EXAM II - VERSION B

Principles of Finance Spring 2012

Dr. M. Schmidt

NAME
Section

This exam consists of 50 multiple choice questions (2 points each). For each question mark
only ONE answer on both the exam and your scantron sheet.
1. The most valuable investment given up if an alternative investment is chosen is a(n):
A) Salvage value expense.
B) Net working capital expense.
C) Sunk cost.
D) Opportunity cost.
E) Erosion cost.
2. A bond sold five weeks ago for $1,100. The bond is worth $1,050 in today's market.
Assuming no changes in risk, which of the following is FALSE?
A) The bond has less maturity today than it did five weeks ago.
B) The bond has a smaller premium today than it did five weeks ago.
C) Interest rates must be higher now than they were five weeks ago.
D) The bond's current yield has increased from five weeks ago.
E) The coupon payment of the bond must have increased.
3. A bond which, at the election of the holder, can be swapped for a fixed number of shares
of common stock at any time prior to the bond's maturity is called a _________ bond.
A) zero coupon
B) callable
C) putable
D) convertible
E) warrant
4. Payments made by a corporation to its shareholders, in the form of either cash or stock
are called:
A) Retained earnings.
B) Net income.
C) Dividends.
D) Options.
E) Infused equity.

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5. What would you pay today for a stock that is expected to make a $2 dividend in one year
if the expected dividend growth rate is 5% and you require a 12% return on your
investment?
A) $28.57
B) $29.33
C) $31.43
D) $43.14
E) $54.30
6. The changes in the firm's future cash flows that are a direct consequence of accepting a
project are called:
A) Incremental cash flows.
B) Opportunity cost cash flows.
C) After-tax cash flows.
D) Net present value cash flows.
E) Erosion cash flows.
7. What is the payback period of a $15,000 investment with the following cash flows?
Year
C a s h F lo w

A)
B)
C)
D)
E)

1
$ 3 ,0 0 0

2
$ 4 ,0 0 0

3
$ 5 ,0 0 0

4
$ 6 ,0 0 0

5
$ 7 ,0 0 0

2.75 years
3.50 years
3.75 years
4.50 years
4.75 years

8. The written, legally binding agreement between the corporate borrower and the lender
detailing the terms of a bond issue is called the:
A) Indenture.
B) Covenant.
C) Terms of trade.
D) Form 5140.
E) Call provision.
9. Calculate the NPV of the following project using a discount rate of 10%:
Yr 0 = $800; Yr 1 = $80; Yr 2 = $100; Yr 3 = $300; Yr 4 = $500; Yr 5 = $500
A)
B)
C)
D)
E)

$ 8.04
$ 87.28
$208.04
$459.17
$887.28

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10. Dizzy Corp. bonds bearing an annual coupon rate of 12%, pay coupons semiannually,
have 3 years remaining to maturity, and are currently priced at $940 per bond. What is the
yield to maturity as an annual stated rate?
A) 12.00%
B) 13.99%
C) 14.54%
D) 15.25%
E) 15.57%
11. As illustrated using the dividend growth model, the total return on a share of common
stock is comprised of a ________.
A) capital gains yield and a dividend growth rate
B) capital gains growth rate and a dividend growth rate
C) dividend payout ratio and a required rate of return
D) dividend yield and the present dividend
E) dividend yield and a capital gains yield
12. Which bond would most likely possess the least degree of interest rate risk?
A) 8% coupon rate, 10 years to maturity
B) 10% coupon rate, 10 years to maturity
C) 12% coupon rate, 10 years to maturity
D) 8% coupon rate, 20 years to maturity
E) 12% coupon rate, 20 years to maturity
13. What is the profitability index of the following investment if the required return = 10%?
Year
C a s h F lo w

A)
B)
C)
D)
E)

0
$150

1
$50

2
$75

3
$75

0.94
1.09
1.18
1.27
1.45

14. Llano's stock is currently selling for $40.00. The expected dividend one year from now is
$2 and the required return is 13%. What is this firm's dividend growth rate assuming the
constant dividend growth model is appropriate?
A) 8%
B) 9%
C) 10%
D) 11%

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15. If the following bonds are identical except for the coupon payment, what is the price of
bond B? (note: use bond A to calculate the missing YTM for bond B)
F a c e v a lu e
S e m ia n n u a l C o u p o n
Y e a rs to m a tu rity
P ric e

A)
B)
C)
D)
E)

B ond A
$ 1 ,0 0 0
$50
25
$ 1 ,1 5 0 .0 0

B ond B
$ 1 ,0 0 0
$40
25
?

$ 944.73
$ 975.31
$1,037.86
$1,150.00
$1,279.47

16. Etling Inc.'s dividend is expected to grow at 5% for the next 2 years and then at 3%
forever. If the current dividend is $2 and the required return is 14%, what is the price of
the stock? (Note: the dividend in time 0 is not included in the price of the stock.)
A) $19.43
B) $23.82
C) $25.15
D) $27.58
E) $29.70
17. A financial market is ________ if it is possible to easily observe its prices and trading
volume.
A) transparent
B) efficient
C) ordered
D) in equilibrium
E) chaotic
18. An agreement giving the bond issuer the option to repurchase the bond at a specified
price prior to maturity is the _______ provision.
A) sinking fund
B) call
C) seniority
D) collateral
E) trustee

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19. Which of the following statements is true?

