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savannahstate.edu/misc/dowlingw/3155/Practice%20Exams/quiz_2_-_review.htm
1.
If a firm pays 10% compounded semi-annually, the true rate of interest is greater than 10%.
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2.
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3.
It takes longer than 8 years to retire a $24,000 loan at 8% if the annual payment is $3,000.
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4.
An annuity of $100 for 10 years is currently less valuable if interest rates are 10% instead of 12%.
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5.
If a person buys a stock for $10 and sells it after 10 years for $20, the annual compound return is 10%.
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6.
If interest rates are 9 percent, an annuity of $100 for 10 years is to be preferred to $1,000 after 10 years.
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7.
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8.
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9.
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10.
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11.
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12.
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13.
The expected return on an investment includes both the expected of income plus expected price
appreciation.
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14.
If a firm sells inventory at cost for cash, its total assets rise.
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15.
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16.
Retained earnings represents the earnings accumulated by the firm over its life.
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17.
Accounts receivable are adjusted for doubtful accounts (i.e., accounts that may not be paid).
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18.
Accountants suggest that assets should always be valued at their market value.
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19.
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20.
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21.
The numerical value of the quick ratio can never exceed the numerical value of the current ratio.
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22.
Leverage ratios indicate the extent to which the firm uses debt financing.
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23.
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24.
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25.
Cumulative voting concentrates voting power in the hands of a majority of corporate voters.
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26.
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27.
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28.
A reverse split (e.g., 1 for 2) increases the number of shares the firm has outstanding.
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29.
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30.
Most publicly held American firms that pay dividends tend to pay a regular quarterly cash dividend.
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31.
Stock dividends increase the wealth of stockholders who receive additional shares.
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32.
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33.
The value of stock depends in part on future dividends and investors' required return.
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34.
The required return for an investment in a stock increases if the firm's beta declines.
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35.
An increase in the required return on the market will tend to decrease stock prices.
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36.
The value of a common stock depends in part on the expected growth in dividends.
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37.
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38.
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39.
The risk-adjusted model for the valuation of common stock excludes yields on competitive securities.
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40.
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Multiple Choice
Identify the choice that best completes the statement or answers the question.
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41.
2.
3.
4.
a.
1 and 3
b.
1 and 4
c.
2 and 3
d.
2 and 4
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42.
b.
c.
d.
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43.
2.
3.
4.
a.
1 and 3
b.
1 and 4
c.
2 and 3
d.
2 and 4
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44.
b.
c.
d.
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45.
b.
equal to 1.0
c.
d.
negative
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46.
b.
c.
d.
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47.
beta
b.
c.
d.
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48.
b.
c.
d.
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49.
b.
c.
d.
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50.
unsystematic risk
b.
systematic risk
c.
d.
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51.
b.
systematic risk
c.
unsystematic risk
d.
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52.
inflation
b.
c.
d.
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53.
b.
c.
d.
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54.
b.
c.
d.
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55.
b.
a decrease in inventory
c.
d.
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56.
b.
c.
an increase in plant
d.
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57.
plant
b.
inventory
c.
equipment
d.
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58.
Equity includes
a.
cash
b.
investments
c.
retained earnings
d.
assets
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59.
b.
cash
c.
retained earnings
d.
depreciation
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60.
b.
c.
d.
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61.
accrued interest
b.
inventory
c.
cash equivalents
d.
retained earnings
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62.
b.
c.
d.
is profitable
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63.
b.
c.
d.
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64.
b.
c.
d.
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65.
investments
2.
3.
retained earnings
a.
1 and 2
b.
1 and 3
c.
2 and 3
d.
1, 2, and 3
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66.
b.
c.
d.
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67.
declaration date
b.
ex dividend date
c.
date of record
d.
distribution date
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68.
b.
c.
d.
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69.
b.
c.
d.
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70.
An increase in investors' required return should cause the value of a common stock to
a.
rise
b.
fall
c.
remain unchanged
d.
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Problem
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71.
If you open an individual retirement account (IRA) at a commercial bank and deposit $1,000 in the account
per year, how much will be in the account after 20 years if the funds earn 7% annually?
RESPONSE:
ANSWER:
$1,000(40.995) = $40,995
40.995 is the interest factor for the future value of an annuity at 7% for twenty years.
