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Chapter 30Financial Distress Multiple Choice Questions1. Financial distress can be best described by which of the following situations in which the firm is forced to take corrective action?A. Cash payments are delayed to creditors.B. The market value of the stock declines by 10%.C. The firm's operating cash flow is insufficient to pay current obligations.D. Cash distributions are eliminated because the board of directors considers the surplus account to be low.E. None of the above.2. Insolvency can be defined as:A. not having cash.B. being illiquid.C. an inability to pay one's debts.D. an inability to increase one's debts.E. the present value of payments being less than assets.3. Stock-based insolvency is a:A. income statement measurement.B. balance sheet measurement.C. a book value measurement only.D. Both A and C.E. Both B and C.4. Flow-based insolvency is:A. a balance sheet measurement.B. a negative equity position.C. when operating cash flow is insufficient to meet current obligations.D. inability to pay one's debts.E. Both C and D.5. Financial restructuring can occur as:A. a private workout.B. an employee buy-out.C. a bankruptcy reorganization.D. Both A and C.E. Both B and C.6. Financial distress can involve which of the following:A. asset restructuring.B. financial restructuring.C. liquidation.D. All of the above.E. None of the above.7. APR, as it relates to financial distress, means the rules of:A. absolute profitability.B. arbitration priority.C. absolute priority.D. arbitration profitability.E. automatic profitability.8. The difference between liquidation and reorganization is:A. reorganization terminates all operations of the firm and liquidation only terminatesnon-profitable operations.B. liquidation terminates only profitable operations and reorganization terminates onlynon-profitable operations.C. liquidation terminates all operations and reorganization maintains the option of the firm as a going concern.D. liquidation only deals with current assets and reorganization only consolidates debt.E. None of the above.9. A firm that has a series of negative earnings, sales declines and workforce reductions is likely headed to:A. acquisition of another firm.B. a merger.C. financial distress.D. new financing.E. None of the above.10. Some of the various events which typically occur around the period of financial distress fora firm are:A. continued increase in earnings.B. steady growth.C. dividend reductions.D. Both A and B.E. Both A and C.11. Bankruptcy reorganizations are used by management to:A. forestall the inevitable liquidation in all cases.B. provide time to turn the business around.C. allow the courts time to set up an administrative structure.D. All of the above.E. None of the above.12. A firm has several options available to it in times of financial distress. The firm may:A. reduce capital and R & D spending.B. raise new funds by selling securities or major assets.C. file for bankruptcy.D. negotiate with lenders.E. All of the above statements are true.13. Most firms in financial distress do not fail and cease to exist. Many firms can actually benefit from distress by:A. forcing a firm to reevaluate their core operations.B. realigning their capital structure to reduce interest costs.C. entering Chapter 11 and liquidating the firm.D. Both A and B.E. Both A and C.14. Whether bankruptcy is entered voluntarily or involuntarily the major difference between Chapter 7 and Chapter 11 is:A. that liquidation occurs in Chapter 11 but reorganization is the objective under Chapter 7.B. that there is no priority of claims under Chapter 11.C. that liquidation occurs in Chapter 7 but reorganization is the objective under chapter 11.D. no lawyers fees are necessary under Chapter 7.E. None of the above.15. If a firm has a stock based insolvency in both book and market value terms and liquidates:A. the payoff will not be 100% to all investors.B. the unsecured creditors are likely to get less than full value.C. the equityholders typically should receive nothing.D. All of the above.E. None of the above.16. A firm in financial distress that reorganizes:A. continues to run the business as a going concern.B. must have acceptance of the plan by the creditors.C. may distribute new securities to creditors and shareholders.D. All of the above.E. None of the above.17. A corporation is adjudged bankrupt under Chapter 7. When do the shareholders receive any payment?A. After the trustee liquidates the assets and pays the administrative expenses, the shareholders are paid before the creditors.B. After the trustee liquidates the assets, the administrative expenses and secured creditors are paid, then the unsecured creditors, and then the shareholders divide any remainder.C. After the trustee liquidates the assets, the shareholders are paid, next the administrative expenses, the secured creditors, and then the unsecured creditors divide any remainder.D. After the trustee liquidates the assets the shareholders are paid first because they are the owners of the firm and have the principal stake.E. None of the above.18. What is the absolute priority rule of the following claims once a corporation is determined to be bankrupt?A. administrative expenses, wages claims, government tax claims, debtholder and then equityholder claimsB. administrative expenses, wages claims, government tax claims, equityholder and then debtholder claimsC. wage claims, administrative expenses, debtholder claims, government tax claims and equityholder claimsD. wage claims, administrative expenses, debtholder claims, equityholder claims and government tax claimsE. None of the above19. The absolute priority rule:A. is set to ensure senior claims are paid first.B. is the priority rule in liquidations.C. distributes proceeds of secured assets sales to the secured creditors first and the remainder to the unsecured.D. All of the above.E. None of the above.20. Many corporations choose Chapter 11 bankruptcy proceedings voluntarily because the management can:A. take up to 120 days to file a reorganization plan.B. continue to run the business.C. reorganize if the required fractions of creditors approve of the plan and it is confirmed when the reorganization takes place.D. All of the above.E. None of the above.21. Which of the following statements about private workouts of financial distress is NOT true?A. Senior debt is usually replaced with junior debt.B. Debt is usually replaced with equity.C. Private workouts account for about three quarters of all reorganizations.D. Top management is often dismissed or takes pay reductions.E. None of the above.22. Successful private workouts are better for firms than formal bankruptcy because:A. direct costs are considerably lower in private workouts.B. private workout firms can issue new debt senior to all prior debt.C. stock price increases are greater for private workouts than for firms emerging from formal bankruptcy.D. Both A and B.E. Both A and C.23. Equityholders may prefer a formal bankruptcy filing because:A. the firm can issue debtor in possession debt.B. the firm can delay pre-bankruptcy interest payments.C. the lack of information about the length and magnitude of the cash flow problem favors equityholders.D. All of the above.E. None of the above.24. Prepackaged bankruptcies are:A. described as a combination of a private workout and a liquidation.B. the easiest way to transfer wealth to the shareholders.C. described as a combination of a completed private workout and the formal bankruptcy filing.D. All of the above.E. None of the above.25. In a prepackaged bankruptcy the firm:A. and creditors agree to a private reorganization outside formal bankruptcy.B. must reach agreement privately with most of the creditors.C. will have difficulty when there are thousands of reluctant trade creditors.D. All of the above.E. None of the above.26. Financial distress may be more expensive if the:A. information about the permanency of the shortfall is limited.B. firm has many different types of creditors and other investors.C. firm has never entered into bankruptcy before.D. Both A and B.E. Both B and C.27. The net payoff to creditors in formal bankruptcy may be low in present value terms because:A. the financial structure may be complicated with several groups and types of creditors.B. indirect costs of bankruptcy may have been costly in lost revenues and poor maintenance.C. administrative costs are high and increase with the complexity and length of time in the formal bankruptcy process.D. All of the above.E. None of the above.28. Firms deal with financial distress by:A. selling major assets.B. merging with another firm.C. issuing new securities.D. exchanging debt for equity.E. All of the above.29. Perhaps equally, if not more damaging are the indirect costs of financial distress. Some examples of indirect costs are:A. loss of current customers.B. loss of business reputation.C. management consumed in survival and not on a strategic direction.D. All of the above.E. Both A and B.30. Credit scoring models are used by lenders to:A. determine the borrowers capacity to pay.B. aid in the prediction of default or bankruptcy.C. determine the optimal debt equity ratio.D. Both A and B.E. Both A and C.31. Altman develop the Z-score model for publicly traded manufacturing firms. Using financial statement data and multiple discriminant analysis, he found that:A. in actual use, a Z-score greater than 2.99 meant bankruptcy within one year.B. in actual use, a Z-score greater than 1.81 implied a 90% chance of bankruptcy within one year.C. in actual use, a Z-score of less than 1.81 would predict bankruptcy within one year.D. in actual use, a Z-score less than 2.99 meant non-bankruptcy within one year.E. None of the above.32. The key intuition of a Z-score model like Altman's is that:A. only publicly traded firms can be evaluated.B. one will be just as well off by guessing on default rates.C. all corporations will default at least once.D. financial profiles of bankrupt and non-bankrupt firms are very different one year before bankruptcy.E. privately traded firms have better financial information which are disclosed to lenders and need not rely on any efficient market notions.33. Approximately ____ of all firms going through a Chapter 11 bankruptcy successfully reorganize.A. 0%B. 15%C. 25%D. 50%E. 85%34. Altman's Z-score predicts the:A. percentage of payout to equityholders in liquidations.B. percentage of payout to equityholders in reorganization.C. likelihood of a private workout.D. likelihood of bankruptcy of a firm within one year.E. None of the above.35. Very small firms (i.e. firms with assets less than $100,000) are more likely to:A. file for strategic bankruptcy.B. file for bankruptcy protection earlier than large firms.C. reorganize than liquidate compared to large firms.D. liquidate than reorganize compared to large firms.E. None of the above.36. A large negative equity position will lead a firm to be more likely to try to:A. not file bankruptcy.B. liquidate.C. reorganize.D. consolidate.E. None of the above.Magic Mobile Homes is to be liquidated. All creditors, both secured and unsecured, are owed $2 million. Administrative costs of liquidation and wage payments are expected to be $500,000.A sale of assets is expected to bring $1.8 million after taxes. Secured creditors have a mortgage lien for $1,200,000 on the factory which will be liquidated for $900,000 out of the sale proceeds. The corporate tax rate is 34%.37. How much and what percentage of their claim will the unsecured creditors receive, in total?A. $100,000; 12.50%.B. $290,909; 36.36%.C. $300,000; 37.50%.D. $600,000; 75.00%.E. Not enough information to answer38. How much and what percentage of their claim will the secured creditors receive, in total?A. $900,000; 75%B. $981,818; 81.82%C. $1,009,091; 84.1%D. $1,200,000; 100%E. Not enough information to answer.The management of Magic Mobile Homes has proposed to reorganize the firm. The proposal is based on a going-concern value of $2 million. The proposed financial structure is $750,000 in new mortgage debt, $250,000 in subordinated debt and $1,000,000 in new equity. All creditors, both secured and unsecured, are owed $2.5 million dollars. Secured creditors have a mortgage lien for $1,500,000 on the factory. The corporate tax rate is 34%.39. How much should the secured creditors receive?A. $1,000,000B. $1,250,000C. $1,333,333D. $1,500,000E. None of the above.40. How much should the unsecured creditors receive?A. $500,000B. $667,000C. $750,000D. $1,000,000E. None of the above.41. What will the equityholders receive if they had 5 million shares with a par value of $0.50 each?A. $0B. $35,714C. $583,333D. $1,000,000E. None of the above.The management of Schroeder Books has proposed to reorganize the company. The proposal is based on a going-concern value of $2.3 million. The proposed financial structure is $500,000 in new mortgage debt, $300,000 in subordinated debt and $1,500,000 in new equity. All creditors, both secured and unsecured, are owed $3 million dollars. Secured creditors have a mortgage lien for $2,000,000 on the book bindery. The corporate tax rate is 34%.42. How much should the secured creditors receive?A. $1,500,000B. $2,000,000C. $2,300,000D. $3,000,000E. None of the above.43. How much should the unsecured creditors receive?A. $300,000B. $500,000C. $1,000,000D. $2,300,000E. None of the above.44. What will the equityholders receive if they had 5 million shares with a par value of $0.50 each?A. $0B. $35,714C. $583,333D. $1,000,000E. None of the above.Essay Questions45. The Steel Pony Company, a maker of all-terrain recreational vehicles, is having financial difficulties due to high interest payments. The estimated "going concern" value of Steel Pony is $4.0 million. The senior debt claim is on all fixed assets. The balance sheet of the firm is as shown:If Steel Pony decides to file for formal bankruptcy and expects to sell the firm for the "going concern" value and pay administrative fees which amount to 5% of the total going concern value, determine