Selected practice questions from Chapters 6 8, FIN

335, with Dr !raham

.
Answer: B
3. The rate of h larger coupon payments will have a lower price today.
Answer: A
15. Your broer o!ers you the opportunity to purchase a bond with coupon
payments of "#$ per year and a face value of "1$$$. %f the yield to maturity
on similar bonds is &'( this bond should:
A) *ell for the same price as the similar bond regardless of their respective
maturities.
B) *ell at a premium.
+) *ell at a discount.
,) *ell for either a premium or a discount but it-s impossible to tell which.
.) *ell fo .) %( %%( and %%%
/1. %f investors are uncertain that they will be able to sell a corporate bond
0uicly( the investors will demand a higher yield in the form of a1n)
222222222222.
A) in3ation premium
B) li0uidity ris premium
+) interest rate ris premium
,) default ris premium
.) increased real rate of interest
Answer: B
//. ,i44y +orp. bonds bearing a coupon rate of 1/'( pay coupons semiannually(
have 3 years remaining to maturity( and are currently priced at "#5$ per
bond. 6hat is the yield to maturity7
A) 1/.$$'
B) 13.##'
+) 15.55'
,) 15./5'
.) 15.58'
Answer: +
9esponse: "#5$ : 1$$$ ;<( =$ >?T( = @( A#5$ ><( +>T %BY : 8./8'C
YT? : 8./8' D / : 15.55'
/3. 6hitesell Athletic +orporation-s bonds have a face value of "1($$$ and a #'
coupon paid semiannuallyC the bonds mature in & years. 6hat current yield
would be reported in The Wall Street Journal if the yield to maturity is 8'7
A) 5'
B) 5'
+) ='
,) 8'
.) &'
Answer: .
9esponse:
1$$$ ;<( 55 >?T( 1= @( 3.5 %BY( +>T >< : "1(1/$.#5C Annual coupon is 55 D /
: #$.
+urrent Yield 1+Y) : "#$ B 1(1/$.#5 : &.$3'
/5. ,EF .nterprises issues bonds with a "1($$$ face value that mae coupon
payments of "3$ every 3 months. 6hat is the coupon rate7
A) $.3$'
B) 3.$$'
+) #.$$'
,) 1/.$$'
.) 3$.$$'
Answer: ,
9esponse: coupon rate : 1"3$ D 5) B 1($$$ : 1/'
/5. *uppose you purchase a 4ero coupon bond with face value "1($$$( maturing
in /5 years( for "1&$. 6hat is the implicit interest( in dollars( in the Grst year
of the bond-s life7
A) " /.&=
B) " #.&5
+) "1/.8&
,) "1#./8
.) "3$.$$
Answer: +
1$$$ ;<( /5 @( A1&$ ><( +>T %BY : YT? : 8.1'C Year 1 interest : "1&$ D .$81
: "1/.8&
/=. *uppose you purchase a 4ero coupon bond with a face value of "1($$$ and a
maturity of /5 years( for "1&$. %f the yield to maturity on the bond remains
unchanged( what will the price of the bond be 5 years from now7
A) "/53.=5
B) "/&8.5/
+) "31$.#1
,) "3&$.5&
.) "5$$.$$
Answer: A
1$$$ ;<( /5 @( A1&$ ><( +>T %BY : 8.1'C A1&$ ><( 5 @( 8.1 %BY( +>T ;< :
"/53.=5
/8. 6hat is the yield to maturity on an 1&Ayear( 4ero coupon bond selling for 3$'
of par value7
A) 5.&='
B) 5.&='
+) =.38'
,) =.#/'
.) 3$.$$'
Answer: ,
1$$$ ;<( 1& @( A3$$ ><( +>T %BY : YT? : =.#/'
/&. HEH .nterprises wants to issue siDty /$Ayear( "1($$$ 4eroAcoupon bonds. %f
each bond is to yield 8'( how much will HEH receive 1ignoring issuance costs)
when the bonds are Grst sold7
A) "11(/1/
B) "1/(3#3
+) "15(5$5
,) "1&(&&$
.) "/$($$$
Answer: +
9esponse: price : "1($$$ B 1.$8
/$
: "/5&.5/C proceeds : "/5&.5/ D =$ :
"15(5$5
There is the algebra( but what are the entries using your T<I? eys on your
T% BA %% >lus7
And what of the algebra and eystroes for numbers /#A5$ below7
9ecogni4ing the algebra is important( and eDtending that recognition to the
eystroes is Jey.K
/#. HEH .nterprises wants to issue /$Ayear( "1($$$ face value 4eroAcoupon bonds.
%f each bond is to yield 8'( what is the minimum number of bonds HEH must
sell if they wish to raise "5 million from the sale7 1%gnore issuance costs.)
A) 18(/#$
B) 1#(35#
+) /$(1=5
,) /3(&&$
.) /=(15#
Answer: B
9esponse: price : "1($$$ B 1.$8/$ : "/5&.5/C L of bonds : "5($$$($$$ B
/5&.5/ : 1#(35#
3$. 6hat is the maret value of a bond that will pay a total of Gfty semiannual
coupons of "&$ each over the remainder of its life7 Assume the bond has a
"1($$$ face value and a 1/' yield to maturity.
