FULL Source FIN202

Chapter 5
36. The time value of money refers to the issue of

A) what the value of the stream of future cash flows is today.
B) why a dollar received tomorrow is worth more than a dollar received today.
C) why a dollar received tomorrow is worth the same as a dollar received today.
D) None of the above.
Ans: A
Format: Multiple Choice
Learning Objective: LO 1
Level of Difficulty: Easy
37. Which one of the following statements is NOT true?
A) The time value money refers to what the value of the stream of future cash flows
today is.
B) A dollar received today is worth more than a dollar received tomorrow.
C) A dollar received tomorrow is worth less than a dollar received today.
D) A dollar received today is worth less than a dollar received tomorrow.
Ans: D
A) The value of a dollar invested at a positive interest rate grows over time.
B) The further in the future you receive a dollar, the less it is worth today.
C) A dollar in hand today is worth more than a dollar to be received in the future.
D) The further in the future you receive a dollar, the more it is worth today.
Ans: D
39. Future value measures
A) what one or more cash flows are worth at the end of a specified period.
B) what one or more cash flows that is to be received in the future will be worth
today.
C) both a and b
D) None of the above
Ans: A
40. Which one of the following statements is true?
A) Individuals prefer to consume goods right away rather than in the future.
B) Individuals prefer to consume goods in the future rather than right away.
C) The time of consumption is irrelevant to individuals.
Ans: A
Level of Difficulty: easy
41. The process of converting an amount given at the present time into a future value is
called
A) time value of money.
B) discounting.
C) compounding.
Ans: C
42. The process of converting future cash flows to what its present value is
A) time value of money.
B) discounting.
C) compounding.
D) none of the above.
Ans: B
A) Present value calculations involve bringing a future amount back to the present.
B) The present value (PV) is often called the discounted value of future cash
payments.
C) The present value factor is more commonly called the discount factor.
D) All of the above are true statements.
Ans: D
A) Present value calculations involve bringing a future amount back to the present.
B) The future value is often called the discounted value of future cash payments.
C) The present value factor is more commonly called the discount factor.
D) The higher the discount rate, the lower the present value of a dollar.
Ans: B
45. The Rule of 72
A) can be used to determine the amount of time it takes to double an investment.
B) is fairly accurate for interest rates between 25 and 50 percent.
C) states that the time to double your money (TDM) approximately equals 72/i,
where 72 represents the years it takes to double your investment.
D) None of the above describe the Rule of 72.
Ans: A
Level of Difficulty: Medium
46. Using higher discount rates will
A) not affect the present value of the future cash flow.
B) increase the present value of any future cash flow.
C) decrease the present value of any future cash flow.
Ans: C
47. Using higher interest rates will
A) not affect the future value of the investment.
B) increase the future value of any investment.
C) decrease the future value of any investment.
Ans: B
48. Using lower discount rates will
A) not affect the present value of the future cash flow.
B) increase the present value of any future cash flow.
C) decrease the present value of any future cash flow.
Ans: B
49. Using lower interest rates will
A) decrease the future value of any investment.
B) increase the future value of any investment.
C) not affect the future value of the investment.
Ans: A
50. Your aunt is looking to invest a certain amount today. Which of the following choices
should she opt for?
A) three-year CD at 6.5% annual rate
B) three-year CD at 6.75% annual rate
C) three-year CD at 6.25% annual rate
D) three-year CD at 7% annual rate
Ans: D
51. Future value: You are interested in investing $10,000, a gift from your grandparents,
for the next four years in a mutual fund that will earn an annual return of 8 percent.
What will your investment be worth at the end of four years? (Round to the nearest
dollar.)
A) $10,800
B) $13,605
C) $13,200
Ans: B
Feedback:
Present value of the investment = PV = $10,000
Return on mutual fund = i = 8%
No. of years = n = 4.
0 1 2 3 4
├───┼───┼───┼────┤
-$10,000 FV=?
52. Future value: Ning Gao is planning to buy a house in five years. She is looking to
invest $25,000 today in an index mutual fund that will provide her a return of 12
percent annually. How much will she have at the end of five years? (Round to the
nearest dollar.)
A) $45,000
B) $28,000
C) $44,059
Ans: C
Feedback:
Return on mutual fund = i = 12%
0 1 2 3 4 5
├───┼───┼───┼────┼───┤
-$25,000 FV = ?
53. Future value: Carlos Lopes is looking to invest for the next three years. He is looking
to invest $7,500 today in a bank CD that will earn interest at 5.75 percent annually.
How much will he have at the end of three years? (Round to the nearest dollar.)
A) $8,870
B) $8,000
C) $8,681
Ans: A
Feedback:
Interest rate on CD = i = 5.75%
0 1 2 3
├───┼───┼───┤
-$7,500 FV=?
54. Future value: Wes Ottey would like to buy a condo in Florida in six years. He is
looking to invest $75,000 today in a stock that is expected to earn a return of 18.3
percent annually. How much will he have at the end of six years? (Round to the nearest
dollar.)
A) $205,575
B) $157,350
C) $184,681
Ans: A
Feedback:
Return on stock = i = 18.3%
0 1 2 3 4 5 6
├───┼───┼────┼───┼───┼───┤
-$75,000 FV=?
55. Future value: Brittany Willis is looking to invest for retirement, which she hopes will
be in 20 years. She is looking to invest $22,500 today in U.S. Treasury bonds that will
earn interest at 6.25 percent annually. How much will she have at the end of 20 years?
(Round to the nearest dollar.)
A) $68,870
B) $50,625
C) $75,642
Ans: C
Feedback:
Return on Treasury bonds = i = 6.25%
0 1 2 3 19 20
├───┼───┼───┼……………─┼────┤
-$22,500 FV=?
56. Multiple compounding periods (FV): Your brother has asked you to help him with
choosing an investment. He has $5,000 to invest today for a period of two years. You
identify a bank CD that pays an interest rate of 4.25 percent with the interest being paid
quarterly. What will be the value of the investment in two years?
A) $5,434
B) $5,441
C) $5,107
D) $5,216
Ans: B
Feedback:
0 2 years
├────────────────────┤
PV = $5,000 FV = ?
Amount invested today = PV = $5,000
Duration of investment = n = 2 years
Frequency of compounding = m = 4
Value of investment after 4 years = FV4
57. Multiple compounding periods (FV): Normandy Textiles had a cash inflow of $1
million, which it needs for a long-term investment at the end of one year. It plans to
deposit this money in a bank CD that pays daily interest at 3.75 percent. What will be
the value of the investment at the end of the year? (Round to the nearest dollar.)
A) $1,211,375
B) $1,000,103
C) $1,037,500
D) $1,038,210
Ans: D
Feedback:
0 1
├────────────────────┤
PV = $1,000,000 FV = ?
Amount invested today = PV = $1,000,000
Duration of investment = n = 1 year
Value of investment after 1 year = FV1
58. Multiple compounding periods (FV): Your mother is trying to choose one of the
following bank CDs to deposit $10,000. Which one will have the highest future value if
she plans to invest for three years?
A) 3.5% compounded daily
B) 3.25% compounded monthly
C) 3.4% compounded quarterly
D) 3.75% compounded annually
Ans: A
Feedback:
A) Interest rate on CD = i = 3.5%

B) Interest rate on CD = i = 3.25%

C) Interest rate on CD = i = 3.4%

D) Interest rate on CD = i = 3.75%
= $10,000 x (1.0375)3
= $11,167.71
59. Multiple compounding periods (FV): Carlyn Botti wants to invest $3,500 today in a
money market fund that pays quarterly interest at 5.5 percent. She plans to fund a
scholarship with the proceeds at her alma mater, Towson University. How much will
Carlyn have at the end of seven years? (Round to the nearest dollar.)
A) $5,091
B) $3,548
C) $5,130
D) $5,075
Ans: C
Feedback:

Interest rate on money market account = i = 5.5%
60. Multiple compounding periods (FV): Hector Cervantes started on his first job last
year and plans to save for a down payment on a house in 10 years. He will be able to
invest $12,000 today in a money market account that will pay him an interest of 6.25
percent on a monthly basis. How much will he have at the end of 10 years?
A) $12,640
B) $22,383
C) $24,839
Ans: B
Feedback:

Interest rate on money market account = i = 6.25%
61. Compounding: Trish Harris has deposited $2,500 today in an account paying 6 percent
interest annually. What would be the simple interest earned on this investment in five
years? If the account paid compound interest, what would be the interest-on-interest in
five years?
A) $750; $95.56
B) $150; $845.56
C) $150; $95.56
D) $95.56; $845.56
Ans: A
Feedback:
Deposit today = PV = $2,500
Interest rate = i = 6%
No. of years = n = 5
Simple interest:
Simple interest per year = $2,500 (0.06) = $150.00
Simple interest for 5 years = $150 x 5 = $750.00
Future value with compound interest:

FV5 = $2,500 (1 + 0.06)5 = $3,345.56
Simple interest = $750
Interest on interest = $3,345.56 – $2,500 – $750 = $95.56
62. Compounding: Joachim Noah is investing $5,000 in an account paying 6.75 percent
annually for three years. What is the interest-on-interest if interest is compounded?
A) $1,012.50
B) $1,082.38
C) $82.38
D) $69.88
Ans: D
Feedback:
Interest rate = i = 6.75%
Simple interest:
Simple interest for 3 years = $337.50 x 3 = $1,012.50

FV3 = $5,000 (1 + 0.0675)3 = $6,082.38
Simple interest = $1,012.50
Interest on interest = $6,082.38 – $5,000 – $1,012.50 = $69.88
63. Compounding: Chung Lee wants to invest $3,000 in an account paying 5.25 percent
compounded quarterly. What is the interest on interest after four years?
A) $695.98
B) $65.98
C) $630.00
Ans: B
Feedback:
Simple interest:
Simple interest for 4 years = $157.50 x 4 = $630

Interest on interest = $3,695.98 – $3,000 – $630 = $65.98
64. Compounding: Dat Nguyen is depositing $17,500 in an account paying an annual
interest rate of 8.25 percent compounded monthly. What is the interest-on-interest after
six years?
A) $8,662.50
B) $10,925
C) $2,497.63
D) $1,092.48
Ans: C
Feedback:
Simple interest:
Simple interest per year = $17,500 (0.0825) = $1,443.75
Simple interest for 6 years = $1,443.75 x 6 = $8,662.50
Simple interest = $8,662.50

Interest on interest = $28,660.13 – $17,500 – $8,662.50 = $2,497.63
65. Compounding: Richard Delgado invested $10,000 in a money market account that will
pay 5.75 percent compounded daily. How much will the interest-on-interest be after
two years?
A) $1,218.63
B) $1,150.00
C) $33.06
D) $68.63
Ans: D
Feedback:
Simple interest:
Simple interest per year = $10,000 (0.0575) = $575
Simple interest for 2 years = $575 x 2 = $1,150

Interest-on-interest = $11,218.63 – $10,000 – $1,150 = $68.63
66. Present value: Tommie Harris is considering an investment that pays 6.5 percent
annually. How much must he invest today such that he will have $25,000 in seven
years? (Round to the nearest dollar.)
A) $23,474
B) $38,850
C) $26,625
D) $16,088
Ans: D
Feedback:
0 7 years
├────────────────────┤
PV = ? i = 6.5% FV = $25,000
Value of investment after 7 years = FV7 = $25,000

Return expected from investment = i = 6.5%
Amount to be invested today = PV
67. Present value: Jack Robbins is saving for a new car. He needs to have $ 21,000 for the
car in three years. How much will he have to invest today in an account paying 8
percent annually to achieve his target? (Round to nearest dollar.)
A) $22,680
B) $26,454
C) $16,670
D) $19,444
Ans: C
Feedback:
0 3 years
├────────────────────┤
PV = ? i = 8% FV = $21,000

Return expected from investment = i = 8%
68. Present value: Derek's friend, Jackson, is asking to borrow today with a promise to
repay $7,418.87 in four years. If Derek could earn 5.45 percent annually on the any
investment he makes today, how much would he be willing to lend Jackson today?
(Round to nearest dollar.)
A) $6,000
B) $7,035
C) $6,500
D) $7,150
Ans: A
Feedback:
0 4 years
├────────────────────┤
PV = ? i = 5.45% FV = $7,418.87
Loan repayment amount after 4 years = FV4 = $7,418.87

Return expected from loan = i = 5.45%
Duration of loan = n = 4 years
Amount to be loaned today = PV
69. Present value: Becky Sayers wants to buy a house in six years. She hopes to be able to
put down $25,000 at that time. If the bank CD she wants to invest in will pay 7.5
percent annually, how much will she have to invest today? (Round to the nearest
dollar.)
A) $18,472
B) $13,987
C) $16,199
D) $23,256
Ans: C
Feedback:
0 6 years
├────────────────────┤
PV = ? i = 7.5% FV = $25,000
Amount needed for down payment after 6 years = FV6 = $25,000

70. Present value: John Hsu wants to start a business in 10 years. He hopes to have
$100,000 at that time to invest in the business. To reach his goal, he plans to invest a
certain amount today in a bank CD that will pay him 9.50 percent annually. How much
will he have to invest today to achieve his target? (Round to the nearest dollar.)
A) $54,233
B) $63,837
C) $91,324
D) $40,351
Ans: D
Feedback:
0 10 years
├────────────────────┤
PV = ? i = 9.5% FV = $100,000

71. Multiple compounding (PV): Rick Rodriquez plans to invest some money today so
that he will receive $7,500 in three years. If the investment he is considering will pay
3.65 percent compounded daily, how much will he have to invest today?
A) $5,276
B) $6,722
C) $6,897
D) $7,140
Ans: B
Feedback:
0 3 years
├────────────────────┤
PV = ? i = 3.65% FV = $7,500

Target investment proceeds in 3 years = FV3 = $7,500
Present value of amount = PV
72. Multiple compounding (PV): You need to have $15,000 in five years to payoff a
home equity loan. You can invest in an account that pays 5.75 percent compounded
quarterly. How much will you have to invest today to attain your target in five years?
A) $4,903
B) $11,275
C) $14,184
D) $12,250
Ans: B
Feedback:
0 5 years
├────────────────────┤
PV = ? i = 5.75% FV = $15,000

Present Value of amount = PV
73. Multiple compounding (PV): Marcie Witter is saving for her daughter's college
education. She wants to have $50,000 available when her daughter graduates from high
school in four years. If the investment she is considering will pay 8.25 percent
compounded monthly, how much will she have to invest today to reach her target?
A) $35,987
B) $49,659
C) $41,275
D) $36,450
Ans: A
Feedback:
0 4 years
├────────────────────┤
PV = ? i = 8.25% FV = $50,000

74. Multiple compounding (PV): Darius Miller is seeking to accumulate $50,000 in six
years to invest in a real estate venture. He can earn 6.35 percent annual interest with
monthly compounding in a private investment. How much will he have invest today to
reach his goal? (Round to the nearest dollar.)
A) $37,527
B) $47,015
C) $34,193
D) $31,648
Ans: C
Feedback:
0 6 years
├────────────────────┤
PV = ? i = 6.35% FV = $50,000

75. Multiple compounding (PV): Joan Alexander wants to go on a cruise in three years.
She could earn 8.2 percent compounded monthly in an account if she were to deposit
the money today. She needs to have $10,000 in three years. How much will she have to
deposit today? (Round to the nearest dollar.)
A) $6,432
B) $7,826
C) $8,148
D) $7,763
Ans: B
Feedback:
0 3 years
├────────────────────┤
PV = ? i = 8.2% FV = $10,000

76. Interest rate: Your tuition for the coming year is due today. You borrow $8,000 from
your uncle and agree to repay in the three years an amount of $9,250. What is the
interest rate on this loan? Round to the nearest percent.
A) 5%
B) 6%
C) 7%
D) 8%
Ans: A
Feedback:
0 3 years
├────────────────────┤
PV = $8,000 FV = $9,250
Amount to be borrowed = PV = $8,000
Amount to be paid back after 3 years = FV3 = $9,250
Interest rate on investment = i = ?
Duration of investment = n = 3 years.
Present value of investment = PV
77. Interest rate: Rachael Steele wants to borrow $6,000 for a period of four years. She
has two choices. Her bank is offering to lend her the amount at 7.25 percent
compounded annually. She can also borrow from her firm and will have to repay a total
of $8,130.93 at the end of four years. Should Rachael go with her bank or the firm, and
what is the interest rate if she borrows from her firm? (Round to the nearest percent.)
A) Bank: 9%
B) Firm: 7%
C) Bank: 8%
D) Firm: 6%
Ans: C
Feedback:
0 4 years
├────────────────────┤
PV = $6,000 FV = $8,130.93
Amount to be borrowed = PV = $6,000
Amount to be paid back after 4 years = FV = $8,130.93
Since borrowing from her firm results in a loan rate of 8 percent, she should take the
bank loan at 7.25 percent.
78. Interest rate: Ray Seo has $5,000 to invest in a small business venture. His partner has
promised to pay him back $8,200 in five years. What is the return earned on this
investment?
A) 9.3%
B) 8.7%
C) 11.1%
D) 10.4%
Ans: D
Feedback:
0 5 years
├────────────────────┤
PV = $5,000 FV = $8,200
Amount being invested = PV = $5,000
Amount to be paid back after 5 years = FV = $8,200
79. Interest rate: Pedro Martinez wants to invest $25,000 in a spa that his sister is starting.
He will triple his investment in six years. What is the rate of return that Pedro is being
promised? (Rounded to the nearest percent.)
A) 18%
B) 20%
C) 12%
D) 25%
Ans: B
Feedback:
0 6 years
├────────────────────┤
PV = $25,000 FV = $75,000
80. Interest rate: Trayne Rice has $3,000 to invest for three years. He wants to receive
$5,000 at the end of the three years. What invest rate would his investment have to earn
to achieve his goal? (Round to the nearest percent.)
A) 19%
B) 21%
C) 13%
D) 16%
Ans: A
Feedback:
0 3 years
├────────────────────┤
PV = $3,000 FV = $5,000
81. Growth rate: Trojan Traps manufactures an innovative mouse trap. Sales this year are
$325,000. The company expects its sales to go up to $500,000 in five years. What is the
expected growth rate in sales for this firm? (Round to the nearest percent.)
A) 9%
B) 11%
C) 6%
D) 12%
Ans: A
Feedback:
0 5 years
├────────────────────┤
PV = $325,000 FV = $500,000
Current sales = PV = $325,000

Expected sales five years from now = $500,000
To calculate the expected sales growth rate, we set up the future value equation.
82. Growth rate: Petry Corp. is a growing company with sales of $1.25 million this year.
The firm expects to grow at an annual rate of 25 percent for the next three years,
followed by a growth of 20 percent per year for the next two years. What will be Petry's
sales at the end of five years? (Round to the nearest percent.)
A) $2,160,000
B) $3,515,625
C) $1,875,000
D) $2,929,688
Ans: B
Feedback:
0 5 years
├────────────────────┤
g1-3 = 25% g4-5 = 20%
PV = $1.25 million FV = $?
Current sales = PV = $1,025,000

Expected sales five years from now = FV
To calculate the expected sales, we set up the future value equation.
Level of Difficulty: Hard
83. Growth rate: Cleargen, a detergent manufacturer, has announced this year's net income
as $832,500. It expects its net earnings to grow at a rate of 15 percent per year for the
next two years, before dropping to 12 percent for each of the following two years. What
is the firm's net income after four years? (Round to the nearest dollar.)
A) $1,381,071
B) $1,266,128
C) $1,233,099
D) $1,072,260
Ans: A
Feedback:
0 4 years
├────────────────────┤
g1-2 = 15% g3-4 = 12%
PV = $832,500 FV = $?
Current net income = PV = $832,500
Expected net income four years from now = FV
To calculate the expected net earnings, we set up the future value equation.
84. Growth rate: Peterson Electrical Supplies has generated a net income of $161,424 this
year. The firm expects to see an annual growth of 30 percent for the next five years,
followed by a growth rate of 15 percent for each of the next three years. What will be
the firm's expected net income in eight years? (Round to the nearest dollar.)
A) $319,157
B) $241,329
C) $911,546
D) $689,259
Ans: C
Feedback:
0 5 8 years
├────────────────┼────────────┤
g1-5 = 30% g6-8 = 15%
PV = $161,424 FV = $?
Current net income = PV = $161,424

Expected net income four years from now = FV
To calculate the expected net earnings, we set up the future value equation.
85. Growth rate: Vidmar Agencies is a fast-growing advertising agency. Currently, their
sales are at $700,000. They expect their sales to grow at an annual rate of 35 percent in
the next two years, followed by an annual rate of 25 percent in years 3 through 7.
Finally, their growth rate would slow down to 10 percent in years 8–10. What will be
their sales as of year 10? (Round to the nearest dollar.)
A) $1,698,023
B) $2,843,323
C) $3,893,280
D) $5,181,956
Ans: D
Feedback:
0 5 10 years
├────────────────┼──────────────────┤
g1-2 = 35% g3-7 = 25% g8-10 = 10%
PV = $700,000 FV = $?
Current sales = PV = $700,000

