Section B - Corporate Finance

Question 1

A bond sells at a premium when its coupon rate:

Answer 1

is greater than its yield to maturity

A bond sells at a premium when its coupon rate is greater than its yield to maturity.

Question 2

The ease with which a security can be converted into cash is called:

Answer 2

marketability

Marketability refers to how easily a security can be converted into cash.

Question 3

When a company issues a stock dividend, which of the following would be affected?

Answer 3

Earnings per share

When a company issues a stock dividend, earnings per share is affected in that it decreases as the number of shares outstanding increases. There is no effect to total assets, total liabilities, or total stockholders’ equity.

Question 4

Expected annual use of a particular raw material is 2,000,000 units, and the standard order size is 10,000 units. The invoice cost of each unit is $500, and the cost to place one purchase order is $80. The estimated annual order cost is:

Answer 4

$16,000

Number of orders = (Total use ÷ Units per order) = (2,000,000 ÷ 10,000 units) = 200 orders

Ordering costs = Number of orders × Cost per order = 200 × $80 = $16,000

Question 5

Scott, Inc., is planning to invest $120,000 in a 10-year project. Scott estimates that the annual cash inflow, net of income taxes, from this project will be $20,000. Scott’s desired rate of return on investments of this type is 10%. Information on present value factors is as follows:

At 10% At 12%
Present value of $1 for 10 periods 0.386 0.322
Present value of an annuity of $1 for 10 periods 6.145 5.650
Scott’s expected rate of return on this investment is:

Answer 5

less than 12% but more than 10%

The true rate of return is that rate which equates the present value of the future returns with the cost of the investment.

PV = FV × PVIF

120,000 = 20,000 × PVIF

120,000 ÷ 20,000 = PVIF

6.000 = PVIF

As the factor is between the factors for 10% and 12%, the rate of return is less than 12% and more than 10%.

Question 6

Which type of foreign exchange system determines exchange rates solely based on market supply and demand?

Answer 6

Floating exchange rate

Flexible or floating exchange rates are set by market supply and demand for currencies.

Question 7

A company obtained a short-term bank loan of $250,000 at an annual interest rate of 6%. As a condition of the loan, the company is required to maintain a balance of $25,000 in its checking account, which earns 2%. What is the effective interest rate of the loan?

Answer 7

6.44%

Loan amount: 250,000 × 6% = $15,000

Amount to be kept in the checking account: 25,000 × 2% = $500

Net interest cost = $14,500

Effective interest = (net interest cost ÷ loan amount available for actual utilization) × 100 = (14,500 ÷ 225,000) × 100 = 6.44%

The company has to put an extra $25,000 into the checking account as a condition of the loan, so the amount free to be utilized out of the loan proceeds is only $225,000. Similarly, the interest is $15,000, out of which $500 is received on the checking account, which earns 2%. Net cost to the company is $14,500. Effective interest is calculated taking into account net cost and net loan proceeds. The cost of debt financing has become less expensive (and, therefore, more attractive) for a firm due to the deductibility of interest costs for tax purposes.

Question 8

The interest rate risk of a bond is the:

Answer 8

risk that arises from the uncertainty about the bond’s return caused by changes in interest rates over time

Interest rate risk is the probability of an increase in interest rates causing a bond’s price to decrease.

Question 9

What does a beta (β) that is greater than one mean?

Answer 9

More systematic risk than the market

Question 10

Although less common, if investors expect decreasing inflation, what would be the shape of the yield curve?

Answer 10

a downward sloping yield curve

The shape of the yield curve reflects investor expectations about the future behavior of inflation and market interest rates. Thus, if investors believe inflation will be slowing down in the future, they will require lower long-term rates today and, therefore, the yield curve will be downward sloping.

Question 11

When a company issues common stock with no par value which account increases compared to common stock issued with par value?

Answer 11

Common stock account

When a company issues common stock with no par value, the common stock account increases compared to common stock issued with par value. Common stock issued with no par value is simply recorded as common stock and would eliminate the additional paid-in capital account altogether.

