1. Which of the following statements is most correct?

a. One drawback of forming a corporation is that it subjects the firm to additional

regulations.
b. One drawback of forming a corporation is that it subjects the firm to unlimited
liability.
c. One drawback of forming a corporation is that it makes it more difficult for the firm
to raise capital.
d. One drawback of forming a corporation is that it makes it more difficult to transfer
ownership.
Answer is a.
2. A retirement plan guarantees to pay you or your estate a fixed amount for 25 years. At the time
of retirement you will have $100,000 to your credit in the plan. The plan anticipates earning
5% interest annually over the period you receive benefits. How much will your annual
benefits be assuming the first payment occurs one year from your retirement date?
a.
b.
c.
d.

$4,000
$5,272
$6,101
$7,095

Answer is d. 100,000+/25
5
CPT PMT

PV
N
I/Y
= 7,095.25

3. Of the following, which differs in meaning from the other three?

a. Macroeconomic Risk
b. Market Risk
c. Nondiversifiable Risk
d. Unsystematic Risk

Answer is d.
4. Consider a 10 year semi-annual bond with a 7% coupon rate, $1000 face value, and YTM of
10%. If YTM remains the same, the price of the bond will _______ over the next year.
a.
b.
c.
d.

increase
decrease
stay the same
could increase or decrease

Answer is a.
1

5. Pro forma financial statements are:

a.
b.
c.
d.
e.

Illegal.
Accounting statements filed with the Securities and Exchange Commission (SEC).
Accounting statements filed with the Internal Revenue Service (IRS).
Projected accounting statements based on a sales forecast and other assumptions.
The most-recently compiled accounting statements of the firm released to the public.

Use the Following Information on Questions 6 and 7

Johnson Company
Balance Sheet
Assets:
Cash and marketable securities
Accounts receivable
Inventories
Total current assets
Fixed assets
2,700,000
Less: accum. depr. (1,087,500)
Net fixed assets
Total assets

$ 300,000
1,239,000
1,747,500
3,286,500
1,612,500
$4,899,000

Liabilities:
Accounts payable
Notes payable
Accrued taxes
Total current liabilities
Long-term debt
Owner's equity
Total liabilities and owner's equity

$ 240,000
825,000
42,000
$1,107,000
975,000
2,817,000
$4,899,000

Net sales (all credit)

Less: Cost of goods sold
Selling and administrative expense
Depreciation expense
Interest expense
Earnings before taxes
Income taxes
Net income

$6,375,000
(4,312,500)
(1,387,500)
(135,000)
(127,000)
$ 412,500
(225,000)
$ 187,500

6. The quick ratio for Johnson Company is:

a. 2.97
b. 1.31
c. 1.39
d. 2.11
Quick ratio = (current assets inventory) (current liabilities)

(3,286,500 1,747,500) (1,107,000)

(1,539,000) (1,107,000) = 1.39.
Answer is c.
7. The inventory turnover ratio for Johnson Company is:
a.
b.
c.
d.

0.29 times
2.35 times
0.43 times
2.47 times

Inventory turnover = (cost of goods sold) (inventory)

(4,312,500) (1,747,500) = 2.4678. Answer is d.

8. Find the Payback Period and NPV of the following project. The cost of capital is 10%.
Time
0
1
2
3
a.
b.
c.
d.
e.

Cash Flows
-10000
5000
4000
3000

2 years; $105
2 years; $540
2.33 years, $105
2.33 years; $540
3 years; $2,000

Payback
Year
0
1
2
3

Outflow
-10,000

Inflow
5,000
4,000
3,000

Balance
-10,000
-5,000
-1,000
-2,000

Breakeven took place in third year. Since the balance was 1,000, and cash inflow during the
third year was 3,000, we assume that the breakeven point was one third of the way into the
third year. Answer for breakeven is 2.33 years.
NPV
PV of 5,000 discounted at 10% for one year =
PV of 4,000 discounted at 10% for two years =
PV of 3,000 discounted at 10% for three years =
PV of the future cash flows =

4,545.45
3,305.79
2,253.94
10,105.18

Less initial outlay

NPV =

- 10,000.00
105.18

Answer is c.