Expected sales 10 years from now = FV
To calculate the expected sales, we set up the future value equation.
86. Time to attain goal: Your uncle is looking to double his investment of $10,000. He
claims he can get earn 14 percent on his investment. How long will it be before he can
double his investment? Use the Rule of 72 and round to the nearest year.
A) 5 years
B) 14 years
C) 10 years
Ans: A
Feedback:
Initial investment = $10,000
Rate of return on investment = i = 14%
Time to double the investment = TDM = 72/i = 72 / 14 = 5.14 years
87. Time to attain goal: Elegant Designers have generated sales of $625,000 for the
current year. If they can grow their sales at a rate of 12 percent every year, how long
will they take to triple their sales? (Round off to the nearest year.)
A) 8 years
B) 7 years
C) 10 years
D) 9 years
Ans: C
Feedback:
Enter
9.69 12% -$625,000 $1,875,000
N g (i)% PMT PV FV
88. Time to attain goal: Franklin Foods announced that its sales were $1,233,450 this
year. The company forecasts a growth rate of 16 percent for the foreseeable future.
How long will it take the firm to produce earnings of $3 million? (Round off to the
nearest year.)
A) 7 years
B) 6 years
C) 8 years
D) 10 years
Ans: B
Feedback:
Enter
5.99 16% -$1,233,450 $3,000,000
N g (i)% PMT PV FV
89. Time to attain goal: Ryan Holmes wants to deposit $4,500 in a bank account that pays
8.25 percent annually. How many years will it take for his investment to grow to
$10,000? (Round off to the nearest year.)
A) 8 years
B) 11 years
C) 10 years
D) 12 years
Ans: C
Feedback:
Enter
10.21 8.25% -$4,500 $10,000
N i% PMT PV FV
90. Time to attain goal: Cheryl Merriweather wants to invest in a bank CD that will pay
her 7.8 percent annually. If she is investing $11,500 today, when will she reach her goal
of $15,000? (Round off to the nearest year.)
A) 5 years
B) 7 years
C) 2 years
D) 4 years
Ans: D
Feedback:
Enter
3.56 7.8% -$11,500 $15,000
N g (i)% PMT PV FV
91. Which of the following statements is true?
A) A dollar received today is worth more than a dollar to be received in the future
because future dollars are not affected by inflation.
B) A dollar to be received in the future is worth more than a dollar received today
because of the positive impact of rates of return.
C) A dollar received today is worth more than a dollar to be received in the future
because funds received today can be invested to earn a return.
D) A dollar to be received in the future is worth more than a dollar received today
because it would have less risk associated with it.
Ans: C
A) The longer the time period that funds are invested, the greater the future value,
regardless of investment rate.
B) The lower the discount rate that funds are invested at, the greater the future value.
C) The shorter the time period that funds are invested, the greater the future value,
regardless of investment rate.
D) The higher the interest rate, the slower the value of an investment will grow.
Ans: A
93. Future Value: Herbert Hall just received an inheritance of $35,775 from his great aunt.
He plans to invest the funds for retirement. If Herbert can earn 4.75% per year with
quarterly compounding for 32 years, how much will he have accumulated? (Round off
to the nearest dollar.)
A) $237,416
B) $ 71,550
C) $184,622
D) $162,113
Ans: D
Feedback:

Interest rate = i = 4.75% ÷ 4 = 1.1875%
Duration of investment = n = 32 years × 4 = 128 periods
Value of investment after 7 years, or 128 periods = FV128 = $162,113.25
94. Which of the following statements is false with respect to the present value of a future
amount?
A) The higher the discount rate, the lower the present value of a single sum for a
given time period.
B) The relation between present value and time is exponential.
C) The greater the time period, the lower the present value of a single sum for a
given interest rate.
D) The lower the discount rate, the lower the present value of a single sum for a
given time period.
Ans: D
95. Present Value: Juan and Carla Herman plan to buy a time-share in six years in the
amount of $16,860. In order to have adequate funds to do so, the Herman’s want to
make a deposit to their money market fund today. Assume that they will be able to earn
an investment rate of 5.75%, compounded annually. How much will Juan and Carla
need to deposit today to achieve their goal? (Round off to the nearest dollar.)
A) $19,138
B) $ 8,885
C) $12,055
D) $14,243
Ans: C
Feedback:
Amount needed = FV = $16,860
Present Value = PV6 = $12,055.22
96. Number of Periods it Takes an Investment to Grow a Certain Amount: Sally
Wilson is planning her retirement. She is presently investing in a 401(k) but needs an
additional $500,000 to reach her retirement goal. As luck would have it, Sally just won
a brand new car that is worth $36,000 in a raffle. If Sally were to sell the car and invest
the $36,000 proceeds at a rate of 6.50%, compounded annually, how long will it be
before Sally could retire? (Round off to the nearest 1/10 of a year)
A) 36.6 years
B) 41.8 years
C) 52.2 years
D) 24.0 years
Ans: B
Present Value = PV = $36,000
Future Value = FV = $500,000
Number of Periods = n = 41.8 years
97. Rate of growth: Link Net, Inc. just generated earnings per share of $3.75 for the fiscal
year ending September 30, 2010. The firm is expected to achieve earnings per share of
$8.76 in 5-years. At what rate will Link Net, Inc.’s earnings per share be growing over
this 5-year period? (Round off to the nearest 1/10 percent)
A) 15.7%
B) 18.5%
C) 21.3%
D) 13.4%
Ans: B
Feedback:
Present Value = PV = $3.75
Period = n = 5 years
Future Value = FV5 = $8.76
Chapter 6
31. To solve future value problems with multiple cash flows involves which of the
following steps?
A) First, draw a time line to make sure that each cash flow is placed in the correct
time period.
B) Second, calculate the future value of each cash flow for its time period.
C) Third, add up the future values.
D) All of the above are necessary steps.
Ans: D
32. Which one of the following steps is NOT involved in solving future value problems?
time period.
B) Second, discount each cash flow for its time period.
C) Third, add up the values.
Ans: B
33. To solve present value problems with multiple cash flows involves which of the
following steps?
time period.
B) Second, calculate the present value of each cash flow for its time period.
C) Third, add up the present values.
Ans: D
34. Which one of the following steps is NOT involved in solving present value problems?
time period.
B) Second, compound each cash flow for its time period.
C) Third, add up the values.
Ans: B
Level of Difficulty: easy
35. Calculating the present and future values of multiple cash flows is relevant
A) for businesses only.
B) for individuals only
C) for both individuals and businesses.
Ans: C
36. In computing the present and future value of multiple cash flows,
A) each cash flow is discounted or compounded at the same rate.
B) each cash flow is discounted or compounded at a different rate.
C) earlier cash flows are discounted at a higher rate.
D) later cash flows are discounted at a higher rate.
Ans: A
37. In computing the present and future value of multiple cash flows,
A) earlier cash flows are discounted at a lower rate.
B) each cash flow is discounted or compounded at the same rate.
C) earlier cash flows are discounted at a higher rate.
Ans: B
38. The present value of multiple cash flows is
A) greater than the sum of the cash flows.
B) equal to the sum of all the cash flows.
C) less than the sum of the cash flows.
Ans: C
39. The future value of multiple cash flows is
A) greater than the sum of the cash flows.
B) equal to the sum of all the cash flows.
C) less than the sum of the cash flows
Ans: A
40. If your investment pays the same amount at the end of each year for a period of six
years, the cash flow stream is called
A) a perpetuity.
B) an ordinary annuity.
C) an annuity due.
Ans: B
41. If your investment pays the same amount at the beginning of each year for a period of
10 years, the cash flow stream is called
A) a perpetuity.
C) an annuity due.
Ans: C
42. If your investment pays the same amount at the end of each year forever, the cash flow
stream is called
A) a perpetuity.
C) an annuity due.
Ans: A
43. Cash flows associated with annuities are considered to be
A) an uneven cash flow stream.
B) a cash flow stream of the same amount (a constant cash flow stream).
C) a mix of constant and uneven cash flow streams.
Ans: B
44. Which ONE of the following statements is true about amortization?
A) Amortization refers to the way the borrowed amount (principal) is paid down
over the life of the loan.
B) With an amortized loan, each loan payment contains some payment of principal
and an interest payment.
C) A loan amortization schedule is just a table that shows the loan balance at the
beginning and end of each period, the payment made during that period, and how
much of that payment represents interest and how much represents repayment of
principal.
D) All of the above are true.
Ans: D
45. Which one of the following statements is NOT true about amortization?
A) Amortization refers to the way the borrowed amount (principal) is paid down
over the life of the loan.
B) With an amortized loan, each loan payment contains some payment of principal
and an interest payment.
C) With an amortized loan, a smaller proportion of each month's payment goes
toward interest in the early periods.
D) A loan amortization schedule is just a table that shows the loan balance at the
beginning and end of each period, the payment made during that period, and how
much of that payment represents interest and how much represents repayment of
principal.
Ans: C
46. Which one of the following statements is true about amortization?
A) With an amortized loan, a bigger proportion of each month's payment goes
B) With an amortized loan, a bigger proportion of each month's payment goes
toward interest in the later periods.
C) With an amortized loan, a smaller proportion of each month's payment goes
Ans: A
47. The annuity transformation method is used to transform
A) a present value annuity to a future value annuity.
B) a present value annuity to an annuity due.
C) an ordinary annuity to an annuity due.
D) a perpetuity to an annuity.
Ans: C
48. A firm receives a cash flow from an investment that will increase by 10 percent
annually for an infinite number of years. This cash flow stream is called
A) an annuity due.
B) a growing perpetuity.
C) an ordinary annuity.
D) a growing annuity.
Ans: B
49. Your investment in a small business venture will produce cash flows that increase by
15 percent every year for the next 25 years. This cash flow stream is called
A) an annuity due.
B) a growing perpetuity.
C) an ordinary annuity.
D) a growing annuity.
Ans: D
50. Which one of the following statements is TRUE about the effective annual rate (EAR)?
A) The effective annual interest rate (EAR) is defined as the annual growth rate that
takes compounding into account.
B) The EAR conversion formula accounts for the number of compounding periods
and, thus, effectively adjusts the annualized interest rate for the time value of
money.
C) The EAR is the true cost of borrowing and lending.
Ans: D
51. The true cost of borrowing is the
A) annual percentage rate.
B) effective annual rate.
C) quoted interest rate.
D) periodic rate.
Ans: B
52. The true cost of lending is the
A) annual percentage rate.
B) effective annual rate.
C) quoted interest rate.
Ans: B
A) The APR is the appropriate rate to do present and future value calculations.
B) The EAR is the appropriate rate to do present and future value calculations.
C) The EAR is the true cost of borrowing and lending.
D) The EAR takes compounding into account.
Ans: A
A) The Truth-in-Lending Act was passed by Congress to ensure that the true cost
of credit was disclosed to consumers.
B) The Truth-in-Savings Act was passed to provide consumers an accurate
estimate of the return they would earn on an investment.
C) The above two pieces of legislation require by law that the APR be disclosed on
all consumer loans and savings plans.
Ans: D
A) The correct way to annualize an interest rate is to compute the effective annual
interest rate (EAR).
B) The APR is the annualized interest rate using simple interest.
C) The correct way to annualize an interest rate is to compute the annual percentage
rate (APR).
D) You can find the interest rate per period by dividing the quoted annual rate by the
number of compounding periods.
Ans: C
56. FV of multiple cash flows: Chandler Corp. is expecting a new project to start
producing cash flows, beginning at the end of this year. They expect cash flows to be as
follows:
1 2 3 4 5
$643,547 $678,214 $775,908 $778,326 $735,444
If they can reinvest these cash flows to earn a return of 8.2 percent, what is the future
value of this cash flow stream at the end of five years? (Round to the nearest dollar.)
A) $3,889,256
B) $4,227,118
C) $5,214,690
D) $4, 809,112
Ans: B
Feedback:
57. FV of multiple cash flows: Stiglitz, Inc., is expecting the following cash flows starting
at the end of the year—$113,245, $132,709, $141,554, and $180,760. If their
opportunity cost is 9.6 percent, find the future value of these cash flows. (Round to the
nearest dollar.)
A) $644,406.10
B) $732,114
C) $685,312
D) $900,810
Ans: A
Feedback:
58. FV of multiple cash flows: Tariq Aziz will receive from his investment cash flows of
$3,125, $3,450, and $3, 800. If he can earn 7.5 percent on any investment that he
makes, what is the future value of his investment cash flows at the end of three years?
A) $11,120
B) $10,944
C) $10,812
D) $12,770
Ans: A
Feedback:
59. FV of multiple cash flows: Shane Matthews has invested in an investment that will
pay him $6,200, $6,450, $7,225, and $7,500 over the next four years. If his opportunity
cost is 10 percent, what is the future value of the cash flows he will receive? (Round to
the nearest dollar.)
A) $27,150
B) $29,900
C) $30,455
D) $31,504
Ans: D
Feedback:
60. FV of multiple cash flows: International Shippers, Inc., have forecast earnings of $1,
233,400, $1,345,900, and $1,455,650 for the next three years. What is the future value
of these earnings if the firm's opportunity cost is 13 percent? (Round to the nearest
dollar.)
A) $4,214,360
B) $4,551,446
C) $3,900,865
D) $4,875,212
Ans: B
Feedback:
61. PV of multiple cash flows: Jack Stuart has loaned money to his brother at an interest
rate of 5.75 percent. He expects to receive $625, $650, $700, and $800 at the end of the
next four years as complete repayment of the loan with interest. How much did he loan
out to his brother? (Round to the nearest dollar.)
A) $2,713
B) $2,250
C) $2,404
D) $2,545
Ans: C
Feedback:
0 1 2 3 4
$625 $650 $700 $800
n = 4; i=5.75%
62. PV of multiple cash flows: Ferris, Inc., has borrowed from their bank at a rate of 8
percent and will repay the loan with interest over the next five years. Their scheduled
payments, starting at the end of the year are as follows—$450,000, $560,000,
$750,000, $875,000, and $1,000,000. What is the present value of these payments?
A) $2,735,200
B) $2,615,432
C) $2431,224
D) $2,815,885
Ans: D
Feedback:
63. PV of multiple cash flows: Hassan Ali has made an investment that will pay him
$11,455, $16,376, and $19,812 at the end of the next three years. His investment was to
fetch him a return of 14 percent. What is the present value of these cash flows? (Round
A) $33,124
B) $36,022
C) $41,675
D) $39,208
Ans: B
Feedback:
64. PV of multiple cash flows: Ajax Corp. is expecting the following cash flows—
$79,000, $112,000, $164,000, $84,000, and $242,000—over the next five years. If the
company’s opportunity cost is 15 percent, what is the present value of these cash flows?
A) $429,560
B) $414,322
C) $480,906
D) $477,235
Ans: A
Feedback:
65. PV of multiple cash flows: Pam Gregg is expecting cash flows of $50,000, $75,000,
$125,000, and $250,000 from an inheritance over the next four years. If she can earn 11
percent on any investment that she makes, what is the present value of her inheritance?
A) $361,998
B) $309,432
C) $412,372
D) $434,599
Ans: A
Feedback:
66. Present value of an annuity: Transit Insurance Company has made an investment in
another company that will guarantee it a cash flow of $37,250 each year for the next
five years. If the company uses a discount rate of 15 percent on its investments, what is
the present value of this investment? (Round to the nearest dollar.)
A) $101,766
B) $124,868
C) $251,154
D) $186,250
Ans: B
Feedback:
Annual payment = PMT = $37,250

No. of payments = n = 5
Required rate of return = 15%
Present value of investment = PVA5
67. Present value of an annuity: Herm Mueller has invested in a fund that will provide
him a cash flow of $11,700 for the next 20 years. If his opportunity cost is 8.5 percent,
what is the present value of this cash flow stream? (Round to the nearest dollar.)
A) $234,000
B) $132,455
C) $110,721
D) $167,884
Ans: C
Feedback:
68. Present value of an annuity: Myers, Inc., will be making lease payments of $3,895.50
for a 10-year period, starting at the end of this year. If the firm uses a 9 percent discount
rate, what is the present value of this annuity? (Round to the nearest dollar.)
A) $23,250
B) $29,000
C) $25,000
D) $20,000
Ans: C
Feedback:
69. Present value of an annuity: Lorraine Jackson won a lottery. She will have a choice of
receiving $25,000 at the end of each year for the next 30 years, or a lump sum today. If
she can earn a return of 10 percent on any investment she makes, what is the minimum
amount she should be willing to accept today as a lump-sum payment? (Round to the
nearest hundred dollars.)
A) $750,000
B) $334,600
C) $212,400
D) $235,700
Ans: D
Feedback:
70. Present value of an annuity: Craymore Tech is expecting cash flows of $67,000 at the
end of each year for the next five years. If the firm's discount rate is 17 percent, what is
the present value of this annuity? (Round to the nearest dollar.)
A) $214,356
B) $241,653
C) $278,900
D) $197,776
Ans: A
Feedback:
71. Future value of an annuity: Carlos Menendez is planning to invest $3,500 every year
for the next six years in an investment paying 12 percent annually. What will be the
amount he will have at the end of the six years? (Round to the nearest dollar.)
A) $21,000
B) $28,403
C) $24,670
D) $26,124
Ans: B
Feedback:
72. Future value of an annuity: Jayadev Athreya has started on his first job. He plans to
start saving for retirement early. He will invest $5,000 at the end of each year for the
next 45 years in a fund that will earn a return of 10 percent. How much will Jayadev
have at the end of 45 years? (Round to the nearest dollar.)
A) $2,667,904
B) $3,594,524
C) $1,745,600
D) $5,233,442
Ans: B
Feedback:
73. Future value of an annuity: You plan to save $1,250 at the end of each of the next
three years to pay for a vacation. If you can invest it at 7 percent, how much will you
have at the end of three years? (Round to the nearest dollar.)
A) $3,750
B) $3,918
C) $4,019
D) $4,589
Ans: C
Feedback:
74. Future value of an annuity: Zhijie Jiang is saving to buy a new car in four years. She
will save $5,500 at the end of each of the next four years. If she invests her savings at
6.75 percent, how much will she have after four years? (Round to the nearest dollar.)
A) $22,000
B) $23,345
C) $27,556
D) $24,329
Ans: D
Feedback:
75. Future value of an annuity: Terri Garner will invest $3,000 in an IRA for the next 30
years starting at the end of this year. The investment will earn 13 percent annually.
How much will she have at the end of 30 years? (Round to the nearest dollar.)
A) $897,598
B) $912,334
C) $748,212
D) $1,233,450
Ans: A
Feedback:
76. Computing annuity payment: Maricela Sanchez needs to have $25,000 in five years.
If she can earn 8 percent on any investment, what is the amount that she will have to
invest every year at the end of each year for the next five years? (Round to the nearest
dollar.)
A) $5,000
B) $4,261
C) $4,640
D) $4,445
Ans: B
Feedback:
77. Computing annuity payment: Jane Ogden wants to save for a trip to Australia. She
will need $12,000 at the end of four years. She can invest a certain amount at the
beginning of each of the next four years in a bank account that will pay her 6.8 percent
annually. How much will she have to invest annually to reach her target? (Round to the
nearest dollar.)
A) $3,000
B) $2,980
C) $2,538
D) $2,711
Ans: C
Feedback:
78. Computing annuity payment: Jackson Electricals has borrowed $27,850 from its
bank at an annual rate of 8.5 percent. It plans to repay the loan in eight equal
installments, beginning in a year. What is its annual loan payment? (Round to the
nearest dollar.)
A) $4,708
B) $5,134
C) $4,939
D) $4,748
Ans: C
Feedback:
PVAn = $27,850 n = 8; i = 8.5%
Present value of annuity = PVA = $27,850

Return on investment = i = 8.5%
Payment required to meet target = PMT
Using the PVA equation:
Each payment made by Jackson Electricals will be $4,938.66, starting at the end of next
year.
79. Computing annuity payment: John Harper has borrowed $17,400 to pay for his new
truck. The annual interest rate on the loan is 9.4 percent, and the loan needs to be repaid
in four payments. What will be his annual payment if he begins his payment beginning
now? (Round to the nearest dollar.)
A) $5,229
B) $5,450
C) $4,850
D) $4,953
Ans: D
Feedback:
PVAn = $17,400 n = 4; i = 9.4%
Present value of annuity = PVA = $17,400

Return on investment = i = 9.4%
Payment required to meet target = PMT
Type of annuity = Annuity due
Using the PVA equation:
= $4,952.53
Each payment made by John Harper will be $4,952.53, starting today.

