BA 3341
Larry Merville
Spring, 1999
EXAM II
1. Assume that the required return on a zero-coupon bond will remain constant over the remainder of its life. The market value of the bond will
A. increase each year by an amount equal to the imputed coupon rate for the period.
B. increase each year by an amount equal to the imputed interest rate for the period.
C. increase each year by an amount equal to the bond’s current yield.
D. decrease each year by an amount equal to the bond’s yield to maturity.
E. Remain unchanged.
2. Which bond would most likely possess the highest degree of interest rate risk?
A. 8% coupon rate, 10 years to maturity
B. 8% coupon rate, 20 years to maturity
C. 10% coupon rate, 10 years to maturity
D. 10% coupon rate, 20 years to maturity
E. 12% coupon rate, 20 years to maturity
3. D&G Enterprises issues bonds with a $1,000 face value that make coupon payments of $30 every 3 months. What is the coupon rate?
A. 0.30%
B. 3.00%
C. 9.00%
D. 12.00%
E. 30.00%
4. Dizzy Corp. has bonds outstanding bearing a coupon rate of 15%. The bonds pay coupons semiannually, have two years remaining to maturity, and are currently priced at $980 per bond. What is the yield to maturity on the bonds?
A. 15.00%
B. 15.99%
C. 16.21%
D. 16.25%
E. 16.57%
5. If investors require a 7% nominal return and the expected inflation rate is 3%, what is the expected real return?
A. 1.04%
B. 3.00%
C. 3.88%
D. 4.00%
E. 0.21%
6. The bonds of Microhard, Inc. carry a 10% annual coupon, have a $1,000 face value, and mature in 4 years. Bonds of equivalent rist yield 7%. The market value of Microhard’s bonds should be
A. $1,011.20
B. $1,087.25
C. $1,095.66
D. $1,101.62
E. $1,160.25
7. Over the past four years, a company has paid dividends of $1.00, $1.10, $1.20, and $1.30, respectively. This pattern is expected to continue into the future. This is an example of a company paying a
A. dividend that grows by 10% each year.
B. dividend that grows at a constant rate.
C. dividend that grows by a decreasing amount.
D. dividend that grows at a decreasing rate.
E. Preferred stock dividend.
8. Which of the following is NOT a right of an owner of a share of common stock?
A. the right to share proportionately in dividends paid
B. the right to share proportionately in assets after liabilities have been paid in a liquidation
C. the right to vote for directors
D. preference over preferred shareholders in the payment of dividends
E. the right to vote on stockholder matters of great importance
9. Which of the following is true about the differences between debt and common stock?
A. Debt is ownership in a firm but equity is not.
B. Creditors have voting power while stockholders do not.
C. Periodic payments made to either class of security are tax deductible for the issuer.
D. Interest payments are promised while dividend payments are not.
E. Bondholders can also won equity, but not vice versa.
10. What would you pay for a share of ABC Corporation stock today if it is going to pay a $2 dividend and will be worth $110 in one year? You require a 12% return on your equity investments.
A. $95
B. $100
C. $110
D. $115
E. $120
15. Which of the following is generally true about a firm’s “cost of debt?
A. It is easier to calculate than the “cost” of equity.
B. It is the return creditors require on existing borrowing.
C. It normally cannot be observed directly, or indirectly, in the marketplace.
D. It is greater than the average coupon payments on outstanding debt.
E. The “cost” of debt based on its new borrowing is known as its embedded debt cost.
16. The cost of capital
I. is an opportunity cost that depends on the use of the funds, not the source
II. is the same thing as the required rate of return
III. is the same as the WACCAT for projects with the same risk as the firm as a whole
IV. is also known as the appropriate discount rate
A. I, II, and III are true.
B. I, II, and IV are true.
C. II, III, and IV are true.
D. I, III, and IV are true.
E. I, II, III, and IV are all true.
17. Suppose that Topstone Industries has a “cost” of equity of 14% and a “cost” of debt of 9%. If the target debt/equity ratio is 75%, and the tax rate is 34%, what is topstone’s weighted average cost of capital (WACCAT)?
A. 6.6%
B. 7.9%
C. 8.4%
D. 10.5%
E. 10.9%
18. Anthony’s Anchovies, Inc. sold a 20 year bond issue 2 years ago. The issue has a 5.35% annual coupon and a $1,000 face value. If the current market price per bond is $751.64 and the tax rate is 34%, what is the after-tax “cost” of debt?
