Title: Fundamentals of Financial Management, Concise 5th Edition
Author(s): Eugene F. Brigham and Joel F. Houston
1) If a bank loan officer were considering a company's request for a loan, which of the following statements would you consider to be CORRECT?
A.The lower the company's TIE ratio, other things held constant, the lower the interest rate the bank would charge the firm.
B.The lower the company's EBITDA coverage ratio, other things held constant, the lower the interest rate the bank would charge the firm.
C.Other things held constant, the lower the current asset ratio, the lower the interest rate the bank would charge the firm.
D.Other things held constant, the lower the debt ratio, the lower the interest rate the bank would charge the firm.
E. Other things held constant, the higher the debt ratio, the lower the interest rate the bank would charge the firm.
2. Which of the following statements is CORRECT?
A. If a market is strong-form efficient, this implies that the returns on bonds and stocks should be identical.
B. If a market is weak-form efficient, this implies that above-average returns can best be achieved by focusing on past movement of stock prices.
C.If your uncle earned a higher return on his portfolio over a 10-year period than the return on the overall stock market, this would demonstrate that the stock market is inefficient.
D. Because of increased globalization, all of the world's stock markets are equally efficient as that term is defined in the text.
E. If a market is semistrong-form efficient, this implies that above-average returns cannot be achieved by analyzing publicly available data because such information is already reflected in stock prices.
3. Which of the following statements is NOT CORRECT?
A. If a bond is selling at its par value, its current yield equals its yield to maturity.
B. If a bond is selling at a discount to par, its current yield will be less than its yield to maturity.
C. All else equal, bonds with longer maturities have more interest rate (price) risk than do bonds with shorter maturities.
D. All else equal, bonds with larger coupons have greater interest rate (price) risk than do bonds with smaller coupons.
E. If a bond is selling at a premium, its current yield will be greater than its yield to maturity.
4. The Connors Company's last dividend was $1.00. Its dividend growth rate is expected to be constant at 15% for 2 years, after which dividends are expected to grow at a rate of 10% forever. Connors' required return (rs) is 12%. What is Connors' current stock price?
5. You were hired as a consultant to Locke Company, and you were provided with the following data: Target capital structure: 40% debt, 10% preferred, and 50% common equity. The interest rate on new debt is 7.5%, the yield on the preferred is 7.0%, the cost of retained earnings is 11.50%, and the tax rate is 40%. The firm will not be issuing any new stock. What is the firm's WACC?
6. Safeco Company and Risco Inc are identical in size and capital structure. However, the riskiness of their assets and cash flows are somewhat different, resulting in Safeco having a WACC of 10% and Risco a 12% WACC. Safeco is considering Project X, which has an IRR of 10.5% and is of the same risk as a typical Safeco project. Risco is considering Project Y, which has an IRR of 11.5% and is of the same risk as a typical Risco project.
Now assume that the two companies merge and form a new company, Safeco/Risco Inc. Moreover, the new company's market risk is an average of the pre-merger companies' market risks, and the merger has no impact on either the cash flows or the risks of projects X and Y. Which of the following statements is CORRECT?
A. Safeco/Risco's WACC, as a result of the merger, would be 10%.
B. If evaluated using the correct post-merger WACC, Project X would have a negative NPV.
C. After the merger, Safeco/Risco would have a corporate WACC of 11%. Therefore, it should reject Project X but accept Project Y.
D. If the firm evaluates these projects and all other projects at the new overall corporate WACC, it will become riskier over time.
E. After the merger, Safeco/Risco should select Project Y but reject Project X.
7. Swannee Resorts is considering a new project whose data are shown below. The equipment that would be used has a 3-year tax life, would be depreciated by the straight line method over the project's 3 year life, and would have zero salvage value. No new working capital would be required. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's NPV? If you are working this problem by hand rather than by computer, ignore small rounding differences between your answer and the choices given. (Hint: Cash flows are constant in Years 1-3.)
Net investment cost (depreciable basis) $65,000
Straight line depr'n rate 33.33%
Sales revenues $70,000
Operating costs excl. depr'n $25,000
Tax rate 35%
8. Harmon Industries is considering adding a new store. As a final step in reviewing the proposed project, the CFO wants to take into account two real options that are attached to the proposed project.
First, there is a timing option. One year from now, the company will have a much better idea of whether the county will raise or lower its property taxes. The firm might want to wait a year to decide whether it makes sense to proceed with their proposed project because the county taxes could significantly affect the project's cash flows.
Second, there is an abandonment option. After two years, the company will have the option to shut down the store if it is determined that the store is losing money and will continue to lose money.
Which of the following statements is most correct?
A. In this case, the option to delay the project actually takes value away from the project.
B. The abandonment option is likely to increase the project's expected cash flows.
C. The abandonment option is likely to increase the project's risk.
D. An abandonment and investment timing option can not exist for the same project.
E. In this case, the option to delay the project is likely to increase the project's risk.
9. Business risk is concerned with the operations of the firm. Which of the following is NOT associated with (or not a part of) business risk?
A. demand variability
B. sales price variability
C. the extent to which operating costs are fixed
D. changes in required returns due to financing decisions
E. the ability to change prices as costs change