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CHP 9-11
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Terms in this set (60)
The concept of time value of money is important to financial decision making because
a. it recognizes that earning a return makes $1 today worth less than $1 received in the future
b. all of these options are true
c. it emphasizes earnings a return on invested capital
d. it can be applied to future cash flows in order to compare different streams of income
b. all of these options are true
a dollar today is worth worth more than a dollar to be received in the future because
A.
a stated rate of return is guaranteed on all investment opportunities.
B.
inflation will increase the purchasing power of a future dollar.
C.
the dollar can be invested today and earn interest.
D.
None of these options are true.
c. the dollar can be invested today and earn interest
Mr. Darden is selling his house for $200,000. He bought it for $164,000 ten years ago. What is the annual return on his investment?
A.
Less than 1%
B.
10%
C.
2%
D.
Between 3% and 4%
c. 2%
John Doeber borrowed $150,000 to buy a house. His loan cost was 6% and he promised to repay the loan in 10 equal annual payments. What is the principal outstanding after the first loan payment?
A.
$134,560
B.
$138,620
C.
$141,200
D.
$143,555
b. $138,620
In determining the future value of a single amount, one must consider
A.
the periodic payments at a given interest rate and time.
B.
the present value at a given interest rate and time.
C.
the future periodic payments discounted at a given interest rate and time.
D.
the future value at a given interest rate and time
b. the present value at a given interest rate and time
The higher the interest rate used in determining the future value of a $1 annuity,
A.
the greater the future value at the end of a period.
B.
None of these options. The interest has no effect on the future value of an annuity.
C.
the smaller the future value at the end of the period.
D.
the greater the present value at the beginning of a period.
a. the greater the future value at the end of a period
You will deposit $200,000 today. It will grow for five years at 12% interest, but compounded semi-annually. What will your investment grow to?
A.
$352,468
B.
$1,120,000
C.
$358,200
D.
$111,600
c. $358,200
Mr. Blochirt is creating a college investment fund for his daughter. He will put in $1,000 per year for the next 5 years starting one year from now and expects to earn a 6% annual rate of return. How much money will his daughter have when she starts college?
A.
$4,212
B.
$5,000
C.
$12,263
D.
$5,637
d. $5,637
An annuity may best be defined as
A.
a series of payments of unequal amount.
B.
a series of yearly payments, regardless of amount.
C.
a payment at a fixed interest rate.
D.
a series of consecutive payments of equal amounts.
d. a series of consecutive payments of equal amounts
Mr. Nailor invests $5,000 in a money market account at his local bank. He receives annual interest of 8% compounded for four years. How much total return will his investment earn during this time period?
A.
$6,254
B.
$1,800
C.
$3,675
D.
$8,570
b. $1,800
If you invest $10,000 today at 10% interest, how much will you have in 10 years
A.
$3,860
B.
$13,860
C.
$25,940
D.
$80,712
c. $25,940
If Gerry makes a deposit of $1,500 at the end of each quarter for five years, how much will he have at the end of the five years assuming a 12% annual return and quarterly compounding?
A.
$108,078
B.
$40,305
C.
$161,220
D.
$30,000
b. $40,305
How much must you invest today at 8% interest in order to see your investment grow to $8,000 in 10 years?
A.
$3,704
B.
$17,272
C.
$3,105
D.
$3,070
a. $3,704
Dr. Stein has just invested $10,000 for his son (age 7). The money will be used for his son's education 10 years from now. He calculates that he will need $21,598 for his son's education by the time the boy goes to school. What rate of return will Dr. Stein need to achieve this goal? Choose the closest answer.
A.
1%
B.
10%
C.
8%
D.
4%
c. 8%
As the interest rate increases, the present value
A.
increases.
B.
decreases.
C.
remains the same.
D.
Not enough information is given to tell.
b. decreases
As the time period until receipt increases, the present value
A.
decreases.
B.
increases.
C.
Not enough information is given to tell.
D.
remains the same.
a. decreases
Sharon Smith will receive $1 million in 20 years. The discount rate is 10%. As an alternative, she can receive $200,000 today. Which should she choose?