the distribution of the proceeds under the rules of absolute priority.46. The Here Today Corporation has applied to your bank for a loan. You have their financial statements and the revised Z-score model of:Z = 6.56 (Net Working Capital/Total Assets) + 3.26 (Accumulated Retained Earnings/Total Assets) + 1.05 (EBIT/Total Assets) + 6.72 (Book Value of Equity/Total Liabilities) where:Z < 1.23 predicts bankruptcy. A Z score between 1.23 and 2.90 indicates gray area. A Z score greater than 2.90 indicates no bankruptcy. From the financial statements you gathered net working capital of $237,500; accumulated retained earnings of $120,000; book value of equity of $950,000; total assets of $4,750,000; EBIT of $261,250; and total liabilities of $3,800,000. Should the bank lend to Here Today?47. When choosing between liquidation and reorganization, what are some of the empirical factors that lead a firm toward one choice or the other?Chapter 30 Financial Distress Answer KeyMultiple Choice Questions1. Financial distress can be best described by which of the following situations in which the firm is forced to take corrective action?A. Cash payments are delayed to creditors.B. The market value of the stock declines by 10%.C. The firm's operating cash flow is insufficient to pay current obligations.D. Cash distributions are eliminated because the board of directors considers the surplus account to be low.E. None of the above.Difficulty level: EasyTopic: FINANCIAL DISTRESSType: DEFINITIONS2. Insolvency can be defined as:A. not having cash.B. being illiquid.C. an inability to pay one's debts.D. an inability to increase one's debts.E. the present value of payments being less than assets.Difficulty level: EasyTopic: INSOLVENCYType: DEFINITIONS3. Stock-based insolvency is a:A. income statement measurement.B. balance sheet measurement.C. a book value measurement only.D. Both A and C.E. Both B and C.Difficulty level: EasyTopic: STOCK-BASED INSOLVENCYType: DEFINITIONS4. Flow-based insolvency is:A. a balance sheet measurement.B. a negative equity position.C. when operating cash flow is insufficient to meet current obligations.D. inability to pay one's debts.E. Both C and D.Difficulty level: EasyTopic: FLOW-BASED INSOLVENCYType: DEFINITIONS5. Financial restructuring can occur as:A. a private workout.B. an employee buy-out.C. a bankruptcy reorganization.D. Both A and C.E. Both B and C.Difficulty level: MediumTopic: FINANCIAL RESTRUCTURINGType: DEFINITIONS6. Financial distress can involve which of the following:A. asset restructuring.B. financial restructuring.C. liquidation.D. All of the above.E. None of the above.Difficulty level: EasyTopic: FINANCIAL DISTRESSType: DEFINITIONS7. APR, as it relates to financial distress, means the rules of:A. absolute profitability.B. arbitration priority.C. absolute priority.D. arbitration profitability.E. automatic profitability.Difficulty level: MediumTopic: RULES OF ABSOLUTE PRIORITYType: DEFINITIONS8. The difference between liquidation and reorganization is:A. reorganization terminates all operations of the firm and liquidation only terminatesnon-profitable operations.B. liquidation terminates only profitable operations and reorganization terminates onlynon-profitable operations.C. liquidation terminates all operations and reorganization maintains the option of the firm as a going concern.D. liquidation only deals with current assets and reorganization only consolidates debt.E. None of the above.Difficulty level: MediumTopic: REORGANIZATION AND LIQUIDATIONType: DEFINITIONS9. A firm that has a series of negative earnings, sales declines and workforce reductions is likely headed to:A. acquisition of another firm.B. a merger.C. financial distress.D. new financing.E. None of the above.Difficulty level: MediumTopic: FINANCIAL DISTRESSType: CONCEPTS10. Some of the various events which typically occur around the period of financial distress fora firm are:A. continued increase in earnings.B. steady growth.C. dividend reductions.D. Both A and B.E. Both A and C.Difficulty level: EasyTopic: FINANCIAL DISTRESSType: CONCEPTS11. Bankruptcy reorganizations are used by management to:A. forestall the inevitable liquidation in all cases.B. provide time to turn the business around.C. allow the courts time to set up an administrative structure.D. All of the above.E. None of the above.Difficulty level: EasyTopic: REORGANIZATIONType: CONCEPTS12. A firm has several options available to it in times of financial distress. The firm may:A. reduce capital and R & D spending.B. raise new funds by selling securities or major assets.C. file for bankruptcy.D. negotiate with lenders.E. All of the above statements are true.Difficulty level: MediumTopic: FINANCIAL DISTRESSType: CONCEPTS13. Most firms in financial distress do not fail and cease to exist. Many firms can actually benefit from distress by:A. forcing a firm to reevaluate their core operations.B. realigning their capital structure to reduce interest costs.C. entering Chapter 11 and liquidating the firm.D. Both A and B.E. Both A and C.Difficulty level: EasyTopic: FINANCIAL DISTRESSType: CONCEPTS14. Whether bankruptcy is entered voluntarily or involuntarily the major difference between Chapter 7 and Chapter 11 is:A. that liquidation occurs in Chapter 11 but reorganization is the objective under Chapter 7.B. that there is no priority of claims under Chapter 11.C. that liquidation occurs in Chapter 7 but reorganization is the objective under chapter 11.D. no lawyers fees are necessary under Chapter 7.E. None of the above.Difficulty level: EasyTopic: LIQUIDATION OR REORGANIZATIONType: CONCEPTS15. If a firm has a stock based insolvency in both book and market value terms and liquidates:A. the payoff will not be 100% to all investors.B. the unsecured creditors are likely to get less than full value.C. the equityholders typically should receive nothing.D. All of the above.E. None of the above.Difficulty level: EasyTopic: STOCK BASED INSOLENCYType: CONCEPTS16. A firm in financial distress that reorganizes:A. continues to run the business as a going concern.B. must have acceptance of the plan by the creditors.C. may distribute new securities to creditors and shareholders.D. All of the above.E. None of the above.Difficulty level: EasyTopic: REORGANIZATIONType: CONCEPTS17. A corporation is adjudged bankrupt under Chapter 7. When do the shareholders receive any payment?A. After the trustee liquidates the assets and pays the administrative expenses, the shareholders are paid before the creditors.B. After the trustee liquidates the assets, the administrative expenses and secured creditors are paid, then the unsecured creditors, and then the shareholders divide any remainder.C. After the trustee liquidates the assets, the shareholders are paid, next the administrative expenses, the secured creditors, and then the unsecured creditors divide any remainder.D. After the trustee liquidates the assets the shareholders are paid first because they are the owners of the firm and have the principal stake.E. None of the above.Difficulty level: EasyTopic: LIQUIDATIONType: CONCEPTS18. What is the absolute priority rule of the following claims once a corporation is determined to be bankrupt?A. administrative expenses, wages claims, government tax claims, debtholder and then equityholder claimsB. administrative expenses, wages claims, government tax claims, equityholder and then debtholder claimsC. wage claims, administrative expenses, debtholder claims, government tax claims and equityholder claimsD. wage claims, administrative expenses, debtholder claims, equityholder claims and government tax claimsE. None of the aboveDifficulty level: MediumTopic: RULES OF ABSOLUTE PRIORITYType: CONCEPTS19. The absolute priority rule:A. is set to ensure senior claims are paid first.B. is the priority rule in liquidations.C. distributes proceeds of secured assets sales to the secured creditors first and the remainder to the unsecured.D. All of the above.E. None of the above.Difficulty level: EasyTopic: RULES OF ABSOLUTE PRIORITYType: CONCEPTS20. Many corporations choose Chapter 11 bankruptcy proceedings voluntarily because the management can:A. take up to 120 days to file a reorganization plan.B. continue to run the business.C. reorganize if the required fractions of creditors approve of the plan and it is confirmed when the reorganization takes place.D. All of the above.E. None of the above.Difficulty level: EasyTopic: REORGANIZATIONType: CONCEPTS21. Which of the following statements about private workouts of financial distress is NOT true?A. Senior debt is usually replaced with junior debt.B. Debt is usually replaced with equity.C. Private workouts account for about three quarters of all reorganizations.D. Top management is often dismissed or takes pay reductions.E. None of the above.Difficulty level: MediumTopic: PRIVATE WORKOUTSType: CONCEPTS22. Successful private workouts are better for firms than formal bankruptcy because:A. direct costs are considerably lower in private workouts.B. private workout firms can issue new debt senior to all prior debt.C. stock price increases are greater for private workouts than for firms emerging from formal bankruptcy.D. Both A and B.E. Both A and C.Difficulty level: MediumTopic: PRIVATE WORKOUTSType: CONCEPTS23. Equityholders may prefer a formal bankruptcy filing because:A. the firm can issue debtor in possession debt.B. the firm can delay pre-bankruptcy interest payments.C. the lack of information about the length and magnitude of the cash flow problem favors equityholders.D. All of the above.E. None of the above.Difficulty level: MediumTopic: FINANCIAL DISTRESS- EQUITY HOLDER PREFERENCESType: CONCEPTS24. Prepackaged bankruptcies are:A. described as a combination of a private workout and a liquidation.B. the easiest way to transfer wealth to the shareholders.C. described as a combination of a completed private workout and the formal bankruptcy filing.D. All of the above.E. None of the above.Difficulty level: EasyTopic: PREPACKAGED BANKRUPTCIESType: CONCEPTS25. In a prepackaged bankruptcy the firm:A. and creditors agree to a private reorganization outside formal bankruptcy.B. must reach agreement privately with most of the creditors.C. will have difficulty when there are thousands of reluctant trade creditors.D. All of the above.E. None of the above.Difficulty level: MediumTopic: PREPACKAGED BANKRUPTCIESType: CONCEPTS26. Financial distress may be more expensive if the:A. information about the permanency of the shortfall is limited.B. firm has many different types of creditors and other investors.C. firm has never entered into bankruptcy before.D. Both A and B.E. Both B and C.Difficulty level: MediumTopic: COSTS OF FINANCIAL DISTRESSType: CONCEPTS27. The net payoff to creditors in formal bankruptcy may be low in present value terms because:A. the financial structure may be complicated with several groups and types of creditors.B. indirect costs of bankruptcy may have been costly in lost revenues and poor maintenance.C. administrative costs are high and increase with the complexity and length of time in the formal bankruptcy process.D. All of the above.E. None of the above.Difficulty level: MediumTopic: PAYOFF TO CREDITORSType: CONCEPTS28. Firms deal with financial distress by:A. selling major assets.B. merging with another firm.C. issuing new securities.D. exchanging debt for equity.E. All of the above.Difficulty level: MediumTopic: FINANCIAL DISTRESSType: CONCEPTS29. Perhaps equally, if not more damaging are the indirect costs of financial distress. Some examples of indirect costs are:A. loss of current customers.B. loss of business reputation.C. management consumed in survival and not on a strategic direction.D. All of the above.E. Both A and B.Difficulty level: EasyTopic: INDIRECT COSTS FO FINANCIAL DISTRESSType: CONCEPTS。

Chapter 13 Risk, Cost of Capital, and Capital Budgeting Answer KeyMultiple Choice Questions1. The weighted average of the firm's costs of equity, preferred stock, and after tax debt is the:A. reward to risk ratio for the firm.B. expected capital gains yield for the stock.C. expected capital gains yield for the firm.D. portfolio beta for the firm.E. weighted average cost of capital (WACC).Difficulty level: EasyTopic: WACCType: DEFINITIONS2. If the CAPM is used to estimate the cost of equity capital, the expected excess market return is equal to the:A. return on the stock minus the risk-free rate.B. difference between the return on the market and the risk-free rate.C. beta times the market risk premium.D. beta times the risk-free rate.E. market rate of return.Difficulty level: EasyTopic: CAPMType: DEFINITIONS3. The best fit line of a pairwise plot of the returns of the security against the market index returns is called the:A. Security Market Line.B. Capital Market Line.C. characteristic line.D. risk line.E. None of the above.Difficulty level: MediumTopic: CHARACTERISTIC LINEType: DEFINITIONS4. The use of debt is called:A. operating leverage.B. production leverage.C. financial leverage.D. total asset turnover risk.E. business risk.Difficulty level: MediumTopic: USE OF DEBTType: DEFINITIONS5. The weighted average cost of capital for a firm is the:A. discount rate which the firm should apply to all of the projects it undertakes.B. overall rate which the firm must earn on its existing assets to maintain the value of its stock.C. rate the firm should expect to pay on its next bond issue.D. maximum rate which the firm should require on any projects it undertakes.E. rate of return that the firm's preferred stockholders should expect to earn over the long term. Difficulty level: MediumTopic: WEIGHTED AVERAGE COST OF CAPITALType: DEFINITIONS6. The WACC is used to _______ the expected cash flows when the firm has ____________.A. discount; debt and equity in the capital structureB. discount; short term financing on the balance sheetC. increase; debt and equity in the capital structureD. decrease; short term financing on the balance sheetE. None of the above.Difficulty level: MediumTopic: WACCType: CONCEPTS7. Using the CAPM to calculate