9. Assume that two investments have equal lives, and require the same initial investment. The
first investment will pay more cash in total, but the bulk of this cash will be paid in the later
years of the investments life. The second investment will pay less cash in total, but will pay
most of this cash during the next few years. A high discount rate tends to favor:
a. the investment with large cash flows early.
b. the investment paying more cash in total (even if the cash is paid later).
c. the investment with even cash flow.
d. neither investment since they have equal lives.

Answer is a.
10. Global Airways common stock just paid a dividend of $1.75. The firm expects dividends to
grow at a rate of 6.5% indefinitely. If investors require a rate of return on the stock of
13.75%, what is the value of the common stock today? (round to nearest 10 cents)
a.
b.
c.
d.

$66.20
$25.70
$22.00
$36.40

What is the formula for determining stock price?

Price = dividend (required rate of return dividend growth rate)
But, theres a wrinkle to this question!
The dividend just paid was $1.75. If I am interested in buying this stock, I am
interested in buying it based on the anticipated dividend. If the dividend is
growing at 6.5%, then the next dividend is anticipated to be $1.86375 (1.065 x
1.75).
So, lets apply the formula to the expected dividend.
Price = $1.86375 (13.75 6.5)
Price = $1.86375 7.25
Price = $25.706896

11. Assume interest rates (YTM) on long-term government and corporate bonds are as follows:
T-bond = 7.72%
AAA = 8.72%

A = 9.64%
BBB = 10.18%

The differences in the YTMs on these bonds are caused primarily by

a.
b.
c.
d.

Tax effects.
Default risk differences.
Maturity risk differences.
Inflation differences.

e. Statements b and d are correct

Answer is b.

12. Which of the following statements is most correct?

a. Market participants are able to eliminate virtually all systematic risk if they hold a
large diversified portfolio of stocks.
b. Market participants are able to eliminate virtually all company-specific risk if they
hold a large diversified portfolio of stocks.
c. Market participants are able to eliminate all beta risk if they hold a large, diversified
portfolio of stocks.
d. Market participants are able to eliminate all risk if they hold a large, diversified
portfolio of stocks.
Answer is b.
13. Last year, Sallys Spaniel Salon had total revenues of $130,000 and total expenses of
$98,000. Next year, revenues are projected to increase by 7%, and expenses are expected to
increase by 8%. What will be the (approximate) percent increase in Net Income? (Ignore
Taxes).
a 11%
b. 8%
c. 7%
d. 6%
e. 4%
Per below, answer is e.
Last year

Next year

Percent change

Revenues

130,000

139,100

7%

Expenses

98,000

105,840

8%

Net Income

32,000

33,260

4%

14. Tigger Inc.s expected dividend next year is $3.50 per share (i.e., D1 = $3.50). The dividend
is expected to grow at a rate of 7 percent per year. The risk-free rate is 5 percent and the
return on the market is 12 percent. If the companys beta is 1.15, what is the price of the
stock today?
a. $32.22
b. $34.75
c. $44.05

d. $57.85
e. $31.05

What is the formula for determining stock price?

Price = dividend (required rate of return dividend growth rate)
We need to solve this in two steps. The first step is to determine the required rate of return.
Once we know the required rate of return, we can determine the price of the stock.
From the CAPM; required rate of return = risk free rate + (beta(market return-risk free rate).
Required rate of return = 5% + (1.15(12% - 5%).
Required rate of return = 5% + (1.15 x 7%)
Required rate of return = 5% + 8.05%
Required rate of return = 13.05%
Now that we know the required rate of return, we can calculate the price of the stock
Price = dividend (required rate of return dividend growth rate)
Price = 3.50 (13.05% 7%)
Price = 3.50 (6.05%)
Price = 57.85
Answer is d
15. Which of the following statements is/are true, all else the same
I. Present values decrease as the discount rate decreases.
II. Present values decrease the further away in time the future value.
III. The effective annual return will always be less than or equal to the APR.
a.
b.
c.
d.
e.