A.
Neither option would be preferred.
B.
The $200,000 today.
C.
Both equal the same value.
D.
The $1 million in 20 years.
b. the $200,000 today
Mr. Bubble wants to sell his bubble machine for $1,000,000, but it might take awhile before it is valued that high. He bought it for $149,000 and is earning annual interest of 10% on the machine. How long will Mr. Bubble have to wait before the machine is valued at $1,000,000?
A.
5 years
B.
20 years
C.
10 years
D.
More than 20 years
b. 20 years
A home buyer signed a 20-year, 8% mortgage for $72,500. Given the following information, how much should the annual loan payments be?
A.
$7,384
B.
$15,588
C.
$15,555
D.
$1,584
a. $7,384
To save for her newborn son 's college education, Lea Wilson will invest $1,000 at the end of each year for the next 20 years. The interest rate is 10%. What is the future value?
A.
$57,275
B.
$2,980
C.
$63,440
D.
$8,514
a. $57,275
A firm is paying an annual dividend of $2.65 for its preferred stock that is selling for $57.00. There is a selling cost of $3.30. What is the after-tax cost of preferred stock if the firm's tax rate is 33%?
A.
5.79%
B.
4.93%
C.
3.30%
D.
6.11%
b. 4.93%
In determining the cost of retained earnings
A.
flotation costs are included.
B.
the dividend valuation model is inappropriate.
C.
the capital asset pricing model can be used.
D.
growth is not considered.
c. the capital asset pricing model can be used
For a firm paying 5% for new debt, the higher the firm's tax rate
A.
the after-tax cost is unchanged.
B.
Not enough information to judge.
C.
the lower the after-tax cost of debt.
D.
the higher the after-tax cost of debt.
c. the lower the after tax cost of debt
A firm's stock is selling for $65. The dividend yield is 6%. A 7% growth rate is expected for the common stock. The firm's tax rate is 40%. What is the firm's cost of retained earnings?
A.
13.00%
B.
7.8%
C.
8.16%
D.
12.35%
a. 13%
The pre-tax cost of debt for a new issue of debt is determined by
A.
the investor's required rate of return on issued stock.
B.
the yield to maturity of outstanding or comparable bonds.
C.
the coupon rate of existing debt.
D.
All of these options are true.
b. the yield to maturity of outstanding or comparable bonds
Although debt financing is usually the cheapest component of capital, it cannot be used in excess because
A.
interest rates may change.
B.
the firm's stock price will increase and raise the cost of equity financing.
C.
underwriting costs may change.
D.
the financial risk of the firm may increase and thus drive up the cost of all sources of financing.
d. the financial risk of a firm may increase and thus drive up the cost of all sources of financing
The general rule for using the weighted average cost of capital (WACC) in capital budgeting decisions is to accept all projects with
A.
rates of return greater than or equal to the WACC.
B.
positive rates of return.
C.
rates of return equal to or less than the WACC.
D.
rates of return less than the WACC.
a. rates of return greater than or equal to the WACC
Debreu Beverages has an optimal capital structure that is 70% common equity, 20% debt, and 10% preferred stock. Debreu's pretax cost of equity is 9%. Its pretax cost of preferred equity is 7%, and its pretax cost of debt is also 5%. If the corporate tax rate is 35%, what is the weighted average cost of capital?
A.
Between 8% and 9%
B.
Between 7% and 8%
C.
Between 9% and 10%
D.
Between 10% and 12%
b. between 7 and 8%
Flotation cost is the
A.
cost of holding stock on hand.
B.
cost of issuing new stock.
C.
cost of issuing new debt.
D.
sales price of common stock.
b. cost of issuring new stock
Within the capital asset pricing model
A.
the risk-free rate is usually higher than the return in the market.
B.
the higher the beta, the lower the required rate of return.
C.
dividends are considered in the calculations.
D.
beta measures the volatility of an individual stock relative to a stock market index.
d. beta measures the volatility of an individual stock relative to a stock market index
The weighted average cost of capital is used as a discount rate because
A.
returns below the cost of capital will cover all fixed costs associated with capital and provide an excess return to stockholders.