80. Computing annuity payment: Trevor Smith wants to have a million dollars at
retirement, which is 15 years away. He already has $200,000 in an IRA earning 8
percent annually. How much does he need to save each year, beginning at the end of
this year to reach his target? Assume he could earn 8 percent on any investment he
makes. (Round to the nearest dollar.)
A) $13,464
B) $14,273
C) $10,900
D) $16,110
Ans: A
Feedback:
Retirement investment target in 15 years = $1,000,000
Amount invested in IRA account now = PV = $200,000
Return earned by investment = i = 8%
Value of current investment in 15 years = FV15
Balance of money needed to buy car = $1,000,000 -$634,433.82 =$365,566.18 = FVA

Payment needed to reach target = PMT
81. Perpetuity: Your father is 60 years old and wants to set up a cash flow stream that
would be forever. He would like to receive $20,000 every year, beginning at the end of
this year. If he could invest in account earning 9 percent, how much would he have to
invest today to receive his perpetual cash flow? (Round to the nearest dollar.)
A) $222,222
B) $200,000
C) $189,000
D) $235,200
Ans: A
Feedback:
Annual payment needed = PMT = $20,000
Investment rate of return = i = 9%
Term of payment = Perpetuity
Present value of investment needed = PV
82. Perpetuity: A lottery winner was given a perpetual payment of $11, 444. She could
invest the cash flows at 7 percent. What is the present value of this perpetuity? (Round
A) $112,344
B) $163,486
C) $191,708
D) $201,356
Ans: B
Feedback:
Annual payment needed = PMT = $11,444
83. Perpetuity: Roger Barkley wants to set up a scholarship at his alma mater. He is
willing to invest $500,000 in an account earning 10 percent. What will be the annual
scholarship that can be given from this investment? (Round to the nearest dollar.)
A) $5,000
B) $500,000
C) $50,000
Ans: C
Feedback:
Annual payment needed = PMT
Present value of investment = PVA = $500,000
= $50,000
84. Perpetuity: Chris Collinge has funded a retirement investment with $250,000 earning a
return of 5.75 percent. What is the value of the payment that he can receive in
perpetuity? (Round to the nearest dollar.)
A) $12,150
B) $15,250
C) $14,375
D) $14,900
Ans: C
Feedback:
Annual payment needed = PMT
Present value of investment = PVA = $250,000
Investment rate of return = i = 5.75%
85. Perpetuity: Jeff Conway wants to receive $25,000 in perpetuity and will invest his
money in an investment that will earn a return of 13.5 percent annually. What is the
value of the investment that he needs to make today to receive his perpetual cash flow
stream? (Round to the nearest dollar.)
A) $640,225
B) $252,325
C) $144,350
D) $185,185
Ans: D
Feedback:
Annual Payment needed = PMT = $25,000
Investment rate of return = i = 13.5%
86. Annuity due: You plan to save $1,400 for the next four years, beginning now, to pay
for a vacation. If you can invest it at 6 percent, how much will you have at the end of
four years? Round to the nearest dollar.
A) $6,124
B) $5,618
C) $4,019
D) $6,492
Ans: D
Feedback:
0 1 2 3 4
├───────┼────────┼───────┼────────┤
$1,400 $1,400 $1,400 $1,400
n = 4; i = 6%
87. Annuity due: Mark Holcomb has a five-year loan on which he will make annual
payments of $2,235, beginning now. If the interest rate on the loan is 8.3 percent, what
is the present value of this annuity? (Round to the nearest dollar.)
A) $9,588
B) $8,854
C) $8,612
D) $9,122
Ans: A
Feedback:
0 1 2 3 4 5
├───────┼────────┼───────┼────────┼───────┤
$2,235 $2,235 $2,235 $2,235 $2,235
n = 5; i = 8.3%

Required rate of return = 8.3%
88. Annuity due: Jenny Abel is investing $2,500 today and will do so at the beginning of
each of the next six years for a total of seven payments. If her investment can earn 12
percent, how much will she have at the end of seven years? (Round to the nearest
dollar.)
A) $25,223
B) $28,249
C) $31,127
D) $29,460
Ans: B
Feedback:
0 1 2 3 6 7
├───────┼────────┼───────┼………………┼───────┤
PMT PMT PMT PMT PMT
n = 7; i = 12%
Present value of annuity = PVA Return on investment = i = 9.4%

Payment required to meet target = $2,500
Type of annuity = Annuity due
89. Annuity due: Your inheritance will pay you $100,000 a year for five years beginning
now. You can invest it in a CD that will pay 7.75 percent annually. What is the present
value of your inheritance? (Round to the nearest dollar.)
A) $399,356
B) $401,916
C) $433,064
D) $467,812
Ans: C
Feedback:
0 1 2 3 4 5
├───────┼────────┼───────┼────────┼───────┤
$100,000 $100,000 $100,000 $100,000 $100,000
n = 5; i = 7.75%

Required rate of return = 7.75%
90. Growing perpetuity: Jack Benny is planning to invest in an insurance company
product. The product will pay $10,000 at the end of this year. Thereafter, the payments
will grow annually at a 3 percent rate forever. Jack will be able to invest his cash flows
at a rate of 6.5 percent. What is the present value of this investment cash flow stream?
A) $326,908
B) $312,766
C) $285,714
D) $258,133
Ans: C
Feedback:
Cash flow at t=1 = CF1 = $10,000
Annual growth rate = g = 3%
Discount rate = i = 6.5%
Present value of growing perpetuity = PVA¥
91. Growing perpetuity: Norwood Investments is putting out a new product. The product
will pay out $25,000 in the first year, and after that the payouts will grow by an annual
rate of 2.5 percent forever. If you can invest the cash flows at 7.5 percent, how much
will you be willing to pay for this perpetuity? (Round to the nearest dollar.)
A) $312,000
B) $233,000
C) $250,000
D) $500,000
Ans: D
Feedback:
Cash flow at t=1 = CF1 = $25,000
Annual growth rate = g = 2.5%
Discount rate = i = 7.5%
Present value of growing perpetuity = PVA¥
92. Growing annuity: Hill Enterprises is expecting tremendous growth from its newest
boutique store. Next year the store is expected to bring in net cash flows of $675,000.
The company expects its earnings to grow annually at a rate of 13 percent for the next
15 years. What is the present value of this growing annuity if the firm uses a discount
rate of 18 percent on its investments? (Round to the nearest dollar.)
A) $6,448,519
B) $6,750,000
C) $7,115,449
D) $5,478,320
Ans: A
Feedback:
Time of growth = n = 15 years
Next year's expected net cash flow = CF1 = $675,000
Expected annual growth rate = g = 13%
Firm's required rate of return = i = 18%
Present value of growing annuity = PVAn
=$13,500,000 x .477668
= $6,448,519.47
93. Growing annuity: Wilbon Corp. is evaluating whether it should take over the lease of
an ethnic restaurant in Manhattan. The current owner had originally signed a 25-year
lease, of which 16 years still remain. The restaurant has been growing steadily at a 7
percent growth for the last several years. Wilbon Corp. expects the restaurant to
continue to grow at the same rate for the remaining lease term. Last year, the restaurant
brought in net cash flows of $310,000. If the firm evaluates similar investments at 15
percent, what is the present value of this investment? (Round to the nearest dollar.)
A) $2,966.350
B) $2,838,182
C) $3,109,460
D) $2,709,124
Ans: B
Feedback:
Time for lease to expire = n = 16 years
Last year's net cash flow = CF0 = $310,000
Expected annual growth rate = g = 7%
Firm's required rate of return = i = 15%
Expected cash flow next year = CF1 = $310,000(1 + g) = $310,000(1.07) = $331,700
Present value of growing annuity = PVAn
94. Effective annual rate: Desire Cosmetics borrowed $152,300 from a bank for three
years. If the quoted rate (APR) is 11.75 percent, and the compounding is daily, what is
the effective annual rate (EAR)? (Round to one decimal place.)
A) 11.75%
B) 14.3%
C) 12.5%
D) 11.6%
Ans: C
Feedback:
Loan amount = PV = $152,300
Interest rate on loan = i = 11.75%
Effective annual rate = EAR
95. Effective annual rate: Largent Supplies Corp. has borrowed to invest in a project. The
loan calls for a payment of $17,384 every month for three years. The lender quoted
Largent a rate of 8.40 percent with monthly compounding. At what rate would you
discount the payments to find amount borrowed by Largent? (Round to two decimal
places.)
A) 8.40%
B) 8.73%
C) 8.95%
Ans: B
Feedback:
Loan amount = PV
Interest rate on loan = i = 8.4%
Effective annual rate = EAR
To discount present or future value of cash flows, the most appropriate rate is the EAR,
that is, 8.73 percent.
Chapter 8
31. In an efficient capital market,
A) security prices fully reflect the knowledge and expectations of all investors at a
particular point in time.
B) investors and financial managers have no reason to believe the securities are not
priced at or near their true value.
C) prices of securities adjust as new information becomes available to the market.
Ans: D
A) The overall efficiency of a capital market depends on its operational efficiency
and its informational efficiency.
B) Operational efficiency focuses on bringing buyers and sellers together at the
lowest possible cost.
C) If market prices reflect all relevant information about securities at a particular
point in time, the market is operationally efficient.
Ans: C
A) Competition among investors is an important driver of informational efficiency.
B) If market prices reflect all relevant information about securities at a particular
point in time, the market is informationally efficient.
C) In an informationally efficient market, market prices adjust quickly to new
information about a security as it becomes available.
Ans: D
34. With strong-form market efficiency,
A) the price of a security in the market reflects all public information only.
B) it would not be possible to earn abnormally high returns by trading on private
information.
C) investors who have access to inside or private information will be able to earn
abnormal returns.
Ans: B
35. With semistrong-form market efficiency,
A) the price of a security in the market reflects all public information only.
B) it would be possible to earn abnormally high returns by trading on public
information.
C) investors who have access to inside or private information will be unable to earn
abnormal returns.
Ans: A
A) Weak-form market efficiency implies that investors who have access to inside or
private information will be able to earn abnormal returns.
B) Semistrong-form market efficiency implies that investors who have access to
inside or private information will be able to earn abnormal returns.
C) Strong-form market efficiency implies that investors who have access to inside or
private information will be able to earn abnormal returns.
Ans: C
37. Which ONE of the following statements is true?
A) The largest investors in corporate bonds are life insurance companies and pension
funds.
B) The market for corporate bonds is thin.
C) Prices in the corporate bond market also tend to be more volatile.
Ans: D
A) Prices in the corporate bond market also tend to be more volatile than the markets
for stocks or money market securities.
B) Corporate bonds are more marketable than the securities that have higher daily
trading volumes.
C) The market for corporate bonds is thin.
D) The largest investors in corporate bonds are life insurance companies and pension
funds.
Ans: B
39. It is easy for individuals to trade in the corporate bond market because
A) the corporate bond market is considered to be very transparent.
B) prices in the corporate bond market tend to be more stable.
C) centralized reporting of deals between buyers and sellers take place.
D) None of the above statements are true.
Ans: D
40. Which one of the following statements about vanilla bonds is NOT true?
A) They have no special provisions.
B) The face value, or par value, for most corporate bonds is $1,000.
C) Coupon payments are usually made quarterly.
D) The bond's coupon rate is calculated as the annual coupon payment divided by
the bond's face value.
Ans: C
A) Zero coupon bonds have no coupon payments over its life and only offer a single
payment at maturity.
B) Zero coupon bonds sell well below their face value (at a deep discount) because
they offer no coupons.
C) The most frequent and regular issuer of zero coupon securities is the U.S.
Treasury Department.
Ans: D
A) To secure the conversion option on a bond, bondholders would be willing to pay
a premium.
B) The conversion ratio is set so that the firm's stock price must appreciate 15 to 20
percent before it is profitable to convert bonds into equity.
C) Convertible bonds can be converted into shares of common stock at some
predetermined ratio at the discretion of the bondholder.
Ans: D
43. Which one of the following statements about bond price is NOT true?
A) To compute a bond's price, one needs to calculate the present value of the bond's
expected cash flows.
B) The value, or price, of any asset is the future value of its cash flows.
C) The required rate of return, or discount rate, for a bond is the market interest rate
called the bond's yield to maturity
D) Estimate the expected future cash flows using the coupons that the bond will pay
and the maturity value to be received.
Ans: B
44. If a bond's coupon rate is equal to the market rate, then the bond will sell
A) at a price equal to its face value.
B) at a price greater than its face value.
C) at a price less than its face value.
D) None of the above are true.
Ans: A
45. Bonds sell at a discount off the par value when market rates for similar bonds are
A) less than the bond's coupon rate.
B) greater than the bond's coupon rate.
C) equal to the bond's coupon rate.
D) Market rates are irrelevant in determining a bond's price.
Ans: B
46. Bonds sell at a premium over the par value when market rates for similar bonds are
A) less than the bond's coupon rate.
B) greater than the bond's coupon rate.
C) equal to the bond's coupon rate.
D) Market rates are irrelevant in determining a bond's price.
Ans: A
47. In calculating the current price of a bond paying semiannual coupons, one needs to
A) use double the number of years for the number of payments.
B) use half the annual coupon.
C) use half the annual rate as the discount rate.
D) All of the above need to be done.
Ans: D
48. Which one of the following statements about zero coupon bonds is NOT true?
A) Zero coupon bonds have no coupon payments but promise a single payment at
maturity.
B) Zero coupon bonds must sell for less than similar bonds that make periodic
coupon payments.
C) Zero coupon bonds make coupon payments but no principal payment at maturity.
D) All of the above statements are true.
Ans: C
A) The yield to maturity of a bond is the discount rate that makes the present value
of the coupon and principal payments equal to the price of the bond.
B) It is the yield that the investor earns if the bond is held to maturity, and all the
coupon and principal payments are made as promised.
C) A bond's yield to maturity changes daily as interest rates increase or decrease.
Ans: D
50. The yield to maturity of a bond is the discount rate that makes the present value of the
coupon and principal payments
A) exceed the price of the bond.
B) equal to zero.
C) equal to the price of the bond.
D) less than the price of the bond.
Ans: C
A) The realized yield is the return earned on a bond given the cash flows actually
received by the investor.
B) The realized yield is equal to the yield to maturity even if the bond is sold prior to
maturity.
C) It is the interest rate at which the present value of the actual cash flows generated
by the investment equals the bond's price at the time of sale of the bond.
Ans: C
A) Interest rate risk is the risk that bond prices will change as interest rates change.
B) Interest rate changes and bond prices are inversely related.
C) As interest rates increase, bond prices increase.
D) Long-term bonds are more price volatile than short-term bonds of similar risk.
Ans: C
A) Long-term bonds have lower price volatility than short-term bonds.
B) As interest rates decline, the prices of bonds rise; and as interest rates rise, the
prices of bonds decline.
C) All other things being equal, short-term bonds are more risky than long-term
bonds.
D) Interest rate risk decreases as maturity increases.
Ans: B
54. Marketability is the ability of an investor
A) to sell a security quickly, at a low transaction cost, and at a price close to its fair
market value.
B) to sell at a profit under all circumstances.
C) to sell the security above its par value.
Ans: A
A) The lower the transaction costs are, the greater a security's marketability.
B) The interest rate, or yield, on a security varies inversely with its degree of
marketability.
C) U.S. Treasury bills have the largest and most active secondary market and are
considered to be the most marketable of all securities.
Ans: D
A) The risk that the lender may not receive payments as promised is called default
risk.
B) Investors must pay a premium to purchase a security that exposes them to default
risk.
C) U.S. Treasury securities do not have any default risk and are the best proxy
measure for the risk-free rate.
Ans: B
57. Inverted yield curves are observed when
A) the economy is growing.
B) the economy is stagnant.
C) the economy is in recession.
Ans: C
A) The relationship between yield and marketability is known as the term structure
of interest rates.
B) The shape of the yield curve is not constant over time.
C) As the general level of interest rises and falls over time, the yield curve shifts up
and down and has different slopes.
D) Yield curves show graphically how market yields vary as term to maturity
changes.
Ans: A
59. The three economic factors that determine the shape of the yield curve are
A) the real rate of interest, the expected rate of inflation, and marketability.
B) the real rate of interest, the expected rate of inflation, and interest rate risk.
C) the nominal rate of interest, the expected rate of inflation, and interest rate risk.
D) the real rate of interest, the nominal rate of interest, and interest rate risk.
Ans: B
A) The longer the maturity of a security, the greater its interest rate risk.
B) If investors believe inflation will be subsiding in the future, the prevailing yield
will be upward sloping.
C) The real rate of interest varies with the business cycle, with the lowest rates seen
at the end of a period of business expansion and the lowest at the bottom of a
recession.
D) The interest risk premium always adds a downward bias to the slope of the yield
curve.
Ans: A
61. Bond price: Briar Corp is issuing a 10-year bond with a coupon rate of 7 percent. The
interest rate for similar bonds is currently 9 percent. Assuming annual payments, what
is the present value of the bond? (Round to the nearest dollar.)
A) $872
B) $1,066
C) $990
D) $945
Ans: A
Feedback:
Years to maturity = n = 10
Coupon rate = C = 7%
Annual coupon = $1,000 x 0.07 = $70
Current market rate = i = 9%
Present value of bond = PB
62. Bond price: Regatta, Inc., has six-year bonds outstanding that pay a 8.25 percent
coupon rate. Investors buying the bond today can expect to earn a yield to maturity of
6.875 percent. What should the company's bonds be priced at today? Assume annual
coupon payments. (Round to the nearest dollar.)
A) $972
B) $1,066
C) $1,014
D) $923
Ans: B
Feedback:
Coupon rate = C = 8.25%
Annual coupon = $1,000 x 0.0825 = $82.50
Current market rate = i = 6.875%
63. Bond price: Triumph Corp. issued five-year bonds that pay a coupon of 6.375
annually. The current market rate for similar bonds is 8.5 percent. How much will you
be willing to pay for Triumph's bond today? Round to the nearest dollar.
A) $1,023
B) $1,137
C) $916
D) $897
Ans: C
Feedback:
Annual coupon = $1,000 x 0.06375 = $63.75
64. Bond price: Your friend recommends that you invest in a three-year bond issued by
Trimer, Inc., that will pay annual coupons of 10 percent. Similar investments today will
yield 6 percent. How much should you pay for the bond? (Round to the nearest dollar.)
A) $1,024
B) $979
C) $886
D) $1,107
Ans: D
Feedback:
Annual coupon = $1,000 x 0.10 = $100
65. Bond price: Kevin Rogers is interested in buying a five-year bond that pays a coupon
of 10 percent on a semiannual basis. The current market rate for similar bonds is 8.8
percent. What should be the current price of this bond? (Round to the nearest dollar.)
A) $1,048
B) $965
C) $1,099
D) $982
Ans: A
Feedback:
Frequency of payment = m = 2
Semiannual coupon = $1,000 x (0.10/2) = $50.00
66. Bond price: Giant Electronics is issuing 20-year bonds that will pay coupons
semiannually. The coupon rate on this bond is 7.8 percent. If the market rate for such
bonds is 7 percent, what will the bonds sell for today? (Round to the nearest dollar.)
A) $1,037
B) $1,085
C) $861
D) $923
Ans: B
Feedback:
67. Bond price: Jane Thorpe has been offered a seven-year bond issued by Barone, Inc., at
a price of 943.22. The bond has a coupon rate of 9 percent and pays the coupon
semiannually. Similar bonds in the market will yield 10 percent today. Should she buy
the bonds at the offered price? (Round to the nearest dollar.)
A) Yes, the bond is worth more at $1,015.
B) No, the bond is only worth $921.
C) Yes, the bond is worth more at $951.
D) No, the bond is only worth $912.
Ans: C
Feedback:
68. Bond price: Kevin Oh is planning to sell a bond that he owns. This bond has four years
to maturity and pays a coupon of 10 percent on a semiannual basis. Similar bonds in the
current market will yield 12 percent. What will be the price that he will get for his
bond? (Round to the nearest dollar.)
A) $1,044
B) $938
C) $970
D) $1,102
Ans: B
Feedback:
69. Bond price: Jeremy Kohn is planning to invest in a 10-year bond that pays a 12 percent
coupon. The current market rate for similar bonds is 9 percent. Assume semiannual
coupon payments. What is the maximum price that should be paid for this bond?
A) $951
B) $882
C) $1,033
D) $1,195
Ans: D
Feedback:
70. Zero coupon bonds: Shana Norris wants to buy five-year zero coupon bonds with a
face value if $1,000. Her opportunity cost is 8.5 percent. Assuming annual
compounding, what would be the current market price of these bonds? (Round to the
nearest dollar.)
A) $1,023
B) $665
C) $890
D) $1,113
Ans: B
Feedback:
71. Zero coupon bonds: The U.S. Treasury has issued 10-year zero coupon bonds with a
face value of $1,000. Assume that coupon payments are normally semiannual. What
will be the current market price of these bonds if the opportunity cost for similar
investments in the market is 6.75 percent? (Round to the nearest dollar.)
A) $684
B) $860
C) $515
D) $604
Ans: C
Feedback:
Years to maturity = n = 10; Coupon rate = C = 0%
72. Zero coupon bonds: Robertsons, Inc., is planning to expand ita specialty stores into
five other states and finance the expansion by issuing 15-year zero coupon bonds with a
face value of $1,000. If your opportunity cost is 8 percent and similar coupon-bearing
bonds will pay semiannually, what will be the price at which you will be willing to
purchase these bonds? (Round to the nearest dollar.)
A) $308
B) $383
C) $803
D) $866
Ans: A
Feedback:
73. Zero coupon bonds: Jarmine Corp. is planning to fund a project by issuing 10-year
zero coupon bonds with a face value of $1,000. Assuming semiannual coupons to be
the norm, what will be the price of these bonds if the appropriate discount rate is 14
percent? (Round to the closest answer.)
A) $852
B) $258
C) $419
D) $841
Ans: B
Feedback:
74. Yield to maturity: Jenny LePlaz is looking to invest in some five-year bonds that pay
annual coupons of 6.25 percent and are currently selling at $912.34. What is the current
market yield on such bonds? (Round to the closest answer.)
A) 9.5%
B) 8.5%
C) 6.5%
D) 7.5%
Ans: B
Feedback:
Annual coupon = $1,000 x (0.0625) = $62.50
Yield to maturity = i
Present value of bond = PB = $912.34
Use the trial-and-error approach to solve for YTM. Since the bond is selling at a
discount, we know that the yield to maturity is higher than the coupon rate. Try YTM =
8%:
Try a higher rate, say YTM = 8.5%:
The YTM is approximately 8.5 percent. Using a financial calculator provided an exact
YTM of 8.47 percent.
Enter 5 $62.50 -$912.34 $1,000
N i% PMT PV FV
75. Yield to maturity: Nathan Akpan is planning to invest in a seven-year bond that pays
annual coupons at a rate of 7 percent. It is currently selling at $927.23. What is the
current market yield on such bonds? (Round to the closest answer.)
A) 10.4%
B) 9.5%
C) 8.4%
D) 7.5%
Ans: C
Feedback:
Annual coupon = $1,000 x (0.07) = $70
8%:
Try a lower rate, say YTM = 8.4%:

Enter 7 $70 –$927.23 $1,000
N i% PMT PV FV
76. Yield to maturity: Jane Almeda is interested in a 10-year bond issued by Roberts
Corp. that pays a coupon of 10 percent annually. The current price of this bond is
$1,174.45. What is the yield that Jane would earn by buying it at this price and holding
it to maturity? (Round to the closest answer.)
A) 7%
B) 7.5%
C) 8%
D) 8.5%
Ans: B
Feedback:
Annual coupon = $1,000 x (0.10) = $100
Present value of bond = PB = $1,174.45
premium, we know that the yield to maturity is lower than the coupon rate. Try YTM =
8%:
Enter 10 $100 -$1,174.45 $1,000
N i% PMT PV FV
77. Yield to maturity: Shawna Carter wants to invest her recent bonus in a four-year bond
that pays a coupon of 11 percent semiannually. The bonds are selling at $962.13 today.
If she buys this bond and holds it to maturity, what would be her yield? (Round to the
closest answer.)
A) 11.5%
B) 11.8%
C) 12.5%
D) 12.2%
Ans: D
Feedback:
Semiannual coupon = $1,000 x (0.011/2) = $55
12%:
The YTM is approximately 12.2 percent. Using a financial calculator provided an

exact YTM of 12.22 percent (2 x 6.11%).
Enter 8 $55 - $962.13 $1,000
N i% PMT PV FV
78. Yield to maturity: Alice Trang is planning to buy a six-year bond that pays a coupon
of 10 percent semiannually. Given the current price of $878.21, what is the yield to
maturity on these bonds?
A) 11%
B) 12%
C) 13%
D) 14%
Ans: C
Feedback:
12%:
Try a higher rate, say YTM = 13%:
The YTM is approximately 13 percent. Using a financial calculator provided an exact