I only
I and II only
II only
III only
II and III only

Answer is c.
16. Which of the following statements is most correct?
a. The ability of firms to engage in ethical behavior must be balanced against the need
to raise capital at low cost, as defined by the Capital Asset Pricing Model.
b. It is acceptable for a firm to inflate operating results slightly in an effort to maximize
shareholder wealth (as long as no one is hurt).
c. Actions that maximize a firm's stock price are inconsistent with maximizing social
welfare.
d. The concepts of social responsibility and ethical responsibility on the part of
corporations are completely different and neither is relevant in maximizing stock
price.

e. It is possible for a firm to behave ethically and, at the same time, maximize
shareholder value.
Answer is e.

17. Firm specific events, like a new product introduction or the resolution of a lawsuit, represent
what type of risk?
a.
b.
c.
d.

Beta risk
Market risk
Systematic risk
Diversifiable risk

Answer is d.

18. At what rate must $500 be compounded annually for it to grow to $814.45 in 10 years?
a.
b.
c.
d.

6 percent
5 percent
7 percent
8 percent

Set it up on the calculator.

814.45
FV
10
500+/PV
CPT I/Y =
5%

19. Because Vigorous Growth Company retains and invests all of its earnings (in positive NPV
projects!), the firm currently pays no dividends. Investors believe that the firm will pay its
first dividend (of $12 per share) 20 years from today. Investors then believe the dividend will
remain constant at $12 per share, forever. Given a required return of 6%, what is the stock
price today?
a.
b.
c.
d.
e.

$ 49.92
$ 61.16
$ 66.10
$200.00
The firm has no value because it does not pay dividends.

We need to solve this in two steps. Step one is to determine the price of the stock once it
starts to pay a dividend twenty years from now. Step two is to discount that price back to the
present value.

This is a series of PV calculations. Lets draw a timeline to understand this series:

+_______________________+__+____________________
0
19 20

We know that this stock will pay a dividend of $12/share forever. This is the
same as a perpetuity. The PV of a perpetuity is payment divided by required rate
of return. In this case, $12 .06 = $200.
So we know that in the present value of the dividend stream will be $200. But we
wont start to collect this dividend stream for 20 years!
At first, we might think to calculate the present value of $200, at 6%, with an N
of 20. But the N is actually 19. Because the first payment is received 20
years from today. Remember our assumption about annuities is that the payment
is received at the end of the year.
So lets calculate the PV 0f $200, when the I/Y is 6%, and N is 19. (200 FV; 19 N;
6 I/Y; CPT PV = $66.10). Answer is c.

20. If you invest $375 every six months at 8 percent compounded semi-annually, how much
would you accumulate at the end of 10 years?
a.
b.
c.
d.

$ 5,033
$ 5,117
$10,866
$11,167
Set this up on the calculator
20
4

N (semi-annually for 10 years)

I/Y (8% semi annually)

375+/CPT FV =

PMT (change the sign because its an outflow)

11,166.78

21. Comparison of the financial ratios for two firms may be difficult if:
I. The firms operate in different industries.
II. Both firms use FIFO to account for inventory.
III. The firms financial statements are prepared using different fiscal year-ends.
a. I only
b. III only

c. I and II only
d. I and III only
e. I, II and III
Answer is d.
22. Craigs Manufacturing Company is considering the purchase of a new machine for a cost of
$250,000. The new machine will have a 5-year useful life and will be depreciated to an
expected salvage value of zero using the straight-line method. The machine will allow the
firm to produce a new product, which is expected to increase the firms income before
depreciation, interest, and taxes by $100,000 per year (in each of the five years). Craigs
income tax rate is 34%. What is the projected incremental operating cash flow of the machine
in each of years 1 to 5?
a.
b.
c.
d.
e.

