are constant at $700 per month. Construct a single month's cash budget with the information given. What is the average cash gain or (loss) during a typical month for Chadmark Corporation?
a. $2,600
b. $ 800
c. $ 776
d. $ 740
e. $ 728

c. $ 776

Cross Collectibles currently fills mail orders from all over the U.S. and receipts come in
to headquarters in Little Rock, Arkansas. The firm's average accounts receivable (A/R) is
$2.5 million and is financed by a bank loan with 11 percent annual interest. Cross is
considering a regional lockbox system to speed up collections which it believes will
reduce A/R by 20 percent. The annual cost of the system is $15,000. What is the
estimated net annual savings to the firm from implementing the lockbox system?
a. $500,000
b. $ 30,000
c. $ 60,000
d. $ 55,000
e. $ 40,000

e. $ 40,000

Your firm buys on credit terms of 2/10, net 45 days, and it always pays on Day 45. If
you calculate that this policy effectively costs your firm $159,621 each year, what is the
firm's average accounts payable balance? (Hint: Use the nominal cost of trade credit
and carry its cost out to 6 decimal places.)
a. $1,234,000
b. $ 75,000
c. $ 157,500
d. $ 625,000
e. $ 750,000

e. $ 750,000

Suppose the credit terms offered to your firm by your suppliers are 2/10, net 30 days.
Out of convenience, your firm is not taking discounts, but is paying after 20 days, instead
of waiting until Day 30. You point out that the nominal cost of not taking the discount
and paying on Day 30 is approximately 37 percent. But since your firm is not taking
discounts and is paying on Day 20, what is the effective annual cost of your firm's
current practice, using a 365-day year?
a. 36.7%
b. 105.4%
c. 73.4%
d. 43.6%
e. 109.0%

e. 109.0%

Hayes Hypermarket purchases $4,562,500 in goods over a 1-year period from its sole
supplier. The supplier offers trade credit under the following terms: 2/15, net 50 days. If
Hayes chooses to pay on time but not to take the discount, what is the average level of the
company's accounts payable, and what is the effective annual cost of its trade credit?
(Assume a 365-day year.)
a. $208,333; 17.81%
b. $416,667; 17.54%
c. $416,667; 27.43%
d. $625,000; 17.54%
e. $625,000; 23.45%

e. $625,000; 23.45%

A firm is offered trade credit terms of 2/8, net 45 days. The firm does not take the discount, and it pays after 58 days. What is the effective annual cost of not taking this discount? (Assume a 365-day year.)
a. 21.63%
b. 13.35%
c. 14.90%
d. 15.89%
e. 18.70%

d. 15.89%

Dalrymple Grocers buys on credit terms of 2/10, net 30 days, and it always pays on the 30th
day. Dalrymple calculates that its annual costly trade credit is $375,000. What is the firm's
average accounts payable balance? Assume a 365-day year.
a. $187,475
b. $374,951
c. $223,333
d. $562,426
e. $457,443

d. $562,426

Quickbow Company currently uses maximum trade credit by not taking discounts on its purchases. Quickbow is considering borrowing from its bank, using notes payable, in order to take trade discounts. The firm wants to determine the effect of this policy change on its net income. The standard industry credit terms offered by all its suppliers are 2/10, net 30 days, and Quickbow pays in 30 days. Its net purchases are $11,760 per day, using a 365-
day year. The interest rate on the notes payable is 10 percent and the firm's tax rate is 40 percent. If the firm implements the plan, what is the expected change in Quickbow's net income?
a. -$23,520
b. -$31,440
c. +$23,520
d. +$38,448
e. +$69,888

d. +$38,448

Callison Airlines is deciding whether to pursue a restricted or relaxed working capital investment policy. Callison's annual sales are expected to total $3.6 million, its fixed assets turnover ratio equals 4.0, and its debt and common equity are each 50 percent of total assets. EBIT is $150,000, the interest rate on the firm's debt is 10 percent, and the firm's tax rate is 40 percent. If the company follows a restricted policy, its total assets turnover will be 2.5. Under a relaxed policy, its total assets turnover will be 2.2
If the firm adopts a restricted policy, how much will it save in interest expense (relative to
what it would be if Callison were to adopt a relaxed policy)?
a. $ 3,233
b. $ 6,175
c. $ 9,818
d. $ 7,200
e. $10,136

c. $ 9,818

Callison Airlines is deciding whether to pursue a restricted or relaxed working capital investment policy. Callison's annual sales are expected to total $3.6 million, its fixed assets turnover ratio equals 4.0, and its debt and common equity are each 50 percent of total assets. EBIT is $150,000, the interest rate on the firm's debt is 10 percent, and the firm's tax rate is 40 percent. If the company follows a restricted policy, its total assets turnover will be 2.5. Under a relaxed policy, its total assets turnover will be 2.2
What is the difference in the projected ROEs between the restricted and relaxed policies?
a. 2.24% b. 1.50% c. 1.00% d. 0.50% e. 0.33%

b. 1.50%

A firm's credit policy consists of which of the following items?
a. Credit period, cash discounts, credit standards, receivables monitoring.
b. Credit period, cash discounts, credit standards, collection policy.
c. Credit period, cash discounts, receivables monitoring, collection policy.
d. Cash discounts, credit standards, receivables monitoring, collection policy.
e. Credit period, receivables monitoring, credit standards, collection policy.

b. Credit period, cash discounts, credit standards, collection policy.