A) " 835.&=
B) " #5/./=
+) "1(135.#$
,) "1(315./5
.) "1(555.=/
Answer: ,
5$ @( &$ >?T( 1$$$ ;<( 1/B/ : %BY( +>T >< : A1(315
31. HEH ?anufacturing Must issued a bond with a "1($$$ face and a coupon rate of
&'. The bond has a life of /$ years( annual coupons( and a yield to maturity
is 8.5'( what will the bond sell for7
A) " #85
B) "1($/$
+) "1($51
,) "1($&8
.) "1(1=/
Answer: +
1$$$ ;<( &$ >?T( /$ @( 8.5 %BY( +>T >< : A1($51
3/. HEH ?anufacturing Must issued a bond with a "1($$$ face value and a coupon
rate of &'. %f the bond has a life of /$ years( pays annual coupons( and the
yield to maturity is 8.5'( what percent of the bond-s total price is
represented by the present value of the coupons7
A) 55.8'
B) 5=.1'
+) 88.='
,) #3./'
.) 1$$.$'
Answer: +
9esponse:
Nsing the T<I? eystroes above( you get the price of around "1($51.
@ow( in this problem( you must calculate the value of the annuity stream 1the
interest payments or coupons) and divide that into the bond price. 9ecall that
the total bond value is comprised of the >< of the coupons plus the >< of the
maturity payo! of "1$$$.
Oeystroes for the >< of the coupons7 &$ >?T( 8.5 %BY( /$ @( +>T >< :
A&15.5=. ,ivide that into 1$51 and you get "&15.5= B 1($5$.#8 : 88.='.
33. HEH ?anufacturing Must issued a bond with a "1($$$ face value and a coupon
rate of &'. %f the bond has a life of /$ years( pays annual coupons( and the
yield to maturity is 8.5'( what is the present value of the bond-s face value7
A) " /35.51
B) " 351.15
+) " &15.5=
,) "1($$$.$$
.) "1($5$.#8
Answer: A( 9esponse: >< of par : "1($$$ B 1.$85
/$
: "/35.51
11$$$ ;<( /$ @( 8.5 %BY( +>T >< : /35.51)
35. HEH ?anufacturing Must issued a bond with a "1($$$ face value and a coupon
rate of &'. %f the bond has a life of /$ years( pays annual coupons( and the
yield to maturity is 8.5'( what is the total present value of the bond-s coupon
payments7
A) " /35.51
B) " 351.15
+) " &15.5=
,) "1($$$.$$
.) "1($5$.#8
Answer: +
9esponse: >< of coupons : "&$ P11 1B1.$85
/$
)B .$85Q : "&15.5=
Nsing the T<I? eys instead of algebra7
+oupon payments are &' of "1$$$ or "&$. *o( &$ >?T( /$ @( 8.5%BY( +>T >< :
&15.5=
35. The maret price of a bond is "1(/3=.#5( it has 15 years to maturity( a "1($$$
face value( and pays an annual coupon of "1$$ in semiannual installments.
6hat is the yield to maturity7
A) 3.1&'
B) 5./='
+) 5.38'
,) =.11'
.) 8./8'
Answer: .
9esponse:
"1(/3=.#5 : "5$ RP1 A 1B11 S 9)
/&
Q B 9T S 1($$$ B 11 S 9)
/&
C 9 : 3.=38'C
YT? : 3.=5' D / : 8./8'
The algebra is a bit annoying( so do the T<I? stu!( thusly: A1(/3=.#5><( 1$$$
;<( /& @( 5$ >?T( +>T %BY : 3.=38. %BY D / : 3.=38 D / : 8./85 or 8./8'
3=. 6hat would you pay for a bond that pays an annual coupon of "55( has a
face value of "1($$$( matures in 11 years( and has a yield to maturity of
1$'7
A) "=5/.88
B) "885.35
+) "&$$.1&
,) "#1$.15
.) "#8=.3&
Answer: A
9esponse: price : "55 P11 A 1B1.1
11)
B .1Q S 1($$$ B 1.1
11
: "=5/.88
T<I? stu!7 1$$$ ;<( 55 >?T( 11 @( 1$ %BY( +>T >< : A=5/.88
38. Oing @oodles- bonds have a #' coupon rate. %nterest is paid 0uarterly
and the bonds have a maturity of 1$ years. %f the appropriate discount rate is 1$'
on similar bonds( what is the price of Oing @oodles- bonds7
A) "#38./5
B) "#3&.55
+) "#81./8
,) "#&#.=3
.) "##1./8
Answer: A
1$$$ ;<( #$B5 : //.5 >?T( 1$ D 5 : 5$ @( 1$B5:/.5 %BY( +>T >< : A#38./5
3&. +ornerstone %ndustries has a bond outstanding with an &' coupon rate and a
maret price of "&85.=&. %f the bond matures in = years and interest is paid
semiannually( what is the YT?7
A) 5.#'
B) =.#'
+) &.#'
,) 1$.#'
.) 1/.#'
Answer: ,
9esponse: "&85.=& : "5$ RP1 A 1B11 S 9)
1/
Q B 9T S 1($$$ B 11 S 9)
1/
C 9 :
5.55'C YT? : 5.55' D / : 1$.#'
T<I? eystroes7 5$ >?T( 1/ @( 1$$$ ;<( A&85.=& ><( +>T %BY : 5.55 D / :
YT? : 1$.#'
3#. The maeAbelieve bonds of ;aceboo carry a 1/' annual coupon( have a
"1($$$ face value( and mature in 5 years. Bonds of e0uivalent ris yield #'.