YTM of 12.98 percent (2 x 6.49%).
Enter 12 $50 - $878.21 $1,000
N i% PMT PV FV
79. Yield to maturity: John Wong purchased a five-year bond today at $1,034.66. The
bond pays 6.5 percent semiannually. What will be his yield to maturity?
A) 6.7%
B) 6.2%
C) 5.9%
D) 5.7%
Ans: D
Feedback:
Present value of bond = PB = $1,034.66
premium, we know that the yield to maturity is lower than the coupon rate. Try YTM =
6%:
YTM of 5.69 percent (2 x 2.847%).
Enter 10 $32.50 - $1,034.66 $1,000
N i% PMT PV FV
80. Yield to maturity: Huan Zhang bought a 10-year bond that pays 8.25 percent
semiannually for $911.10. What is the yield to maturity on this bond?
A) 7.6%
B) 8.6%
C) 9.6%
D) 10.6%
Ans: C
Feedback:
9.4%:
YTM of 9.656percent (2 x 4.828%).
Enter 20 $41.25 - $911.10 $1,000
N i% PMT PV FV
81. Realized yield: Five years ago, Shirley Harper bought a 10-year bond that pays 8
percent semiannually for $981.10. Today, she sold it for $1,067.22. What is the realized
yield on her investment? (Round to the nearest percent.)
A) 7%
B) 8%
C) 9%
D) 10%
Ans: D
Feedback:
Purchase price of bond = $981.10
Years investment held = n = 5
Annual coupon = $1,000 x (0.08/2) = $40
Realized Yield = i
Selling price of bond = PB = $1,067.22
To compute the realized return, either the trial-and-error approach or the financial
calculator can be used. Since the price has increased, market rates must have decreased.
So, the realized return is going to be greater than the bond's coupon. Try rates higher
than the coupon rate.
Try i = 10%, or i/2 = 5%:
Try a lower rate, i = 9.6% or i/2 = 4.8%:

The realized rate of return is approximately 9.6 percent. Using a financial calculator
provided an exact yield of 9.56 percent.
82. Realized yield: Rachel McGovern bought a 10-year bond for $921.77 seven years ago.
The bond pays a coupon of 15 percent semiannually. Today, the bond is priced at
$961.92. If she sold the bond today, what would be her realized yield? (Round to the
nearest percent.)
A) 17%
B) 18%
C) 9%
D) 10%
Ans: A
Feedback:
Purchase price of bond = $921.77
Annual coupon = $1,000 x (0.015/2) = $75.00
Realized Yield = i
Selling price of bond = PB = $961.92
Try i = 17%, or i/2 = 8.5%:
Try a lower rate, i = 16.6% or i/2 = 8.3%:

83. Realized yield: Jorge Cabrera paid $980 for a 15-year bond 10 years ago. The bond
pays a coupon of 10 percent semiannually. Today, the bond is priced at $1,054.36. If he
sold the bond today, what would be his realized yield? (Round to the nearest percent.)
A) 12%
B) 8%
C) 11%
D) 9%
Ans: C
Feedback:
Purchase price of bond = $980
Annual coupon = $1,000 x (0.010/2) = $50.00
Realized Yield = i
Selling price of bond = PB = $1,054.36
Try i = 10.5%, or i/2 = 5.25%:
Try a higher rate, i = 10.7% or i/2 = 5.35%:

84. Effective annual yield: Suppose an investor earned a semiannual yield of 6.4 percent
on a bond paying coupons twice a year. What is the effective annual yield (EAY) on
this investment?
A) 12.80%
B) 6.40%
C) 6.50%
Ans: C
Feedback:
Semiannual yield = 6.4%
The effective annual yield can be computed as:
85. Effective annual yield: Stanley Hart invested in a municipal bond that promised an
annual yield of 6.7 percent. The bond pays coupons twice a year. What is the effective
annual yield (EAY) on this investment?
A) 13.4%
B) 6.81%
C) 6.70%
Ans: B
Feedback:
Annual yield = 6.81%
The effective annual yield can be computed as:
86. Which of the following statements is true about convertible bonds?
A) The most significant disadvantage to a corporation of issuing convertible bonds is
that they increase the cash that the firm must use to make interest payments.
B) The typical conversion ratio is set so that the firm’s stock price must appreciate
5% or less before it is profitable for the holder to convert the bond to stock.
C) Firms that issue convertible bonds can do so at a lower interest rate.
D) The typical issue of convertible bonds allows the holder of the bond to convert it
to preferred stock.
Ans: C
87. Which of the following statements is most true about zero coupon bonds?
A) They typically sell at a premium over par when they are first issued.
B) They typically sell for a higher price than similar coupon bonds.
C) They are always convertible to common stock.
D) They typically sell at a deep discount below par when they are first issued.
Ans: D
A) For a given change in market interest rates, the prices of higher-coupon bonds
change more that the prices of lower-coupon bonds.
B) If market interest rates rise, a 1-year bond will fall in value more than a 10-year
bond.
C) If interest rates rise, bond prices will rise.
D) If market interest rates rise, a 10-year bond will fall in value more than a 1-year
bond.
Ans: D
A) Investment grade bonds are those rated single B and higher.
B) Federal laws typically allow insurance companies and pension funds to purchase
non-investment grade bonds.
C) Because investors are risk averse, they require a premium to purchase a security
that exposes them to default risk.
D) All else equal, the higher a bond’s rating the higher the coupon rate.
Ans: C
A) Downward sloping yield curves typically appear in the early to mid-period of a
business expansion.
B) Interest rate risk always provides an upward bias to the slope of the yield curve.
C) If investors believe that inflation will be increasing in the near future, the yield
curve will be downward sloping.
D) Downward or inverted yield curves are the type most commonly observed.
Ans: B
Chapter 9
1. The largest holders of equity securities are
a. mutual funds.
b. pension funds.
c. foreign investors.
d. households.
Ans: d
2. Which ONE of the following statements is true about secondary markets?
a. In secondary markets, outstanding shares of stock are bought and sold among investors.
b. For an investor, the function of secondary markets is to provide profitability for the
shares of securities they own.
c. An active secondary market causes firms to sell their new debt or equity issues at a
higher cost of funds.
d. All of the above are true statements
Ans: a
3. Which ONE of the following statements is true about secondary markets in the United States?
a. In terms of total volume of activity and total capitalization of the firms listed, the
NASDAQ is the largest in the world and the NYSE is the second largest.
b. In terms of the number of companies listed and shares traded on a daily basis, NASDAQ
is larger than the NYSE.
c. Firms listed on the NASDAQ tend to be, on average, larger in size, and their shares trade
more frequently than firms whose securities trade on NYSE.
d. In the United States, most secondary market transactions are done over the counter.
Ans: b
4. Which one of the following statements is NOT true about secondary markets?
a. In terms of total volume of activity and total capitalization of the firms listed, the
NASDAQ is the largest in the world and the NYSE is the second largest.
b. In terms of the number of companies listed and shares traded on a daily basis, the
NASDAQ is larger than the NYSE.
c. Firms listed on the NYSE tend to be, on average, larger in size and their shares trade
more frequently than firms whose securities trade on NASDAQ.
d. In the United States, most secondary market transactions are done on one of the many
stock exchanges.
Ans: a
5. In comparison to the NYSE,
a. NASDAQ has less companies listed.

b. total share volume is lower on the NASDAQ.
c. firms listed on the NASDAQ tend to be smaller.
d. NASDAQ firms exceed NYSE listed firms in total capitalization.
Ans: c
6. Direct search markets are characterized by

a. complete price information.
b. extensive broker and dealer participation
c. private placement transactions and sale of common stock of small private companies.
d. a high level of efficiency.
Ans: c
7. The least efficient of all the different types of secondary markets is the
a. auction market.
b. direct search market.
c. dealer market.
d. broker market.
Ans: b
8. Which one of the following statements is NOT true about broker markets?
a. Brokers bring buyers and sellers together to earn a fee, called a commission.
b. Brokers’ extensive contacts provide them with a pool of price information that
individual investors could not economically duplicate themselves.
c. Investors have an incentive to hire a broker because they charge a commission that is
less than the cost of direct search.
d. Brokers can guarantee an order because they have an inventory of securities.
Ans: d
9. In brokered markets
a. the commission charged by brokers is a lower cost to buyers and sellers than the cost of
direct search.
b. buyers and sellers are brought together for a transaction fee.
c. brokers build a pool of price information through their extensive contacts.
d. All of the above are true of broker markets.
Ans: d
10. Which ONE of the following statements is true about dealer markets?
a. NYSE is the best-known example of a dealer market.

b. A dealer market involves time-consuming search for a fair deal.
c. The advantage of a dealer over a brokered market is that brokers cannot guarantee that
an order will be executed promptly, while dealers can because they have an inventory of
securities.
d. All of the above are true of dealer markets.
Ans: c
11. Dealer markets are characterized by
a. no time-consuming search for a fair deal.

b. a guarantee of order fulfillment because the dealer holds an inventory of securities.
c. improved market efficiency because dealers provide continuous bid and ask prices for
securities.
d. All of the above characterize dealer markets.
Ans: d
12. Which one of the following statements is NOT true about auction markets?
a. In an auction market, buyers and sellers face each other directly and bargain over price.
b. The NASDAQ is the most efficient stockmarket in the United States.
c. The New York Stock Exchange is the best-known example of an auction market.
d. The auctioneer in this case is the specialist, who is designated by the exchange to
represent orders placed by public customers.
Ans: b
13. Which one of the following statements is NOT true about common stock?
a. Common-stock holders have the right to vote on the selection of the board of directors
for the firm.
b. Common stock is considered to have no fixed maturity.
c. Owners of common stock are guaranteed dividend payments by the firm.
d. Common-stock holders have limited liability.
Ans: c
14. Which ONE of the following statements is true about common stock?
a. Common stock is considered to have a fixed maturity.

b. Owners of common stock are guaranteed dividend payment by the firm.
c. Owners of common stock have the lowest-priority claim on the firm’s assets in the
event of bankruptcy.
d. Common-stock holders have unlimited liability.
Ans: c
15. Which one of the following statements is NOT true about preferred stock?
a. Preferred stock represents ownership in the firm.

b. Owners of preferred stock are not guaranteed dividend payments by the firm.
c. Preferred stock dividends are fixed financial amounts paid regularly by the firm just like
bond coupon payments.
d. Preferred stock holders have limited voting privileges relative to common-stock
owners.
Ans: b
16. Which ONE of the following statements is NOT true about preferred stock?
a. Preferred dividend payments are fixed amounts paid regularly by the firm, similar to
the interest payments on corporate bonds.
b. Preferred dividends are deductable from taxable income just like the interest on
bonds.
c. Preferred stock holders have limited voting privileges relative to common-stock
owners.
d. While preferred stock is legally classified as perpetuities, some issues do have a fixed
maturity.
Ans: b
17. Owners of preferred stock
a. have limited voting rights.

b. usually receive fixed dividend payments.
c. are given priority treatment over common stock with respect to dividends payments
and the claims against the firm’s assets in the event of bankruptcy or liquidation.
d. All of the above statements are true.
Ans: d
18. Preferred stock is sometimes regarded like a debt security because
a. legally preferred stock is a debt security.

b. preferred dividend payments like bond interest payments are fixed amounts regardless
of the firm’s earnings.
c. preferred dividends are deductable from taxable income just like interest payments on
bonds.
d. preferred stock holders receive a residual value and not a stated value.
Ans: b
19. Applying the valuation procedure to common stocks is more difficult than applying it to
bonds because
a. the size and timing of the dividend cash flows are less certain than the coupon
payments for bonds.
b. common stocks have no final maturity date.
c. unlike the rate of return, or yield, on bonds, the rate of return on common stock is
not directly observable.
d. All of the above are true.
Ans: d
20. Which one of the following statements is NOT true about the general dividend valuation model?
a. The model does not assume any specific pattern for dividend growth.
b. It makes a specific assumption about when the stock is going to be sold in the future.
c. The model calls for forecasting an infinite number of dividends for a stock.
d. All of the above are true.
Ans: b
21. Which ONE of the following statements is true about fast growth stocks?
a. These are firms that grow their sales at above-average rates and are expected to do so
for a length of time.
b. These are firms that grow their earnings at above-average rates and are expected to
do so for a length of time.
c. They generally pay dividends during their fast growth phase.
d. None of the above.
Ans: b
22. The three simplifying assumptions that cover most stock growth patterns are
a. dividends that stay constant over time, dividends that grow at a constant rate, and
dividends that are equal to zero.
b. dividends that have a zero-growth rate, dividends that grow at a varying rate, and
dividends that are equal to zero.
c. dividends that stay constant over time, dividends that grow at a constant rate, and
dividends that have a mixed growth pattern.
Ans: c
23. Which one of the following statements is NOT true about zero-growth stocks?
a. Dividend stays constant over time.

b. The cash flow pattern resembles a perpetuity with a constant cash flow.
c. Dividend payment pattern shows constant growth over time.
d. There is no growth in dividends over time.
Ans: c
24. Which one of the following statements is NOT true about constant-growth stocks?
a. Dividend stays constant over time.

b. Mature companies with a history of stable growth show this pattern.
c. Dividends grow at a constant rate each period forever.
d. Dividends that are to be paid out in the distant future have a very small present value
and add little to the stock’s price.
Ans: a
25. The constant-growth dividend model will provide invalid solutions when
a. the growth rate of the stock exceeds the required rate of return for the stock.
b. the growth rate of the stock is less than the required rate of return for the stock.
c. the growth rate of the stock is smaller than 10%.
Ans: a
26. PV of dividends: Cortez, Inc., is expecting to pay out a dividend of $2.50 next year. After that it
expects its dividend to grow at 7 percent for the next four years. What is the present value of
dividends over the next five-year period if the required rate of return is 10 percent?
a. $10.76
b. $9.80
c. $11.88
d. $11.50
Ans: a
Feedback:
Expected dividends for Cortez, Inc., and their present value:
D2 = D1(1 + g) = $2.50(1 + 0.07) = $2.675

D3 = D2(1 + g) = $2.675(1.07) = $2.862
D4 = D3(1 + g) = $2.862(1.07) = $3.063
D5 = D4(1 + g) = $3.063(1.07) = $3.277
Present value of the dividends = PV(D1) + PV(D2) + PV(D3) + PV(D4) + PV(D5)
27. PV of dividends: Next year Jenkins Traders will pay a dividend of $3.00. It expects to increase its
dividend by $0.25 in each of the following three years. If their required rate of return is 14
percent, what is the present value of their dividends over the next four years?
a. $13.50
b. $9.72
c. $12.50
d. $11.63
Ans: b
Feedback:
Expected dividends for Jenkins Traders and their present value:
D1 = $3.00; D2 = $3.25; D3 = $3.50; D4 = $3.75
Present value of the dividends = PV(D 1) + PV(D2) + PV(D3) + PV(D4)

28. PV of dividends: Kleine Toymakers is introducing a new line of robotic toys, which it expects to
grow their earnings at a much faster rate than normal over the next three years. After paying a
dividend of $2.00 last year, it does not expect to pay a dividend for the next three years. After
that Kleine plans to pay a dividend of $4.00 in year 4 and then increase the dividend at a rate of
10 percent in years 5 and 6. What is the present value of the dividends to be paid out over the
next six years if the required rate of rat of return is 15 percent?
a. $13.24
b. $12.00
c. $6.57
d. $10.24
Ans: c
Feedback:
Expected dividends for Kleine Toymakers and their present value:
D0 = $2.00; D1 = D2 = D3 = $0
D4 = $4.00
D5 = D4(1 + g) = $4.00(1.10) = $4.40
D6 = D5(1 + g) = $4.40(1.10) = $4.84

Present value of the dividends = PV(D1) + PV(D2) +…………+ PV(D6)
29. PV of dividends: Givens, Inc., is a fast growing technology company that paid a $1.25 dividend
last week. The company’s expected growth rates over the next four years are as follows: 25
percent, 30 percent 35 percent, and 30 percent. The company then expects to settle down to a
constant-growth rate of 8 percent annually. If the required rate of return is 12 percent, what is
the present value of the dividends over the fast growth phase?
a. $1.25
b. $6.46
c. $8.37
d. $7.23
Ans: d
Feedback:
Expected dividends for Givens, Inc., and their present value:
D0 = $1.25
D1 = D0(1 + g) = $1.25(1.25) = $1.563
D2 = D1(1 + g) = $1.563(1.30) = $2.031

D3 = D2(1 + g) = $2.031(1.35) = $2.742
D4 = D3(1 + g) = $2.742(1.30) = $3.565
Present value of the dividends = PV(D1) + PV(D2) + PV(D3) + PV(D4)
30. PV of dividends: Jacobs Suppliers has not paid out any dividend in the last three years. It does
not expect to pay dividends in the next two years either as it recovers from an economic
slowdown. Three years from now it expects to pay a dividend of $2.50 and then $3.00 in the
following two years. What is the present value of the dividends to be received over the next five
years if the discount rate is 15 percent?
a. $4.85
b. $5.37
c. $5.50
d. $6.14
Ans: a
Feedback:
Expected dividends for Jacobs Suppliers and their present value:
D0 = D1 = D2 = $0; D3 = $2.50; D4 = $3.00; D5 = $3.00
Present value of the dividends = PV(D1) + PV(D2) +…………+ PV(D5)

31. Zero growth: Xinhua Manufacturing Company has been generating stable revenues but sees no
growth in it for the foreseeable future. The company’s last dividend was $3.25, and it is unlikely
to change the amount paid out. If the required rate of return is 12 percent, what is the stock
worth today?
a. $39.00
b. $3.69
c. $27.08
d. $21.23
Ans: c
Feedback:
D0 = $3.25; g = 0; R = 12%
32. Zero growth: Zephyr Electricals is a company with no growth potential. Its last dividend was
$4.50, and it expects no change in future dividends. What is the current price of the company’s
stock given a discount rate of 9 percent?
a. $40.50
b. $50.00
c. $45.00
d. $500.00
Ans: b
Feedback:
D0 = $4.50; g = 0; R = 9%
33. Zero growth: Metasteel Limited Co. has a stable sales track record but does not expect to grow
in the next several years. Its last annual dividend was $5.75. If the required rate of return on
similar investments is 18 percent, what is the current stock price?
a. $103.50
b. $13.50
c. $39.30
d. $31.94
Ans: d
Feedback:
D0 = $5.75; g = 0; R = 18%
34. Zero growth: Ambassador Corp. sells household cleaners producing a revenue stream that has
remained unchanged in the last few years. The firm does not expect any change in its sales or
earnings in the next several years. The stock is currently selling at $46.88. If the required rate of
return is 16 percent, what is the dividend paid by this company?
a. $2.93
b. $4.65
c. $6.89
d. $7.50
Ans: d
Feedback:
P0 = $46.88; g = 0; R = 16%
35. Zero growth: A communications company pays annual dividends of $8.50 with no possibility of
it changing in the next several years. If the firm’s stock is currently selling at $60.71, what is the
required rate of return? (Round to nearest whole number.)
a. 14%
b. 16%
c. 13%
d. 15%
Ans: a
Feedback:
P0 = $60.71; g = 0; D0 = $8.50
36. Constant growth: You are interested in investing in a company that expects to grow steadily at
an annual rate of 6 percent for the foreseeable future. The firm paid a dividend of $2.30 last
year. If your required rate of return is 10 percent, what is the most you would be willing to pay
for this stock? (Round to the nearest dollar.)
a. $58
b. $61
c. $23
d. $24
Ans: b
Feedback:
D0 = $2.30; g = 6%; R = 10%
37. Constant growth: Johnson Corporation has just paid a dividend of $4.45. The company has
forecasted a growth rate of 8 percent for the next several years. If the appropriate discount rate
is 14 percent, what is the current price of this stock? (Round to the nearest dollar.)
a. $74
b. $32
c. $80
d. $60
Ans: c
Feedback:
D0 = $4.45; g = 8%; R = 14%

38. Constant growth: Ryder Supplies has its stock currently selling at $63.25. The company is
expected to grow at a constant rate of 7 percent. If the appropriate discount rate is 17 percent,
what is the expected dividend, a year from now?
a. $4.43
b. $3.25
c. $10.75
d. $6.33
Ans: d
Feedback:
P0 = $63.25; g = 7%; R = 17%
39. Constant growth: Prior, Inc., is expected to grow at a constant rate of 9 percent. If the
company’s next dividend is $2.75 and its current price is $37.35, what is the required rate of
return on this stock? (Round to the nearest percent.)
a. 13%
b. 16%
c. 20%
d. 21%
Ans: b
Feedback:
D1 = $2.75; P0 = $37.35; g = 9%
40. Constant growth: A company is growing at a constant rate of 8 percent. Last week it paid a
dividend of $3.00. If the required rate of return is 15 percent, what is the price of the stock
three years from now?
a. $58.31
b. $46.29
c. $51.02
d. $42.83
Ans: a
Feedback:
R = 15%; D0 = $3.00; g= 8%
41. Preferred stock valuation: Ajax Company has issued perpetual preferred stock with a par of
$100 and a dividend of 5.5 percent. If the required rate of return is 7.75 percent, what is the
stock’s current market price?
a. $12.90
b. $70.97
c. $53.27
d. $62.14
Ans: b
Feedback:
D = 5.5% ($100) = $5.50; R = 7.75%

42. Preferred stock valuation: The National Bank of Columbia has issued perpetual preferred stock
with a $100 par value. The bank pays a quarterly dividend of $1.40 on this stock. What is the
current price of this preferred stock given a required rate of return of 8.5 percent?
a. $23.06
b. $65.88
c. $37.57
d. $43.25
Ans: b
Feedback:
Quarterly dividend = $1.40
Required rate of return = R = 8.5%
43. Preferred stock: The preferred stock of Acme International is selling currently at $110.35. If your
required rate of return is 9.75 percent, what is the dividend paid by this stock?
a. $9.75
b. $11.32
c. $10.76
d. $8.53
Ans: c
Feedback:
P0 = $110.35; R = 9.75%
44. Preferred stock: Each quarter, Transam, Inc., pays a dividend on its perpetual preferred stock.
Today, the stock is selling at $83.45. If the required rate of return for such stocks is 10.5 percent,
what is the quarterly dividend paid by this firm?
a. $8.76
b. $10.50
c. $2.19
d. $2.63
Ans: c
Feedback:
P0 = $83.45; R = 10.5%
Annual dividend = $8.76

Quarterly dividend = $8.76 /4 = $2.19
45. Preferred stock valuation: The Columbia Consumer Products Co. has issued perpetual preferred
stock with a $100 par value. The firm pays a quarterly dividend of $2.60 on this stock. What is
the current price of this preferred stock given a required rate of return of 12.5 percent?
a. $47.25
b. $80.00
c. $20.80
d. $83.20
Ans: d
Feedback:
Quarterly dividend = $2.60
Required rate of return = R = 12.5%