$ 66,000
$ 77,000
$ 83,000
$100,000
$116,000

Income will increase by $100,000 in each of the five years. But we need to find
after tax incremental cash flow.
So we start with annual positive cash flow of $100,000 per year. Now we have to
determine the tax implications. From this positive $100,000 we get to deduct
depreciation. At a cost of $250,000, and salvage value of zero, with straight line
depreciation, we depreciate at 50,000/year (250,000 5 = 50,000). This means
taxable income is 100,000 less 50,000 or 50,000. At 34%, the tax on $50,000 =
$17,000. So we have 50,000 in profit, less the 17,000 in taxes, or $33,000. But, we
get to add the depreciation back as depreciation (although it is an expense) is not
an outlay of cash. $33,000 profit plus $50,000 depreciation = $83,000. Answer is
c.
23. Which of the following statements is most correct?
a. A 5-year $100 ordinary annuity will have a higher present value than a 5- year $100
annuity due.
b. A 30-year mortgage will have larger monthly payments than a 15-year mortgage of the
same amount and same interest rate.
c. If an investment pays 10 percent interest compounded monthly, its effective rate will be
greater than 10 percent.
d. If the interest rate is positive, the present value of an amount will exceed its future
value.
Answer is c.

24. In finance, all risk is not equal because:

a. some risk can be diversified away and some cannot.
b. some risk is free while some is not.
c. risk is inversely related to return.
d. the level of risk depends on whether it is measured as standard deviation or risk-tomaturity.
Answer is a.
25. A new public issue of securities is regulated by the:
a.
b.
c.
d.
e.

FDIC
Investment Bankers Association
Federal Reserve Bank (the FED)
SEC
IPO

Answer is d.
26. What is present value of one $1,500,000 payment, to be paid in 250 years, if the discount rate
is 0%?
a. $ Infinity
b. $ 1,500,000
c. $ 16,133
d. $ 0
Answer is b. Without the concept of interest (discount rate), there is no difference between
present value and future value.
27. What is the current yield on a $1000 face value bond, priced at $1,166.67, with a coupon rate
of 7%?
a.
b.
c.
d.

6.0%
6.5%
7.0%
7.5%

Formula for current yield is: current yield = interest payment price
Current yield = 70 1,166.67 = 5.9999%
Answer is a.
28. What is the IRR of an investment that costs $13,500 and pays $3,475 a year for 6 years?
a. 10%

10

b.
c.
d.
e.

12%
13%
14%
18%

Set this up on the calculator as if it were an annuity, and we want to solve for I/Y.
6
13,500+/3,475
CPT I/Y

N
PV
PMT
14.04%

Answer is d.

29. What is the expected return for the following stock?

Outcome
Average
Recession
Depression
a.
b.
c.
d.
e.

Probability
.50
.35
.15

Return
.21
.10
.40

.05
.08
.09
.10
.12

Lets set this up in a table

Outcome
Average
Recession
Depression

Probability
.50
.35
.15
1.0

Return
.21
.10
-.40

Weighted Return
.105
.035
(.06)
.08

Answer is b.
30. You are interested in investing your money in a bank account. Which of the following banks
provides you with the highest effective rate of interest?
a.
b.
c.
d.
e.

Bank 1; 5.8 percent with monthly compounding.

Bank 2; 5.8 percent with annual compounding.
Bank 3; 5.8 percent with quarterly compounding.
Bank 4; 6 percent with annual compounding.
You are indifferent between Banks 2 and 4. You should select the
bank you find to have the best customer service.

Answer is d. We can prove this by calculating the FV of $1 under each of these options.