A. 4.2%
B. 4.4%
C. 5.3%
D. 6.6%
E. 8.0%
19. A firm has 800,000 shares selling for $120 a share. It wants to raise $10,000,000 via a rights offering. The subscription price is $100 a share. How many rights are requited to purchase 1 share?
A. 0.1
B. 1.2
C. 2.0
D. 4.8
E. 8.0
20. Which of the following is NOT accurate regarding financial leverage?
A. Whenever a firm’s debt increases faster than its equity, financial leverage increases.
B. Leverage is most beneficial when EBIT is relatively high.
C. Investors can undo the effects of decreases in financial leverage by using homemade leverage.
D. Increasing financial leverage will always increase the ROE and EPS of stockholders.
E. The level of financial leverage that produces the highest firm value is one of the most beneficial to Stockholders.
21. Which of the following is NOT true about bankruptcy and its costs?
A. As the debt-to-equity ratio falls, the probability that a firm will be able to meet the promised payments on the bonds decreases.
B. If a firm is economically bankrupt, then an ensuing legal bankruptcy will likely end with the bondholders not receiving all they owed.
C. The amount of debt a firm can raise decreases as the probability of bankruptcy increases.
D. A firm is economically bankrupt when the value of a firm’s assets is less than the value of its debt.
E. Direct bankruptcy costs are a disincentive of debt financing.
22. The main lesson to be learned from the M&M theory of capital structure is that
A. a firm can affect its value by changing its capital structure.
B. The size of a pie is determined by how many slices it has.
C. The WACC increases as a financial leverage decreases.
D. A firm’s capital structure should be one hundred percent equity.
E. The value of the firm is determined by its total cash flows.
23. Suppose you were to draw a graph with EBIT on the horizontal axis and EPS on the vertical axis. If you were to compare the graphs for a levered firm versus an unlevered firm, which of the following is true? There are no taxes.
A. The levered firm has a lower intercept than the unlevered firm but we can not say anything about the slope.
B. The levered firm has a lower intercept and a higher slope than does the unlevered firm.
C. The levered firm has a higher intercept and a lower slope than does the unlevered firm.
D. The unlevered firm has a higher intercept than the levered firm but we can not say anything about the slope.
E. The unlevered firm has a lower intercept and a higher slope than does the levered firm.
24. According to ______, a firm’s “cost” of equity is a positive linear function of its decree of leverage.
A. M&M proposition I with taxes
B. M&M proposition I without taxes
C. The static theory of capital structure
D. M&M proposition II without taxes
E. M&M proposition III with taxes
25. Suppose a firm issues perpetual debt with a face value of $5,000, and a coupon rate of 12%. If the firm is subject to a 40% tax rate and the appropriate discount rate is 10%, what is the present value of the interest tax shield?
A. $1,667
B. $2,000
C. $2,400
D. $3,600
E. $6,000
26. An operating lease is ______.
A. a short-term lease in which the lessor is responsible for insurance, taxes and upkeep
B. a lease in which a firm sells an asset to the lessor and then leases it
C. a long-term fully amortized lease in which the lessee is responsible for asset upkeep
D. a lease in which the lessor borrows a large fraction of the cost of the leased asset
E. a lease in which the lessee borrows a substantial portion of the lease payments
27. A good reason for leasing is ______.
A. that leasing provides 100% financing
B. that leasing provides a source of off-balance sheet financing
C. that by leasing, the lessee’s income statement will be stronger
D. that taxes may be reduced by leasing
E. that, unlike borrowing and buying, leasing decreases a firm’s financial leverage
28. Assume the lessor borrows to purchase an asset, and then leases it to another firm. If the lease is a(n) ______and the lessee subsequently defaults, the lessor does not have to continue making payments to the loan.
A. single investor lease
B. operating lease
C. conditional sales agreement lease
D. sale-and-leaseback arrangement
E. leveraged lease
29. From the viewpoint of the lessee, the relevant discount rate for evaluating a lease versus purchase is ______.
A. the cost of issuing new common stock
B. the pre-tax cost of issuing debt
C. the lessor’s cost of debt
D. the firm’s cost of capital
E. the after-tax cost of issuing debt
30. Your company is considering purchasing a fleet of cars for $195,000. It can borrow at 8.5%. The cars will be used for four years. At the end of 4 years they will be worthless. The corporate tax rate is 34%. If you use straight-line depreciation, what is the break-even lease payment (pre-tax)?
A. $35,675
B. $47,328
C. $55,000
D. $56,128
E. $59,391