the cost of capital for a risky project assumes that:A. using the firm's beta is the same measure of risk as the project.B. the firm is all-equity financed.C. the financial risk is equal to business risk.D. Both A and B.E. Both A and C.Difficulty level: MediumTopic: CAPMType: CONCEPTS8. The use of WACC to select investments is acceptable when the:A. correlation of all new projects are equal.B. NPV is positive when discounted by the WACC.C. risk of the projects are equal to the risk of the firm.D. firm is well diversified and the unsystematic risk is negligible.E. None of the above.Difficulty level: EasyTopic: WACCType: CONCEPTS9. If the risk of an investment project is different than the firm's risk then:A. you must adjust the discount rate for the project based on the firm's risk.B. you must adjust the discount rate for the project based on the project risk.C. you must exercise risk aversion and use the market rate.D. an average rate across prior projects is acceptable because estimates contain errors.E. one must have the actual data to determine any differences in the calculations. Difficulty level: EasyTopic: DISCOUNT RATEType: CONCEPTS10. If the project beta and IRR coordinates plot above the SML the project should be:A. accepted.B. rejected.C. It is impossible to tell.D. It will depend on the NPV.E. None of the above.Difficulty level: MediumTopic: SECURITY MARKET LINEType: CONCEPTS11. The beta of a security provides an:A. estimate of the market risk premium.B. estimate of the slope of the Capital Market Line.C. estimate of the slope of the Security Market Line.D. estimate of the systematic risk of the security.E. None of the above.Difficulty level: EasyTopic: BETAType: CONCEPTS12. Regression analysis can be used to estimate:A. beta.B. the risk-free rate.C. standard deviation.D. variance.E. expected return.Difficulty level: EasyTopic: BETA ESTIMATIONType: CONCEPTS13. Beta measures depend highly on the:A. direction of the market variance.B. overall cycle of the market.C. variance of the market and asset, but not their co-movement.D. covariance of the security with the market and how they are correlated.E. All of the above.Difficulty level: MediumTopic: BETAType: CONCEPTS14. The formula for calculating beta is given by the dividing the ___________ of the stock with the market portfolio by the ___________ of the market portfolio.A. variance; covarianceB. covariance; varianceC. standard deviation; varianceD. expected return; varianceE. expected return; covarianceDifficulty level: MediumTopic: BETAType: CONCEPTS15. The slope of the characteristic line is the estimated:A. intercept.B. beta.C. unsystematic risk.D. market variance.E. market risk premium.Difficulty level: MediumTopic: BETA AND CHARACTERISTIC LINEType: CONCEPTS16. Companies that have highly cyclical sales will have a:A. low beta if sales are highly dependent on the market cycle.B. high beta if sales are highly dependent on the market cycle.C. high beta if sales are independent of the market cycle.D. All of the above.E. None of the above.Difficulty level: MediumTopic: CYCLICAL BUSINESS AND BETAType: CONCEPTS17. Betas may vary substantially across an industry. The decision to use the industry or firm beta to estimate the cost of capital depends on:A. how small the estimation errors are of all betas across industries.B. how similar the firm's operations are to the operations of all other firms in the industry.C. whether the company is a leader or follower.D. the size of the company's public float.E. None of the above.Difficulty level: MediumTopic: INDUSTRY OR FIRM BETAType: CONCEPTS18. Beta is useful in the calculation of the:A. company's variance.B. company's discount rate.C. company's standard deviation.D. unsystematic risk.E. company's market rate.Difficulty level: MediumTopic: BETAType: CONCEPTS19. For a multi-product firm, if a project's beta is different from that of the overall firm, then the:A. CAPM can no longer be used.B. project should be discounted using the overall firm's beta.C. project should be discounted at a rate commensurate with its own beta.D. project should be discounted at the market rate.E. project should be discounted at the T-bill rate.Difficulty level: MediumTopic: PROJECT AND FIRM BETAType: CONCEPTS20. The problem of using the overall firm's beta in discounting projects of different risk is the:A. firm would accept too many high-risk projects.B. firm would reject too many low risk projects.C. firm would reject too many high-risk projects.D. firm would accept too many low risk projects.E. Both A and B.Difficulty level: MediumTopic: FIRM'S BETAType: CONCEPTS21. The asset beta of a levered firm is generally:A. equal to the equity beta.B. different from the equity beta.C. different from the debt beta.D. the simple average of the equity beta and debt beta.E. Both B and C.Difficulty level: MediumTopic: ASSET BETAType: CONCEPTS22. Comparing two otherwise equal firms, the beta of the common stock of a levered firm is ____________ than the beta of the common stock of an unlevered firm.A. equal toB. significantly lessC. slightly lessD. greaterE. None of the above.Difficulty level: MediumTopic: LEVERED VS. UNLEVERED BETAType: CONCEPTS23. The beta of a firm is determined by which of the following firm characteristics?A. Cycles in revenuesB. Operating leverageC. Financial leverageD. All of the above.E. None of the above.Difficulty level: MediumTopic: DETERMINANTS OF BETAType: CONCEPTS24. The beta of a firm is more likely to be high under what two conditions?A. High cyclical business activity and low operating leverageB. High cyclical business activity and high operating leverageC. Low cyclical business activity and low financial leverageD. Low cyclical business activity and low operating leverageE. None of the above.Difficulty level: MediumTopic: FACTORS AFFECTING BETAType: CONCEPTS25. A firm with cyclical earnings is characterized by:A. revenue patterns that vary with the business cycle.B. high levels of debt in its capital structure.C. high fixed costs.D. high price per unit.E. low contribution margins.Difficulty level: MediumTopic: CYCLICAL EARNINGSType: CONCEPTS26. A firm with high operating leverage has:A. low fixed costs in its production process.B. high variable costs in its production process.C. high fixed costs in its production process.D. high price per unit.E. low price per unit.Difficulty level: MediumTopic: OPERATING LEVERAGEType: CONCEPTS27. If a firm has low fixed costs relative to all other firms in the same industry, a large change in sales volume (either up or down) would have:A. a smaller change in EBIT for the firm versus the other firms.B. no effect in any way on the firms as volume does not effect fixed costs.C. a decreasing effect on the cyclical nature of the business.D. a larger change in EBIT for the firm versus the other firms.E. None of the above.Difficulty level: MediumTopic: OPERATING LEVERAGEType: CONCEPTS28. A firm with high operating leverage is characterized by __________ while one with high financial leverage is characterized by __________.A. low fixed cost of production; low fixed financial costsB. high variable cost of production; high variable financial costsC. high fixed costs of production; high fixed financial costsD. low costs of production; high fixed financial costsE. high fixed costs of production; low variable financial costsDifficulty level: MediumTopic: OPERATING AND FINANCIAL LEVERAGEType: CONCEPTS29. Firms whose revenues are strongly cyclical and whose operating leverage is high are likely to have:A. low betas.B. high betas.C. zero betas.D. negative betas.E. None of the above.Difficulty level: MediumTopic: DETERMINANTS OF BETAType: CONCEPTS30. An industry is likely to have a low beta if the:A. stream of revenues is stable and less volatile than the market.B. economy is in a recession.C. market for its goods is unaffected by the market cycle.D. Both A and B.E. Both A and C.Difficulty level: MediumTopic: DETERMINANTS OF BETAType: CONCEPTS31. For the levered firm the equity beta is __________ the asset beta.A. greater thanB. less thanC. equal toD. sometimes greater than and sometimes less thanE. None of the above.Difficulty level: MediumTopic: ASSET AND EQUITY BETASType: CONCEPTS32. All else equal, a more liquid stock will have a lower ________.A. betaB. market premiumC. cost of capitalD. Both A and B.E. Both A and C.Difficulty level: ChallengeTopic: LIQUIDITYType: CONCEPTS33. Two stock market based costs of liquidity that affects the cost of capital are the:A. bid-ask spread and the specialist spread.B. market impact cost and the brokerage costs.C. investor opportunity cost and the brokerage costs.D. bid-ask spread and the market impact costs.E. None of the above.Difficulty level: MediumTopic: LIQUIDITYType: CONCEPTS34. When a specialist is caught in the middle of a trade between informed and uniformed traders, which effectively eliminates the spread or causes a loss, is subject to:A. market impact costs.B. adverse selection.C. broker's quotation bias.D. increasing the number of uninformed traders.E. None of the above.Difficulty level: ChallengeTopic: ADVERSE SELECTIONType: CONCEPTS35. All else equal, new shareholders will ____ the capital gains of existing shareholders.A. diluteB. hold constantC. increaseD. All of the aboveE. It is impossible to tell.Difficulty level: MediumTopic: CAPITAL GAINSType: CONCEPTS36. The following are methods to estimate the market risk premium:A. use historical data to estimate future risk premium.B. use the dividend discount model to estimate risk premium.C. use the bond valuation model to estimate growth in bond prices with different costs of capital.D. A and B.E. A and C.Difficulty level: MediumTopic: MARKET RISK PREMIUMType: CONCEPTS37. Beta is the slope of the:A. efficient frontier.B. market portfolio.C. security market line.D. characteristic line.E. None of the above.Difficulty level: MediumTopic: BETAType: CONCEPTS38. Two stocks that have the same beta ____ have the same correlation because _______:A. may; because correlation measures the sensitivity of the S&P to the market portfolio.B. will; because correlation measures the tightness of fit around the regression line.C. may not; because correlation measures the tightness of fit around the regression line.D. may not; because correlation measures the sensitivity to change.E. None of the above.Difficulty level: MediumTopic: BETA AND CORRELATIONType: CONCEPTS39. When using the cost of debt, the relevant number is the:A. pre-tax cost of debt since most corporations pay taxes at the same tax rate.B. pre-tax cost of debt since it is the actual rate the firm is paying bondholders.C. post-tax cost of debt since dividends are tax deductible.D. post-tax cost of debt since interest is tax deductible.E. None of the above.Difficulty level: MediumTopic: COST OF DEBTType: CONCEPTS40. Jack's Construction Co. has 80,000 bonds outstanding that are selling at par value. Bonds with similar characteristics are yielding 8.5%. The company also has 4 million shares of common stock outstanding. The stock has a beta of 1.1 and sells for $40 a share. The U.S. Treasury bill is yielding 4% and the market risk premium is 8%. Jack's tax rate is 35%. What is Jack's weighted average cost of capital?A. 7.10%B. 7.39%C. 10.38%D. 10.65%E. 11.37%R e = .04 + (1.1 ⨯ .08) = .128Debt: 80,000 ⨯ $1,000 = $80mCommon: 4m ⨯ $40 = $160mTotal = $80m + $160m = $240mDifficulty level: MediumTopic: WEIGHTED AVERAGE COST OF CAPITALType: PROBLEMS41. Peter's Audio Shop has a cost of debt of 7%, a cost of equity of 11%, and a cost of preferred stock of 8%. The firm has 104,000 shares of common stock outstanding at a market price of $20 a share. There are 40,000 shares of preferred stock outstanding at a market price of $34 a share. The bond issue has a total face value of $500,000 and sells at 102% of face value. The tax rate is 34%. What is the weighted average cost of capital for Peter's Audio Shop?A. 6.14%B. 6.54%C. 8.60%D. 9.14%E. 9.45%Debt: $500,000 ⨯ 1.02 = $.51mPreferred: 40,000 ⨯ $34 = $1.36mCommon: 104,000 ⨯ $20 = $2.08mTotal = $.51m + $1.36m + $2.08m = $3.95mDifficulty level: MediumTopic: WEIGHTED AVERAGE COST OF CAPITALType: PROBLEMS42. Phil's Carvings, Inc. wants to have a weighted average cost of capital of 9%. The firm has an after-tax cost of debt of 5% and a cost of equity of 11%. What debt-equity ratio is needed for the firm to achieve its targeted weighted average cost of capital?A. .33B. .40C. .50D. .60E. .67.09 = [W e⨯ .11] + [(1 - W e) ⨯ .05) = .11W e + .05 - .05W e; .04 = .06W e; W e = 66.67%; W d = 1 - W e = 100% - 66.67% = 33.33%; Debt - equity ratio = 33.33% ÷ 66.67% = .50Difficulty level: MediumTopic: WEIGHTED AVERAGE COST OF CAPITALType: PROBLEMS43. Jake's Sound Systems has 210,000 shares of common stock outstanding at a market price of $36 a share. Last month, Jake's paid an annual dividend in the amount of $1.593 per share. The dividend growth rate is 4%. Jake's also has 6,000 bonds outstanding with a face value of $1,000 per bond. The bonds carry a 7% coupon, pay interest annually, and mature in 4.89 years. The bonds are selling at 99% of face value. The company's tax rate is 34%. What is Jake's weighted average cost of capital?A. 5.3%B. 5.8%C. 6.3%D. 6.9%E. 7.2%Debt: 6,000 ⨯ $1,000 ⨯ .99 = $5.94mCommon: 210,000 ⨯ $36 = $7.56mTotal = $5.94m + $7.56m = $13.50mR e = [($1.593 ⨯ 1.04) ÷ $36] + .04 = .08602Difficulty level: MediumTopic: WEIGHTED AVERAGE COST OF CAPITALType: PROBLEMS44. The Consolidated Transfer Co. is an all-equity financed firm. The beta is .75, the market risk premium is 8% and the risk-free rate is 4%. What is the expected return of Consolidated?A. 7%B. 8%C. 9%D. 10%E. 13%.04 + 0.75(.08) = .10 = 10%Difficulty level: EasyTopic: CAPMType: PROBLEMS45. Assuming the CAPM or one-factor model holds, what is the cost of equity for a firm if the firm's equity has a beta of 1.2, the risk-free rate of return is 2%, the expected return on the market is 9%, and the return to the company's debt is 7%?A. 10.4%B. 10.8%C. 12.8%D. 14.4%E. None of the above.Rs = Rf + β(Rm - Rf) = .02 + 1.2(.09 - .02) = .104 = 10.4%Difficulty level: MediumTopic: CAPMType: PROBLEMS46. The cost of equity for Ryan Corporation is 8.4%. If the expected return on the market is 10% and the risk-free rate is 5%, then the equity beta is ___.A. 0.48B. 0.68C. 1.25D. 1.68E. Impossible to calculate with information given.Rs = Rf + β (Rm - Rf); .084 = .05 + β (.10 - .05); β = .68Difficulty level: MediumTopic: EQUITY BETAType: PROBLEMS47. Suppose that the Simmons Corporation's common stock has a beta of 1.6. If the risk-free rate is 5% and the market risk premium is 4%, the expected return on Simmons' common stock is:A. 4.0%.B. 5.0%.C. 5.6%.D. 10.6%.E. 11.4%.Rs = Rf + β(Rm - Rf) = .05 + 1.6(.04) = .114 = 11.4%Difficulty level: EasyTopic: CAPMType: PROBLEMS48. Suppose the Barges Corporation's common stock has an expected return of 12%. Assume that the risk-free rate is 5%, and the market risk premium is 6%. If no unsystematic influence affected Barges' return, the beta for Barges is ______.A. 1.00B. 1.17C. 1.20D. 2.50E. It is impossible to calculate with the information given.Rs = Rf + β(Rm - Rf); .12 = .05 + β(.06); β = .07/.06 = 1.17Difficulty level: MediumTopic: CALCULATING BETAType: PROBLEMS49. Slippery Slope Roof Contracting has an equity beta of 1.2, capital structure with 2/3 debt, and a zero tax rate. What is its asset beta?A. 0.40B. 0.72C. 1.20D. 1.80E. None of the aboveβA = (E/(D + E.) βE = (1/3)(1.2) = .40Difficulty level: MediumTopic: ASSET BETAType: PROBLEMS50. The Template Corporation has an equity beta of 1.2 and a debt beta of .8. The firm's market value debt to equity ratio is .6. Template has a zero tax rate. What is the asset beta?A. 0.70B. 0.72C. 0.96D. 1.04E. 1.05.8(.6/1.6) + 1.2(1/1.6) = 1.05Difficulty level: MediumTopic: ASSET BETAType: PROBLEMS51. The NuPress Valet Co. has an improved version of its hotel stand. The investment cost is expected to be $72 million and will return $13.5 million for 5 years in net cash flows. The ratio of debt to equity is 1 to 1. The cost of equity is 13%, the cost of debt is 9%, and the tax rate is 34%. The appropriate discount rate, assuming average risk, is:A. 8.65%B. 9%C. 9.47%D. 10.5%E. 13%WACC = .09(1 - .34)(.5) + .13(.5) = .0297 + .065 = .0947 = 9.47%Difficulty level: EasyTopic: WACCType: PROBLEMSEssay Questions。

Chapter 21Leasing Multiple Choice Questions1.In a lease arrangement, the owner of the asset is:A.the lesser.B.the lessee.C.the lessor.D.the leaser.E.None of the above.2.In a lease arrangement, the user of the asset is:A.the lesser.B.the lessee.C.the lessor.D.the leaser.E.None of the above.3.Which of the following would not be a characteristic of a financial lease?A.They are not usually fully amortized.B.They usually do not have maintenance necessary for the leased assets.C.They usually do not include a cancellation option.D.The lessee usually has the right to renew the lease at expiration.E.All of the above are characteristics of financial leases.4.An independent leasing company supplies ___________ leases versus the manufacturer who supplies ________________ leases.A.leveraged; directB.sales and leaseback; sales-typeC.capital; sales-typeD.direct; sales-typeE.None of the above5.Which of the following is not a financial lease?A.A leveraged leaseB.An operating leaseC.A sale-and-leasebackD.Both A and B.E.None of the above.6.If the lessor borrows much of the purchase price of a leased asset, the lease is called:A.a leveraged lease.B.a sale-and-leaseback.C.a capital lease.D.a nonrecourse lease.E.None of the above.7.An operating lease's primary characteristics are:A.fully amortized, lessee maintains equipment and there is no cancellation clause.B.not fully amortized, lessor maintains equipment and there is a cancellation clause.C.fully amortized, lessor maintains equipment and there is a cancellation clause.D.not fully amortized, lessor maintains equipment and there is not cancellation clause.E.fully amortized, lessee maintains equipment and lessee can acquire assets at end of lease for fair market value.8.If a lease is for 35 years, it is regarded as a:A.financial lease.B.operating lease.C.capital lease.D.conditional sale.E.sale and leaseback.9.The city of Oakland sold some buildings and used the proceeds to improve its financial position. The city then leased the buildings back in order to continue to use these facilities. This is an example of:A.an operating lease.B.a short-term lease.C.a sale and leaseback.D.a fully amortized lease.E.None of the above.10.A financial lease has the following as its primary characteristics:A.is fully amortized, lessee maintains equipment and there is no renewal clause and no cancellation clause.B.is not fully amortized, lessor maintains equipment and there is a renewal clause but no cancellation clause.C.is fully amortized, lessor maintains equipment and there is a renewal clause and a no cancellation clause.D.is not fully amortized, lessor maintains equipment and there is a renewal clause.E.is fully amortized, lessee maintains equipment and there is a renewal clause and a no cancellation clause.11.An advantage of leasing is that the lessor does not own the asset and can cancel:A.only financial leases.B.only operating leases.C.only capital leases.D.any kind of leases anytime.E.None of the above.12.A leveraged lease typically involves a non-recourse loan in which:A.the lessee's payments go directly to the lender in case of default.B.the lessor is not obligated in case of default.C.the third party lenders have a first lien on the assets.D.All of the above.E.None of the above.13.For accounting purposes, which of the following conditions would automatically cause a lease to be a capital lease?A.The lessee can purchase the asset below fair market value at the end of the lease.B.The lease transfers ownership of the asset to the lessee by the end of the lease.C.The lease term is more than 75% of the asset's economic life.D.The present value of the lease payments is more than 90% of the asset's market value at lease inception.E.All of the above would lead to the lease being considered a capital lease.14.Capital leases would show up on the balance sheet of the firm in which manner for a six year machinery lease worth $700,000?A.Capital leases do not have to be put on the balance sheet; only financial leases do.B.Asset - Machinery $700,000; Liabilities - Long Term debt $700,000 because of debt displacement.C.Asset - Assets under Capital Lease $700,000; Liabilities - Obligations under Capital Lease $700,000.D.Assets - Assets under Capital Lease $700,000; Liabilities - Long Term Debt $700,000 because of debt displacement.E.None of the above.15.Prior to FASB 13, "Accounting for Leases", lease activity was only reported in financial footnotes. This off-balance-sheet-financing made firms with:A.capital leases appear financially stronger than firms that used debt to purchase the asset.B.operating leases appear financially stronger than firms that used debt to purchase the asset.C.leases of any type appear financially stronger than firms that used debt to purchase the asset.D.All of the above.E.None of the above.16.Which of the following is not an implication of FASB 13, Accounting for Leases?A.FASB 13 requires that the PV of the lease payments appear on the right hand side of the balance sheet.B.FASB 13 requires that the present value of the asset appear on the left hand side of the balance sheet.C.FASB 13 allows for off-balance-sheet financing for operating leases.D.All of the above.E.None of the above.17.The reason the IRS is most concerned about lease contracts is:A.firms that lease generally pay no taxes.B.that leasing usually leads to bankruptcy.C.that leases can be set up solely to avoid taxes.D.because leasing leads to off-balance-sheet-financing.E.All of the above.18.A lease with high payments early in its life which then decline to termination would:A.provide greater cash flow to the lessee in the beginning years.B.be evidence of tax avoidance and not acceptable to the IRS.C.be qualified as a capital lease under FASB 13.D.provide a lower residual value and thus ensure a bargain-purchase price option.E.All of the above.19.In valuing the lease versus purchase option, the relevant cash flows are the:A.tax shield from depreciation.B.investment outlay for the equipment.C.a decrease in the firm's operating costs that are not affected by leasing.D.All of the above are relevant.E.None of the above are relevant.20.The appropriate discount rate for valuing a financial lease is:A.the firm's after-tax weighted average cost of capital.B.the after-tax required return on assets of risks similar to the leased asset.C.the after-tax cost of secured borrowing.D.Either A or B.E.All of the above.21.The WACC is not used in the lease versus purchase decision because:A.the WACC was used in the decision to acquire the asset, this is only a financing decision.B.the WACC is used only when a lease alone is considered and not a lease versus purchase.C.the WACC does not include the lease cost of capital and therefore should not be used.D.tax rates of the lessor may be different than the lessee and therefore the WACC is incorrect.E.when a bank arranges a lease they do not consider the lessee's cost of capital.22.Firms that use financial leases must consider their debt-to-equity ratios as inadequate measures of financial leverage because:A.lenders are concerned about the firm's total liabilities and related cash flow.B.debt displacement occurs with leasing.C.less future debt can be raised for a growing firm when a lease is used.D.All of the above.E.None of the above.23.______ would be evidence the lease is being used to avoid taxes and not a legitimate business purpose.A.Early balloon paymentste balloon paymentsC.Capitalizing a leaseD.Transfer of lease payments to a second ownerE.None of the above24.Debt displacement is associated with leases because:A.all assets not purchased with equity use debt financing.B.debt is always a cheaper source of financing and preferred to equity financing.C.FASB 13 and the IRS mandate debt displacement.D.lease financing is all debt and causes an imbalance in the optimal debt to equity ratio which reduces future debt financing.E.None of the above.25.A lease is likely to be most beneficial to both parties when:A.the lessor's tax rate is lower than the lessee's.B.the lessor's tax rate is higher than the lessee's.C.the lessor's tax rate is equal to the lessee's.D.a lease cannot be beneficial to both parties.E.a lease always has zero NPV, so both parties always break even.26.The price or lease payment that the lessee sets as their bound is known as:A.the present value of the tax shields.B.the reservation payment, L MIN.C.the present value of operating savings.D.the reservation payment, L MAX.E.None of the above.27.Which of the following is probably not a good reason for leasing instead of buying?A.Taxes may be reduced by leasing.B.Leasing may reduce transactions costs.C.Leasing may provide a beneficial reduction of uncertainty.D.All of the above are good reasons.E.All of the above are not good reasons.28.Which of the following is probably a good reason for leasing instead of buying?A.Leasing provides 100% financing.B.Leasing is not considered a form of debt financing.C.Leasing may increase EPS relative to buying.D.All of the above are good reasons.E.None of the above is a good reason.29.Some assets are leased more than others because:A.the value of the asset under a lease is not highly affected by term of use or maintenance decisions.B.a lease may be used to fool clients into "buying" high priced assets above market value.C.leasing allows sellers to attract clients with low prices as the basis for setting the contract.D.Both A and B.E.Both A and C.30.To meet IRS guidelines for leasing, the lease should:A.limit the lessee's right to issue debt or pay dividends while the lease is operative.B.not limit the lessee's right to issue debt or pay dividends while the lease is operative.C.pay a very high return to the lessor.D.transfer ownership of the asset at the end of the lease at below fair market value.E.be over 30 years.Your firm is considering leasing a new computer. The lease lasts for 9 years. The lease calls for 10 payments of $1,000 per year with the first payment occurring immediately. The computer would cost $7,650 to buy and would be straight-line depreciated to a zero salvage value over 9 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 8%. The corporate tax rate is 30%.31.What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in years 1-9?A.$-255B.$-955C.$-1,295D.$-1,850E.None of the above32.What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in year 0?A.$-4,865B.$-700C.$6,950D.$7,650E.None of the above33.What is the NPV of the lease relative to the purchase?A.$-1,039.78B.$339.78C.$360.22D.$6,610.22E.None of the above34.What would the after-tax cash flow in year 9 be if the asset had a residual value of $500 (ignoring any possible risk differences)?A.$-605B.$-955C.$-1,455D.$-1,305E.None of the above35.This lease would be classified as a(n):A.operating lease because the asset will be obsolete.B.operating lease because there is no amortization.C.leveraged lease because it is being financed.D.capital lease because the lease life is greater than 75% of the economic life.E.sale and leaseback because the company gets full use of the asset.Your firm is considering leasing a new robotic milling control system. The lease lasts for 5 years. The lease calls for 6 payments of $300,000 per year with the first payment occurring at lease inception. The system would cost $1,050,000 to buy and would be straight-line depreciated to a zero salvage value. The actual salvage value is zero. The firm can borrow at 8%, and the corporate tax rate is 34%.36.What is the appropriate discount rate for valuing the lease?A.2.72%B.5.28%C.8.00%D.12.12%E.None of the above.37.What is the after-tax cash flow from leasing in year 0?A.$300,000B.$495,000C.$852,000D.$948,000E.None of the above38.What is the after-tax cash flow in years 1 through 5?A.$-126,600B.$-198,000C.$-269,400D.$-287,250E.None of the above39.What is the NPV of the lease?A.$-111,690B.