B.
it is comparable to the prevailing market interest rates.
C.
it is an indication of how much the firm is earning overall.
D.
as long as the cost of capital is earned, the common stock value of the firm will be maintained.
d. as long as the cost of capital is earned, the common stock value of the firm will be maintained
For many firms, the cheapest and most important source of equity capital is in the form of
A.
retained earnings.
B.
common stock.
C.
debt.
D.
preferred stock.
a. retained earnings
Using the constant dividend growth model for common stock, if the market price of stock (P0) goes up,
A.
Further information is needed to answer the question.
B.
the assumed cost goes down.
C.
the assumed cost goes up.
D.
the assumed cost remains unchanged.
b. the assumed cost goes down
if a firm's bonds are currently yielding 6% in the marketplace, why would the firm's cost of debt be lower?
A.
Interest rates have changed.
B.
Additional debt can be issued more cheaply than the original debt.
C.
Interest is tax-deductible, so tax savings are considered.
D.
There should be no difference; the cost of debt is the same as the bond's market yield.
c. interest is tax-deductible, so tax savings are considered
The cost of equity capital in the form of new common stock will be higher than the cost of retained earnings because of
A.
the existence of flotation costs.
B.
the existence of financial leverage.
C.
the existence of taxes.
D.
investors' unwillingness to purchase additional shares of common stock.
a. the existence of flotation costs
Debreu Beverages has an optimal capital structure that is 70% common equity, 10% preferred stock, and 20% debt. Debreu's pretax cost of equity is 9%. Its pretax cost of preferred equity is 7%, and its pretax cost of debt is also 5%. If the corporate tax rate is 35%, what is the weighted average cost of capital?
A.
5.2%
B.
7.65%
C.
8%
D.
8.74%
b. 7.65%
The coupon rate on a debt issue is 6%. If the yield to maturity on the debt is 9%, what is the after-tax cost of debt in the weighted average cost of capital if the firm's tax rate is 34%?
A.
4.08%
B.
5.94%
C.
3.96%
D.
7.92%
b. 5.94%
Retained earnings has a cost associated with it because
A.
Ke > g.
B.
new funds must be raised.
C.
flotation costs increase the cost of funding.
D.
there is an opportunity cost associated with stockholder funds.
d. there is an opportunity cost associated with stockholder funds
Financial capital does not include
A.
stocks.
B.
working capital.
C.
bonds.
D.
preferred stocks.
b. working capital
The after-tax cost of preferred stock to the issuing corporation
A.
is usually lower than the cost of debt.
B.
None of these options are true.
C.
is dependent on the firm's tax bracket.
D.
is the same as the before-tax cost.
d. is the same as the before tax cost
In a general sense, the value of any asset is the
A.
present value of the cash flows expected to be received from the asset.
B.
value of the dividends received from the asset.
C.
future value of the expected earnings discounted by the asset's cost of capital.
D.
value of past dividends and price increases for the asset.
a. present value of the cash flows expected to be received from the asset
An issue of common stock's most recent dividend is $1.75. Its growth rate is 5.7%. What is its price if the market's rate of return is 7.7%?
A.
None of these options are correct
B.
$24.63
C.
$87.50
D.
$92.50
d. $92.50
An issue of preferred stock is paying an annual dividend of $1.50. The growth rate for the firm's common stock is 5%. What is the preferred stock price if the required rate of return is 7%?
A.
$30.00
B.
None of these options are correct
C.
$22.50
D.
$21.43
d. $21.43
A 10-year bond, with a par value equaling $1,000, pays 7% annually. If similar bonds are currently yielding 6% annually, what is the market value of the bond? Use semi-annual analysis.
A.
$1,074.70
B.
$700.00
C.
$1,520.70
D.
$927.50
a. $1,074.70
Market Enterprises would like to issue $1,000 bonds and needs to determine the approximate rate it would need to pay investors. A firm with similar risk recently issued bonds with the following current features: a 5% coupon rate, 10 years until maturity, and a current price of $1,170.50. At what rate would Market Enterprises expect to issue bonds, assuming annual interest payments? Please round to the closest answer.