A) NPV should never be used if the project under consideration has non-conventional
cash flows.
B) NPV is a cost/benefit ratio.
C) If the financial manager relies on NPV in making capital budgeting decisions, she
acts in the shareholders' best interests.
D) NPV can normally be directly observed in the marketplace.
E) The PI is generally preferred to NPV in making correct capital budgeting acceptance
decisions.
20. Given the following information and assuming straight-line depreciation to zero, what is
the profitability index for this project? Initial investment = $75,000; life = 5 years;
operating cash flow = $21,600 per year; salvage value = $10,000 in year 5; tax rate =
34%; discount rate = 13%.
A) 0.53
B) 0.84
C) 1.06
D) 1.49
E) 1.81
21. Which of the following statements is true regarding pro forma financial statements?
A) Pro forma statements are sufficient for tax purposes.
B) Pro forma statements are rarely prepared in advance.
C) Pro forma statements represent the best current estimate of the future.
D) Pro forma statements need only be prepared when applying for a bank loan.
E) Pro forma statements need not be accurate to be useful to the financial manager.
22. The market in which new securities are originally sold to investors is the _______
market.
A) dealer
B) auction
C) over-the-counter (OTC)
D) secondary
E) primary
23. The voting procedure where shareholders grant authority to another individual to vote
their shares is called:
A) Democratic voting.
B) Cumulative voting.
C) Straight voting.
D) Deferred voting.
E) Proxy voting.

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24. A project costs $60,000, will be depreciated straight-line to zero over its 4 year life, and
will require a net working capital investment of $5,000 up-front. The firm has a tax rate
of 35% and a required return of 10%. The project generates annual OCF of $22,000.
What is the project's NPV?
A) $ 6,724
B) $ 8,152
C) $ 9,393
D) $10,393
E) $12,485
25. Interest rates or rates of return on investment that have not been adjusted for the effects of
inflation (i.e. that include inflation) are called:
A) Coupon rates.
B) Stripped rates.
C) Effective rates.
D) Real rates.
E) Nominal rates.
26. Which of the following items would usually appear for a stock quote in the financial
press?
A) Capital gains rate
B) Dividend yield
C) Number of shares outstanding
D) Par value of the stock
E) Dividend growth rate
27. A cost that has already been paid, or the liability to pay has already been incurred, is a(n):
A) Salvage value expense.
B) Net working capital expense.
C) Sunk cost.
D) Opportunity cost.
E) Erosion cost.
28. What would you pay for a share of ABC Corporation stock today if the next dividend will
be $3 per share, your required return on equity investments is 15%, and the stock is
expected to be worth $90 one year from now?
A) $78.26
B) $80.87
C) $82.56
D) $90.00
E) $98.12

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29. Your broker offers you the opportunity to purchase a bond with coupon payments of $90
per year and a face value of $1000. If the yield to maturity on similar bonds is 8%, this
bond should:
A) Sell for the same price as the similar bond regardless of their respective maturities.
B) Sell at a premium.
C) Sell at a discount.
D) Sell for either a premium or a discount but it's impossible to tell which.
E) Sell for par value.
30. Which of the following is true with regards to special cases in capital budgeting?
I) Setting the bid price requires finding the sales price point at which the project NPV is
equal to zero.
II) In a cost-cutting proposal the reduction in costs has the same effect as an increase in
sales.
III) The equivalent annual cost (EAC) is used to evaluate mutually exclusive projects
with different economic lives if the projects are expected to be continuously
replicated.
A) I only
B) II only
C) III only
D) I, II, and III
E) none of the above.
31. The internal rate of return (IRR) rule can be best stated as:
A) An investment is acceptable if its IRR is exactly equal to its net present value (NPV).
B) An investment is acceptable if its IRR is exactly equal to zero.
C) An investment is acceptable if its IRR is less than the required return, else it should
be rejected.
D) An investment is acceptable if its IRR exceeds the required return, else it should be
rejected.
32. Suppose a project costs $2,500 and produces cash flows of $400 over each of the
following 8 years. What is the IRR of the project?
A) There is not enough information; a discount rate is required
B) 3.27%
C) 5.84%
D) 9.61%
E) 12.06%

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33. Project selection ambiguity can arise if one relies on IRR instead of NPV when:
A) The first cash flow is negative and the remaining cash flows are positive.
B) Projects are independent of one another.
C) A project has more than one NPV.
D) The profitability index is greater than one.
E) Project cash flows are not conventional.
34. You discover the engine-oil additive your scientists developed three years ago makes a
great men's after-shave once diluted properly using certain chemicals. How should you
treat the original $125,000 of R&D expenditures that went into developing the engine-oil
additive for your present decision regarding whether or not to begin production of the
after-shave?
A) Treat it as a cash outflow three years ago for the current project; that is, find the
future value today of the $125,000 spent three years ago.
B) The full $125,000 should be treated as an initial investment today.
C) As a cash inflow since the formula has obviously increased in value over the years.
D) As an opportunity cost if the formula cannot presently be sold to another
manufacturer.
E) As a sunk cost since the R&D expenditure has no bearing on today's decision.
35. J&J Enterprises wants to issue sixty 20-year, $1,000 zero-coupon bonds. If each bond is
to yield 7%, how much will J&J receive (ignoring issuance costs) when the bonds are
first sold?
A) $11,212
B) $12,393
C) $15,505
D) $18,880
E) $20,000
36. An investment generates $1.10 in present value benefits for each dollar of invested costs.
This conclusion was most likely reached by calculating the project's:
A) Net present value
B) Profitability index
C) Internal rate of return
D) Payback period
E) Average accounting return