6hat is the maret value of ;aceboo bonds7
A) "1($11./$
B) "1($&8./5
+) "1($#5.==
,) "1(11=.=#
.) "1(1=$./5
Answer: ,
9esponse: price : "1/$ P11 A 1B1.$#
5
) B .$#Q S 1($$$ B 1.$#
5
: "1(11=.=#
1$$$ ;<( 1/$ >?T( 5 @( # %BY( +>T >< : A1(11=.=#
5$. %f the following bonds are identical eDcept for coupon( what is the price of
bond B7
A) " #55.5&
B) " #85.31
+) "1($38.&=
,) "1(15$.$$
.) "1(/8#.58
Answer: A
9esponse:
Bond A: "1(15$ : "5$ RP1 A 1B11 S 9)
5$
QB 9T S 1($$$ B 11 S 9)
5$
C 9 : 5./8'C
Bond B: price : "5$ P11 A 1B1.$5/8
5$
) B .$5/8Q S 1($$$ B 1.$5/8
5$
: "#55.5&
;irst( compute the YT? for bond A( thusly:
1$$$ ;<( /5D/:@( 5$ >?T( A1(15$ ><( +>T %BY : YT? : 5./8. Then compute
>< of bond B:
1$$$ ;<( 5$ >?T( /5D/: @( 5./8 %BY( +>T >< : A#55.5&
51. %f corporate bond yields are at &.5' and you are in the 35' federal marginal
income taD bracet( at what level of municipal bond yields would you be
indi!erent between owning corporate bonds or muni bonds7 %gnore the
impact of state and local taDes.
A) 5.#5'
B) 5.55'
+) 5.$3'
,) 5.=8'
.) 5.11'
Answer: B
9esponse: &.511 A .35) : 5.55'
CHAPTER 6 QUESTIONS END HERE.
CHAPTER 7 QUESTIONS BEGIN HERE
1. The stoc valuation model that determines the current stoc price as the neDt
dividend divided by the 1discount rate less the dividend growth rate) is called
the:
A) Uero growth model.
B) ,ividend growth model.
+) +apital Asset >ricing ?odel.
,) .arnings capitali4ation model.
Answer: B
/. A stoc-s neDt eDpected dividend divided by the current stoc price is the:
A) +urrent yield.
B) Total yield.
+) ,ividend yield.
,) +apital gains yield.
.) .arnings yield.
Answer: +
3. The rate at which the stoc price is eDpected to appreciate 1or depreciate) is
the:
A) +urrent yield.
B) Total yield.
+) ,ividend yield.
,) +apital gains yield.
.) .arnings yield.
Answer: ,
5. >ayments made by a corporation to its shareholders( in the form of either
cash( stoc( or payments in ind( are called:
A) 9etained earnings.
B) @et income.
+) ,ividends.
,) 9edistributions.
.) %nfused e0uity.
Answer: +
5. The maret in which new securities are originally sold to investors is the
22222222 maret.
A) dealer
B) auction
+) overAtheAcounter 1IT+)
,) secondary
.) primary
Answer: .
=. The maret in which previously issued securities are traded among investors
is the:
A) ,ealer maret.
B) Auction maret.
+) IverAtheAcounter 1IT+) maret.
,) *econdary maret.
.) >rimary maret.
Answer: ,
8. +ommon stoc valuation re0uires( among other things( information regarding
the:
%. .Dpected dividend growth rate.
%%. +urrent dividend payment.
%%%. >ar value of the common stoc.
A) % only
B) % and %% only
+) % and %%% only
,) %% and %%% only
.) %( %%( and %%%
Answer: B
&. As illustrated using the dividend growth model( the total return on a share of
common stoc is comprised of a 22222222222.
A) capital gains yield and a dividend growth rate
B) capital gains growth rate and a dividend growth rate
+) dividend payout ratio and a re0uired rate of return
,) dividend yield and the present dividend
.) dividend yield and a capital gains yield
Answer: .
#. 6hich of the following items would usually appear for a stoc 0uote in The
Wall Street Journal7
A) +apital gains rate
B) ,ividend yield
+) @umber of shares outstanding
,) >ar value of the stoc
.) ,ividend growth rate
Answer: B
1$. %f dividends on a common stoc are eDpected to grow at a constant rate
forever( and if you are told the most recent dividend paid( the dividend
growth rate( and the appropriate discount rate today( you can calculate
22222222222.
%. the price of the stoc today
%%. the dividend that is eDpected to be paid ten years from now
%%%. the appropriate discount rate ten years from now
A) % only
B) % and %% only
+) % and %%% only
,) %% and %%% only
.) %( %%( and %%%
Answer: B
11. 6hich of the following statements regarding dividend yields is true7
A) %t measures how much the stoc-s price will increase in a year.
B) %t incorporates the par value of the stoc into the calculation.
+) %t is analogous to the current yield for a bond.
,) %t is always greater than the stoc-s capital gains yield.
.) %t measures the total annual return an investor can eDpect to earn by
owning the stoc.
Answer: +
1/. 6hich of the following is 1are) true7
%. The dividend yield on a stoc is the annual dividend divided by the par
value.
%%. 6hen the constant dividend growth model holds( g : capital gains yield.
%%%. The total return on a share of stoc : dividend yield S capital gains yield.
A) % only
B) %% only
+) % and %% only
,) %% and %%% only
.) %( %%( and %%%
Answer: ,
13. %f some shareholders have greater voting power than others( it must be that:
A) The company has both preferred stoc and common stoc outstanding.