(PV = 0; N = 20; I = 7; PMT = -1000, and FV = ?. FV = 40995.)
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72.
You borrow $100,000 to buy a house; if the annual interest rate is 6% and the term of the loan is 20 years,
what is the annual payment required to retire the mortgage loan?
RESPONSE:
ANSWER:
X = $100,000/11.470 = $8,718.40
8.514 is the interest factor for the present value of an annuity at 6% for twenty years.
(PV = 100000; N = 20; I = 6; PMT = ?, and FV = 0. PMT = -8718.46.)
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73.
A firm has a $1,000,000 debt (e.g., a bond) outstanding that matures after 10 years. The sinking fund
requires the firm to set aside annually an amount so the debt may be retired at maturity. If the firm can earn
10% annually on these funds, how much must it invest annually to meet the sinking fund?
RESPONSE:
ANSWER:
X(15.937) = $1,000,000
X = $1,000,000/15.937 = $62,747
15.937 is the interest factor for the future value of $1 at 10% for 10 years. (PV = 0; N =
10; I = 10; PMT = ?, and FV = 1000000. PMT = -62745.39.)
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74.
An investor expects a stock to double in 7 years. What is the expected annual rate of growth in the price of
the stock?
RESPONSE:
ANSWER:
$1(1 + g) 7 = $2
(1 + g) 7 = $2/$1 = 2
g is approximately 10%.
(PV = -1; N = 7; I = ?; PMT = 0, and FV = 2. I = 10.41.)
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75.
You are offered two jobs. One initially pays $25,000 annually, and your salary will grow annually at 10%.
The other pays $22,000 annually, but your salary will grow at 12%. After 10 years, which job pays the
higher salary?
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76.
You bought a stock for $30 and after 10 years sold it for $50. It paid an annual dividend of $2. Set up an
equation that illustrates how the annual return is determined. Show that this return is not 14%.
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77.
A person has an individual retirement account and can deposit $2,000 a year. What will be the difference in
the amount in the account if this investor earns 8% instead of 6%?
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78.
The Big-Sox currently have 30,000 spectators per game and anticipate annual growth in attendance of
9%. If the Big Stadium holds 65,000 people, how long will it take for the team reach capacity?
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79.
If a company paid a dividend of $1 in 2006 and the dividend grows annually by 7 percent, what will be the
dividend in 2011?
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80.
If an individual can save $1,500 annually, how much will have been accumulated after 4 years if the funds
earn 7 percent?
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81.
If an annuity costs $200,000 and yields 7 percent annually for 5 years, how much cash can an individual
withdraw each year such that the principal is consumed at the end of the time period?
RESPONSE:
ANSWER:
This illustrates the present value of an annuity of $1.00. The interest factor at 7
percent for 5 years is 4.10.
(FVAIF)(X) = $200,000
4.1X = $200,000
X = $200,000/4.1 = $48,780
The person may withdraw over $48,778 annually for five years. (PV = -200000; N = 5;
FV = 0; I = 7; PMT = ? PMT = 48778.14.)
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82.
How much additional interest will you earn on $1,000 at 10 percent for 10 years if interest is compounded
semi-annually instead of annually?
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83.
What is the expected return on a stock if the firm will earn 24% during a period of economic boom, 14%
during normal economic periods, and 2% during a period of recession if the probabilities of these economic
environments are 20%, 65%, and 15%, respectively?
RESPONSE:
ANSWER:
The expected return is a weighted average of the individual possible returns, each
weighted by the probability of their occurring:
Expected return
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84.
What is the required return using the capital asset pricing model if a stock's beta is 1.2 and the individual,
who expects the market to rise by 11.2%, can earn 4.4% invested in a risk-free Treasury bill?
RESPONSE:
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85.
You bought a stock with a beta of 1.4 and earned a return of 8.3%. Did you outperform the market if, during
the same period, the market rose by 7.4% and you could have earned 5.4% by investing in a Treasury bill?
RESPONSE:
ANSWER:
The material in this problem was not explicitly covered in the chapter. You may use the
problem to set up the question, "What return should you have earned during a
particular investment horizon?" The answer uses the capital asset model to evaluate
performance. Thus, the return that should have been realized is
Rf + (R m - Rf) beta = 5.4% + (8.3 - 5.4)1.4 = 9.46%.