Question 12

Which of the following statements about forward contracts is false?

Answer 12

A forward contract can be exercised at any time

Delivery of the underlying asset occurs on the contract’s delivery date.

Question 13

How are payments to equity holders (dividends) and debt holders (interest) treated for tax purposes?

Answer 13

Dividends are non tax deductible and interest is tax deductible

Companies can deduct interest payments on debt on their taxes, but cannot deduct dividend payments.

Question 14

National Auto uses debt, preferred stock, and common stock to finance operations. Calculating the cost of capital requires identifying the:

Answer 14

Percentage of financing coming from each financing source

The weighted-average cost of capital is a weighted average of the marginal costs of each relevant component. The weights are based on the percentage each particular component represents in the firm’s capital structure. Those sources providing more financing of firm assets have a greater weight in calculation of the firm’s cost of capital.

Question 15

Which of the following is a key assumption for the constant growth dividend model used to value stock?

Answer 15

The dividend increases over time at a constant rate

Question 16

In valuing a compensatory stock option using a computer pricing model, several variables must be included in arriving at the value. Which of the following is not one of those variables?

Answer 16

The salary level of the employee

Question 17

Which form of market efficiency is described below?

Security prices reflect all available information. This form is more of an ideal than a reality. If this form held true, it would not be possible to earn returns greater than market averages based on private information.

Answer 17

Strong-form efficiency

Question 18

Banks whose specialty is helping companies sell new debt and equity in the primary markets are called:

Answer 18

investment banks

Question 19

A(n)_______________________ is when a firm offers additional ownership shares for a stock that is already publicly listed.

Answer 19

Secondary public offering

Question 20

Starrs Company has current assets of $300,000 and current liabilities of $200,000. Starrs could increase its working capital by the:

Answer 20

Refinancing of $50,000 of short term debt with long term debt

The refinancing of $50,000 of short-term debt with long-term debt decreases current liabilities and increases long-term debt. The decrease in short-term debt decreases current liabilities, causing working capital to go up.

Question 21

A lockbox system:

Answer 21

accelerates the inflow of funds

A company has numerous locations throughout their servicing area that will receive payments, which are immediately deposited in the company’s bank accounts, thereby speeding the availability of the funds.

Question 22

Which of the following reasons would not be considered a benefit of using U.S. Treasury securities as a marketable security?

Answer 22

High rate of return

As a “safe” investment with low default risk, backed by the U.S. government, U.S. Treasury securities typically have low rates of return.

Question 23

What information is provided to a firm by an accounts receivable aging schedule?

Answer 23

How much time has passed since the initial sale of each account receivable

Question 24

Which of the following provides a spontaneous source of financing for a firm?

Answer 24

Accounts payable

Question 25

Which of the following is a defense against corporate takeovers that still results in the firm being acquired by another firm?

Answer 25

White knight defense

The white knight defense involves the targeted company finding a friendly buyer to outbid the potential acquirer. The firm will still be acquired, but is able to have input as to who the acquiring firm will be.

Question 26

Which of the following types of business divestitures would a firm use in order to most effectively monitor the performance of a strategic business unit?

Answer 26

Tracking stock

Tracking stocks are ownership shares that are issued by a parent company to monitor the performance of one t SBU.

Question 27

Which of the following financial instruments is a contract that gives a firm the right but not the obligation to engage in a foreign currency exchange?

Answer 27

Currency option

Question 28

Which of the following financial tools requires payment be made upon the completion of an obligated action?

Answer 28

Time drafts

Question 29

Beta, Inc. recently made an investment in a startup company. The initial investment was $100,000. Over the most recent reporting period, Beta, Inc. received a $10,000 dividend payment. The value of the investment also increased by $10,000. What is the rate of return of Beta’s investment (round to 2 decimals)?

Answer 29

20%

Return = (Capital Appreciation + Income) ÷ Investment, and is calculated as ($10,000 + $10,000) ÷ $100,000 = 20%.