$-295,040C.$-305,388D.$-309,690E.None of the above40.What is the maximum lease payment that you would be willing to make?A.$170,655B.$175,000C.$187,842D.$210,307E.None of the above41.What is the minimum lease payment that the lessor would be willing to accept?A.$161,000B.$176,995C.$217,645D.$237,083E.None of the aboveYour firm is considering leasing a new laser light. The lease lasts for 3 years. The lease calls for 4 payments of $10,000 per year with the first payment occurring immediately. The computer would cost $45,000 to buy and would be straight-line depreciated to a zero salvage value over 3 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 10%. The corporate tax rate is 35%.42.What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in years 1-3?A.$-32,775B.$-11,750C.$-1,750D.$-1,850E.None of the above43.What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in year 0?A.$-35,000B.$-38,500C.$35,000D.$38,500E.None of the above44.What is the NPV of the lease relative to the purchase?A.$-6,500B.$7,380C.$4,678D.$12,400E.None of the above45.What would the after-tax cash flow in year 3 be if the asset had a residual value of $1,000 (ignoring any possible risk differences)?A.$-11,750B.$11,750C.$12,400D.$-12,400E.None of the above46.This lease would be classified as a(n):A.operating lease because the asset will be obsolete.B.operating lease because there is no amortization.C.leveraged lease because it is being financed.D.capital lease because the lease life is greater than 75% of the economic life.E.sale and leaseback because the company gets full use of the asset.Essay Questions47.Sardinas Sardines has assets valued at $10 million and equity of $10 million. The firm recently leased new equipment worth $1 million. Present the balance sheet under two conditions; the lease is judged to be an operating lease, and the lease is judged to be a capital lease.48.The Blank Button Company is considering the purchase of a new machine for $30,000. The machine is expected to save the firm $12,500 per year in operating costs over a 5 year period, and can be depreciated on a straight-line basis to a zero salvage value over its life. Alternatively, the firm can lease the machine for $6,500 per year for 5 years, with the first payment due in 1 year. The firm's tax rate is 34%, and its cost of debt is 10%. Calculate the NPV of the lease versus the purchase decision. Calculate the reservation payment of the lessee.49.The Plastic Iron Company has decided to acquire a new electronic milling machine. Plastic Iron can purchase the machine for $87,000 which has an expected life of 8 years and will be depreciated using 7 class MACRS ratesof .1428, .2449, .1749, .125, .0892, .0892, .0892 and any remainder in year 8. Miller Leasing has offered to lease the machine to Plastic Iron for $14,000 a year for 8 years. Plastic Iron has an 18.64% cost of equity, 12% cost of debt, a 1:1 D/E ratio and faces a 34% marginal tax rate. Should they lease or buy? Show all work.50.What are some of the advantages and disadvantages of leasing?Chapter 21 Leasing Answer KeyMultiple Choice Questions1.In a lease arrangement, the owner of the asset is:A.the lesser.B.the lessee.C.the lessor.D.the leaser.E.None of the above.Difficulty level: EasyTopic: LESSORType: DEFINITIONS2.In a lease arrangement, the user of the asset is:A.the lesser.B.the lessee.C.the lessor.D.the leaser.E.None of the above.Difficulty level: EasyTopic: LESSEEType: DEFINITIONS3.Which of the following would not be a characteristic of a financial lease?A.They are not usually fully amortized.B.They usually do not have maintenance necessary for the leased assets.C.They usually do not include a cancellation option.D.The lessee usually has the right to renew the lease at expiration.E.All of the above are characteristics of financial leases.Difficulty level: MediumTopic: FINANCIAL LEASEType: DEFINITIONS4.An independent leasing company supplies ___________ leases versus the manufacturer who supplies ________________ leases.A.leveraged; directB.sales and leaseback; sales-typeC.capital; sales-typeD.direct; sales-typeE.None of the aboveDifficulty level: EasyTopic: TYPES OF LEASESType: DEFINITIONS5.Which of the following is not a financial lease?A.A leveraged leaseB.An operating leaseC.A sale-and-leasebackD.Both A and B.E.None of the above.Difficulty level: EasyTopic: TYPES OF LEASESType: DEFINITIONS6.If the lessor borrows much of the purchase price of a leased asset, the lease is called:A.a leveraged lease.B.a sale-and-leaseback.C.a capital lease.D.a nonrecourse lease.E.None of the above.Difficulty level: EasyTopic: TYPES OF LEASESType: DEFINITIONS7.An operating lease's primary characteristics are:A.fully amortized, lessee maintains equipment and there is no cancellation clause.B.not fully amortized, lessor maintains equipment and there is a cancellation clause.C.fully amortized, lessor maintains equipment and there is a cancellation clause.D.not fully amortized, lessor maintains equipment and there is not cancellation clause.E.fully amortized, lessee maintains equipment and lessee can acquire assets at end of lease for fair market value.Difficulty level: MediumTopic: OPERATING LEASEType: DEFINITIONS8.If a lease is for 35 years, it is regarded as a:A.financial lease.B.operating lease.C.capital lease.D.conditional sale.E.sale and leaseback.Difficulty level: MediumTopic: TYPES OF LEASESType: DEFINITIONS9.The city of Oakland sold some buildings and used the proceeds to improve its financial position. The city then leased the buildings back in order to continue to use these facilities. This is an example of:A.an operating lease.B.a short-term lease.C.a sale and leaseback.D.a fully amortized lease.E.None of the above.Difficulty level: EasyTopic: TYPES OF LEASEType: CONCEPTS10.A financial lease has the following as its primary characteristics:A.is fully amortized, lessee maintains equipment and there is no renewal clause and no cancellation clause.B.is not fully amortized, lessor maintains equipment and there is a renewal clause but no cancellation clause.C.is fully amortized, lessor maintains equipment and there is a renewal clause and a no cancellation clause.D.is not fully amortized, lessor maintains equipment and there is a renewal clause.E.is fully amortized, lessee maintains equipment and there is a renewal clause and a no cancellation clause.Difficulty level: EasyTopic: FINANCIAL LEASEType: CONCEPTS11.An advantage of leasing is that the lessor does not own the asset and can cancel:A.only financial leases.B.only operating leases.C.only capital leases.D.any kind of leases anytime.E.None of the above.Difficulty level: EasyTopic: ADVANTAGE TO LEASINGType: CONCEPTS12.A leveraged lease typically involves a non-recourse loan in which:A.the lessee's payments go directly to the lender in case of default.B.the lessor is not obligated in case of default.C.the third party lenders have a first lien on the assets.D.All of the above.E.None of the above.Difficulty level: MediumTopic: LEVERAGED LEASEType: CONCEPTS13.For accounting purposes, which of the following conditions would automatically cause a lease to be a capital lease?A.The lessee can purchase the asset below fair market value at the end of the lease.B.The lease transfers ownership of the asset to the lessee by the end of the lease.C.The lease term is more than 75% of the asset's economic life.D.The present value of the lease payments is more than 90% of the asset's market value at lease inception.E.All of the above would lead to the lease being considered a capital lease.Difficulty level: MediumTopic: CAPITAL LEASEType: CONCEPTS14.Capital leases would show up on the balance sheet of the firm in which manner for a six year machinery lease worth $700,000?A.Capital leases do not have to be put on the balance sheet; only financial leases do.B.Asset - Machinery $700,000; Liabilities - Long Term debt $700,000 because of debt displacement.C.Asset - Assets under Capital Lease $700,000; Liabilities - Obligations under Capital Lease $700,000.D.Assets - Assets under Capital Lease $700,000; Liabilities - Long Term Debt $700,000 because of debt displacement.E.None of the above.Difficulty level: EasyTopic: CAPITAL LEASEType: CONCEPTS15.Prior to FASB 13, "Accounting for Leases", lease activity was only reported in financial footnotes. This off-balance-sheet-financing made firms with:A.capital leases appear financially stronger than firms that used debt to purchase the asset.B.operating leases appear financially stronger than firms that used debt to purchase the asset.C.leases of any type appear financially stronger than firms that used debt to purchase the asset.D.All of the above.E.None of the above.Difficulty level: ChallengeTopic: FASB 13Type: CONCEPTS16.Which of the following is not an implication of FASB 13, Accounting for Leases?A.FASB 13 requires that the PV of the lease payments appear on the right hand side of the balance sheet.B.FASB 13 requires that the present value of the asset appear on the left hand side of the balance sheet.C.FASB 13 allows for off-balance-sheet financing for operating leases.D.All of the above.E.None of the above.Difficulty level: MediumTopic: FASB 13Type: CONCEPTS17.The reason the IRS is most concerned about lease contracts is:A.firms that lease generally pay no taxes.B.that leasing usually leads to bankruptcy.C.that leases can be set up solely to avoid taxes.D.because leasing leads to off-balance-sheet-financing.E.All of the above.Difficulty level: EasyTopic: TAX IMPLICATIONSType: CONCEPTS18.A lease with high payments early in its life which then decline to termination would:A.provide greater cash flow to the lessee in the beginning years.B.be evidence of tax avoidance and not acceptable to the IRS.C.be qualified as a capital lease under FASB 13.D.provide a lower residual value and thus ensure a bargain-purchase price option.E.All of the above.Difficulty level: MediumTopic: TAX IMPLICATIONSType: CONCEPTS19.In valuing the lease versus purchase option, the relevant cash flows are the:A.tax shield from depreciation.B.investment outlay for the equipment.C.a decrease in the firm's operating costs that are not affected by leasing.D.All of the above are relevant.E.None of the above are relevant.Difficulty level: MediumTopic: LEASE VS. BUYType: CONCEPTS20.The appropriate discount rate for valuing a financial lease is:A.the firm's after-tax weighted average cost of capital.B.the after-tax required return on assets of risks similar to the leased asset.C.the after-tax cost of secured borrowing.D.Either A or B.E.All of the above.Difficulty level: EasyTopic: APPROPRIATE DISCOUNT RATEType: CONCEPTS21.The WACC is not used in the lease versus purchase decision because:A.the WACC was used in the decision to acquire the asset, this is only a financing decision.B.the WACC is used only when a lease alone is considered and not a lease versus purchase.C.the WACC does not include the lease cost of capital and therefore should not be used.D.tax rates of the lessor may be different than the lessee and therefore the WACC is incorrect.E.when a bank arranges a lease they do not consider the lessee's cost of capital.Difficulty level: ChallengeTopic: APPROPRIATE DISCOUNT RATEType: CONCEPTS22.Firms that use financial leases must consider their debt-to-equity ratios as inadequate measures of financial leverage because:A.lenders are concerned about the firm's total liabilities and related cash flow.B.debt displacement occurs with leasing.C.less future debt can be raised for a growing firm when a lease is used.D.All of the above.E.None of the above.Difficulty level: MediumTopic: FINANCIAL LEASEType: CONCEPTS23.______ would be evidence the lease is being used to avoid taxes and not a legitimate business purpose.A.Early balloon paymentste balloon paymentsC.Capitalizing a leaseD.Transfer of lease payments to a second ownerE.None of the aboveDifficulty level: MediumTopic: TAX IMPLICATIONSType: CONCEPTS24.Debt displacement is associated with leases because:A.all assets not purchased with equity use debt financing.B.debt is always a cheaper source of financing and preferred to equity financing.C.FASB 13 and the IRS mandate debt displacement.D.lease financing is all debt and causes an imbalance in the optimal debt to equity ratio which reduces future debt financing.E.None of the above.Difficulty level: ChallengeTopic: LEASES AND DEBTType: CONCEPTS25.A lease is likely to be most beneficial to both parties when:A.the lessor's tax rate is lower than the lessee's.B.the lessor's tax rate is higher than the lessee's.C.the lessor's tax rate is equal to the lessee's.D.a lease cannot be beneficial to both parties.E.a lease always has zero NPV, so both parties always break even.Difficulty level: ChallengeTopic: TAX IMPLICATIONSType: CONCEPTS26.The price or lease payment that the lessee sets as their bound is known as:A.the present value of the tax shields.B.the reservation payment, L MIN.C.the present value of operating savings.D.the reservation payment, L MAX.E.None of the above.Difficulty level: MediumTopic: RESERVATION PAYMENTType: CONCEPTS27.Which of the following is probably not a good reason for leasing instead of buying?A.Taxes may be reduced by leasing.B.Leasing may reduce transactions costs.C.Leasing may provide a beneficial reduction of uncertainty.D.All of the above are good reasons.E.All of the above are not good reasons.Difficulty level: MediumTopic: REASON FOR LEASINGType: CONCEPTS28.Which of the following is probably a good reason for leasing instead of buying?A.Leasing provides 100% financing.B.Leasing is not considered a form of debt financing.C.Leasing may increase EPS relative to buying.D.All of the above are good reasons.E.None of the above is a good reason.Difficulty level: MediumTopic: REASON FOR LEASINGType: CONCEPTS29.Some assets are leased more than others because:A.the value of the asset under a lease is not highly affected by term of use or maintenance decisions.B.a lease may be used to fool clients into "buying" high priced assets above market value.C.leasing allows sellers to attract clients with low prices as the basis for setting the contract.D.Both A and B.E.Both A and C.Difficulty level: MediumTopic: REASON FOR LEASINGType: CONCEPTS30.To meet IRS guidelines for leasing, the lease should:A.limit the lessee's right to issue debt or pay dividends while the lease is operative.B.not limit the lessee's right to issue debt or pay dividends while the lease is operative.C.pay a very high return to the lessor.D.transfer ownership of the asset at the end of the lease at below fair market value.E.be over 30 years.Difficulty level: MediumTopic: TAX IMPLICATIONSType: CONCEPTS。