B) The company has outstanding debentures.
+) The company is located outside the Nnited *tates in a taDAhaven locale.
,) The company has multiple classes of common stoc.
.) The company is in banruptcy proceedings.
Answer: ,
15. 6hat would you pay for a share of AB+ +orporation stoc today if the neDt
dividend will be "3 per share( your re0uired return on e0uity investments is
15'( and the stoc is eDpected to be worth "#$ one year from now7
A) "8&./=
B) "&$.&8
+) "&/.5=
,) "#$.$$
.) "#&.1/
Answer: B
9esponse: >$ : "3 B 1.15 S #$ B 1.15 : "&$.&8
15. The dividend on *imple ?otors common stoc will be "3 in 1 year( "5./5 in /
years( and "=.$$ in 3 years. You can sell the stoc for "1$$ in 3 years. %f you
re0uire a 1/' return on your investment( how much would you be willing to
pay for a share of this stoc today7
A) "85.55
B) "88./5
+) "&1.5/
,) "&5.==
.) "#1.3$
Answer: +
9esponse: >$ : "3.$$ B 1.1/ S 5./5 B 1.1// S 1$= B 1.1/3 : "&1.5/
1=. A stoc that pays a constant dividend of "1.5$ forever currently sells for
"1$.81. 6hat is the re0uired rate of return7
A) 1$'
B) 1/'
+) 13'
,) 15'
.) 15'
Answer: ,
9esponse: "1$.81 : "1.5$ B 9C 9 : 15'
18. AB+ +ompany-s preferred stoc is selling for "3$ a share. %f the re0uired
return is &'( what will the dividend be two years from now7
A) "/.$$
B) "/./$
+) "/.5$
,) "/.&$
.) "3./5
Answer: +
9esponse: "3$ : , B .$&C , : "/.5$
1&. 6hat would you pay today for a stoc that is eDpected to mae a "/ dividend
in one year if the eDpected dividend growth rate is 5' and you re0uire a 1/'
return on your investment7
A) "/&.58
B) "/#.33
+) "31.53
,) "53.15
.) "55.3$
Answer: A
9esponse: >$ : "/ B 1.1/ A .$5) : "/&.58
1#. The stoc of ?TY Folf 6orld currently sells for "#$ per share. The Grm has a
constant dividend growth rate of =' and Must paid a dividend of "5.$#. %f the
re0uired rate of return is 1/'( what will the stoc sell for one year from now7
A) " #$.$$
B) " #3.5/
+) " #5.5$
,) " ##.&$
.) "11/.8&
Answer: +
9esponse: >
1
: >$11 S g) : "#$ 11.$=) : "#5.5$
/$. Vlano-s stoc is currently selling for "5$.$$. The eDpected dividend one year
from now is "/ and the re0uired return is 13'. 6hat is this Grm-s dividend
growth rate assuming the constant dividend growth model is appropriate7
A) &'
B) #'
+) 1$'
,) 11'
Answer: A
9esponse: g : .13 A 1"/ B 5$) : &'
/1. The current price of WYU stoc is "&$.$$. ,ividends are eDpected to grow at
5' indeGnitely and the most recent dividend was "/.85. 6hat is the re0uired
rate of return on WYU stoc7
A) 8.3'
B) &.8'
+) #.5'
,) 1$.='
.) 11./'
Answer: B
9esponse: 9 : 1"/.&# B &$) S .$5 : &.8'
//. AB+ +orporation-s common stoc dividend yield is 3.=1'( it Must paid a
dividend of "/.85( and is eDpected to pay a dividend of "/.&# one year from now.
,ividends are eDpected to grow at a constant rate indeGnitely. 6hat is the re0uired
rate of return on AB+ stoc7
A) 8.3'
B) &.8'
+) #.5'
,) 1$.='
.) 11./'
Answer: B
9esponse: 1"/.&# A /.85) B /.85 : .$51C 9 : .$3= S .$51 : &.8'
/3. %f Big Amp( %nc. stoc closed at "3= and the current 0uarterly dividend is
"$.85 per share( what dividend yield would be reported for the stoc in The
Wall Street Journal7
A) /.$'
B) 3.='
+) 5.8'
,) =.='
.) &.3'
Answer: .
9esponse: ,Y : 1"$.85 D 5) B 3= : &.3'
/5. *uppose @oFro( %nc. has Must issued a dividend of "3./5 per share.
*ubse0uent dividends will remain at "3./5 indeGnitely. 9eturns on the stoc
of Grms lie @oFro are currently running 1$'. 6hat is the value of one share
of stoc7
A) "//.5$
B) "/8./5
+) "3/.5$
,) "38./5
.) "3#.85
Answer: +
9esponse: >
$
: "3./5 B .1$ : "3/.5$
/5. *uppose >ale Xose( %nc. has Must paid a dividend of "1.&$ per share. *ales and
proGts for >ale Xose are eDpected to grow at a rate of &' per year. %ts
dividend is eDpected to grow by the same amount. %f the re0uired return is
15'( what is the value of a share of >ale Xose7
A) "1&.$$
B) "/5./$
+) "/8.&$
,) "3$.=$
.) "3/.5$
Answer: .