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37. A project costs $80,000 and will be depreciated straight-line to zero over its 4 year life.
The project generates annual OCF of $22,000 and the fixed assets will be sold for $9,000
at the termination of the project. If the firm has a tax rate of 35% and a required return of
10%, what is the NPV?
A) $6,267
B) $2,426
C) $ 339
D) $2,181
E) $4,770
38. In comparing two projects using a NPV profile, at the point where the net present value
of the projects involved are equal, ________.
A) the IRR of each is equal to zero
B) the IRR of each is equal to the cost of capital
C) the discount rate that equates them is called the crossover rate
D) the projects both have NPVs equal to zero
E) the AAR exceeds the cost of capital
39. The cash flows of a new project that come at the expense of a firm's existing projects are:
A) Salvage value expenses.
B) Net working capital expenses.
C) Sunk costs.
D) Opportunity costs.
E) Erosion costs.
40. The current rate of return required by investors in the market for owning a bond is called
the:
A) Coupon.
B) Face value.
C) Current yield.
D) Yield to maturity.
E) Coupon rate.
41. The annual coupon of a bond divided by its face value is called the bond's:
A) Coupon payment.
B) Face value.
C) Maturity.
D) Yield to maturity.
E) Coupon rate.

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42. A situation in which taking one investment prevents the taking of another is called:
A) Net present value profiling.
B) Operational ambiguity.
C) Mutually exclusive investment decisions.
D) Issues of scale.
E) Multiple rates of return.
43. A firm has 500,000 shares outstanding. If 4 directors will be elected, how many shares do
you need to control to assure yourself a seat on the board under cumulative voting
procedures?
A) 50,001
B) 66,668
C) 100,001
D) 125,001
E) 500,000
44. Suppose that you have just purchased a share of stock for $40. The most recent dividend
was $2 and dividends are expected to grow at a rate of 7% indefinitely. What must your
required return be on the stock?
A) 5.45%
B) 7.00%
C) 10.25%
D) 12.35%
E) 13.65%
45. You presently own stock that you purchased one year ago. Your nominal return on the
stock for the past year was 20%. You calculate your real return on investment was
12.15%. The rate of inflation must have been _____.
A) 3%
B) 5%
C) 7%
D) 9%
E) 11%
46. The discounted payback rule can be best stated as:
A) An investment is acceptable if its discounted payback period is greater than some
pre-specified number of years.
B) An investment should be accepted if the discounted payback is positive and rejected
if it is negative.
C) An investment should be rejected if the discounted payback is positive and accepted
if it is negative.
D) An investment is acceptable if its discounted payback period is less than some prespecified number of years.

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47. A stock that pays a constant dividend of $1.50 forever currently sells for $10.71. What is
the required rate of return?
A) 10%
B) 12%
C) 13%
D) 14%
E) 15%
48. The annual annuity stream of payments with the same present value as a project's costs is
called the project's:
A) Incremental cost.
B) Sunk cost.
C) Opportunity cost.
D) Erosion cost.
E) Equivalent annual cost.
49. Which of the following is a right of an owner of a share of common stock?
A) The right to directly choose the auditing firm the company uses.
B) The right to sue the company in bankruptcy proceedings if common dividends are not
paid.
C) The right to vote for directors.
D) The right to participate in any new debt offerings the company sells to the public.
E) Preference over preferred shareholders in the payment of dividends.
50. A project costs $50,000, will be depreciated straight-line to zero over its 3 year life, and
will require a net working capital investment of $10,000 up-front. The project generates
annual OCF of $30,000. The fixed assets will be sold for $8,000 at the end of the project.
If the firm has a tax rate of 35% and a required return of 12%, what is the project NPV?
A) $15,756
B) $16,901
C) $22,874
D) $25,489
E) $31,141

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Answer Key -- FIN 3403 Exam II version b

1. D
2. E
3. D
4. C
5. A
6.
7.
8.
9.
10.

A
B
A
B
C

11.
12.
13.
14.
15.

E
C
B
A
A

16.
17.
18.
19.
20.

A
A
B
C
C

21.
22.
23.
24.
25.

C
E
E
B
E

26.
27.
28.
29.
30.

B
C
B
B
D

31.
32.
33.
34.
35.

D
C
E
E
C

36.
37.
38.
39.
40.

B
A
C
E
D

41.
42.
43.
44.
45.

E
C
C
D
C

46.
47.
48.
49.
50.

D
D
E
C
C

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