11

31. You have determined the profitability of a planned project by finding the present value of all
the cash flows from that project. Which of the following would cause the project to look
more appealing in terms of the present value of those cash flows?
a. The discount rate decreases.
b. The cash flows are stretched over a longer period of time, but the total amount of the
cash flows remains the same.
c. The discount rate increases.
d. The cost of the project increases.
e. Sunk costs related to the project decrease.
As the discount rate decreases, the PV increases. Answer is a.
32. Mary purchased Lamb Hair Inc. common stock one year ago for $17.50 per share. She just
received a dividend of $1.40 per share, and then sold the stock for $17.85 per share. What
was Marys holding period return on this investment, her dividend yield, and her capital gains
yield, respectively?
a. 5.9%
b. 8.0%
c. 10.0%
d. 10.0%

7.8%
10%
7.8%
8%

1.9%
2%
2.4%
2.0%

Lets break this down into each separate question. Lets start with solving for return on
investment. We had a formula for this.
Return on investment = positive cash flow + (capital gain/capital loss of the asset)
starting price of the asset
Return on investment = $1.40 + ($17.85 $17.50)
$17.50
Return on investment = $1.40 + .35
$17.50
Return on investment = $1.75
$17.50
Return on investment = 10%
The second question being asked is dividend yield.
Yield = return investment.
$1.40 $17.50 = .08, or 8%
The last question being asked is capital gains yield.
Yield = return investment.

12

Capital gain = $17.85 - $17.50 = .35

.35 $17.50 = .02, or 2%
So the answer is d; 10%, 8%, and 2%
33. All else the same, if interest rates fall, then

I. bond prices will fall

II. coupon payments on fixed rate bonds will fall
III. the percentage price change for short-term bonds will be greater than for long-term
bonds
IV. the percentage price change for long-term bonds will be greater than for short-term
bonds
a.
b.
c.
d.
e.

I and II only
I and III only
I and IV only
III only
IV only

34. Bell Weather Inc. has a beta of 1.25. The return on the market portfolio is 12.5% and the risk
free rate is 5%. According to CAPM, what is the required return on this stock?
a.
b.
c.
d.

20.62%
9.37%
14.38%
15.62%

35. Consider two mutually exclusive projects with conventional cash flows. The IRRs of projects
A and B are 10% and 15% respectively. Which of the following statements is true about the
net present values of the two projects?
a. Project A will have the higher NPV because IRR and NPV are inversely related.
b. Project B will have the higher NPV because IRR and NPV are positively related.
c. It is possible for either Project A or Project B to have the higher NPV, depending on
the discount rate (i.e., the cost of capital).
d. The NPV of both projects must be positive because the IRR exceeds 0.

36. You and your spouse have found your dream home. The selling price is $300,000; you will
put $50,000 down and obtain a 30-year fixed-rate mortgage at 12% APR for the balance.
What is your monthly payment?

13

a.
b.
c.
d.
e.

$ 4215.52
$ 3,058.83
$ 694.44
$ 3,185.69
$ 2,517.53

37. An investment in Larrys Dodge Ball Company is expected to provide the following cash
flows at the end of each respective year:
Year

Cash Flow

1
2
3
4

$200,000
350,000
500,000
600,000

What is the PV of these cash flows if the appropriate discount rate is 10%?
a.
b.
c.
d.

$1,033,994
$1,256,540
$1,410,373
$1,767,433

38. A bond will sell at a premium if:

a.
b.
c.
d.

the market value of the bond is greater than the discount rate of the bond.
the yield to maturity is below the coupon rate of the bond.
the bond is issued by a firm with an outstanding credit rating.
the yield to maturity is higher than the coupon rate of the bond.

39. ABC Corporation stock is currently selling for $40.00. It is expected to pay a dividend of
$2.00 at the end of the year. If the required return on this investment is 8%, what is the
(constant and perpetual) dividend growth rate?
a.
b.
c.
d.
e.