46. Nonconstant growth: Starskeep, Inc., is a fast growing technology company. The firm projects a
rapid growth of 40 percent for the next two years and then a growth rate of 20 percent for the
following two years. After that, the firm expects a constant-growth rate of 8 percent. The firm
expects to pay its first dividend of $1.25 a year from now. If your required rate of return on such
stocks is 20 percent, what is the current price of the stock?
a. $15.63
b. $4.70
c. $30.30
d. $22.68
Ans: a
Feedback:
g1 = g2 = 40%, g3 = g4 = 20%, g = 8%, D1 = $1.25, R = 20%
D1 = $1.25, D2 = $1.25(1.40) = $1.75, D3 = $1.75(1.20) = $2.10
D4 = $2.10(1.20) = $2.52, D5 = 2.52(1.08) = $2.722

47. Nonconstant growth: BioSci, Inc., a biotech firm has forecast the following growth rates for the
next three years: 30 percent, 25 percent, and 20 percent. The company then expects to grow at
a constant rate of 7 percent for the next several years. The company paid a dividend of $2.00
last week. If the required rate of return is 16 percent, what is the market value of this stock?
a. $51.03
b. $36.86
c. $56.12
d. $46.37
Ans: b
Feedback:
g1 = 30%; g2 = 25%, g4 = 20%, g = 7%, D0 = $2.00, R = 16%
D1 = $2.00(1.30) = $2.60, D2 = $2.60(1.25) = $3.25, D3 = $3.25(1.20) = $3.90
D4 = $3.90(1.07) = $4.173;
48. Nonconstant growth: Grant, Inc., is a fast growth stock and expects to grow at a rate of 25
percent for the next four years. It then will settle to a constant-growth rate of 10 percent. The
first dividend will be paid out in year 3 and will be equal to $5.00. If the required rate of return is
18 percent, what is the current price of the stock?
a. $85.94
b. $97.19
c. $50.59
d. $65.68
Ans: c
Feedback:
g1-4 = 25%; g = 10%; D3 = $5.00; R = 18%
D4 = D3 (1.25) = $5.00(1.25) = $6.25; D5 = $6.25(1.10) =$6.875
49. Nonconstant growth: Stag Corp. will pay dividends of $4.75, $5.25, $5.75, and $7 for the next
four years. Thereafter, the company expects its growth rate to be at a constant rate of 7
percent. If the required rate of return is 15 percent, what is the current market price of the
stock?
a. $69.41
b. $93.63
c. $57.54
d. $80.29
Ans: a
Feedback:
D1 = $4.75; D2 = $5.25; D3 = 5.75; D4 = $7; g = 7%; R = 15%
50. Nonconstant growth: Lincoln, Inc. expects to pay no dividends for the next four years. It has
projected a growth rate of 35 percent for the next four years. After four years, the firm will grow
at a constant rate of 6 percent. Its first dividend to be paid in year 5 will be worth $4.25. If your
required rate of return is 20 percent, what is the stock worth today?
a. $14.64
b. $32.18
c. $36.43
d. $21.82
Ans: a
Feedback:
gconstant = 6%; R = 20%; D5 = $4.25; D1 – D4 = 0
PV (D1)+PV(D2)+PV(D3)+PV(D4) = 0
81. Which of the following is not a widely know stock market index?
A) The Dow Jones Industrial Average.
B) The OTQ Composite Index.
C) The New York Stock Exchange Index.
D) The Standard and Poor’s 500 Index.
Ans: B
A) Preferred stockholders are considered to be the true owners of public corporations.
B) Dividends paid to preferred stockholders are not fixed.
C) Preferred stockholders do not typically have voting rights.
D) Preferred stock can never be converted to common stock.
Ans: C
83. One-Period Model: Assume that you are considering the purchase of a stock which will pay
dividends of $4.50 during the next year. Further assume that you will be able to sell the stock
for $85.00 one year from today and that your required rate of return is 15 percent. How much
would you be willing to pay for the stock today? (Round off to the nearest $0.01)
A) $89.50
B) $65.37
C) $94.10
D) $77.82
Ans: D
Feedback:
84. Which of the following statements is true about the general dividend valuation model?
A) It implies that the underlying value of a share of stock is determined by the market’s
expectations of the future dividends that the firm will generate.
B) It implies that the value of a firm’s common stock can be determined only if the
expected future dividends are infinite.
C) It implies that the value of a growth stock can be determined by forecasting the future
price of the stock.
D) The model cannot be used to calculate the value of a common stock unless the
dividends exceed the firm’s expected growth rate.
Ans: A
85. Which of the following is the most typical example of a zero-growth dividend stock?
A) The common stock of a firm in the biotechnology industry.
B) The preferred stock of a utility company.
C) The stock of a firm in the health care industry.
D) The stock of a firm in the information technology industry.
Ans: B
86. The constant growth dividend model would be useful to determine the value of all but which
of the following firms?
A) A firm whose earnings and dividends are declining at a fairly steady rate.
B) A firm whose sales, profits, and dividends are growing at an annual average compound
rate of 5 percent.
C) A firm whose earnings and dividends are growing at a fairly steady rate.
D) A firm whose expected sales, profits, and dividends are flat.
Ans: D
87. Supernormal growth: Suppose a firm’s expected dividends for the next three years are as
follows: D1 = $1.10, D2 = $1.20, and D3 = $1.30. After three years, the firm’s dividends are
expected to grow at 5.00 percent per year. What is should the current price of the firm’s stock
(P0) be today if investors require a rate of return of 12.00 percent on the stock? (Round off to
the nearest $0.01)
A) $61.30
B) $10.10
C) $16.74
D) $24.12
Ans: C
Feedback:
A) In order for the constant growth dividend model to properly value a firm’s common
stock, R must be greater than g.
B) From a practical perspective, the growth rate in the constant growth dividend model
must be greater than the sum of the long-term rate of inflation and the long-term real
growth rate of the economy.
C) In order for the constant growth dividend model to properly value a firm’s common
stock, g must be greater than R.
D) The constant growth dividend model can be used effectively to value the common
shares of a mixed growth stock.
Ans: A
89. Which of the following statements about preferred stock is false?
A) Preferred stock has a higher-priority claim on the firm’s assets than common stock.
B) Failure to pay dividends will result in default.
C) Preferred stock has a lower-priority claim on the firm’s assets than the firm’s creditors
in the event of default.
D) Preferred stock typically pays a fixed dividend.
Ans: B
90. Preferred Stock Yield-to-Maturity: Durango Water Works has an outstanding issue of
preferred stock that has a par (maturity value) of $75.00. The stock, which pays a quarterly
dividend of $1.10, will be retired by the firm in 20 years. If the preferred stock is currently
selling for $68.00, what is the preferred stock’s yield-to-maturity? (Round off to the nearest
0.01%)
A) 6.72%
B) 5.64%
C) 4.28%
D) 7.73%
Ans: A
Feedback:
N = 20 × 4 = 80
PV = -$68.00
PMT = $ 1.10
FV = $75.00
Solve for I% = 1.68% × 4 = 6.72%

Chapter 10
31. Which of the following is NOT true about capital budgeting.
A) It involves identifying projects that will add to the firm's value.
B) It involves large capital investments.
C) The large capital investments can be reversed at any time.
D) It allows the firm's management to analyze potential business opportunities and
decide on which ones to undertake.
Ans: C
32. Which of the following are aspects of independent projects?
A) Their cash flows are related.
B) Their cash flows are unrelated.
C) Selecting one would automatically eliminate accepting the other.
Ans: B
33. Two projects are considered to be independent if
A) selecting one would have no bearing on accepting the other.
B) their cash flows are unrelated.
C) Both a and b.
Ans: C
34. Two projects are considered to be mutually exclusive if
A) the projects perform the same function.
B) selecting one would automatically eliminate accepting the other.
C) Both a and b.
Ans: C
35. Two projects are considered to be contingent projects if
A) selecting one would automatically eliminate accepting the other.
B) the acceptance of one project is dependent on the acceptance of the other.
C) rejection of one project does not eliminate the selection of the other.
Ans: B
36. Contingent projects would imply that
A) the acceptance of one project is dependent on the acceptance of the other.
B) the projects can be either mandatory or optional.
C) Both a and b.
Ans: C
Use the following to answer questions 37-38:
A construction firm is evaluating two value-adding projects. The first project deals with building
access roads to a new terminal at the local airport. The second project is to build a parking
garage on a piece of land that the firm owns adjacent to the airport.
Reference: Ref 10-1
37. The firm's decision will be to
A) accept both projects because they are independent projects.
B) accept both projects because they are contingent projects.
C) pick the one that adds the most value because they are mutually exclusive
projects.
D) pick neither project.
Ans: A
Reference: Ref 10-1
38. If both projects are positive-NPV projects, then the firm should
A) accept both projects because they are independent projects.
B) select the higher NPV project because they are mutually exclusive.
C) accept both projects because they are contingent projects.
D) Not enough information is given to make a decision.
Ans: A
39. The cost of capital is
A) the minimum return that a capital budgeting project must earn for it to be
accepted.
B) the maximum return a project can earn.
C) the return that a previous project for the firm had earned.
Ans: A
40. Capital rationing implies that
A) the firm does not have enough resources to fund all of the available projects.
B) funding needs equal funding resources.
C) the available capital will be allocated equally to all available projects.
Ans: A
41. Capital rationing implies that
A) funding resources exceed funding needs.
B) funding needs exceed funding resources.
C) funding needs equal funding resources.
Ans: B
A) Accepting a positive-NPV project increases shareholder wealth.
B) Accepting a negative-NPV project has no impact on shareholder wealth.
C) Accepting a negative-NPV project decreases shareholder wealth.
D) Managers are indifferent about accepting or rejecting a zero NPV project.
Ans: B
A) Accepting a positive-NPV project increases shareholder wealth.
B) Accepting a negative-NPV project decreases shareholder wealth.
C) Accepting a zero NPV project has a negative impact on shareholder wealth.
D) Managers are indifferent about accepting or rejecting a zero NPV project.
Ans: C
44. In computing the NPV of a capital budgeting project, one should NOT
A) estimate the cost of the project.
B) discount the future cash flows over the project's expected life.
C) ignore the salvage value.
D) make a decision based on the project's NPV.
Ans: C
45. The net present value
A) uses the discounted cash flow valuation technique.
B) will provide a direct measure of how much the firm value will change because of
the capital project.
C) is consistent with shareholder wealth maximization goal.
D) all of the above.
Ans: D
46. To accept a capital project when using NPV,
A) the project NPV should be less than zero.
B) the project NPV should be greater than zero.
C) both a and b.
Ans: B
47. Which ONE of the following statements about the payback method is true?
A) The payback method is consistent with the goal of shareholder wealth
maximization
B) The payback method represents the number of years it takes a project to recover
its initial investment plus a required rate of return.
C) There is no economic rational that links the payback method to shareholder
wealth maximization.
D) None of the above statements are true.
Ans: C
48. Which one of the following statements about the discounted payback method is NOT
true?
A) The discounted payback method represents the number of years it takes a project
to recover its initial investment.
B) The discounted payback method calls for the project to be accepted if the
payback period is greater than a target period.
C) The discount payback method is a risk indicator.
D) The expected cash flows from the project are discounted at the cost of capital.
Ans: B
49. Advantages of the payback method include the following.
A) The technique is simple for managers to compute and interpret.
B) It is a good measure of liquidity risk.
C) Both a and b,
Ans: C
50. Disadvantages of the payback method include the following.
A) It ignores the time value of money.
B) It is inconsistent with the goal of maximizing shareholder wealth.
C) It ignores cash flows beyond the payback period.
D) All of the above.
Ans: D
51. Which one of the following statements about IRR is NOT true?
A) The IRR is the discount rate that makes the NPV greater than zero.
B) The IRR is a discounted cash flow method.
C) The IRR is an expected rate of return.
Ans: A
52. The internal rate of return is
A) the discount rate that makes the NPV greater than zero.
B) the discount rate that makes the NPV equal to zero.
C) the discount rate that makes the NPV less than zero.
D) both a and c.
Ans: B
53. When evaluating capital projects, the decisions using the NPV method and the IRR
method will agree if
A) the projects are independent.
B) the cash flow pattern is conventional.
C) the projects are mutually exclusive.
D) both a and b.
Ans: D
54. In evaluating capital projects, the decisions using the NPV method and the IRR method
may disagree if
A) the projects are independent.
B) the cash flows pattern is unconventional.
C) the projects are mutually exclusive.
D) both b and c.
Ans: D
55. Which one of the following cash flow patterns is NOT an unconventional cash flow
pattern?
A) A positive initial cash flow is followed by negative future cash flows.
B) Future cash flows from a project could include both positive and negative cash
flows.
C) A negative initial cash flow is followed by positive future cash flows.
D) A cash flow stream looks similar to a conventional cash flow stream except for a
final negative cash flow.
Ans: C
56. Net present value: The Cyclone Golf Resorts is redoing its golf course at a cost of
$2,744,320. It expects to generate cash flows of $1, 223,445, $2,007,812, and
$3,147,890 over the next three years. If the appropriate discount rate for the firm is 13
percent, what is the NPV of this project?
A) $7,581,072
B) $2,092,432
C) $4,836,752
D) $3,112,459
Ans: B
Feedback:
Initial investment = $2,744,320
Length of project = n = 3 years
Required rate of return = k = 13%
Net present value = NPV
57. Net present value: Johnson Entertainment Systems is setting up to manufacture a new
line of video game consoles. The cost of the manufacturing equipment is $1,750,000.
Expected cash flows over the next four years are $725,000, $850,000, $1,200,000, and
$1,500,000. Given the company's required rate of return of 15 percent, what is the NPV
of this project?
A) $1,169,806
B) $2,919,806
C) $4,669,806
D) $3,122, 607
Ans: A
Feedback:
Initial investment = 1,750,000
58. Net present value: Cortez Art Gallery is adding to its existing buildings at a cost of $2
million. The gallery expects to bring in additional cash flows of $520,000, $700,000,
and $1,000,000 over the next three years. Given a required rate of return of 10 percent,
what is the NPV of this project?
A) $1,802,554
B) $197,446
C) -$1,802,554
D) -$197,446
Ans: D
Feedback:
59. Net present value: Gao Enterprises plans to build a new plant at a cost of $3,250,000.
The plant is expected to generate annual cash flows of $1,225,000 for the next five
years. If the firm's required rate of return is 18 percent, what is the NPV of this project?
A) $2,875,000
B) $3,830,785
C) $580,785
D) $2,1225,875
Ans: C
Feedback:
Annual cash flows = $1,225,000
60. Net present value: Jenkins Corporation is investing in a new piece of equipment at a
cost of $6 million. The project is expected to generate annual cash flows of $1,850,000
over the next six years. The firm's cost of capital is 20 percent. What is the project's
NPV?
A) $722,604
B) $351,097
C) $152,194
D) $261,008
Ans: C
Feedback:
61. Payback: Binder Corp. has invested in new machinery at a cost of $1,450,000. This
investment is expected to produce cash flows of $640,000, $715,250, $823,330, and
$907,125 over the next four years. What is the payback period for this project?
A) 2.12 years
B) 1.88 years
C) 4.00 years
D) 3.00 years.
Ans: A
Feedback:
Binder Corp.
Year CF Cumulative CF
0 $(1,450,000) $(1,450,000)
1 640,000 (810,000)
2 715,250 (94,750)
3 823,330 728,580
4 907,125 1,635,705
PB = Years before cost recovery + (Remaining cost to recover/ Cash flow during the
year
= 2 + ($94,750 / $823,330)
= 2.12 years
62. Payback: Elmer Sporting Goods is getting ready to produce a new line of golf clubs by
investing $1.85 million. The investment will result in additional cash flows of
$525,000, $812,500, and 1,200,000 over the next three years. What is the payback
period for this project?
A) 3 years
B) 2.43 years
C) 1.57 years
D) More than 3 years
Ans: B
Feedback:
Elmer Sporting Goods
0 $(1,850,000) $(1,850,000)
1 525,000 (1,325,000)
2 812,500 (512,500)
3 1,200,000 687,500
year
= 2 + ($512,500 / $1,200,000)
= 2.43 years
63. Payback: Creighton, Inc., has invested $2,165,800 on equipment. The firm uses
payback period criteria of not accepting any project that takes more than four years to
recover costs. The company anticipates cash flows of $424,386, $512,178, $561,755,
$764,997, $816,500, and $825,375 over the next six years. What is the payback period,
and does this investment meet the firm's payback criteria?
A) 4.13 years; no
B) 4.13 years; yes
C) 3.87 years; yes
D) 3.87 years; no
Ans: C
Feedback:
Creighton Inc.
0 $(2,165,800) $(2,165,800)
1 424,386 (1,741,414)
2 512,178 (1,229,236)
3 561,755 (667,481)
4 764,997 97,516
5 816,500 914,016
6 825,375 1,739,391
year
= 3 + ($667,481 / $764,997)
= 3.87 years
Since the payback period of 3.87 years is less than the decision criteria of 4 years, this
project should be accepted.
64. Payback: Kathleen Dancewear Co. has bought some new machinery at a cost of
$1,250,000. The impact of the new machinery will be felt in the additional annual cash
flows of $375,000 over the next five years. What is the payback period for this project?
If their acceptance period is three years, will this project be accepted?
A) 2.67 years; yes
B) 2.67 years; no
C) 3.33 years; yes
D) 3.33 years; no
Ans: D
Feedback:
Kathleen Dancewear Inc.
0 $(1,250,000) $(1,250,000)
1 375,000 (875,000)
2 375,000 (500,000)
3 375,000 (125,000)
4 375,000 250,000
5 375,000 625,000
year
= 3 + ($125,000 / $375,000)
= 3.33 years
Since the payback period of 3.33 years exceeds the decision criteria of 3 years, this
project should be rejected.
65. Payback: Carmen Electronics bought new machinery for $5 million. This is expected
to result in additional cash flows of $1.2 million over the next seven years. What is the
payback period for this project? If their acceptance period is five years, will this project
be accepted?
A) 4.17 years; yes
B) 4.17 years; no
C) 3.83 years; yes
D) 3.83 years; no
Ans: A
Feedback:
Carmen Electronics
0 $(5,000,000) $(5,000,000)
1 1,200,000 (3,800,000)
2 1,200,000 (2,600,000)
3 1,200,000 (1,400,000)
4 1,200,000 (200,000)
5 1,200,000 1,000,000
6 1,200,000 2,200,000
7 1,200,000 3,400,000
year
= 4 + ($200,000 / $1,200,000)
= 4.17 years
Since the payback period of 4.17 years is less than the decision criteria of 5 years, this
project should be accepted.
66. Discounted payback: Roswell Energy Company is installing new equipment at a cost
of $10 million. Expected cash flows from this project over the next five years will be
$1,045,000, $2,550,000, $4,125,000, $6,326,750, and $7,000,000. The company's
discount rate for such projects is 14 percent. What is the project's discounted payback
period?
A) 4.2 years
B) 4.4 years
C) 4.8 years
D) 5.0 years
Ans: A
Feedback:
Roswell Energy
i = 14%
Cumulative PVCF
Year CF PVCF
0 $(10,000,000) $(10,000,000) $(10,000,000
1 1,045,000 916,667 (9,083,333)
2 2,550,000 1,962,142 (7,121,191)
3 4,125,000 2,784,258 (4,336,934)
4 6,326,750 3,745,944 (590,990)
5 7,000,000 3,635,581 3,044,591
year
= 4 + ($590,990/ $3,635,581)
= 4.16 years
67. Discounted payback: Carmen Electronics bought new machinery for $5 million. This
is expected to result in additional cash flows of $1.2 million over the next seven years.
The firm's cost of capital is 12 percent. What is the discounted payback period for this
project? If the firm's acceptance period is five years, will this project be accepted?
A) 5.4 years; no
B) 6.1 years; no
C) 4.6 years; yes
D) 4.2 years; yes
Ans: B
Feedback:
Carmen Electronics
i = 12%
Cumulative PVCF
Year CF PVCF
0 $(5,000,000) $(5,000,000) $(5,000,000
1 1,200,000 1,071,429 (3,928,571)
2 1,200,000 956,633 (2,971,938)
3 1,200,000 854,136 (2,117,802)
4 1,200,000 762,622 (1,355,180)
5 1,200,000 680,912 (674,268)
6 1,200,000 607,957 (66,311)
7 1,200,000 542,819 476,508
year
= 6 + ($66,311 / $542,819)
= 6.12 years
68. Discounted payback: Kathleen Dancewear Co. has bought some new machinery at a
cost of $1,250,000. The impact of the new machinery will be felt in the additional
annual cash flows of $375,000 over the next five years. The firm's cost of capital is 10
percent. What is the discounted payback period for this project? If their acceptance
period is three years, will this project be accepted?
A) 2.7 years; yes
B) 4.7 years; no
C) 2.3 years; yes
D) 4.3 years; no
Ans: D
Feedback:
Kathleen Dancewear Inc.
i = 10%
Cumulative PVCF
Year CF PVCF
0 $(1,250,000) $(1,250,000) $(1,250,000
1 375,000 340,909 (909,091)
2 375,000 309,917 (599,174)
3 375,000 281,743 (317,431)
4 375,000 256,130 (61,300)
5 375,000 232,845 171,545
year
= 4 + ($61,300 / $232,845)
= 4.26 years
69. Accounting rate of return (ARR): LaGrange Corp. has forecasted that over the next
four years the average annual after-tax income will be $45,731. The average book value
of the manufacturing equipment that is used is $167,095. What is the accounting rate of
return?
A) 33.3%
B) 27.4%
C) 29.8%
D) 22.3%
Ans: B
Feedback:
Annual after-tax income = $45,731
Average after-tax income = ($45,731+$45,731 + $45,731+$45,731) / 4 = $45,731
Average book value of equipment = $167,095
70. Accounting rate of return (ARR): Stump Storage Co. is expecting to generate after-
tax income of $155,708, $159,312, and $161,112 for each of the next three years. The
equipment used will have an average book value of $251,575 over that period. What is
the ARR?
A) 65.7%
B) 69.4%
C) 63.1%
D) 66.8%
Ans: C
Feedback:
Average after-tax income = ($155,708+$159,312 +$161,112) / 3 = $158,711
Average book value of equipment = $215,575
71. Internal rate of return: Quick Sale Real Estate Company is planning to invest in a
new development. The cost of the project will be $23 million and is expected to
generate cash flows of $14,000,000, $11,750,000, and $6,350,000 over the next three
years. The company's cost of capital is 20 percent. What is the internal rate of return on
this project? (Round to the nearest percent.)
A) 22%
B) 20%
C) 24%
D) 28%
Ans: A
Feedback:
To determine the IRR, the trial-and-error approach can be used. Set NPV = 0.
Try IRR = 21.6%.
The IRR of the project is 21.6 percent. Using a financial calculator, we find that the
IRR is 21.572 percent.
72. Internal rate of return: Modern Federal Bank is setting up a brand new branch. The
cost of the project will be $1.2 million. The branch will create additional cash flows of
$235,000, $412,300, $665,000 and $875,000 over the next four years. The firm's cost of
capital is 12 percent. What is the internal rate of return on this branch expansion?
(Round to the nearest percent.)
A) 20%
B) 23%
C) 25%
D) 27%
Ans: B
Feedback:
Try IRR =23.1%.
73. Internal rate of return: Signet Pipeline Co. is looking to install new equipment that
will cost $2,750,000. The cash flows expected from the project are $612,335, $891,005,
$1,132,000, and $1,412,500 for the next four years. What is Signet's internal rate of
return? (Round to the nearest percent.)
A) 11%
B) 13%
C) 15%
D) 17%
Ans: C
Feedback:
Try IRR =15.1%.
74. Internal rate of return: Casa Del Sol Property Development Company is refurbishing
a 200-unit condominium complex at a cost of $1,875,000. It expects that this will lead
to expected annual cash flows of $415,350 for the next seven years. What internal rate
of return can the firm earn from this project? (Round to the nearest percent.)
A) 10%
B) 12%
C) 14%
D) 16%
Ans: B
Feedback:
Annual cash flows = $415,350
Length of investment = n = 7 years
Try IRR =12.3%.
75. Internal rate of return: Lowell Communications, Inc., has been installing a fiber-optic
network at a cost of $18 million. The firm expects annual cash flows of $3.7 million
over the next 10 years. What is this project's internal rate of return? (Round to the
nearest percent.)
A) 10%
B) 12%
C) 14%
D) 16%
Ans: D
Feedback:
Try IRR =15.8%.
Turnbull Corp. is in the process of constructing a new plant at a cost of $30 million. It expects
the project to generate cash flows of $13,000,000, $23,000,000, and 29,000,000 over the next
three years. The cost of capital is 20 percent.
Reference: Ref 10-2
76. Payback: What is the payback period for this project?
A) 1.7 years
B) 2.2 years
C) 1.2 years
D) 2.7 years
Ans: A
Feedback:
Turnbull Corp.
i = 20.00%
0 $(30,000,000) $(30,000,000)
1 13,000,000 (17,000,000)
2 23,000,000 6,000,000
3 29,000,000 35,000,000
year
= 1 + ($17,000,000 / $23,000,000)
= 1.74 years
Reference: Ref 10-2
77. Net present value: What is the net present value of this project? (Round to the nearest
million dollars.)
A) $10 million
B) $12 million
C) $14 million
D) $16 million
Ans: C
Feedback:
Reference: Ref 10-2
78. Internal rate of return: What is the internal rate of return that Turnbull can earn on
this project? (Round to the nearest percent.)
A) 41%
B) 42%
C) 43%
D) 44%
Ans: D
Feedback:
Since NPV > 0, try IRR > 20%. Try IRR = 43.6%.
Reference: Ref 10-2
79. Modified Internal rate of return: What is the MIRR on this project? (Round to the
nearest percent.)
A) 36%
B) 37%
C) 38%
D) 39%
Ans: A
Feedback:
PV of costs = $30,000,000
Cost of capital = k = 20%
Jamaica Corp. is adding a new assembly line at a cost of $8.5 million. The firm expects the
project to generate cash flows of $2 million, $3 million, $4 million, and $5 million over the next
four years. Its cost of capital is 16 percent.
Reference: Ref 10-3
A) 2.8 years
B) 2.9 years
C) 3.1 years
D) 3.4 years
Ans: B
Feedback:
Jamaica Inc.
i = 16.00%
0 $(8,500,000) $(8,500,000)
1 2,000,000 (6,500,000)
2 3,000,000 (3,500,000)
3 4,000,000 500,000
4 5,000,000 1,500,000
year
= 2 + ($3,500,000/ $4,000,000)
= 2.88 years
Reference: Ref 10-3
81. Net present value: What is the net present value of this project?
A) $645,366
B) $1,213,909
C) $905,888
D) $777,713
Ans: D
Feedback:
Reference: Ref 10-3
82. Internal rate of return: What is the internal rate of return that Jamaica can earn on this
project? (Round to the nearest percent.)
A) 18%
B) 19%
C) 20%
D) 21%
Ans: C
Feedback:
Reference: Ref 10-3
83. Modified internal rate of return: What is the MIRR on this project? (Round to the
nearest percent.)
A) 18%
B) 19%
C) 20%
D) 21%
Ans: B
Feedback:
Cost of capital = k = 16%
Strange Manufacturing Company is purchasing a production facility at a cost of $21 million. The
firm expects the project to generate annual cash flows of $7 million over the next five years. Its
cost of capital is 18 percent.
Reference: Ref 10-4
A) 2.8 years
B) 3.0 years
C) 3.2 years
D) 3.4 years
Ans: B
Feedback:
Strange Manufacturing
i = 18.00%
0 $(21,000,000) $(21,000,000)
1 7,000,000 (14,000,000)
2 7,000,000 (7,000,000)
3 7,000,000 --
4 7,000,000 7,000,000
5 7,000,000 14,000,000
year
= 3 + ($0 / $7,000,000)
= 3.0 years
Reference: Ref 10-4
85. Discounted payback: What is the discounted payback period for this project?
A) 3.9 years
B) 4.3 years
C) 4.7 years
D) 5.1 years
Ans: C
Feedback:
Strange Manufacturing
i = 18.00%
Cumulative PVCF
Year CF PVCF
0 $(21,000,000) $(21,000,000) $(21,000,000)
1 7,000,000 5,932,203 (15,067,797)
2 7,000,000 5,027,291 (10,040,506)
3 7,000,000 4,260,416 (5,780,090)
4 7,000,000 3,610,522 (2,169,568)
5 7,000,000 3,059,765 890,197
Discounted payback period = Years before Recovery + (Remaining Cost / Next Year's
CF)
= 4 + ($2,169,567/$3,059,765)
= 4.7 years
Reference: Ref 10-4
86. Net present value: What is the net present value of this project?
A) $890,197
B) $1,213,909
C) $905,888
D) $777,713
Ans: A
Feedback:
Reference: Ref 10-4
87. Internal rate of return: What is the internal rate of return on this project? (Round to
the nearest percent.)
A) 17%
B) 18%
C) 19%
D) 20%
Ans: D
Feedback:
88. Which of the following is true about the Net Present Value method?
A) The NPV does not utilize time value of money concepts.
B) The NPV assumes that all cash flows are reinvested at the firm’s discount rate
(the firm’s cost of capital).
C) The NPV allows projects to be ranked by rate of return.
D) The NPV is a rate of return that is acceptable to the firm.
Ans: B
Level of Difficulty: Difficult
89. Crossover Point/Rate: Packard Electronics Corp. is evaluating the two mutually
exclusive projects shown below.
Boundless Corp. Project A Project B