Which of the following is not correct?
a. Collection policy is how a firm goes about collecting past-due accounts.
b. A more aggressive collection policy will reduce bad debt expenses, but may also decrease sales.
c. Collection policy usually has little impact on sales since collecting past-due accounts
occurs only after the customer has already purchased.
d. Typically a firm will turn over an account to a collection agency only after it has tried
several times on its own to collect the account.
e. A lax collection policy will frequently lead to an increase in accounts receivable.

b. A more aggressive collection policy will reduce bad debt expenses, but may also decrease sales.

Which of the following statements is most correct?
a. If credit sales as a percentage of a firm's total sales increases, and the volume of credit
sales also increases, then the firm's accounts receivable will automatically increase.
b. It is possible for a firm to overstate profits by offering very lenient credit terms which encourage additional sales to financially "weak" firms. A major disadvantage of such a policy is that it is likely to increase uncollectible accounts.
c. A firm with excess production capacity and relatively low variable costs would not be
inclined to extend more liberal credit terms to its customers than a firm with similar
costs that is operating close to capacity.
d. Firms use seasonal dating primarily to decrease their DSO.
e. Seasonal dating with terms 2/15, net 30 days, with April 1 dating, means that if the
original sale took place on February 1st, the customer can take the discount up until
March 15th, but must pay the net invoice amount by April 1st

b. It is possible for a firm to overstate profits by offering very lenient credit terms which encourage additional sales to financially "weak" firms. A major disadvantage of such a policy is that it is likely to increase uncollectible accounts.

Which of the following is not correct for a firm with seasonal sales and customers who
all pay promptly at the end of 30 days?
a. DSO will vary from month to month.
b. The quarterly uncollected balances schedule will be the same in each quarter.
c. The level of accounts receivable will be constant from month to month.
d. The ratio of accounts receivable to sales will vary from month to month.
e. The level of accounts receivable at the end of each quarter will be the same.

c. The level of accounts receivable will be constant from month to month.

Seligstine, Inc.'s DSO was 31 days in March, and 45 days in April. Which of the
following is NOT possible?
a. Sales increased from March to April.
b. Sales decreased from March to April.
c. May's quarterly uncollected balances schedule showed a higher percent of April's
sales as uncollected than for March.
d. May's quarterly uncollected balances schedule showed a lower percent of April's
sales as uncollected than for March.
e. All of the above are possible.

e. All of the above are possible.

Which one of the following aspects of banks is considered most relevant to businesses
when choosing a bank?
a. Convenience of location.
b. Competitive cost of services provided.
c. Size of the bank's deposits.
d. Experience of personnel.
e. Loyalty and willingness to assume lending risks

e. Loyalty and willingness to assume lending risks

You have just taken out a loan for $75,000. The stated (simple) interest rate on this loan is 10 percent, and the bank requires you to maintain a compensating balance equal to 15 percent of the initial face amount of the loan. You currently have $20,000 in your checking account, and you plan to maintain this balance. The loan is an add-on installment loan which you will repay in 12 equal monthly installments, beginning at the end of the first month.
How large are your monthly payments?
a. $6,250
b. $7,000
c. $7,500
d. $5,250
e. $6,875

e. $6,875

You have just taken out a loan for $75,000. The stated (simple) interest rate on this loan is 10 percent, and the bank requires you to maintain a compensating balance equal to 15 percent of the initial face amount of the loan. You currently have $20,000 in your checking account, and you plan to maintain this balance. The loan is an add-on installment loan which you will repay in 12 equal monthly installments, beginning at the end of the first month.
What is the nominal annual add-on interest rate on this loan?
a. 10.00%
b. 16.47%
c. 18.83%
d. 20.00%
e. 24.00%

d. 20.00%

Suppose you borrow $2,000 from a bank for one year at a stated annual interest rate of 14
percent, with interest prepaid (a discounted loan). Also, assume that the bank requires
you to maintain a compensating balance equal to 20 percent of the initial loan value.
What effective annual interest rate are you being charged?
a. 14.00%
b. 8.57%
c. 16.28%
d. 21.21%
e. 28.00%

d. 21.21%

Wentworth Greenery harvests its crops four times annually and receives payment for its
crop 90 days after it is picked and shipped. However, the firm must plant, irrigate, and
harvest on a near continual schedule. The firm uses 90-day bank notes to finance its
operations. The firm arranges an 11 percent discount interest loan with a 20 percent
compensating balance four times annually. What is the effective annual interest rate of
these discount loans?
a. 11.00%
b. 15.94%
c. 11.46%
d. 13.75%
e. 12.72%

b. 15.94%

Assume you borrow $12,000 from the bank using a 10.19 percent "add-on", one-year
installment loan, payable in four equal quarterly payments. What is the effective annual
rate of interest?
a. 9.50%
b. 10.19%
c. 15.99%
d. 16.98%
e. 20.38%

d. 16.98%

XYZ Company needs to borrow $200,000 from its bank. The bank has offered the
company a 12-month installment loan (monthly payments) with 9 percent add-on interest.
What is the effective annual rate (EAR) of this loan?
a. 16.22%
b. 17.97%
c. 17.48%
d. 18.67%
e. 18.00%

c. 17.48%

First National Bank of Micanopy has offered you the following loan alternatives in
response to your request for a $75,000, 1-year loan.
Alternative 1: 7 percent discount interest, with a 10 percent compensating balance.
Alternative 2: 8 percent simple interest, with interest paid monthly.
What is the effective annual rate on the cheaper loan?
a. 8.00%
b. 7.23%
c. 7.67%
d. 8.43%
e. 8.30%

e. 8.30%

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