3%
4%
5%
6%
Cannot be determined from the information given (we need the YTM)

40. ______ projects compete with each other; the acceptance of one ______ the others from
consideration.

14

a.
b.
c.
d.

Independent; eliminates
Independent; does not eliminate
Mutually exclusive; eliminates
Mutually exclusive; does not eliminate

41. Here are the expected returns on two stocks:

Returns
Outcome
1
2
3

Probability
0.1
0.8
0.1

X
5%
10%
15%

Y
15%
10%
5%

If you form a 50-50 portfolio of the two stocks, what is the portfolio's standard deviation?
a. 0%
b. 1.58%
c. 2.24%
d. 5%
e. 10%

42. If a corporation were to choose between issuing a debenture, a mortgage bond or a

subordinated debenture, which would have the lowest coupon interest rate (assuming that the
coupon rate is equal to the YTM on the date of issue)?
a.
b.
c.
d.

The debenture
The mortgage bond
The subordinated debenture
All of the above bonds would have the same coupon rate

43. Which of the following statements about dividends is true?

a.
b.
c.
d.
e.

At any point in time, a firms stock price is the sum of the expected dividends.
The payment of dividends is determined by a direct vote of the shareholders.
A corporation can be sued if it does not pay common stock dividends.
A bond covenant can place constraints on a firms ability to pay dividends.
All of the above are true.

44. You invested $1,000,000 in a small business five years ago. The business brought in
$300,000 at the end of each year before you walked away from it. What was your annual
return over this 5-year period?

15

a.
b.
c.
d.

11.2%
12.5%
14.3%
15.2%

45. The voting procedure where shareholders grant authority to another individual to vote their
shares is:
a.
b.
c.
d.
e.

Unethical.
Proxy voting.
No longer allowed (after the Sarbanes-Oxley Act, 2002).
Preferred voting.
Vote syndication.

46. When the net present value is negative, the internal rate of return (of a project with
conventional cash flows) is
the cost of capital.
a.
b.
c.
d.
e.

greater than
greater than or equal to
equal to
less than
greater than, less than, or equal to (depending on the sign of the Eigenvalues)

47. Which of the following statements is most correct?

a. Periodic reporting requirements impose costs on a firm, but the disclosure of this
information also helps firms raise capital.
b. Owners of a corporation have unlimited liability, and this feature helps corporations
raise capital. Without unlimited liability, investors would be unwilling to invest in a
firm where they could not exercise direct control.
c. It is often necessary for entrepreneurs to exaggerate a little when selling shares in an
IPO. To do otherwise would be unethical, as the entrepreneur would not be
maximizing shareholder wealth.
d. All of the statements are true.
e. All of the statements are false.

48. You intend to purchase a 10-year, $1,000 face value bond that pays interest of $60 every 6
months. If your nominal annual required rate of return is 10 percent with semiannual
compounding, how much should you be willing to pay for this bond?
a. $ 826.31

16

b.
c.
d.
e.

$1,086.15
$ 957.50
$1,431.49
$1,124.62

49. Your assistant prepares an analysis of a potential new project. The project will cost
$5,000,000, it has an IRR of 7%, and the present value of its expected cash flows is
$5,200,000. Should the firm make this investment?
a.
b.
c.
d.

50.

No the projects IRR is only 7%.

It depends on whether sunk costs are greater or less than $200,000.
Yes the projects NPV is positive.
Cannot be determined the required return is not given.

Which of the following items is not a cash expenditure, but is still a deductible expense for
income tax purposes?
a.
b.
c.
d.
e.

Marketing expenses.
Payroll tax payments.
Wages and salaries.
Depreciation expense.
Opportunity costs.

Answers:
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17

A
D
D
A
D
C
D
C
A
B
B
B
E
D
C
E
D

17

18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50

B
C
D
D
C
C
A
D
B
A
D
B
D
A
D
E
C
C
E
B
B
A
C
A
B
D
D
B
D
A
E
C
D

18