Period Cash Flows Cash Flows
0 $ (100,000) $ (150,000)
1 50,000 15,000
2 40,000 30,000
3 30,000 50,000
4 20,000 70,000
5 10,000 80,000
What is the “crossover rate” of the two projects? (Round off to the nearest (0.01%)
A) 10.82%
B) 8.24%
C) 13.76%
D) 16.38%
Ans: A
Feedback:
Boundless Corp. Project A Project B Project A Project B Diff in CF's

Period Cash Flows Cash Flows WACC NPV NPV A vs. B
0 $ (100,000) $ (150,000) 0.0% 50,000 95,000 50,000
1 50,000 15,000 5.0% 34,105 54,960 35,000
2 40,000 30,000 10.0% 20,921 23,480 10,000
3 30,000 50,000 12.5% 15,155 10,249 (20,000)
4 20,000 70,000 15.0% 9,856 (1,600) (50,000)
5 10,000 80,000 17.5% 4,976 (12,240) (70,000)
IRR IRR IRR = 10.82%
20.27% 14.65%
90. Payback: You have been asked to analyze an investment project. The project’s cost is
$180,000. Cash inflows are projected to be: year 1 = $55,000, year 2 = $65,000; year 3
= $75,000; year 4 = $85,500; year 5 = $95,000.
What is the investment project’s payback? (Round off to the nearest (0.1 years)
A) 4.1 years
B) 1.6 years
C) 3.5 years
D) 2.8 years
Ans: D
Feedback:
Payback Method
Estimated Cumulative
Year Cash Flows Cash Flows Year
0 ($180,000) (180,000) 0
1 55,000 (125,000) 1
2 65,000 (60,000) 2
3 75,000 15,000 3
4 85,000 100,000 4
5 95,000 195,000 5
= 2.80 Years
Chapter 11
31. The cash flows used in capital budgeting calculations are based on.
A) historical estimates.
B) forecasts of future cash revenues, expenses, and investment outlays.
C) forecasts of net income.
D) forecasts of retained earnings available for financing projects.
Ans: B
32. The NPV of a project is estimated by
A) discounting the expected cash flows of a project in the future.
B) discounting only the certain cash flows of a project in the future.
C) discounting the variance of the expected cash flows of a project in the future.
Ans: A
33. The ___________ is intended to reconcile changes in the balance sheet cash accounts.
A) capital budgeting cash flow calculation
B) accounting statement of cash flows
C) accounting statement of income
D) none of the above
Ans: B
34. The term ___________ refers to the fact that these cash flows reflect the amount by
which the firm's total after-tax free cash flows will change if the project is adopted.
A) periodic
B) ending cash flows
C) incremental
Ans: C
35. _________ refers to the cash flow that a project is expected to generate after all
operating expenses and taxes have been paid.
A) Incremental cash flow from operations
B) Operating income
C) EBITDA
Ans: A
36. In order to calculate free cash flow by starting with incremental cash flow from
operations, we should
A) subtract the incremental capital expenditures and add the incremental additions to
working capital.
B) add the incremental capital expenditures and the incremental additions to
working capital.
C) subtract the incremental capital expenditures and the incremental additions to
working capital.
Ans: C
37. The idea that we can evaluate the cash flows from a project independently of the cash
flows for the firm is known as
A) the stand-alone principle.
B) the dependent principle.
C) the independent principle.
Ans: A
38. The firm's ____________ is used to calculate NOPAT because the profits from a
project are assumed to be incremental to the firm.
A) average tax rate
B) marginal tax rate
C) lowest marginal tax rate
Ans: B
39. Additions to tangible assets, intangible assets ,and current assets can be described as
A) cash flows associated with investments.
B) operating cash flows.
C) free cash flows.
Ans: A
40. The impact of a project on a firm's overall value depends on
A) a firm's accounting earnings.
B) a firm's cash flow.
C) a project's cash flow.
Ans: C
41. Which of the following should not be included in a project's cash flow calculations?
A) cash expenses
B) cash revenues
C) allocated expenses
Ans: C
42. Corporate overhead allocations should only be taken into account on project analysis if
A) the firm is currently covering all of its overhead allocations.
B) the firm is currently unable to cover all of its overhead allocations.
C) the overhead allocations involve cash expenditures.
Ans: D
43. Brown Mack, Inc., currently has two large manufacturing divisions that share a single
plant. Brown Mack owns the plant but has calculated that $6 million of overhead
expenses should be allocated to the two equal-sized divisions. If Brown Mack starts a
third manufacturing division, of equal size to the other two divisions, then what
overhead cost should the new division take into account on its capital budgeting cash
flow analysis?
A) $0
B) $2 million
C) $3 million
D) $6 million
Ans: A
44. A firm is considering taking a project that will produce $12 million of revenue per year.
Cash expenses will be $5 million, and depreciation expenses will be $1 million per
year. If the firm takes that project, then it will reduce the cash revenues of an existing
project by $2 million. What is the free cash flow on the project, per year, if the firm is
in the 40 percent marginal tax rate?
A) $2.4 million
B) $3.4 million
C) $4.6 million
D) $5.0 million
Ans: B
Feedback:
Revenue $12,000,000
Cash exp (5,000,000)
Deprec exp (1,000,000)
Lost revenue (2,000,000)
Pretax income $ 4,000,000
Less taxes 1,600,000
Net income $ 2,400,000
Deprec 1,000,000
Free Cash Flow/yr $ 3,400,000
45. Whenever a project has a negative impact on an existing project's cash flows, then that
effect should
A) be ignored.
B) be ignored if the project is evaluated using the correct cost of capital.
C) be included as a negative revenue amount on the new project's cash flow analysis.
D) be included if the impact is limited to noncash expenditures.
Ans: C
46. If a firm has the option of leasing some factory space to another firm or utilizing it for
another product line, then if the firm chose the product line how should it handle the
lost lease payments on the factory space?
A) Ignore it.
B) Include it as an opportunity cost.
C) Include half of it as additional revenue for the project.
Ans: B
47. Which of the following is the best example of a sunk cost?
A) Future payments on a leased building.
B) Future research and development costs.
C) Historical research and development costs.
D) Historical noncash expenses.
Ans: C
48. _____________ represent dollars stated in terms of constant purchasing power.
A) Nominal dollars
B) Real dollars
C) Inflated dollars
Ans: B
49. If inflation is anticipated to be 10 percent during the next year while a nominal rate of
20 percent will be earned on U.S. Treasury bills, then what is the accurate real rate of
return on these securities?
A) 20.00%
B) 10.00%
C) 9.09%
Ans: C
Feedback:
1 + k = (1 + Pe) x (1 + r)
1 + 0.2 = (1 + 0.1) x (1 + r)
1.0909 = 1 + r
0.0909 = r
50. If the real return on U.S. Treasury bills is 14 percent while the rate of expected inflation
is anticipated to be 8 percent, then what should nominal rate of return be?
A) 14.00%
B) 33.00%
C) 23.12%
D) all of the above
Ans: C
Feedback:
1 + k = (1 + Pe) x (1 + r)
1 + k = (1 + 0.08) x (1 + 0.14)
1 + k = 1.2312
k = 0.2312
51. If you are discounting a project's cash flows using the nominal cost of capital, then that
means that you have taken the following into account:
A) the real rate of return
B) the expected rate of inflation
C) both of the above
Ans: C
52. A tax system in which taxpayers pay a progressively larger share of their income in
taxes as their income rises is called
A) a flat tax system.
B) a progressive tax system.
C) a digressive tax system.
D) a political tax system.
Ans: B
53. For a U.S. corporation with income above $20 million,
A) the average tax rate is less than the marginal tax rate.
B) the average tax rate is equal to the marginal tax rate.
C) the average tax rate is greater than the marginal tax rate.
Ans: B
54. When compared to the straight-line depreciation method, MACRS has
A) a greater proportion of its depreciation early in the life of the asset.
B) a lesser proportion of its depreciation early in the life of the asset.
C) an equal proportion of its depreciation early in the life of the asset.
Ans: A
55. In order for a project to generate a positive net working capital cash flow at the
conclusion of a project,
A) the project must have generated a cumulative negative cash flow during the life
of the project.
B) the project must have generated a cumulative positive cash flow during the life of
the project.
C) the project must have generated a cumulative negative cash flow at the
conclusion of the project.
D) the project could not have generated a positive cash flow at the opening of the
project.
Ans: A
56. If you are deciding whether to take one project or another, where the projects have
different useful lives, then you could utilize
A) a repeated investment analysis to decide which project is better for the firm.
B) an equivalent annual annuity analysis to decide which project is better for the
firm.
C) either of the above.
Ans: C
57. Windy Burgers is trying to determine when to harvest a herd of cows that it currently
owns. If it harvests the herd in year 1, the NPV of the project would increase over an
immediate harvest by 25 percent. A year 2 harvest would create an NPV increase of 15
percent over that of year 1 and year 3 would create an NPV increase of 7 percent over
that of year 2. If the cost of capital is 12 percent for Windy, then which harvest year
would maximize the NPV for the firm? Assume that all NPVs are calculated from the
perspective of today.
A) Harvest immediately.
B) Harvest in year 1.
C) Harvest in year 2.
D) Harvest in year 3.
Ans: C
58. Stillwater Drinks is trying to determine when to harvest the water from the fountain of
youth that it currently owns. If it harvests the water in year 1, the NPV of the project
would increase over an immediate harvest by 18 percent. A year 2 harvest would create
an NPV increase of 12 percent over that of year 1 and year 3 would create an NPV
increase of 8 percent over that of year 2. If the cost of capital is 17 percent for
Stillwater, then which harvest year would maximize the NPV for the firm? Assume that
all NPVs are calculated from the perspective of today.
A) Harvest immediately.
B) Harvest in year 1.
C) Harvest in year 2.
D) Harvest in year 3.
Ans: B
59. The proper time to harvest an asset is when
A) the percentage NPV increase of harvesting a project at a future point in time is at
the last date where the increase is greater than the cost of capital.
B) the percentage NPV increase of harvesting a project at a future point in time is at
the first date where the increase is less than the cost of capital.
C) the percentage NPV increase of harvesting a project at a future point in time is at
the first date where the increase is greater than the cost of capital.
Ans: A
60. Norman, Inc. is considering two mutually exclusive projects. Project A is a six-year
project with a NPV of $3,000 and Project B is a four-year project with an NPV of
$2,278. Project A has an equivalent annual cash flow of $730 and Project B has an
equivalent annual cash flow of $750. Which project should the firm select?
A) Choose Project A because it has the higher NPV.
B) Choose Project B because it has the lower NPV.
C) Choose Project B because it has the higher equivalent annual cash flow.
D) Choose Project A because it has the lower equivalent annual cash flow.
Ans: C
Provo, Inc., had revenues of $10 million, cash operating expenses of $5 million, and depreciation
and amortization of $1 million during 2008. The firm purchased $500,000 of equipment during
the year while increasing its inventory by $300,000 (with no corresponding increase in current
liabilities). The marginal tax rate for Provo is 40 percent.
Reference: Ref 11-1
61. Free cash flow: What is Provo's cash flow from operations for 2008?
A) $2,400,000
B) $2,600,000
C) $3,400,000
D) $4,000,000
Ans: C
Feedback:
Provo, Inc.
Revenue $10,000,000
- Operating Ex 5,000,000
EBITDA $ 5,000,000
- D&A 1,000,000
EBIT $ 4,000,000
x (1 – t) 60%
NOPAT $ 2,400,000
+ D&A 1,000,000
CF Opns $ 3,400,000
Reference: Ref 11-1
62. Free cash flow: What is Provo's free cash flow for 2008?
A) $2,400,000
B) $2,600,000
C) $3,400,000
D) $4,000,000
Ans: B
Feedback:
Provo, Inc.
Revenue $10,000,000
EBITDA $ 5,000,000
- D&A 1,000,000
EBIT $ 4,000,000
x (1 – t) 60%
NOPAT $ 2,400,000
+ D&A 1,000,000
CF Opns $ 3,400,000
- Cap Exp $500,000
- Add WC 300,000
FCF $ 2,600,000
Reference: Ref 11-1
63. Free cash flow: What is Provo's NOPAT for 2008?
A) $2,400,000
B) $2,600,000
C) $3,400,000
D) $4,000,000
Ans: A
Feedback:
Provo, Inc.
Revenue $10,000,000
EBITDA $ 5,000,000
- D&A 1,000,000
EBIT $ 4,000,000
x (1 – t) 60%
NOPAT $ 2,400,000
Reference: Ref 11-1
64. Free cash flow: What is Provo's cash flows associated with investments for 2008?
A) $300,000
B) $500,000
C) $800,000
Ans: C
Champagne, Inc., had revenues of $12 million, cash operating expenses of $8 million, and
depreciation and amortization of $1.5 million during 2008. The firm purchased $700,000 of
equipment during the year while increasing its inventory by $500,000 (with no corresponding
increase in current liabilities). The marginal tax rate for Champagne is 30 percent.
Reference: Ref 11-2
65. Free cash flow: What is Champagne's cash flow from operations for 2008?
A) $2,050,000
B) $2,500,000
C) $3,250,000
D) $4,000,000
Ans: C
Feedback:
Champagne, Inc.
Revenue $12,000,000
EBITDA $ 4,000,000
- D&A 1,500,000
EBIT $ 2,500,000
x (1 – t) 70%
NOPAT $ 1,750,000
+ D&A 1,500,000
CF Opns $ 3,250,000
Reference: Ref 11-2
66. Free cash flow: What is Champagne's free cash flow for 2008?
A) $2,050,000
B) $2,500,000
C) $3,250,000
D) $4,000,000
Ans: A
Feedback:
Champagne, Inc.
Revenue $12,000,000
EBITDA $ 4,000,000
- D&A 1,500,000
EBIT $ 2,500,000
x (1 – t) 70%
NOPAT $ 1,750,000
+ D&A 1,500,000
CF Opns $ 3,250,000
- Cap Exp $700,000
- Add WC 500,000
FCF $ 2,050,000
Reference: Ref 11-2
67. Free cash flow: What is Champagne's NOPAT for 2008?
A) $1,750,000
B) $2,500,000
C) $3,250,000
D) $4,000,000
Ans: A
Feedback:
Champagne, Inc.
Revenue $12,000,000
EBITDA $ 4,000,000
- D&A 1,500,000
EBIT $ 2,500,000
x (1 – t) 70%
NOPAT $ 1,750,000
Reference: Ref 11-2
68. Free cash flow: What are Champagne's cash flows associated with investments for
2008?
A) $500,000
B) $700,000
C) $1,200,000
Ans: C
Feedback:
Cash flows associated with investments equal the purchase of tangible and intangible
assets as well as increases in working capital. Therefore, the cash flows associated with
investments equal $700,000 + $500,000 = $1,200,000.
69. Marginal and average tax rates: Use the tax rate taken from Exhibit 11.6 to calculate
the total taxes paid for Lansing, Inc., this year. Lansing's pretax income was $275,000.
Exhibit 11.6 U.S. Corporate Tax Rate Schedule in 2007
Taxable Income
More But Not More
Than Than Tax Owed
$0 $50,000 15% of amount beyond $0
$50,000 $75,000 $7,500 +25% of amount beyond $50,000
$75,000 $100,000 $13,750 +34% of amount beyond $75,000
$100,000 $335,000 $22,250 +39% of amount beyond $100,000
$335,000 $10,000,000 $113,900 +34% of amount beyond $335,000
$10,000,000 $15,000,000 $3,400,000 +35% of amount beyond $10,000,000
$15,000,000 $18,333,333 $5,150,000 +38% of amount beyond $15,000,000
$18,333,333 ------- 35% on all income
A) $22,500
B) $68,250
C) $90,750
D) $107,250
Ans: C
Feedback:
From the instruction in the table, we can see that the tax bill should be equal to $22,500
+ 0.39 x ($275,000 - $100,000) = $22,500 + $68,250 = $90,750
70. Marginal and average tax rates: Use the tax rate taken from Exhibit 11.6 to calculate
the average tax rate for Lansing, Inc., this year. Lansing's pretax income was $275,000.
Exhibit 11.6 U.S. Corporate Tax Rate Schedule in 2007
Taxable Income
More But Not More
Than Than Tax Owed
$0 $50,000 15% of amount beyond $0
$50,000 $75,000 $7,500 +25% of amount beyond $50,000
$75,000 $100,000 $13,750 +34% of amount beyond $75,000
$100,000 $335,000 $22,250 +39% of amount beyond $100,000
$335,000 $10,000,000 $113,900 +34% of amount beyond $335,000
$10,000,000 $15,000,000 $3,400,000 +35% of amount beyond $10,000,000
$15,000,000 $18,333,333 $5,150,000 +38% of amount beyond $15,000,000
$18,333,333 ------- 35% on all income
A) 8.2%
B) 24.8%
C) 33.0%
D) 39.0%
Ans: C
Feedback:
From the instruction in the table, we can see that the tax bill should be equal to $22,500
+ 0.39 x ($275,000 – $100,000) = $22,500 + $68,250 = $90,750. We see that the taxes
due are $90,750 and with pretax income of $275,000, we then have an average tax rate
of $90,750 / $275,000 = 33.00%.
71. Computing the terminal-year FCF: Miles Cyprus Corp. purchased a truck that
currently has a book value of $1,000. If the firm sells the truck for $5,000 today, then
what is the amount of cash that it will net after taxes if the firm is subject to a 30
percent marginal tax rate?
A) $1,200
B) $3,800
C) $4,000
D) $5,000
Ans: B
Feedback:
The gain on the sale was $5,000 – $1,000 = $4,000
Taxes on the gain are: $4,000 x .3 = $1,200
Net cash flow from the sale is $5,000 – $1,200 = $3,800
72. Computing the terminal-year FCF: Babaloo Nightclubs. purchased a disco mirror
that currently has a book value of $10,000. If Babaloo sells the disco mirror for $500
today, then what is the amount of cash that it will net after taxes if the firm is subject to
a 39 percent marginal tax rate?
A) $500
B) $3,705
C) $4,205
D) $9,500
Ans: C
Feedback:
The loss on the sale was $10,000 – $500 = $9,500
The tax refund on the loss is: $9,500 x .39 = $3,705
Net cash flow from the sale is $500 + $3,705= $4,205
73. Expected cash flows: FireRock Wheel Corp is evaluating a project in which there is a
40 percent probability of revenues totaling $3 million and a 60 percent probability of
revenues totaling $1 million per year. If cash expenses will be $1.0 million while
depreciation expense will be $200,000, then what is the expected free cash flow from
taking the project if the marginal tax rate for the firm is 30 percent?
A) $200,000
B) $420,000
C) $600,000
D) $620,000
Ans: D
Feedback:
Expected revenue = 0.4(3,000,000) + 0.6(1,000,000) = $1,800,000
Expected revenue $1,800,000
- Cash Expenses 1,000,000
- Deprec Expense 200,000
EBIT $ 600,000
- Tax 180,000
NI $ 420,000
+ Deprec Expense 200,000
FCF $ 620,000
74. Projects with different lives: Your firm is deciding whether to purchase a durable
delivery vehicle or a short-term vehicle. The durable vehicle costs $25,000 and should
last five years. The short-term vehicle costs $10,000 and should last two years. If the
cost of capital for the firm is 15 percent, then what is the equivalent annual cost for the
best choice for the firm? (Round to the nearest dollar.)
A) $5,000, either vehicle
B) $5,000, short-term vehicle
C) $6,151, short-term vehicle
D) $7,458, long-term vehicle
Ans: C
Feedback:
, therefore the
, since we are analyzing