9esponse: >
$
: P"1.&$11.$&)Q B 1.15 A .$&) : "3/.5$
/=. *uppose that you have Must purchased a share of stoc for "5$. The most
recent dividend was "/ and dividends are eDpected to grow at a rate of 8'
indeGnitely. 6hat must your re0uired return be on the stoc7
A) 5.55'
B) 8.$$'
+) 1$./5'
,) 1/.35'
.) 13.=5'
Answer: ,
9esponse: 9 : P"/11.$8)Q B 5$ S A .$8 : 1/.35'
/8. The preferred stoc of the Vimbaugh %nstitute pays a constant annual
dividend of "5 and sells for "5$. You believe the stoc will sell for "3/ in one
year. You must( therefore( believe that the re0uired return on the stoc will be
22222 percentage points 22222222 in one year.
A) &C higher
B) &C lower
+) 1.5C higher
,) /.5C lower
.) 5.5C higher
Answer: .
9esponse: current: "5$ : "5 B 9C 9 : &'C future: "3/ : "5 B 9C 9 :
1/.5
/&. A Grm-s stoc has a re0uired return of 1/'. The stoc-s dividend yield is 5'.
6hat is the dividend the Grm is eDpected to pay in one year if the current
stoc price is "5$7
A) "/.$$
B) "/.5$
+) "3.$$
,) "3.5$
.) "5.$$
Answer: B
9esponse: ,
1
: "5$ 1.$5) : "/.5$
/#. A Grm-s stoc has a re0uired return of 1/'. The stoc-s dividend yield is 5'.
6hat dividend did the Grm Must pay if the current stoc price is "5$7
A) "/.1&
B) "/.35
+) "/.5$
,) "/.&8
.) "3.=$
Answer: B
Nse the following to answer 0uestions 3$A3=:
3$. ,ue stoc must have closed at 22222222222 per share on the previous trading
day.
A) "/#.=5
B) "3$.8=
+) "3$.##
,) "31.55
.) "3/.11
Answer: B
9esponse: 3$.8= A $.5= : 3$./$
31. ;or the current year( the eDpected dividend per share is:
A) "$./5
B) "1.$$
+) "/.$$
,) "3.3$
.) "5.$$
Answer: B
,oing the algebra7 .Dpected ,>* : Yld D +lose : .$33 D 3$./$ : 1
3/. Assume the eDpected growth rate in dividends is 1$'. Then the constant
growth model suggests that the re0uired return on ,ue stoc is:
A) 8.5'
B) &.#'
+) 11.$'
,) 13.='
.) 15.&'
Answer: ,
9esponse: 9 : P1"1.$$ D 1.1$) B 3$./$Q S .1$ : 13.='
33. Based on the 0uote( a good estimate of .>* over the last four 0uarters is:
A) "$.&$
B) "1./1
+) "1.=&
,) "1.#1
.) "/.55
Answer: +
9esponse: .>* : "3$./$ B 1& : "1.=&
35. In this trading day( the number of ,ue shares which changed hands was:
A) /$#
B) /($#/
+) /$(#/5
,) /$#(/5$
.) /($#/(5$$
Answer: .
The algebra7 Xow about /$(#/5 D 1$$ : /($#/(5$$
35. Assume that ,ue paid a "$.#/ annual dividend in the previous period. 6hat
is the dividend growth rate based on this 0uote7
A) 5.&'
B) =.$'
+) 8./'
,) &.8'
.) #.#'
Answer: , : 9esponse: g : 1"1.$$ B $.#/) A 1 : &.8'
3=. You believe that the re0uired return on ,ue stoc is 1=' and that the
eDpected dividend growth rate is 1/'( which is eDpected to remain constant
for the foreseeable future. %s the stoc currently overvalued( undervalued( or
fairly priced7
A) Ivervalued
B) Nndervalued
+) ;airly priced
,) +annot tell without more information
Answer: A
9esponse: >
$
: P"1.$$ 11.1/) Q B 1.1= A .1/) : "/&.$$C overvalued at "3$./$ in
the maret
CHAPTER 7 QUESTIONS END HERE
CHAPTER 8 QUESTIONS BEGIN HERE
1. The di!erence between the maret value of an investment and its cost is the:
A) @et present value.
B) %nternal rate of return.
+) >aybac period.
,) >roGtability indeD.
.) ,iscounted paybac period.
Answer: A
/. The net present value 1@><) rule can be best stated as:
A) An investment should be accepted if( and only if( the @>< is eDactly e0ual
to 4ero.
B) An investment should be reMected if the @>< is positive and accepted if it
is negative.
+) An investment should be accepted if the @>< is positive and reMected if its
is negative.
,) An investment with greater cash in3ows than cash out3ows( regardless of
when the cash 3ows occur( will always have a positive @>< and therefore
should always be accepted.
Answer: +
3. The length of time re0uired for an investment to generate cash 3ows
suYcient to recover its initial cost is the:
A) @et present value.
B) %nternal rate of return.
+) >aybac period.
,) >roGtability indeD.
.) ,iscounted paybac period.
Answer: +
5. The paybac rule can be best stated as:
A) An investment is acceptable if its calculated paybac period is less than
some prespeciGed number of years.
B) An investment should be accepted if the paybac is positive and reMected
if it is negative.
+) An investment should be reMected if the paybac is positive and accepted
if it is negative.
,) An investment is acceptable if its calculated paybac period is greater
than some prespeciGed number of years.
Answer: A
5. The discount rate that maes the net present value of an investment eDactly
e0ual to 4ero is the:
A) >aybac period.