The actual return (8.3% return) is less than the return that would be expected given
the beta and the market performance. The stock under-performed the market on a
risk-adjusted basis.
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86.
Given the following information, construct the statement of cash flow. What happened to the firm's liquidity
position during the year?
Net income
$16.7
6.1
13.6
Sale of bonds
55.1
Dividends
14.8
Retirement of bonds
10.8
Increase in inventory
15.2
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Depreciation expense
56.0
72.1
5.0
Sale of stock
0.4
91.0
Beginning cash
1.1
Repurchase of stock
5.6
RESPONSE:
ANSWER:
Statement of Cash Flows for the Period Ending
December 31, 20XX
Operating activities
Net income
$16.7
Depreciation
56.0
6.1
Increase in inventory
(15.2)
13.6
(5.0)
$72.2
Investment activities
Increase in plant
Net cash used in investing activities
(91.0)
($91.0)
Financing activities
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55.1
(10.8)
Dividends
(14.8)
Repurchase of stock
(5.6)
Sale of stock
0.4
$24.3
$1.1
$6.6
The firm's cash position has increased, but that does not mean the firm is more liquid
since inventory and accounts payable increased while accounts receivable declined.
You should also note that the firm increased its investment in plant by using the cash
generated through depreciation and the issuing of new long-term debt. The earnings
and sale of stock did not cover dividends and stock repurchases. This indicates that
the firm is more financially leveraged.
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87.
What is the debt/net worth ratio and the debt to total assets ratio for a firm with total debt of $600,000 and
equity of $400,000?
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88.
Construct a new balance sheet showing the impact of a 5 percent stock dividend. What will be the new
price of the stock?
RESPONSE:
ANSWER:
Cash
$ 10,000,000
Accounts payable
$ 20,000,000
Accounts
250,000,000
Long-term debt
400,000,000
10,500,000
receivable
Inventory
120,000,000
1,050,000 shares
outstanding)
Plant and
325,000,000
equipment
Retained earnings
$705,000,000
92,400,000
182,100,000
$705,000,000
The firm issues (.05)(1,000,000) = 50,000 shares with a $10 par value. The common
stock entry is increased by $500,000 to $10,500,000.
The market value of the stock is $58 50,000 = $2,900,000.
Retained earnings are reduced by $2,900,000 to $182,100,000.
Since retained earnings are reduced by $2,900,000 and common stock is increased
only by $500,000, $2,400,000 is unaccounted for. In order to balance the balance
sheet, additional paid-in capital is increased by $2,400,000.
The new price of the stock is $58 /1.05 = $55.24. This price adjustment is necessary to
adjust for the dilution of the old stock that results from the stock dividend.
Be certain to point out that in both the stock split and the stock dividend (1) assets are
not changed, (2) liabilities are not changed, and (3) total equity is not changed. All that
occurs is (1) a reduction in the price of the stock resulting from the increase in the
number of shares, and (2) some changes in the individual entries in the equity section
of the balance sheet.
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89.
A company whose stock is selling for $45 has the following balance sheet:
Assets
$32,000
Liabilities
$10,000
Common stock
6,000
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2,000
capital
Retained earnings
14,000
a.
Construct a new balance sheet showing a 3 for 1 stock split. What is the new price for the stock?
b.
What would be the balance sheet if the firm paid a 10 percent stock dividend (instead of the stock
split)?
RESPONSE:
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ANSWER:
a.
$32,000
Liabilities
$10,000
Common stock
6,000
2,000
capital
Retained earnings
14,000
The firm now has 3,000 shares outstanding with a $2 par value. The price of
the stock adjusts to $45/3 = $15.
b.
$32,000
Liabilities
$10,000
Common stock
6,600
5,900
capital
Retained earnings
9,500
The 10 percent stock dividend results in the firm issuing 100 new shares.
$4,500 ($45 100) is subtracted from retained earnings and added to the
other equity accounts. $600 (100 $6 par) is added to stock outstanding. The
residual ($3,900) additional paid-in capital.
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90.
What is the value of a preferred stock that pays an annual dividend of $3 a share and competitive yields
are 5%, 10%, and 15%?
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