costs, we should choose the lowest cost per year, which is the short-term vehicle.
75. Projects with different lives: Your firm is deciding whether to purchase a high-quality
printer for your office or one of lesser quality. The high-quality printer costs $40,000
and should last four years. The lesser quality printer costs $30,000 and should last three
years. If the cost of capital for the firm is 13 percent, then what is the equivalent annual
cost for the best choice for the firm? Round to the nearest dollar.
A) $10,000, either printer
B) $10,000, lesser quality printer
C) $12,706, lesser quality printer
D) $13,448, high-quality printer
Ans: C
Feedback:
; therefore the
, since we are analyzing

costs, we should choose the lowest cost per year, which is the lesser quality printer.
76. When to harvest an asset: Cleveland Millicrum is considering when to harvest its
moldy bread supply for antibiotics. It has calculated that the current NPV dollars for
harvesting the bread are increasing according to the following schedule. When should
the firm harvest the bread? The cost of capital for the firm is 14 percent.
NPV increase if harvested next year over that of harvesting now 25%
NPV increase if harvested year 2 over that of harvesting year 1 20%
A) Harvest now
B) Harvest year 2
C) Harvest year 3
D) Harvest year 4
Ans: C
77. When to harvest an asset: Farmer Ag owns a special species of cotton-producing plant
that, if left unharvested, grows a bigger bowl of cotton through time. The NPV, at the
beginning of the year that harvesting takes place, is as follows. When should Farmer
Ag harvest its cotton? Assume a discount rate of 14 percent.
NPV1 = $50,000
NPV2 = $60,000
NPV3 = $69,000
NPV4 = $77,280
NPV5 = $85,008
A) Harvest now
B) Harvest in year 1
C) Harvest in year 2
D) Harvest in year 3
Ans: D
Feedback:
NPV1 = $50,000 ===> NPV 0,1 = $50,000 / (1.14) = $43,860
NPV2 = $60,000 ===> NPV 0,2 = $60,000 / (1.14)2 = $46,168
NPV3 = $69,000 ===> NPV 0,3 = $69,000 / (1.14)3 = $46,573
NPV4 = $77,280 ===> NPV 0,4 = $77,280 / (1.14)4 = $45,756
NPV5 = $85,008 ===> NPV 0,5 = $85,008 / (1.14)5 = $44,150
The current NPV is maximized with a harvest at year 3.
78. When to replace an asset: Nemo Haulers is considering whether to purchase a new
mini tractor for moving furniture within its warehouse. Nemo calculates that its current
mini tractor generates $3,100 of cash flow per year. A new mini tractor would cost
$3,000 and would provide cash flow of $4,000 per year for five years. What is the
equivalent annual cash flow for the new mini tractor (round to the nearest dollar), and
should Nemo purchase the new tractor? Assume the cost of capital for Nemo is 10
percent.
A) $3,000, do not purchase the new tractor
B) $3,209, purchase the new tractor
C) $4,000, purchase the new tractor
D) $12,163, purchase the new tractor
Ans: B
Feedback:
, Since this is
greater than the annual cash flow of $3,100 produced by the old tractor, the new tractor
should be purchased.
79. When to replace an asset: Burt's Pizzas is considering whether to purchase an oven.
Burt's calculates that its current oven generates $4,000 of cash flow per year. A new
oven would cost $15,000 and would provide cash flow of $6,000 per year for six years.
What is the equivalent annual cash flow for the new oven (round to the nearest dollar),
and should Burt's purchase the new oven? Assume the cost of capital for Burt's is 12
percent.
A) $2,352, do not purchase the oven
B) $6,000, purchase the oven
C) $9,668, purchase the oven
D) $24,668, purchase the new oven
Ans: A
Feedback:
, Since this is
less than the annual cash flow of $4,000 produced by the old oven, the new oven should
not be purchased.
80. The cost of using an existing asset: Small Appliances, Inc., is considering starting a
new line of business with the excess capacity it currently has on its rivet machine. The
current machine is expected to last four years at the current rate of production.
However, if a new line of business is taken on, then the machine will have to be
replaced in three years instead of four. A new machine that will last four years would
cost $50,000. What is the cost of taking on the new line of business? Round to the
nearest dollar and assume a 9 percent cost of capital.
A) $11,917
B) $12,500
C) $15,433
D) $50,000
Ans: A
Feedback:
The EAC for the new machine is
, now the
firm would have to economically incur this additional equivalent cost in year 3.
Therefore, the present value of that cost is
81. Which of the following statements is correct?
A) Incremental net operating profits after-tax should include sunk costs associated
with a project.
B) Incremental net operating profits after-tax should include the effects of financing
costs associated with a project.
C) Incremental net operating profits after-tax should exclude the effects of
depreciation costs associated with a project.
D) Incremental net operating profits after-tax should exclude the effects of financing
costs associated with a project.
Ans: D
A) The calculation of free cash flow does not include the impact of income taxes.
B) Accounting earnings are an unreliable measure of the costs and benefits of a
project.
C) The idea that we can evaluate the cash flows from a project independently of the
cash flows for the firm is known as the incremental principle.
D) Depreciation expense should not be included in the calculation of incremental net
operating profits after-tax.
Ans: B
83. General Mills just is undertaking an analysis on a new cereal. The firm realizes that if
they come out with a new product it would affect sales of existing products? What is
the best course of action for General Mills in this analysis?
A) Treat the reduction of sales from existing cereals as a sunk cost.
B) Account for the reduction of sales from existing cereals in the projection of cash
flows on the new product.
C) Include the allocated costs of the new cereal in the sales of the pre-existing
products.
D) Ignore the fact that sales of other products will be affected.
Ans: B
Level of Difficulty: Difficult
84. Operating Cash Flow: Premier Steel, Inc. is considering the purchase of a new
machine for $100,000 that has a useful life of 3 years. The firm’s cost of capital is
11.0% and the tax rate is 40%. This machine will be sold for its salvage value of
$20,000 at the end of 3-years. The machine will require an investment of $2,500 in
spare parts inventory upon installation. The machine will cost $8,000 to ship and
$4,000 to install and modify it.
Sales are as follows: year 1 = $90,000; year 2 = $97,500; year 3 = $105,000. Operating
expenses are year 1 = $25,000; year 2 = $27,000; year 3 = $29,000. The investment in
working capital will be liquidated at termination of the project at the end of year 3.
MACRS Rates 33% 45% 15% 7%
Using MACRS, what is the operating cash flow in year 1?

A) $53,784
B) $35,238
C) $86,999
D) $42,512
Ans: A
Feedback:
OPERATING CASH FLOWS
Year 1 2 3
Sales Revenues $ 90,000 $97,500 $105,000
Operating expenses (25,000) (27,000) (29,000)
Depreciation (36,960) (50,400) (16,800)
Income Before Tax 28,040 20,100 59,200
Income Taxes 11,216 8,040 23,680
Net income 16,824 12,060 35,520
Add: depreciation 36,960 50,400 16,800
Project Net Cash Flow 53,784 62,460 52,320
Useful Life in Years 3 Tax Rate 40%

MACRS Rates 33% 45% 15% 7%
Invoice Cost $100,000
Shipping $ 8,000
Install & Modify $ 4,000
Depreciable Cost Basis $112,000
85. Average versus Marginal Tax Rate: Suppose Franklin Corporation had pre-tax
income of $300,000 in 2010 and that the firm would have paid $100,250.00 in federal
income taxes. What is Franklin’s average income tax rate? (Round off to the nearest
0.1%)
A) 39.0%
B) 34.7%
C) 33.4%
D) 38.6%
Ans: C
Feedback:
Average tax rate is equal to total income tax divided by taxable income.
Income tax on first $100,000 = $22,250
Income tax on next $200,000 = 39% × ($300,000 - $100,000) = .39 × $200,000 = $78,000
Thus, total tax = $22,250 + $78,000 = $100,250

86. Which of the following should not be included in a schedule of cash flows from
operations when evaluating a capital project?
A) Fixed costs.
B) Sunk costs.
C) Depreciation and amortization.
D) Variable costs.
Ans: B
87. Which of the following is an example of a fixed cost?
A) Cost of equipment purchased for an assembly line to be used in the production of
a new product.
B) Assembly costs associated with the production of a new product.
C) Labor costs associated with the production of a new product.
D) Shipping costs associated with the sale of a new product.
Ans: A
88. Your firm is evaluating the merits of several different machines. Machine A has a
useful life of 5-years, generates an NPV of $53,250, an IRR of 13.6% and an equivalent
annual cost of $10,316. Machine B has a useful life of 3-years, an NPV of $61,051, an
IRR of 12.5%, and an equivalent annual cost of $9,724. Machine C has a useful life of
4-years, generates an NPV of $55,225, an IRR of 15.2% and an equivalent annual cost
of $7,535 Machine D has a useful life of 7-years, generates an NPV of $64,020, an IRR
of 11.4% and an equivalent annual cost of $8,885.
Which machine should be purchased and why?

A) Machine C, because it has the highest IRR.
B) Machine D, because it has the highest NPV.
C) Machine A, because it has the most positive EAC.
D) Machine B, because it has the shortest useful life.
Ans: C
89. Equivalent Annual Cost: Your firm is considering an investment that will cost
$750,000 today. The investment will produce cash flows of $250,000 in year 1,
$400,000 in year 2, and $600,000 in year 3. The discount rate that your firm uses for
projects of this type is 11.75%.
What is the investment's equivalent annual cost? (Round off to the nearest)
A) $163,613
B) $225,008
C) $ 68,888
D) $ 92,845
Ans: D
Feedback:
Equivalent Annual Cost
PV of
Estimated Cash Flows at
Year Cash Flows 11.75%
0 ($750,000)
1 250,000 223,714
2 400,000 320,306
3 600,000 429,941
Total PV of CF's $973,960
Minus Cost ($750,000)
Net Present Value $223,960
EAC $92,845
Discount Rate 11.75%
PV = $223,960; N = 3, I% = 11.75%; Thus PMT (EAC) = $92,845
90. When is the appropriate time to harvest an asset?
A) That point in time where harvesting the asset yields the largest internal rate of
return.
B) That point in time where harvesting the asset yields the smallest payback.
C) That point in time where harvesting the asset yields the largest accounting rate of
return.
D) That point in time where harvesting the asset yields the largest net present value.
Ans: D
Format: True/False
1. Whenever the outcome of an event has a number of different possibilities that have
equal probability of occurrence, then the expected value of the outcome is equal to the
simple average of the individual events.
A) True
B) False
Ans: A
Format: True/False
2. The variance of a distribution can be a negative value.
A) True
B) False
Ans: B
Format: True/False
3. The standard deviation of a distribution can be a negative value.
A) True
B) False
Ans: B
Format: True/False
4. The capital appreciation component of a stock's return considers the increase in price of
a stock divided by the beginning of period price of the stock.
A) True
B) False
Ans: A
Format: True/False
5. The capital appreciation component of a stock's return considers the increase in price of
a stock divided by the end of period price of the stock.
A) True
B) False
Ans: B
Format: True/False
6. If the expected return of a bet, which is based on a coin toss, is $15, then that means
that the outcome of the bet will be a $15 cash inflow to the person making the bet.
A) True
B) False
Ans: B
Format: True/False
7. The normal distribution is completely described by its mean and standard deviation
where 50 percent of the distribution's probability is less than the mean and 50 percent
greater than the mean.
A) True
B) False
Ans: A
Format: True/False
8. The variance is denominated in squared units, whereas the standard deviation is
denominated in the same units as the expected value.
A) True
B) False
Ans: A
Format: True/False
9. If the price of an asset has not increased or decreased since the original purchase of the
asset, then the total return of the asset (if no dividends were paid during the period) is
equal to the capital appreciation component return.
A) True
B) False
Ans: A
Format: True/False
10. The income component of return for a common stock comes from the dividend cash
flow stream.
A) True
B) False
Ans: A
Format: True/False
11. If the capital appreciation return from owning a stock is positive, then the total return
from owning the same stock can be negative.
A) True
B) False
Ans: B
Format: True/False
12. In order for the total return of a stock to be equal to –100 percent, the income return
component for that stock must be zero.
A) True
B) False
Ans: A
Format: True/False
13. The best measure of risk within an investment is its variance.
A) True
B) False
Ans: B
Format: True/False
14. Robert paid $100 for a stock one year ago. The total return on the stock was 10 percent.
Therefore, the stock must be selling for $110 today.
A) True
B) False
Ans: B
Format: True/False
15. You have placed a wager such that you will either receive nothing if you lose the bet or
you will receive $10 if you win the bet. If the expected cash receipt of the wager is $9,
then there is a 100 percent probability that you will win the wager.
A) True
B) False
Ans: B
Format: True/False
16. The variance is equal to the square root of the standard deviation.
A) True
B) False
Ans: B
Format: True/False
17. If you are calculating the variance and standard deviation of returns for a stock, the
variance will always be larger than the standard deviation.
A) True
B) False
Ans: B
Format: True/False
18. The appropriate measure of risk for a diversified portfolio is beta.
A) True
B) False
Ans: A
Format: True/False
19. The coefficient of variation divides the variance of the returns of an asset by the
expected return of that asset.
A) True
B) False
Ans: B
Format: True/False
20. The coefficient of variation is a good measure of the amount of risk that an asset will
contribute to a diversified portfolio of assets.
A) True
B) False
Ans: B
Format: True/False
21. If you are building a portfolio, then you desire assets that have a correlation coefficient
of one.
A) True
B) False
Ans: B
Format: True/False
22. If the returns for two assets have a correlation coefficient of one, then there are no
benefits of diversification by combining these assets in a two-asset portfolio.
A) True
B) False
Ans: A
Format: True/False
23. Utilizing the fact that two or more asset values do not always move in the same
direction at the same time in order to reduce the risk of a portfolio is called
diversification.
A) True
B) False
Ans: A
Format: True/False
24. If you are trying to determine whether to purchase Security A or Security B as the only
holding in your portfolio, then you can consider the coefficient of variation in order to
understand the risk-return relationship of the individual securities.
A) True
B) False
Ans: A
Format: True/False
25. The coefficient of variation is useful when deciding which individual stocks to add to
your diversified portfolio.
A) True
B) False
Ans: B
Format: True/False
26. If two assets with return correlation coefficients less than one make up a portfolio, then
the portfolio does not take advantage of any diversification benefits.
A) True
B) False
Ans: B
Format: True/False
27. If the covariance between the returns of two assets is equal to zero, then the correlation
coefficient must also be zero.
A) True
B) False
Ans: A
Format: True/False
28. If the distribution of returns for an asset has a variance of zero, then covariance of
returns between that asset and the returns any other asset must equal zero.
A) True
B) False
Ans: A
Format: True/False
29. The expected return of the market portfolio is equal to the market risk premium.
A) True
B) False
Ans: B
Format: True/False
30. If you were to completely diversify your portfolio by purchasing a portion of every
asset in the investment universe, then the expected return of your portfolio is equal to
the risk-free rate.
A) True
B) False
Ans: B
Format: True/False
31. The market risk-premium is equal to expected return on the market portfolio.
A) True
B) False
Ans: B
Format: True/False
32. If you know the risk-free rate, the market risk-premium, and the beta of a stock, then
using the CAPM you will be able to calculate the expected rate of return for the stock.
A) True
B) False
Ans: A
Format: True/False
33. The market risk-premium is equal to the expected return on the market less the risk-free
rate of return.
A) True
B) False
Ans: A
Format: True/False
34. Given the historical information in the chapter, the beta of a small stock should be
greater than the beta of a corporate bond.
A) True
B) False
Ans: A
Format: True/False
35. Complete diversification means that the portfolio is no longer subject to market risk.
A) True
B) False
Ans: B
36. The expected return for a portfolio without borrowing
A) should never be less than the expected return of the asset with lowest expected
return.
B) should never be greater than the expected return of the asset with highest
expected return.
C) may not be an event with even a positive probability of occurrence.
D) All of the above.
Ans: D
37. In a game of chance, the probability of winning a $50 prize is 40 percent, and the
probability of winning a $100 prize is 60 percent. What is the expected value of a prize
in the game?
A) $50
B) $75
C) $80
D) $100
Ans: C
Feedback:
$50(0.4) + $100 (0.6) = $80
38. In a game of chance, the probability of winning a $50 is 40 percent and the probability
of losing a $50 prize is 60 percent. What is the expected value of a prize in the game?
A) –$10
B) $0
C) $10
D) $25
Ans: A
Feedback:
$50(0.4) – $50 (0.6) = -$10
39. Which of the following is the best measure of the systematic risk in a portfolio?
A) variance
B) standard deviation
C) covariance
D) beta
Ans: D
40. Use the following table to calculate the expected return for the asset.
Return Probability
0.1 0.25
0.2 0.5
0.25 0.25
A) 15.00%
B) 17.50%
C) 18.75%
D) 20.00%
Ans: C
Feedback:
(0.1)(0.25) + (0.2)(0.5) + (0.25)(0.25) = 0.1875
41. Use the following table to calculate the expected return for the asset.
Return Probability
0.05 0.1
0.1 0.15
0.15 0.5
0.25 0.25
A) 12.50%
B) 13.75%
C) 15.75%
D) 16.75%
Ans: C
Feedback:
(0.5)(0.1) + (0.1)(0.15) + (0.15)(0.5) + (0.25)(0.25) = 0.1575
42. The expected return for the asset below is 18.75 percent. If the return distribution for
the asset is described as in the following table, what is the variance for the asset's
returns?
Return Probability
0.1 0.25
0.2 0.5
0.25 0.25
A) 0.002969
B) 0.000613
C) 0.015195
D) 0.054486
Ans: A
Feedback:
(0.1)(0.25 – 0.1875)2 + (0.2)(0.5 – 0.1875) 2 + (0.25)(0.25 – 0.1875) 2 = 0.002969
43. The expected return for the asset shown in the following table is 18.75 percent. If the
return distribution for the asset is described as below, what is the standard deviation for
the asset's returns?
Return Probability
0.1 0.25
0.2 0.5
0.25 0.25
A) 0.002969
B) 0.000613
C) 0.015195
D) 0.054486
Ans: D
Feedback:
{ (0.25)(0.10 – 0.1875)2 + (0.5)(0.2 – 0.1875) 2 + (0.25)(0.25 – 0.1875) 2 }1/2 = 0.054486
44. If you are dealing with percentage returns, then which of the following is generally
true?
A) The variance of the return distribution is generally smaller than the standard
deviation.
B) The variance of the return distribution is generally larger than the standard
deviation.
C) The variance of the return distribution is measured in the same units as expected
return.
D) None of the above is generally true.
Ans: D
45. The return distribution for an asset is as shown in the following table. What are the
missing values if the expected return is 10 percent?
Return Probability
0.1 0.25
x 0.5
x 0.25
A) 0.20
B) 0.15
C) 0.10
Ans: C
46. The expected return for Stock Z is 30 percent. If we know the following information
about Stock Z, then what return will it produce in the Lukewarm state of the world?
Return Probability
Poor 0.2 0.25