B) %nternal rate of return.
+) Average accounting return.
,) >roGtability indeD.
.) ,iscounted paybac period.
Answer: B
=. The internal rate of return 1%99) rule can be best stated as:
A) An investment is acceptable if its %99 is eDactly e0ual to its net present
value 1@><).
B) An investment is acceptable if its %99 is eDactly e0ual to 4ero.
+) An investment is acceptable if its %99 is less than the re0uired return( else
it should be reMected.
,) An investment is acceptable if its %99 eDceeds the re0uired return( else it
should be reMected.
Answer: ,
8. A situation in which taing one investment prevents the taing of another is
called:
A) @et present value proGling.
B) Iperational ambiguity.
+) ?utually eDclusive investment decisions.
,) %ssues of scale.
.) ?ultiple rates of return.
Answer: +
&. The present value of an investment-s future cash 3ows divided by its intial
cost is the:
A) @et present value.
B) %nternal rate of return.
+) Average accounting return.
,) >roGtability indeD.
.) >aybac period.
Answer: ,
#. The proGtability indeD 1>%) rule can be best stated as:
A) An investment is acceptable if its >% is greater than one.
B) An investment is acceptable if its >% is less than one.
+) An investment is acceptable if its >% is greater than the internal rate of
return 1%99).
,) An investment is acceptable if its >% is less than the net present value
1$. 6hich of the following statements is true7
A) @>< should never be used if the proMect under consideration has
nonconventional cash 3ows.
B) @>< is similar to a costBbeneGt ratio.
+) %f the Gnancial manager relies on @>< in maing capital budgeting
decisions( she acts in the shareholders- best interests.
,) @>< can normally be directly observed in the maretplace.
.) %99 is generally preferred to @>< in maing correct capital budgeting
acceptance decisions.
Answer: +
11. @et present value 2222222222222.
A) is e0ual to the initial investment in a proMect
B) is e0ual to the present value of the proMect beneGts
+) is e0ual to 4ero when the discount rate used is e0ual to the %99
,) is simpliGed by the fact that future cash 3ows are easy to estimate
.) re0uires the Grm set an arbitrary cuto! point for determining whether an
investment is acceptable
Answer: +
1/. The 2222222 decision rule is considered the ZbestZ in principle.
A) internal rate of return
B) paybac period
+) average accounting return
,) net present value
.) proGtability indeD
Answer: ,
13. 6hich of the following decision rules is best for evaluating proMects for which
cash 3ows beyond a speciGed point in time( and the time value of money( can
both be ignored7
A) >aybac
B) @et present value
+) Average accounting return
,) >roGtability indeD
.) %nternal rate of return
Answer: A
15. An investment generates "1.1$ in present value beneGts for each dollar of
invested costs. This conclusion was most liely reached by calculating the
proMect-s:
A) @et present value
B) >roGtability indeD
+) %nternal rate of return
,) >aybac period
.) Average accounting return
Answer: B
15. The use of which of the following would lead to correct decisions when
comparing mutually eDclusive investments7
%. >roGtability indeD
%%. @et present value
%%%. Average accounting return
A) % only
B) %% only
+) %%% only
,) % and %% only
.) % and %%% only
Answer: B
1=. You own some manufacturing e0uipment that must be replaced. Two di!erent
suppliers present a purchase and installation plan for your consideration. This
is an eDample of a business decision involving 2222222222222 proMects.
A) mutually eDclusive
B) independent
+) woring capital
,) positive @><
.) crossover
Answer: A
18. %f a proMect with conventional cash 3ows has an %99 less than the re0uired
return( then:
A) The proGtability indeD is less than one.
B) The %99 must be 4ero.
+) The AA9 is greater than the re0uired return.
,) The paybac period is less than the maDimum acceptable period.
.) The @>< is positive.
Answer: A
1&. +alculate the @>< of the following proMect using a discount rate of 1$':
Yr $ : ["&$$C Yr 1 : ["&$C Yr / : "1$$C Yr 3 : "3$$C Yr 5 : "5$$C Yr 5 :
"5$$
A) " &.$5
B) " &8./&
+) "/$&.$5
,) "55#.18
.) "&&8./&
Answer: B
9esponse: @>< : A"&$$ A &$ B 1.1 S 1$$ B 1.1
/
S 3$$ B 1.1
3
S 5$$ B 1.1
5
S
5$$ B 1.1
5
: "&8./&
Nsing your cash3ow eys7 +;$: A&$$( +I1 : A&$( ;I1:1( +I/ : 1$$(
;I/:1( +I3 : 3$$( ;I3:1( +I5 : 5$$( ;I5:/. Then hit the @>< ey( type in
1$ for J%(K hit the down arrow to get you bac to the @>< display( and hit +>T
and you get &8./&.
1#. You are considering a proMect that costs "=$$ and has eDpected cash
3ows of "//5( "/5$.&& and "/&$.## over the neDt three years. %f the appropriate
discount rate for the proMect-s cash 3ows is 1/'( what is the net present value of
this proMect7
A) The @>< is negative
B) " $.$$
+) " #.35
,) "5#.35
.) "&5.85
Answer: B
+;I : A=$$( +I1://5( +I/:/5$.&&( +I3:/&$.##. All the ;I\s are e0ual to
one( with each cash 3ow occurring once. After entering all the +ash3ows 1the
+I1\s( /\s and 3\s)( hit the @>< ey( set % e0ual to 1/( hit the down arrow to
get bac to @><( hit +>T and you get about 4ero( or B.