Chapter 16Capital Structure: Basic Concepts Multiple Choice Questions1. The use of personal borrowing to change the overall amount of financial leverage to which an individual is exposed is called:A. homemade leverage.B. dividend recapture.C. the weighted average cost of capital.D. private debt placement.E. personal offset.2. The proposition that the value of the firm is independent of its capital structure is called:A. the capital asset pricing model.B. MM Proposition I.C. MM Proposition II.D. the law of one price.E. the efficient markets hypothesis.3. The proposition that the cost of equity is a positive linear function of capital structure is called:A. the capital asset pricing model.B. MM Proposition I.C. MM Proposition II.D. the law of one price.E. the efficient markets hypothesis.4. The tax savings of the firm derived from the deductibility of interest expense is called the:A. interest tax shield.B. depreciable basis.C. financing umbrella.D. current yield.E. tax-loss carry forward savings.5. The unlevered cost of capital is:A. the cost of capital for a firm with no equity in its capital structure.B. the cost of capital for a firm with no debt in its capital structure.C. the interest tax shield times pretax net income.D. the cost of preferred stock for a firm with equal parts debt and common stock in its capital structure.E. equal to the profit margin for a firm with some debt in its capital structure.6. The cost of capital for a firm, rWACC, in a zero tax environment is:A. equal to the expected earnings divided by market value of the unlevered firm.B. equal to the rate of return for that business risk class.C. equal to the overall rate of return required on the levered firm.D. is constant regardless of the amount of leverage.E. All of the above.7. The difference between a market value balance sheet and a book value balance sheet is that a market value balance sheet:A. places assets on the right hand side.B. places liabilities on the left hand side.C. does not equate the right hand with the left hand side.D. lists items in terms of market values, not historical costs.E. uses the market rate of return.8. The firm's capital structure refers to:A. the way a firm invests its assets.B. the amount of capital in the firm.C. the amount of dividends a firm pays.D. the mix of debt and equity used to finance the firm's assets.E. how much cash the firm holds.9. A general rule for managers to follow is to set the firm's capital structure such that:A. the firm's value is minimized.B. the firm's value is maximized.C. the firm's bondholders are made well off.D. the firms suppliers of raw materials are satisfied.E. the firms dividend payout is maximized.10. A levered firm is a company that has:A. Accounts Payable as the only liability on the balance sheet.B. some debt in the capital structure.C. all equity in the capital structure.D. All of the above.E. None of the above.11. A manager should attempt to maximize the value of the firm by:A. changing the capital structure if and only if the value of the firm increases.B. changing the capital structure if and only if the value of the firm increases to the benefit of inside management.C. changing the capital structure if and only if the value of the firm increases only to the benefits of the debtholders.D. changing the capital structure if and only if the value of the firm increases although it decreases the stockholders' value.E. changing the capital structure if and only if the value of the firm increases and stockholder wealth is constant.12. The effect of financial leverage depends on the operating earnings of the company. Which of the following is not true?A. Below the indifference or break-even point in EBIT the non-levered structure is superior.B. Financial leverage increases the slope of the EPS line.C. Above the indifference or break-even point the increase in EPS for all equity structures is less than debt-equity structures.D. Above the indifference or break-even point the increase in EPS for all equity structures is greater than debt-equity structures.E. The rate of return on operating assets is unaffected by leverage.13. The Modigliani-Miller Proposition I without taxes states:A. a firm cannot change the total value of its outstanding securities by changing its capital structure proportions.B. when new projects are added to the firm the firm value is the sum of the old value plus the new.C. managers can make correct corporate decisions that will satisfy all shareholders if they select projects that maximize value.D. the determination of value must consider the timing and risk of the cash flows.E. None of the above.14. MM Proposition I without taxes is used to illustrate:A. the value of an unlevered firm equals that of a levered firm.B. that one capital structure is as good as another.C. leverage does not affect the value of the firm.D. capital structure changes have no effect on stockholders' welfare.E. All of the above.15. A key assumption of MM's Proposition I without taxes is:A. that financial leverage increases risk.B. that individuals can borrow on their own account at rates less than the firm.C. that individuals must be able to borrow on their own account at rates equal to the firm.D. managers are acting to maximize the value of the firm.E. All of the above.16. In an EPS-EBI graphical relationship, the slope of the debt ray is steeper than the equity ray. The debt ray has a lower intercept because:A. more shares are outstanding for the same level of EBI.B. the break-even point is higher with debt.C. a fixed interest charge must be paid even at low earnings.D. the amount of interest per share has only a positive effect on the intercept.E. the higher the interest rate the greater the slope.17. In an EPS-EBI graphical relationship, the debt ray and equity ray cross. At this point the equity and debt are:A. equivalent with respect to EPS but above and below this point equity is always superior.B. at breakeven in EPS but above this point debt increases EPS via leverage and decreases EPS below this point.C. equal but away from breakeven equity is better as fewer shares are outstanding.D. at breakeven and MM Proposition II states that debt is the better choice.E. at breakeven and debt is the better choice below breakeven because small payments can be made.18. When comparing levered vs. unlevered capital structures, leverage works to increase EPS for high levels of EBIT because:A. interest payments on the debt vary with EBIT levels.B. interest payments on the debt stay fixed, leaving less income to be distributed over less shares.C. interest payments on the debt stay fixed, leaving more income to be distributed over less shares.D. interest payments on the debt stay fixed, leaving less income to be distributed over more shares.E. interest payments on the debt stay fixed, leaving more income to be distributed over more shares.19. Financial leverage impacts the performance of the firm by:A. maintaining the same level of volatility of the firm's EBIT.B. decreasing the volatility of the firm's EBIT.C. decreasing the volatility of the firm's net income.D. increasing the volatility of the firm's net income.E. None of the above.20. The increase in risk to equityholders when financial leverage is introduced is evidenced by:A. higher EPS as EBIT increases.B. a higher variability of EPS with debt than all equity.C. increased use of homemade leverage.D. equivalence value between levered and unlevered firms in the presence of taxes.E. None of the above.21. The reason that MM Proposition I does not hold in the presence of corporate taxation is because:A. levered firms pay less taxes compared with identical unlevered firms.B. bondholders require higher rates of return compared with stockholders.C. earnings per share are no longer relevant with taxes.D. dividends are no longer relevant with taxes.E. All of the above.22. MM Proposition I with corporate taxes states that:A. capital structure can affect firm value.B. by raising the debt-to-equity ratio, the firm can lower its taxes and thereby increase its total value.C. firm value is maximized at an all debt capital structure.D. All of the above.E. None of the above.23. The change in firm value in the presence of corporate taxes only is:A. positive as equityholders face a lower effective tax rate.B. positive as equityholders gain the tax shield on the debt interest.C. negative because of the increased risk of default and fewer shares outstanding.D. negative because of a reduction of equity outstanding.E. None of the above.24. A firm should select the capital structure which:A. produces the highest cost of capital.B. maximizes the value of the firm.C. minimizes taxes.D. is fully unlevered.E. has no debt.25. In a world of no corporate taxes if the use of leverage does not change the value of the levered firm relative to the unlevered firm is known as:A. MM Proposition III that the cost of stock is less than the cost of debt.B. MM Proposition I that leverage is invariant to market value.C. MM Proposition II that the cost of equity is always constant.D. MM Proposition I that the market value of the firm is invariant to the capital structure.E. MM Proposition III that there is no risk associated with leverage in a no tax world.26. Bryan invested in Bryco, Inc. stock when the firm was financed solely with equity. The firm is now utilizing debt in its capital structure. To unlever his position, Bryan needs to:A. borrow some money and purchase additional shares of Bryco stock.B. maintain his current position as the debt of the firm did not affect his personal leverage position.C. sell some shares of Bryco stock and hold the proceeds in cash.D. sell some shares of Bryco stock and loan it out such that he creates a personal debt-equity ratio equal to that of the firm.E. create a personal debt-equity ratio that is equal to exactly 50% of the debt-equity ratio of the firm.27. The capital structure chosen by a firm doesn't really matter because of:A. taxes.B. the interest tax shield.C. the relationship between dividends and earnings per share.D. the effects of leverage on the cost of equity.E. homemade leverage.28. MM Proposition I with no tax supports the argument that:A. business risk determines the return on assets.B. the cost of equity rises as leverage rises.C. it is completely irrelevant how a firm arranges its finances.D. a firm should borrow money to the point where the tax benefit from debt is equal to the cost of the increased probability of financial distress.E. financial risk is determined by the debt-equity ratio.29. The proposition that the value of a levered firm is equal to the value of an unlevered firm is known as:A. MM Proposition I with no tax.B. MM Proposition II with no tax.C. MM Proposition I with tax.D. MM Proposition II with tax.E. static theory proposition.30. The concept of homemade leverage is most associated with:A. MM Proposition I with no tax.B. MM Proposition II with no tax.C. MM Proposition I with tax.D. MM Proposition II with tax.E. static theory proposition.31. Which of the following statements are correct in relation to MM Proposition II with no taxes?I. The required return on assets is equal to the weighted average cost of capital. II. Financial risk is determined by the debt-equity ratio.III. Financial risk determines the return on assets.IV. The cost of equity declines when the amount of leverage used by a firm rises.A. I and III onlyB. II and IV onlyC. I and II onlyD. III and IV onlyE. I and IV only32. MM Proposition I with taxes supports the theory that:A. there is a positive linear relationship between the amount of debt in a levered firm and its value.B. the value of a firm is inversely related to the amount of leverage used by the firm.C. the value of an unlevered firm is equal to the value of a levered firm plus the value of the interest tax shield.D. a firm's cost of capital is the same regardless of the mix of debt and equity used by the firm.E. a firm's weighted average cost of capital increases as the debt-equity ratio of the firm rises.33. MM Proposition I with taxes is based on the concept that:A. the optimal capital structure is the one that is totally financed with equity.B. the capital structure of the firm does not matter because investors can use homemade leverage.C. the firm is better off with debt based on the weighted average cost of capital.D. the value of the firm increases as total debt increases because of the interest tax shield.E. the cost of equity increases as the debt-equity ratio of a firm increases.34. MM Proposition II with taxes:A. has the same general implications as MM Proposition II without taxes.B. reveals how the interest tax shield relates to the value of a firm.C. supports the argument that business risk is determined by the capital structure employed by a firm.D. supports the argument that the cost of equity decreases as the debt-equity ratio increases.E. reaches the final conclusion that the capital structure decision is irrelevant to the value of a firm.35. MM Proposition II is the proposition that:A. supports the argument that the capital structure of a firm is irrelevant to the value of the firm.B. the cost of equity depends on the return on debt, the debt-equity ratio and the tax rate.C. a firm's cost of equity capital is a positive linear function of the firm's capital structure.D. the cost of equity is equivalent to the required return on the total assets of a firm.E. supports the argument that the size of the pie does not depend on how the pie is sliced.36. The interest tax shield