A.
6%
B.
3%
C.
5%
D.
4%
b. 35
If expected dividends grow at 7% and the appropriate discount rate is 9%, what is the value of a stock with an expected dividend one year from now of $1.00?
A.
$62.88
B.
$50.00
C.
$19.41
D.
$29.12
b. $50.00
An increase in the riskiness of a particular security would NOT affect
A.
investors' willingness to buy the security.
B.
the risk premium for that security.
C.
the total required return for the security.
D.
the premium for expected inflation.
d. the premium for expected inflation
Doug has been approached by his broker to purchase a $1,000 bond for $795. He believes the bond should yield 8%. The bond pays a 5% annual coupon rate and has 10 years left until maturity. What should Doug's analysis of the bond indicate to him? Use annual analysis.
A.
The bond is undervalued; he should not purchase it.
B.
The bond is overvalued; he should not purchase it.
C.
The bond is overvalued; he should purchase it.
D.
The bond is undervalued; he should purchase it.
d. the bond is undervalued; he should prurchase it
As a bond approaches its maturity date, its sales price approaches
A.
U.S. Treasury bond prices.
B.
the par value.
C.
the price of comparable bonds.
D.
the par adjusted for yield to maturity
b. the par value
Star Corp. issued bonds two years ago with a 7% coupon rate. The bonds are currently trading for $928 in the market. Which of the following most likely has occurred since the time of issue?
A.
Real rates of return decreased
B.
Inflation increased
C.
Interest yields decreased
D.
Risk decreased
b. inflation increased
An issue of common stock is selling for $57.20. The year-end dividend is expected to be $2.32, assuming a constant growth rate of 4%. What is the required rate of return?
A.
8.1%
B.
None of these options are correct
C.
10.1%
D.
10.3%
A. 8.1%
Which of the following regarding preferred stock is true?
A.
The price in the market remains at par.
B.
If the required rate of return increases, the price decreases.
C.
If the required rate of return increases, the price increases.
D.
If the price decreases, the required rate of return has decreased.
b. if the required rate of return increases, the price decreases
A 20-year bond pays 6% annually on a face value of $1,000. If similar bonds are currently yielding 4%, what is the market value of the bond?
A.
$1,271.40
B.
Not enough information is given to tell.
C.
$770.80
D.
$573.50
a. $1,271.40
An issue of common stock has just paid a dividend of $2.00. Its growth rate is equal to 4%. If the required rate of return is 7%, what is its current price?
A.
$80.00
B.
$69.33
C.
$19.04
D.
None of these options are correct
b. $69.33
The Required Rate of Return for common stock is Ke = (D1/P0) + g What are the assumptions of the model?
A.
The price earnings ratio stays the same.
B.
Growth (g) is constant to infinity.
C.
All of these options are assumptions of the model.
D.
The firm must pay a dividend to use this model.
c. all of these options are assumptions of the model
Which is a characteristic of the price of preferred stock?
A.
Preferred stock is valued as a perpetuity.
B.
None of these options are true.
C.
Since preferred stock dividends are fixed, they are tax-deductible.
D.
Because preferred stock has no maturity, the price analysis is similar to that of debt.
a. preferred stock is valued as a perpetuity
The value of a common stock is based on its
A.
past performance.
B.
current earnings.
C.
value of future benefits to the holder.
D.
historic dividends.
c. the value of future benefits to the holder
The relationship between a bond's sales price and the yield to maturity
A.
changes at a constant level for each percentage change of yield to maturity.
B.
is a linear relationship.
C.
changes at a constant level for each percentage change of yield to maturity and is an inverse relationship.
D.
is an inverse relationship.
d. is an inverse relationship
A bond that has a "yield to maturity" greater than its coupon interest rate will sell for a price
A.
above par.
B.
below par.
C.
at par.
D.
that is equal to the face value of the bond plus the value of all interest payments.
b. below par
A higher interest rate (discount rate) would
A.
reduce the price of preferred stock.
B.
all of these options are true.
C.
reduce the price of corporate bonds.
D.
reduce the price of common stock.
b. all of these options are true
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