Lukewarm ? 0.5
Dynamite! 0.4 0.25
A) 20%
B) 30%
C) 40%
D) It is impossible to determine.
Ans: B
Feedback:
(0.25)(0.2) + (0.5)(X) + (0.25)(0.4) = 0.3 , X = 0.3
47. The expected return for Stock V is 24.5 percent. If we know the following information
about Stock Z, then what is the probability of the Dynamite state of the world
occurring?
Return Probability
Poor 0.15 0.2

Lukewarm 0.28 0.7
Dynamite! 0.19 ?
A) 5%
B) 10%
C) 15%
D) 20%
Ans: B
Feedback:
0.2 + 0.7 + X = 1.0 ===> X = 0.1 or 10%
48. Ahmet purchased a stock for $45 one year ago. The stock is now worth $65. During the
year, the stock paid a dividend of $2.50. What is the total return to Ahmet from owning
the stock? (Round your answer to the nearest whole percent.)
A) 5%
B) 44%
C) 35%
D) 50%
Ans: D
Feedback:
49. Julio purchased a stock one year ago for $27. The stock is now worth $32, and the total
return to Julio for owning the stock was 37 percent. What is the dollar amount of
dividends that he received for owning the stock during the year?
A) $4
B) $5
C) $6
D) $7
Ans: B
Feedback:
50. Francis purchased a stock one year ago for $20, and it is now worth $24. The stock paid
a dividend of $3 during the year. What was the stock's rate of return from capital
appreciation during the year? (Round your answer to the nearest percent.)
A) 17%
B) 20%
C) 29%
D) 35%
Ans: B
Feedback:
51. Gwen purchased a stock one year ago for $25, and it is now worth $31. The stock paid
a dividend of $1.50 during the year. What was the stock's rate of return income during
the year? (Round your answer to the nearest percent.)
A) 6%
B) 15%
C) 24%
D) 26%
Ans: A
Feedback:
52. Gunther earned a 62.5 percent return on a stock that he purchased one year ago. The
stock is now worth $12, and he received a dividend of $1 during the year. How much
did Gunther originally pay for the stock?
A) $7.00
B) $7.50
C) $8.00
D) $8.50
Ans: C
Feedback:
53. Moshe purchased a stock for $30 last year. He found out today that he had a –100
percent return on his investment. Which of the following must be true?
A) The stock is worth $30 today.
B) The stock is worth $0 today
C) The stock paid no dividends during the year.
D) Both b and c must be true.
Ans: D
54. Babs purchased a piece of real estate last year for $85,000. The real estate is now worth
$102,000. If Babs needs to have a total return of 25 percent during the year, then what
is the dollar amount of income that she needed to have to reach her objective?
A) $3,750
B) $4,250
C) $4,750
D) $5,250
Ans: B
Feedback:
55. Genaro needs to capture a return of 40 percent for his one-year investment in a
property. He believes that he can sell the property at the end of the year for $150,000
and that the property will provide him with rental income of $25,000. What is the
maximum amount that Genaro should be willing to pay for the property?
A) $112,500
B) $125,000
C) $137,500
D) $150,000
Ans: B
Feedback:
56. Books Brothers stock was priced at $15 per share two years ago. The stock sold for $13
last year and now it sells for $18. What was the total return for owning Books Brothers
stock during the most recent year? Assume that no dividends were paid and round to
the nearest percent.
A) 17%
B) 20%
C) 23%
D) 38%
Ans: D
Feedback:
57. Serox stock was selling for $20 two years ago. The stock sold for $25 one year ago, and
it is currently selling for $28. Serox pays a $1.10 dividend per year. What was the rate
of return for owning Serox in the most recent year? (Round to the nearest percent.)
A) 12%
B) 16%
C) 32%
D) 40%
Ans: B
Feedback:
58. You have observed that the average size of a particular goldfish is 1.5 inches long. The
standard deviation of the size of the goldfish is 0.25 inches. What is the size of a
goldfish such that 95 percent of the goldfish are smaller? Assume a normal distribution
for the size of goldfish.
A) 1.01 inches
B) 1.09 inches
C) 1.91 inches
D) 1.99 inches
Ans: C
Feedback:
1.5 + 1645 (0.25) = 1.91 inches
59. You know that the average college student eats 0.75 pounds of food at lunch. If the
standard deviation of that eating is 0.2 pounds of food, then what is the total amount of
food that a cafeteria should have on hand to be 95percent confident that it will not run
out of food when feeding 50 college students.
A) 17.90 pounds
B) 21.05 pounds
C) 53.95 pounds
D) 57.10 pounds
Ans: C
Feedback:
50 students * {0.75 pounds per student + 1.645 (0.2 pounds per student)} = 53.95
pounds of food required.
60. If a random variable is drawn from a normal distribution, what is the probability that
the random variable is larger than 1.96 standard deviations larger than the mean?
A) 1.25%
B) 2.50%
C) 3.75%
D) 5.00%
Ans: B
61. If a random variable is drawn from a normal distribution, what is the probability that
the random variable is larger than 1.96 standard deviations below the mean?
A) 95.00%
B) 96.25%
C) 97.50%
D) 98.75%
Ans: C
62. Niles is making an investment with an expected return of 12 percent. If the standard
deviation of the return is 4.5 percent, and if Niles is investing $100,000, then what
dollar amount is Niles 95 percent sure that he will have at the end of the year?
A) $100,000.00
B) $104,597.50
C) $116,500.00
D) $119,402.50
Ans: B
Feedback:
{ 1 + [0.12 – 1.645 (0.045)]} X $100,000 = $104,597.50
63. Which of the following investment classes had the greatest average return based on
recent historical data?
A) Intermediate-Term Government Bonds
B) Long-Term Government Bonds
C) Large U.S. Stocks
D) Small U.S. Stocks
Ans: D
64. Which of the following investment classes had the greatest variability in returns for
recent historical data?
A) Intermediate-Term Government Bonds
B) Long-Term Government Bonds
C) Large U.S. Stocks
D) Small U.S. Stocks
Ans: D
65. If you were to compare the returns of an individual stock to a market index, select the
answer below that is most true.
A) The returns of the individual stock will show more variability than those of the
market index.
B) The returns of the individual stock will show less variability than those of the
market index.
C) The returns of the individual stock will show the same level of variability than
those of the market index, if they have the same beta.
Ans: A
66. Tommie has made an investment that will generate returns that are subject to the state
of the economy during the year. Use the following information to calculate the standard
deviation of the return distribution for Tommie's investment.
State Return Probability
Weak 0.13 0.3

OK 0.2 0.4
Great 0.25 0.3
A) 0.0453
B) 0.0467
C) 0.0481
D) 0.0495
Ans: B
Feedback:
67. Elrond has made an investment that will generate returns that are subject to the state of
the economy. Use the following information to calculate the variance of the return
distribution for Elrond's investment.
State Return Probability
Weak 0.10 0.8

OK 0.17 0.1
Great 0.28 0.1
A) 0.0536
B) 0.0543
C) 0.0550
D) 0.0557
Ans: D
Feedback:
68. Braniff Ground Services stock has an expected return of 9 percent and a variance of
0.25 percent. What is the coefficient of variation for Braniff?
A) 0.0278
B) 0.5556
C) 1.800
D) 36.00
Ans: B
Feedback:
69. Sayers purchased a stock with a coefficient of variation equal to 0.125. The expected
return on the stock is 20 percent. What is the variance of the stock?
A) 0.000625
B) 0.025000
C) 0.625000
D) 0.790500
Ans: A
Feedback:
70. You have invested 40 percent of your portfolio in an investment with an expected
return of 12 percent and 60 percent of your portfolio in an investment with an expected
return of 20 percent. What is the expected return of your portfolio?
A) 15.2%
B) 16.0%
C) 16.8%
D) 17.6%
Ans: C
Feedback:
71. You have invested 20 percent of your portfolio in Homer, Inc., 40 percent in Marge
Co., and 20 percent in Bart Resources. What is the expected return of your portfolio if
Homer, Marge, and Bart have expected returns of 2 percent, 18 percent, and 3 percent,
respectfully?
A) 7.7%
B) 8.2%
C) 8.7%
D) 9.2%
Ans: B
Feedback:
72. You invested $3,000 in a portfolio with an expected return of 10 percent and $2,000 in
a portfolio with an expected return of 16 percent. What is the expected return of the
combined portfolio?
A) 6.2%
B) 12.4%
C) 13.0%
D) 13.6%
Ans: B
Feedback:
73. Given the returns for two stocks with the following information, calculate the
covariance of the returns for the two stocks. Assume the expected return is 10.8 percent
for Stock 1 and 9.7 percent for Stock 2.
Prob Stock 1 Stock 2
0.4 0.09 0.11

0.5 0.11 0.08
0.1 0.17 0.13
A) 0.000094
B) 0.00051600
C) 0.00032100
D) 0.71750786
Ans: A
Feedback:
Cov(R1,R2)
=0.4*(0.09-0.108)*(0.11-0.097)+0.5*(0.11-0.108)*(0.08-0.097)+0.1*(0.17-0.108)*(0.13-0.097)
= 0.000094
correlation coefficient of the returns for the two stocks. Assume the expected return for
Stock 1 is 10.8 percent and 9.7 percent for Stock 2.
0.4 0.09 0.11

0.5 0.11 0.08
0.1 0.17 0.13
A) 0.230967
B) –0.00002548
C) 0.00032100
D) 0.17671455
Ans: A
Feedback:
From the solution to Problem 73, we find that the covariance between the stocks is
0.000094. We must now solve for the standard deviation of the returns of each
individual stock.
covariance of the returns for the two stocks. Assume the expected return is 14.4 percent
for Stock 1 and 15.9 percent for Stock 2.
0.5 0.11 0.18

0.3 0.17 0.15
0.2 0.19 0.12
A) 0.001204001
B) 0.000549003
C) -0.00079
D) –0.3372012
Ans: C
Feedback:
Cov(R1,R2) = .
(0.5*(0.11-0.144)*(0.18-0.159)+0.3*(0.17-0.144)*(0.15-0.159)+0.2*(0.19-0.144)*(0.12-0.159)
= -0.00079
correlation coefficient of the returns for the two stocks. Assume the expected return is
14.4 percent for Stock 1 and 15.9 percent for Stock 2.
0.5 0.11 0.18

0.3 0.17 0.15
0.2 0.19 0.12
A) 0.001204001
B) 0.000549003
C) –0.00271370
D) -0.971689
Ans: D
Feedback:
Cov(R1,R2) = -0.00079
so p = - .00079 = -.971689
(.03469873)(.02343075)
77. The covariance of the returns between Einstein Stock and Bohr Stock is 0.0087. The
standard deviation of Einstein is 0.26, and the standard deviation of Bohr is 0.37. What
is the correlation coefficient between the returns of the two stocks?
A) 0.090437
B) 0.096200
C) 0.90437
D) 0.96200
Ans: A
Feedback:
78. The covariance of the returns between Wildcat Stock and Sun Devil Stock is 0.09875.
The variance of Wildcat is 0.2116, and the variance of Sun Devil is 0.1369. What is the
correlation coefficient between the returns of the two stocks?
A) 0.170200
B) 0.293347
C) 0.340823
D) 0.578731
Ans: D
Feedback:
79. Horse Stock returns have exhibited a standard deviation of 0.57, whereas Mod T Stock
returns have a standard deviation of 0.63. The correlation coefficient between the
returns is 0.078042. What is the covariance of the returns?
A) 0.028025
B) 0.217327
C) 0.359100
D) 0.993094
Ans: A
Feedback:
80. Batman Stock has exhibited a standard deviation in stock returns of 0.5, whereas
Superman Stock has exhibited a standard deviation of 0.6. The correlation coefficient
between the stock returns is 0.5. What is the variance of a portfolio composed of 70
percent Batman and 30 percent Superman?
A) 0.1549
B) 0.2179
C) 0.4668
D) 0.5500
Ans: B
Feedback:
81. Aquaman Stock has exhibited a standard deviation in stock returns of 0.7, whereas
Green Lantern Stock has exhibited a standard deviation of 0.8. The correlation
coefficient between the stock returns is 0.1. What is the standard deviation of a
portfolio composed of 70 percent Aquaman and 30 percent Green Lantern?
A) 0.32122
B) 0.54562
C) 0.56676
D) 0.75000
Ans: C
Feedback:
82. Most of the risk-reduction benefits from diversification can be achieved in a portfolio
consisting of
A) 5 to 10 stocks
B) 10 to 15 stocks
C) 15 to 20 stocks
D) 20 to 25 stocks
Ans: C
83. Which of the following investors should be willing to pay the highest price for an asset?
A) An investor with a single-asset portfolio.
B) An investor with a 50-asset portfolio.
C) An investor who is not completely diversified.
D) An investor who is so risk-averse that he does not recognize the benefits of
diversification.
Ans: B
84. A portfolio with a level of systematic risk the same as that of the market has a beta that
is
A) equal to zero.
B) equal to one.
C) less than the beta of the risk-free asset.
D) less than zero.
Ans: B
85. The beta of Elsenore, Inc., stock is 1.6, whereas the risk-free rate of return is 8 percent.
If the expected return on the market is 15 percent, then what is the expected return on
Elsenore?
A) 11.20%
B) 19.20%
C) 24.00%
D) 32.00%
Ans: B
Feedback:
86. The beta of RicciCo.'s stock is 3.2, whereas the risk-free rate of return is 9 percent. If
the expected return on the market is 18 percent, then what is the expected return on
RicciCo.?
A) 28.80%
B) 37.80%
C) 48.60%
D) 57.60%
Ans: B
Feedback:
87. The risk-free rate of return is currently 3 percent, whereas the market risk premium is 6
percent. If the beta of Lenz, Inc., stock is 1.8, then what is the expected return on Lenz?
A) 8.40%
B) 10.80%
C) 13.80%
D) 19.20%
Ans: C
Feedback:
88. The expected return on Kiwi Computers stock is 16.6 percent. If the risk-free rate is 4
percent and the expected return on the market is 10 percent, then what is Kiwi's beta?
A) 1.26
B) 2.10
C) 2.80
D) 3.15
Ans: B
Feedback:
89. The expected return on Mike's Seafood stock is 17.9 percent. If the expected return on
the market is 13 percent and the beta for Kiwi is 1.7, then what is the risk-free rate?
A) 4.5%
B) 5.0%
C) 5.5%
D) 6.0%
Ans: D
Feedback:
90. The expected return on KarolCo. stock is 16.5 percent. If the risk-free rate is 5 percent
and the beta of KarolCo is 2.3, then what is the risk premium on the market?
A) 2.5%
B) 5.0%
C) 7.5%
D) 10.0%
Ans: B
Feedback:
91. Which of the following statements is most correct?
A) The greater the risk associated with an investment, the lower the return investors
expect from it.
B) When choosing between two investments that have the same level of risk,
investors prefer the investment with the higher return.
C) If two investments have the same expected return, investors prefer the riskiest
alternative.
D) When choosing between two investments that have the same level of risk,
investors prefer the investment with the lower return.
Ans: B
92. Holding Period Return: George Wilson purchased Bright Light Industries common
stock for $47.50 on January 31, 2010. The firm paid dividends of $1.10 during the last
12 months. George sold the stock today (January 30, 2011) for $54.00. What is
George’s holding period return? Round off the nearest 0.01%.
A) 16.00%
B) 14.35%
C) 11.28%
D) 19.60%
Ans: A
Feedback:
R 1= P 1 −P 0 +CF 1 = $54 . 00−$ 47 .50+$ 1.10 =.1600=16 .00 %
P0 $ 47 . 50
93. Expected Return: Security Analysts that have evaluated Concordia Corporation have
determined that there is a 15% chance that the firm will generate earnings per share of
$2.40; a 60% probability that the firm will generate earnings per share of $3.10; and a
25% probability that the firm will generate earnings per share of $3.80. What are the
expected earnings per share for Concordia Corporation? (Round off to the nearest
$0.01)
A) $3.10
B) $3.17
C) $2.75
D) $2.91
Ans: B
Feedback:
Projected Expected
Probability EPS EPS
15.00% $2.40 $0.36
60.00% 3.10 1.86
25.00% 3.80 0.95
100.00% $3.17
94. Standard Deviation: View Point Industries has forecast a rate of return of 20.00% if
the economy booms (25.00% probability); a rate of return of 15.00% if the economy in
in a growth phase (45.00% probability); a rate of return of 2.50% if the economy in in
decline (20.00% probability); and a rate of return of -15.00% if the economy in a
depression (10.00% probability). What is View Point’s standard deviation of returns?
A) 17.31%
B) 9.25%
C) 15.00%
D) 10.46%
Ans: D
Feedback:
Standard Deviation
A B C D E F G
Probability Calc. Of Proj. Ret. Col. F

State of of Projected Expected Minus Col. E times
Economy Occurance Return Return Exp. Ret. Squared Col. B
Boom 25.00% 20.00% 5.00% 9.25% 0.856% 0.214%
Growth 45.00% 15.00% 6.75% 4.25% 0.181% 0.081%
Decline 20.00% 2.50% 0.50% -8.25% 0.681% 0.136%
Depression 10.00% -15.00% -1.50% -25.75% 6.631% 0.663%
100.00% Total 10.75% Variance 1.09
Standard Deviation 10.46%
95. Which of the following represents a plot of the relation between expected return and
systemic risk?
A) The beta coefficient.
B) The covariance of returns line.
C) The security market line.
D) The variance.
Ans: C
Format: Essay
96. Explain the difference between systematic and nonsystematic risk.
Ans: Systematic risk is risk that cannot be diversified away and describes the risk that
is inherent in the general economic world of investing. Nonsystematic risk is risk
that can be diversified away and describes risk that is unique to a particular
investment.
Format: Essay
97. If you were to regress the historical returns of a stock on the historical return of a
general market index, you would plot the line of best fit through those data points. The
slope of that line represents the beta of the stock in question. However, in most
instances the date points do not lie exactly on that line. Describe why.
Ans: The slope of the line of best fit describes the beta of the stock in question that is
capturing the systematic risk inherent in investing in that stock. The vertical
distance between each point and the line represents the nonsystematic, or
diversifiable, risk in investing in the stock.

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Chapter 5

36. The time value of money refers to the issue of

A) Interest rate on CD = i = 3.5%

B) Interest rate on CD = i = 3.25%

C) Interest rate on CD = i = 3.4%

Amount invested today = PV = $3,500

Amount invested today = PV = $12,000

Future value with compound interest:

Future value with compound interest:

Future value with compound interest:

Simple interest = $630

Future value with compound interest:

Simple interest = $8,662.50

Future value with compound interest:

Simple interest = $575

Value of investment after 7 years = FV7 = $25,000

Value of investment after 7 years = FV3 = $21,000

Loan repayment amount after 4 years = FV4 = $7,418.87

Amount needed for down payment after 6 years = FV6 = $25,000

Value of investment after 10 years = FV10 = $100,000

Return expected from investment = i = 3.65%

Return expected from investment = i = 5.75%

Return expected from investment = i = 8.25%

Return expected from investment = i = 6.35%

Return expected from investment = i = 8.2%

Current sales = PV = $325,000

Current sales = PV = $1,025,000

Current net income = PV = $161,424

Current sales = PV = $700,000

Amount invested today = PV = $35,775

$625 $650 $700 $800

Annual payment = PMT = $37,250

PVAn = $27,850 n = 8; i = 8.5%

Present value of annuity = PVA = $27,850

PVAn = $17,400 n = 4; i = 9.4%

Present value of annuity = PVA = $17,400

Each payment made by John Harper will be $4,952.53, starting today.

Balance of money needed to buy car = $1,000,000 -$634,433.82 =$365,566.18 = FVA

Annual payment = PMT = $2,235

Present value of annuity = PVA Return on investment = i = 9.4%

Annual payment = PMT = $100,000

Try a higher rate, say YTM = 8.5%:

Try a higher rate, say YTM = 8.5%:

Try a lower rate, say YTM = 8.4%:

Try a lower rate, say YTM = 7.5%:

Try a higher rate, say YTM = 12.2%:

The YTM is approximately 12.2 percent. Using a financial calculator provided an

Try a higher rate, say YTM = 13%:

The YTM is approximately 13 percent. Using a financial calculator provided an exact

Try a lower rate, say YTM = 5.7%:

Try a higher rate, say YTM = 9.6%:

Try a lower rate, i = 9.6% or i/2 = 4.8%:

Try a lower rate, i = 16.6% or i/2 = 8.3%:

Try a higher rate, i = 10.7% or i/2 = 5.35%:

2. Which ONE of the following statements is true about secondary markets?

5. In comparison to the NYSE,

a. NASDAQ has less companies listed.

6. Direct search markets are characterized by

a. NYSE is the best-known example of a dealer market.

11. Dealer markets are characterized by

a. no time-consuming search for a fair deal.

a. Common stock is considered to have a fixed maturity.