/$. A proMect costs "3$$ and has cash 3ows of "85 for the Grst three years and
"5$ in each of the proMect-s last three years. 6hat is the paybac period of
the proMect7
A) The proMect never pays bac
B) 3.85 years
+) 5.5$ years
,) 5./5 years
.) 5.5$ years
Answer: +
9esponse: recover "/85 in 5 years( need "/5 B 5$ : 5.5$ years
/1. *uppose a proMect costs "/(5$$ and produces cash 3ows of "5$$ over each of
the following & years. 6hat is the %99 of the proMect7
A) There is not enough informationC a discount rate is re0uired
B) 3./8'
+) 5.&5'
,) #.=1'
.) 1/.$='
Answer: +
9esponse: "/(5$$ : "5$$ RP1 A 1B11 S %99)
&
Q B %99TC %99 : 5.&5'
A/(5$$ ><( 5$$ >?T( & @( +>T %BY : 5.&5'
Ir you could use your +; eys ] but with e0ually si4ed cash3ows( the T<I?
eys are easier.
//. A proMect has an initial investment of "/5($$$( with "=(5$$ annual in3ows for
each of the subse0uent 5 years. %f the re0uired return is 1/'( what is the
@><7
A) ["=(5$$.$$
B) ["/(558.$/
+) ["1(5=&.#5
,) " /15.5=
.) "1(8=3.&1
Answer: +
9esponse: @>< : A"/5($$$ S =(5$$ P11 A 1B1.1/
5
) B .1/Q : A"1(5=&.#5
=(5$$ >?T( 5 @( 1/ %BY( +>T >< : /3(531 the present value of your in3ows.
Your @>< : ><1%n3ows) [ >< 1out3ows) : /3(531 [ /5($$$ or a negative
1(5=#.
/3. 6hat is the @>< of the following set of cash 3ows if the re0uired return
is 15'7
A) The @>< is negative
B) " 5$&./8
+) " #5$.55
,) "1(/58.#$
.) "5(=5=.1/
Answer: B
+;$ : A1$$$$
+I1 : A1$$$
;I1 : 1
+I/ : 1$$$$
;I/ : /
+I3 : A5$$$
% : 15
@>< : 5$&./8
/5. 6ould you accept a proMect which is eDpected to pay "/(5$$ a year for =
years if the initial investment is "1$($$$ and your re0uired return is &'7
A) YesC the @>< is "1(558
B) YesC the @>< is "#/&
+) YesC the @>< is "=3
,) @oC the @>< is ["35=
.) @oC the @>< is ["1(//1
Answer: A
9esponse: @>< : S /(5$$P11 A 1B1.$&
=
) B .$&Q : "1(558./$
/(5$$ >?T( = @( & %BY( +>T >< : 11(558( which is greater than the "1$($$$
cost by "1(558( so you ,I TX%* ,.AV^^ You accept.
/5. 6hat is the paybac period of a "15($$$ investment with the following cash
3ows7
A) /.85 years
B) 3.5$ years
+) 3.85 years
,) 5.5$ years
.) 5.85 years
Answer: B
9esponse: recover "1/($$$ in 3 years( need "3($$$ B =($$$ : 3.5$ years
/=. You are considering an investment which has the following cash 3ows. %f you
re0uire a 5 year paybac period( should you tae the investment7
A) Yes( the paybac is 3.$$$ years.
B) Yes( the paybac is 3.85 years.
+) Yes( the paybac is 5./5 years.
,) @o( the paybac is 5./5 years.
.) @o( the paybac is 5.85 years.
Answer: +
9esponse: recover "/8(5$$ in 5 years( need "/(5$$ B 1$($$$ : 5./5 years
/8. Your re0uired return is 15'. *hould you accept a proMect with the following
cash 3ows7
A) @o( because the %99 is 5'.
B) @o( because the %99 is 1$'.
+) Yes( because the %99 is /$'.
,) Yes( because the %99 is 3$'.
.) Yes( because the %99 is 5$'.
Answer: ,
9esponse: "/5 : "1$ B 11 S %99) S 1$ B 11 S %99)
/
S /5 B 11 S %99)
3C
%99 :
3$'
+;$:A/5( +I1:1$( ;I1:/( +I/:/5( ;I/:1( %99( +>T( %99 : /#.#8' or
about 3$'
/&. You are going to choose between two investments. Both cost "5$($$$( but
investment A pays "/5($$$ a year for 3 years while investment B pays
"/$($$$ a year for 5 years. %f your re0uired return is 1/'( which should you
choose7
A) A because it pays bac sooner.
B) A because its %99 eDceeds 1/'.
+) A because it has a higher %99.
,) B because its %99 eDceeds 1/'.
.) B because it has a higher @><.
Answer: .
9esponse:
A: @>< : S /5($$$ P11 A 1B1.1/
3
) B .1/Q : "1$($5=
B: @>< : S /$($$$ P11 A 1B1.1/
5
) B .1/Q : "1$(858
/#. Nsing the proGtability indeD( which of the following proMects would you choose
if you have limited funds7
>roMect %nitial %nvestment @><
1 "5$($$$ "1$($$$
/ 85($$$ /5($$$
3 =$($$$ 15($$$
5 5$($$$ 18($$$
5 #$($$$ 5$($$$
A) >roMect 1
B) >roMect /
+) >roMect 3
,) >roMect 5
.) >roMect 5
Answer: .