has no value for a firm when:I. the tax rate is equal to zero.II. the debt-equity ratio is exactly equal to 1.III. the firm is unlevered.IV. a firm elects 100% equity as its capital structure.A. I and III onlyB. II and IV onlyC. I, III, and IV onlyD. II, III, and IV onlyE. I, II, and IV only37. The interest tax shield is a key reason why:A. the required rate of return on assets rises when debt is added to the capital structure.B. the value of an unlevered firm is equal to the value of a levered firm.C. the net cost of debt to a firm is generally less than the cost of equity.D. the cost of debt is equal to the cost of equity for a levered firm.E. firms prefer equity financing over debt financing.38. Which of the following will tend to diminish the benefit of the interest tax shield given a progressive tax rate structure?I. a reduction in tax ratesII. a large tax loss carryforwardIII. a large depreciation tax deductionIV. a sizeable increase in taxable incomeA. I and II onlyB. I and III onlyC. II and III onlyD. I, II, and III onlyE. I, II, III, and IV39. Thompson & Thomson is an all equity firm that has 500,000 shares of stock outstanding. The company is in the process of borrowing $8 million at 9% interest to repurchase 200,000 shares of the outstanding stock. What is the value of this firm if you ignore taxes?A. $20.0 millionB. $20.8 millionC. $21.0 millionD. $21.2 millionE. $21.3 million40. Uptown Interior Designs is an all equity firm that has 40,000 shares of stock outstanding. The company has decided to borrow $1 million to buy out the shares of a deceased stockholder who holds 2,500 shares. What is the total value of this firm if you ignore taxes?A. $15.5 millionB. $15.6 millionC. $16.0 millionD. $16.8 millionE. $17.2 million41. You own 25% of Unique Vacations, Inc. You have decided to retire and want to sell your shares in this closely held, all equity firm. The other shareholders have agreed to have the firm borrow $1.5 million to purchase your 1,000 shares of stock. What is the total value of this firm today if you ignore taxes?A. $4.8 millionB. $5.1 millionC. $5.4 millionD. $5.7 millionE. $6.0 million42. Your firm has a debt-equity ratio of .75. Your pre-tax cost of debt is 8.5% and your required return on assets is 15%. What is your cost of equity if you ignore taxes?A. 11.25%B. 12.21%C. 16.67%D. 19.88%E. 21.38%43. Bigelow, Inc. has a cost of equity of 13.56% and a pre-tax cost of debt of 7%. The required return on the assets is 11%. What is the firm's debt-equity ratio based on MM Proposition II with no taxes?A. .60B. .64C. .72D. .75E. .8044. The Backwoods Lumber Co. has a debt-equity ratio of .80. The firm's required return on assets is 12% and its cost of equity is 15.68%. What is the pre-tax cost of debt based on MM Proposition II with no taxes?A. 6.76%B. 7.00%C. 7.25%D. 7.40%E. 7.50%45. The Winter Wear Company has expected earnings before interest and taxes of $2,100, an unlevered cost of capital of 14% and a tax rate of 34%. The company also has $2,800 of debt that carries a 7% coupon. The debt is selling at par value. What is the value of this firm?A. $9,900B. $10,852C. $11,748D. $12,054E. $12,70046. Gail's Dance Studio is currently an all equity firm that has 80,000 shares of stock outstanding with a market price of $42 a share. The current cost of equity is 12% and the tax rate is 34%. Gail is considering adding $1 million of debt with a coupon rate of 8% to her capital structure. The debt will be sold at par value. What is the levered value of the equity?A. $2.4 millionB. $2.7 millionC. $3.3 millionD. $3.7 millionE. $3.9 million47. The Montana Hills Co. has expected earnings before interest and taxes of $8,100, an unlevered cost of capital of 11%, and debt with both a book and face value of $12,000. The debt has an annual 8% coupon. The tax rate is 34%. What is the value of the firm?A. $48,600B. $50,000C. $52,680D. $56,667E. $60,60048. Scott's Leisure Time Sports is an unlevered firm with an after-tax net income of $86,000. The unlevered cost of capital is 10% and the tax rate is 34%. What is the value of this firm?A. $567,600B. $781,818C. $860,000D. $946,000E. $1,152,40049. An unlevered firm has a cost of capital of 14% and earnings before interest and taxes of $150,000. A levered firm with the same operations and assets has both a book value and a face value of debt of $700,000 with a 7% annual coupon. The applicable tax rate is 35%. What is the value of the levered firm?A. $696,429B. $907,679C. $941,429D. $1,184,929E. $1,396,42950. The Spartan Co. has an unlevered cost of capital of 11%, a cost of debt of 8%, and a tax rate of 35%. What is the target debt-equity ratio if the targeted cost of equity is 12%?A. .44B. .49C. .51D. .56E. .6251. Hey Guys!, Inc. has debt with both a face and a market value of $3,000. This debt has a coupon rate of 7% and pays interest annually. The expected earnings before interest and taxes is $1,200, the tax rate is 34%, and the unlevered cost of capital is 12%. What is the firm's cost of equity?A. 13.25%B. 13.89%C. 13.92%D. 14.14%E. 14.25%52. Anderson's Furniture Outlet has an unlevered cost of capital of 10%, a tax rate of 34%, and expected earnings before interest and taxes of $1,600. The company has $3,000 in bonds outstanding that have an 8% coupon and pay interest annually. The bonds are selling at par value. What is the cost of equity?A. 8.67%B. 9.34%C. 9.72%D. 9.99%E. 10.46%53. Walter's Distributors has a cost of equity of 13.84% and an unlevered cost of capital of 12%. The company has $5,000 in debt that is selling at par value. The levered value of the firm is $12,000 and the tax rate is 34%. What is the pre-tax cost of debt?A. 7.92%B. 8.10%C. 8.16%D. 8.84%E. 9.00%54. Rosita's has a cost of equity of 13.8% and a pre-tax cost of debt of 8.5%. The debt-equity ratio is .60 and the tax rate is .34. What is Rosita's unlevered cost of capital?A. 8.83%B. 12.30%C. 13.97%D. 14.08%E. 14.60%55. Your firm has a pre-tax cost of debt of 7% and an unlevered cost of capital of 13%. Your tax rate is 35% and your cost of equity is 15.26%. What is your debt-equity ratio?A. .43B. .49C. .51D. .54E. .5856. Wild Flowers Express has a debt-equity ratio of .60. The pre-tax cost of debt is 9% while the unlevered cost of capital is 14%. What is the cost of equity if the tax rate is 34%?A. 7.52%B. 8.78%C. 15.98%D. 16.83%E. 17.30%57. Your firm has a $250,000 bond issue outstanding. These bonds have a 7% coupon, pay interest semiannually, and have a current market price equal to 103% of face value. What is the amount of the annual interest tax shield given a tax rate of 35%?A. $6,125B. $6,309C. $9,500D. $17,500E. $18,02558. Bertha's Boutique has 2,000 bonds outstanding with a face value of $1,000 each and a coupon rate of 9%. The interest is paid semi-annually. What is the amount of the annual interest tax shield if the tax rate is 34%?A. $58,500B. $60,100C. $60,750D. $61,200E. $62,25059. Juanita's Steak House has $12,000 of debt outstanding that is selling at par and has a coupon rate of 8%. The tax rate is 34%. What is the present value of the tax shield?A. $2,823B. $2,887C. $4,080D. $4,500E. $4,63360. A firm has debt of $5,000, equity of $16,000, a leveraged value of $8,900,a cost of debt of 8%, a cost of equity of 12%, and a tax rate of 34%. What is the firm's weighted average cost of capital?A. 7.29%B. 7.94%C. 8.87%D. 10.40%E. 11.05%61. A firm has zero debt in its capital structure. Its overall cost of capital is 10%. The firm is considering a new capital structure with 60% debt. The interest rate on the debt would be 8%. Assuming there are no taxes or other imperfections, its cost of equity capital with the new capital structure would be _____.A. 9%B. 10%C. 13%D. 14%E. None of the above.62. A firm has a debt-to-equity ratio of .60. Its cost of debt is 8%. Its overall cost of capital is 12%. What is its cost of equity if there are no taxes or other imperfections?A. 10.0%B. 13.5%C. 14.4%D. 18.0%E. None of the above.63. A firm has a debt-to-equity ratio of 1. Its cost of equity is 16%, and its cost of debt is 8%. If there are no taxes or other imperfections, what would be its cost of equity if the debt-to-equity ratio were 0?A. 8%B. 10%C. 12%D. 14%E. 16%64. A firm has a debt-to-equity ratio of 1.20. If it had no debt, its cost of equity would be 15%. Its cost of debt is 10%. What is its cost of equity if there are no taxes or other imperfections?A. 10%B. 15%C. 18%D. 21%E. None of the above.65. If a firm is unlevered and has a cost of equity capital of 12%, what would its cost of equity be if its debt-equity ratio became 2? The expected cost of debt is 8%.A. 14.0%B. 14.67%C. 16.0%D. 20.0%E. None of the above.66. A firm has zero debt in its capital structure. Its overall cost of capital is 9%. The firm is considering a new capital structure with 40% debt. The interest rate on the debt would be 4%. Assuming that the corporate tax rate is 34%, what would its cost of equity capital with the new capital structure be?A. 10.3%B. 11.0%C. 11.2%D. 13.9%E. None of the above.67. A firm has a debt-to-equity ratio of 1. Its cost of equity is 16%, and its cost of debt is 8%. If the corporate tax rate is 25%, what would its cost of equity be if the debt-to-equity ratio were 0?A. 11.11%B. 12.57%C. 13.33%D. 16.00%E. None of the above.68. A firm has a debt-to-equity ratio of .5. Its cost of equity is 22%, and its cost of debt is 16%. If the corporate tax rate is .40, what would its cost of equity be if the debt-to-equity ratio were 0?A. 14.00%B. 20.61%C. 21.07%D. 22.00%E. None of the above.69. A firm has a debt-to-equity ratio of 1.75. If it had no debt, its cost of equity would be 14%. Its cost of debt is 10%. What is its cost of equity if the corporate tax rate is 50%?A. 14.0%B. 16.0%C. 17.5%D. 21.0%E. None of the above.70. What is the cost of equity for a firm if the corporate tax rate is 40%? The firm has a debt-to-equity ratio of 1.5. If it had no debt, its cost of equity would be 16%. Its current cost of debt is 10%.A. 17.4%B. 18.4%C. 19.6%D. 21.4%E. None of the above.71. A firm has a debt-to-equity ratio of 1.75. If it had no debt, its cost of equity would be 9%. Its cost of debt is 7%. What is its cost of equity if the corporate tax rate is 50%?A. 7.73%B. 10.00%C. 10.75%D. 12.50%E. None of the above.72. Batter's Home has 3,000 bonds outstanding with a face value of $1,000 each and a coupon rate of 8%. The interest is paid semi-annually. What is the amount of the annual interest tax shield if the tax rate is 30%?A. $52,000B. $60,000C. $62,500D. $68,000E. $72,00073. Reena Industries has $10,000 of debt outstanding that is selling at par and has a coupon rate of 7%. The tax rate is 34%. What is the present value of the tax shield?A. $2,800B. $3,000C. $3,400D. $3,800E. $7.00074. A firm has debt of $7,000, equity of $12,000, a leveraged value of $8,900,a cost of debt of 7%, a cost of equity of 14%, and a tax rate of 30%. What is the firm's weighted average cost of capital?A. 8.45%B. 9.90%C. 10.65%D. 12.50%E. 14.00%Essay Questions75. Based on MM with taxes and without taxes, how much time should a financial manager spend analyzing the capital structure of his firm? What if the analysis is based on the static theory?76. Explain homemade leverage and why it matters.77. In each of the theories of capital structure the cost of equity rises as the amount of debt increases. So why don't financial managers use as little debt as possible to keep the cost of equity down? After all, isn't the goal of the firm to maximize share value and minimize shareholder costs?Consider two firms, U and L, both with $50,000 in assets. Firm U is unlevered, and firm L has $20,000 of debt that pays 8% interest. Firm U has 1,000 shares outstanding, while firm L has 600 shares outstanding. Mike owns 20% of firm L and believes that leverage works in his favor. Steve tells Mike that this is an illusion, and that with the possibility of borrowing on his own account at 8% interest, he can replicate Mike's payout from firm L.78. Given a level of operating income of $2,500, show the specific strategy that Mike has in mind.79. After seeing Steve's analysis, Mike tells Steve that while his analysis looks good on paper, Steve will never be able to borrow at 8%, but would have to pay a more realistic rate of 12%. If Mike is right, what will Steve's payout be?80. Suppose the tax authorities allow firms to deduct their interest expense from operating income. Both firm U and firm L are in the 34% tax bracket. Show what happens to the market value of both firms if the debt held by firm L is permanent. Assume MM with taxes.。