9esponse:
>roMect 1: >% : "=$($$$ B 5$($$$ : 1./$$C >roMect /: >% : "1$$($$$ B 85($$$ :
1.333
>roMect 3: >% : "85($$$ B =$($$$ : 1./5$C >roMect 5: >% : "58($$$ B 5$($$$ :
1.5/5
>roMect 5: >% : "13$($$$ B #$($$$ : 1.555
3$. You have a choice between / mutually eDclusive investments. %f you
re0uire a 15' return( which investment should you choose7
A) >roMect A( because it has a smaller initial investment.
B) >roMect B( because it has a higher @><.
+) .ither one( because they have the same proGtability indeDes.
,) >roMect A( because it has the higher internal rate of return.
.) >roMect B( because it pays bac faster.
Answer: B
9esponse:
A: @>< : S /$($$$ B 1.15 S 5$($$$ B 1.15
/
S &$($$$ B 1.15
3
: "/3&
B: @>< : S 85($$$ B 1.15 S 55($$$ B 1.15
/
S 5$($$$ B 1.15
3
: "555
31. ;or a proMect with an initial investment of "&($$$ and cash in3ows of "/($$$
each year for = years( calculate @>< given a re0uired return of 13'.
A) ["&5=
B) ["/=3
+) " $
,) "15#
.) "55/
Answer: +
9esponse: @>< : A"&($$$ S /($$$ P11 A 1B1.13
=
) B .13Q : "$ 1actual A"5.#$)
Nse your T<I? eys with e0uallyAsi4ed cash 3ows.
Thusly: /$$$ >?T( = @( 13 %BY( +>T >< : 8(##5( which is less than &($$$( so
your @>< would be about a negative Gve bucs( as with the algebra above.
3/. 6hat is the %99 of an investment that costs "1&(5$$ and pays "5(/5$ a year
for 5 years7
A) 13'
B) 15'
+) 1#'
,) /5'
.) /&'
Answer: A
9esponse: "1&(5$$ : "5(/5$ RP1 A 1B11 S %99)
5
Q B %99TC %99 : 1/.#/'
Hust use your T<I? eys with e0ual cash 3ows to calculate %99. Thusly:
A1&(5$$ ><( 5(/5$ >?T( 5 @( +>T %BY : %99 with e0uallyAsi4ed cashA3ows or
1/.#/'
33. 6hat is the proGtability indeD of the following investment if the re0uired
return : 1$'7
A) $.#5
B) 1.$#
+) 1.1&
,) 1./8
.) 1.55
Answer: B
9esponse: >< : "5$ B 1.1 S 85 B 1.1/ S 85 B 1.1
3
: "1=3.8#C >% : "1=3.8# B
15$ : 1.$#
35. 6hat is the paybac period for the following investment7
A) 5 years
B) 3 years
+) / years
,) 1 year
.) The investment doesn-t paybac
Answer: .
9esponse: recover "1$($$$ S &($$$ S 5($$$ S /($$$ : "/5($$$C never pays
bac
"se the followin# to answer questions 35$38%
Bill plans to open a doAitAyourself dog bathing center in a storefront. The bathing
e0uipment will cost "5$($$$. Bill eDpects the afterAtaD cash in3ows to be "15($$$
annually for & years( after which he plans to scrap the e0uipment and retire to the
beaches of Hamaica.
35. 6hat is the proMect-s paybac period7
A) /.=8 years
B) 3.33 years
+) 3.=8 years
,) 5.33 years
.) 5.=8 years
Answer: B
9esponse: paybac : "5$($$$ B 15($$$ : 3.33 years
3=. Assume the re0uired return is 1$'. 6hat is the proMect-s @><7
A) " &&8
B) "13(3//
+) "//(85#
,) "3$($/5
.) "55($$1
Answer: ,
9esponse: @>< : S 15($$$ P11 A 1B1.1$
&
) B .1$Q : "3$($/3.&#
Nse the +; eys for practice: +;$:A5$($$$( +I1:15($$$( ;I1:&( @><( %:1$(
@>< : 3$($/5
>ractice these 0uestions using our BA %% >lus review sheet problems 1&A//.
38. Assume the re0uired return is /$'. 6hat is the proMect-s %997 *hould it be
accepted7
A) 15'C yes
B) 15'C no
+) /5'C yes
,) /5'C no
.) /$'C indi!erent
Answer: +
9esponse: "5$($$$ : "15($$$ RP1 A 1B11 S %99)
&
Q B %99TC %99 : /5.#5' _
/$'C accept
A5$($$$ ><( 15($$$ >?T( & @( +>T %BY : %99 : /5.#5'
3&. Assume the re0uired return is /$'. 6hat is the proMect-s >%7 *hould it be
accepted7
A) $.&5C yes
B) $.&5C no
+) 1.$$C indi!erent
,) 1.15C yes
.) 1.15C no
Answer: ,
9esponse:
>< of in3ows : "15($$$ P11 A 1B1./
&
) B ./Q : "58(558C >% : "58(558 B 5$($$$ :
1.15C accept
At a discount rate of /$'( the >< of the in3ows e0uals the @>< of 8(558 plus
the cost of 5$($$$ or 58(558. 19ecall the ><1%n3ows) : @>< S ><1Iut3ows))
END OF CHAPTER 8 QUESTIONS