罗斯公司理财题库全集Chapter 26Short-Term Finance and Planning Multiple Choice Questions1. The length of time between the acquisition of inventory and the collection of cash from receivables is called the:A. operating cycle.B. inventory period.C. accounts receivable period.D. accounts payable period.E. cash cycle.2. The length of time between the acquisition of inventory and its sale is called the:A. operating cycle.B. inventory period.C. accounts receivable period.D. accounts payable period.E. cash cycle.3. The length of time between the sale of inventory and the collection of cash from receivables is called the:A. operating cycle.B. inventory period.C. accounts receivable period.D. accounts payable period.E. cash cycle.4. The length of time between the acquisition of inventory bya firm and the payment by the firm for that inventory is called the:A. operating cycle.B. inventory period.C. accounts receivable period.D. accounts payable period.E. cash cycle.5. The length of time between the payment for inventory and the collection of cash from receivables is called the:A. operating cycle.B. inventory period.C. accounts receivable period.D. accounts payable period.E. cash cycle.6. Costs of the firm that rise with increased levels of investment in its current assets are called _____ costs.A. carryingB. shortageC. orderD. safetyE. trading7. Costs of the firm that fall with increased levels of investment in its current assets are called _____ costs.A. carryingB. shortageC. debtD. equityE. payables8. The forecast of cash receipts and disbursements for the next planning period is called a:A. pro forma income statement.B. statement of cash flows.C. cash budget.D. receivables analysis.E. credit analysis.9. A prearranged, short-term bank loan made on a formal or informal basis, and typically reviewed for renewal annually, is called a:A. letter of credit.B. cleanup loan.C. compensating balance.D. line of credit.E. roll-over.10. A prearranged credit agreement with a bank typically open for two or more years is called a:A. letter of credit.B. cleanup loan.C. compensating balance.D. line of credit.E. revolving credit arrangement.11. A fraction of the available credit on a loan agreement deposited by the borrower with the bank in a low or non-interest-bearing account is called a:A. compensating balance.B. cleanup loan.C. letter of credit.D. line of credit.E. roll-over.12. A _____ issued by a bank is a promise by that bank to makea loan if certain conditions are met.A. compensating balanceB. cleanup loanC. letter of creditD. line creditE. revolver13. A short-term loan where the lender holds the borrower's receivables as security is called:A. a compensating balance.B. assigned receivables financing.C. a letter of credit.D. factored receivables financing.E. a bond.14. A type of short-term loan where the borrower sells its receivables to the lender up-front, but at a discount to face value, is called:A. a compensating balance.B. assigned receivables financing.C. a letter of credit.D. factored receivables financing.E. a bond.15. A short-term loan secured by the borrower's inventory, either directly or via an intermediary, is called a(n):A. debenture.B. line of credit.C. banker's acceptance.D. compensating balance.E. inventory loan.16. Net working capital is defined as:A. the current assets in a business.B. the difference between current assets and current liabilities.C. the present value of short-term cash flows.D. the difference between all assets and liabilities.E. None of the above.17. Which one of the following is a source of cash?A. an increase in accounts receivableB. an increase in fixed assetsC. a decrease in long-term debtD. the payment of a cash dividendE. an increase in accounts payable18. Which of the following are uses of cash?I. marketable securities are soldII. the amount of inventory on hand is increasedIII. the firm takes out a long-term bank loanIV. payments are paid on accounts payableA. I and III onlyB. II and IV onlyC. I and IV onlyD. II and III onlyE. II, III and IV only19. Which one of the following will increase net working capital? Assume that the current ratio is greater than 1.0.A. using cash to pay an accounts payableB. uing cash to pay a long-term debtC. selling inventory at costD. collecting an accounts receivableE. using a long-term loan to buy inventory20. Which one of the following will decrease the net working capital of a firm? Assume that the current ratio is greater than 1.0.A. Selling inventory at a profitB. Collecting an accounts receivableC. Paying a payment on a long-term debtD. Selling a fixed asset for book valueE. Paying an accounts payable21. Which one of the following will decrease the operating cycle?A. Paying accounts payable fasterB. Discontinuing the discount given for early payment of an accounts receivableC. Decreasing the inventory turnover rateD. Collecting accounts receivable fasterE. Increasing the accounts payable turnover rate22. Which one of the following will decrease the operating cycle?A. Decreasing the days sales in inventoryB. Decreasing the days in accounts payableC. Decreasing the cash cycle by increasing the accounts payable periodD. Decreasing the accounts receivable turnover rateE. Decreasing the speed at which inventory is sold23. The short-term financial policy that a firm adopts will be reflected in:A. the size of the firm's investment in current assets.B. the financing of current assets.C. the financing of fixed assets.D. Both A and B.E. Both A and C.24. Which one of the following will not affect the operating cycle?A. decreasing the payables turnover from 7 times to 6 timesB. increasing the days sales in receivablesC. decreasing the inventory turnover rateD. increasing the average receivables balanceE. decreasing the credit repayment times for the firm'scustomers25. Which one of the following will increase the cash cycle?A. Improving the cash discounts given to customers who pay their accounts earlyB. Having a larger percentage of customers paying with cash instead of creditC. Buying less raw materials to have on handD. Paying your suppliers earlier to receive the discount they offerE. Ordering raw materials inventory only when you need it26. An increase in which one of the following will decrease the cash cycle, all else equal?A. Payables turnoverB. Days sales in inventoryC. Operating cycleD. Inventory turnover rateE. Accounts receivable period27. ABC Manufacturing historically produced products that were held in inventory until they could be sold to a customer. The firm is now changing its policy and only producing a product when it receives an actual order from a customer. All else equal, this change will:A. increase the operating cycle.B. lengthen the accounts receivable period.C. shorten the accounts payable period.D. decrease the cash cycle.E. decrease the inventory turnover rate.28. Which one of the following statements concerning the cash cycle is correct?A. The cash cycle is equal to the operating cycle minus theinventory period.B. A negative cash cycle is actually preferable to a positive cash cycle.C. Granting credit to slower paying customers tends to decrease the cash cycle.D. The cash cycle plus the accounts receivable period is equal to the operating cycle.E. The most desirable cash cycle is the one that equals zero days.29. Which one of the following statements is correct concerning the cash cycle?A. The longer the cash cycle, the more likely a firm will need external financing.B. Increasing the accounts payable period increases the cash cycle.C. A positive cash cycle is preferable to a negative cash cycle.D. The cash cycle can exceed the operating cycle if the payables period is equal to zero.E. Adopting a more liberal accounts receivable policy will tend to decrease the cash cycle.。

Chapter 21Leasing Multiple Choice Questions1. In a lease arrangement, the owner of the asset is:A. the lesser.B. the lessee.C. the lessor.D. the leaser.E. None of the above.2. In a lease arrangement, the user of the asset is:A. the lesser.B. the lessee.C. the lessor.D. the leaser.E. None of the above.3. Which of the following would not be a characteristic of a financial lease?A. They are not usually fully amortized.B. They usually do not have maintenance necessary for the leased assets.C. They usually do not include a cancellation option.D. The lessee usually has the right to renew the lease at expiration.E. All of the above are characteristics of financial leases.4. An independent leasing company supplies ___________ leases versus the manufacturer who supplies ________________ leases.A. leveraged; directB. sales and leaseback; sales-typeC. capital; sales-typeD. direct; sales-typeE. None of the above5. Which of the following is not a financial lease?A. A leveraged leaseB. An operating leaseC. A sale-and-leasebackD. Both A and B.E. None of the above.6. If the lessor borrows much of the purchase price of a leased asset, the lease is called:A. a leveraged lease.B. a sale-and-leaseback.C. a capital lease.D. a nonrecourse lease.E. None of the above.7. An operating lease's primary characteristics are:A. fully amortized, lessee maintains equipment and there is no cancellation clause.B. not fully amortized, lessor maintains equipment and there is a cancellation clause.C. fully amortized, lessor maintains equipment and there is a cancellation clause.D. not fully amortized, lessor maintains equipment and there is not cancellation clause.E. fully amortized, lessee maintains equipment and lessee can acquire assets at end of lease for fair market value.8. If a lease is for 35 years, it is regarded as a:A. financial lease.B. operating lease.C. capital lease.D. conditional sale.E. sale and leaseback.9. The city of Oakland sold some buildings and used the proceeds to improve its financial position. The city then leased the buildings back in order to continue to use these facilities. This is an example of:A. an operating lease.B. a short-term lease.C. a sale and leaseback.D. a fully amortized lease.E. None of the above.10. A financial lease has the following as its primary characteristics:A. is fully amortized, lessee maintains equipment and there is no renewal clause and no cancellation clause.B. is not fully amortized, lessor maintains equipment and there is a renewal clause but no cancellation clause.C. is fully amortized, lessor maintains equipment and there is a renewal clause and a no cancellation clause.D. is not fully amortized, lessor maintains equipment and there is a renewal clause.E. is fully amortized, lessee maintains equipment and there is a renewal clause and a no cancellation clause.11. An advantage of leasing is that the lessor does not own the asset and can cancel:A. only financial leases.B. only operating leases.C. only capital leases.D. any kind of leases anytime.E. None of the above.12. A leveraged lease typically involves a non-recourse loan in which:A. the lessee's payments go directly to the lender in case of default.B. the lessor is not obligated in case of default.C. the third party lenders have a first lien on the assets.D. All of the above.E. None of the above.13. For accounting purposes, which of the following conditions would automatically cause a lease to be a capital lease?A. The lessee can purchase the asset below fair market value at the end of the lease.B. The lease transfers ownership of the asset to the lessee by the end of the lease.C. The lease term is more than 75% of the asset's economic life.D. The present value of the lease payments is more than 90% of the asset's market value at lease inception.E. All of the above would lead to the lease being considered a capital lease.14. Capital leases would show up on the balance sheet of the firm in which manner for a six year machinery lease worth $700,000?A. Capital leases do not have to be put on the balance sheet; only financial leases do.B. Asset - Machinery $700,000; Liabilities - Long Term debt $700,000 because of debt displacement.C. Asset - Assets under Capital Lease $700,000; Liabilities - Obligations under Capital Lease $700,000.D. Assets - Assets under Capital Lease $700,000; Liabilities - Long Term Debt $700,000 because of debt displacement.E. None of the above.15. Prior to FASB 13, "Accounting for Leases", lease activity was only reported in financial footnotes. This off-balance-sheet-financing made firms with:A. capital leases appear financially stronger than firms that used debt to purchase the asset.B. operating leases appear financially stronger than firms that used debt to purchase the asset.C. leases of any type appear financially stronger than firms that used debt to purchase the asset.D. All of the above.E. None of the above.16. Which of the following is not an implication of FASB 13, Accounting for Leases?A. FASB 13 requires that the PV of the lease payments appear on the right hand side of the balance sheet.B. FASB 13 requires that the present value of the asset appear on the left hand side of the balance sheet.C. FASB 13 allows for off-balance-sheet financing for operating leases.D. All of the above.E. None of the above.17. The reason the IRS is most concerned about lease contracts is:A. firms that lease generally pay no taxes.B. that leasing usually leads to bankruptcy.C. that leases can be set up solely to avoid taxes.D. because leasing leads to off-balance-sheet-financing.E. All of the above.18. A lease with high payments early in its life which then decline to termination would:A. provide greater cash flow to the lessee in the beginning years.B. be evidence of tax avoidance and not acceptable to the IRS.C. be qualified as a capital lease under FASB 13.D. provide a lower residual value and thus ensure a bargain-purchase price option.E. All of the above.19. In valuing the lease versus purchase option, the relevant cash flows are the:A. tax shield from depreciation.B. investment outlay for the equipment.C. a decrease in the firm's operating costs that are not affected by leasing.D. All of the above are relevant.E. None of the above are relevant.20. The appropriate discount rate for valuing a financial lease is:A. the firm's after-tax weighted average cost of capital.B. the after-tax required return on assets of risks similar to the leased asset.C. the after-tax cost of secured borrowing.D. Either A or B.E. All of the above.21. The WACC is not used in the lease versus purchase decision because:A. the WACC was used in the decision to acquire the asset, this is only a financing decision.B. the WACC is used only when a lease alone is considered and not a lease versus purchase.C. the WACC does not include the lease cost of capital and therefore should not be used.D. tax rates of the lessor may be different than the lessee and therefore the WACC is incorrect.E. when a bank arranges a lease they do not consider the lessee's cost of capital.22. Firms that use financial leases must consider their debt-to-equity ratios as inadequate measures of financial leverage because:A. lenders are concerned about the firm's total liabilities and related cash flow.B. debt displacement occurs with leasing.C. less future debt can be raised for a growing firm when a lease is used.D. All of the above.E. None of the above.23. ______ would be evidence the lease is being used to avoid taxes and not a legitimate business purpose.A. Early balloon paymentsB. Late balloon paymentsC. Capitalizing a leaseD. Transfer of lease payments to a second ownerE. None of the above24. Debt displacement is associated with leases because:A. all assets not purchased with equity use debt financing.B. debt is always a cheaper source of financing and preferred to equity financing.C. FASB 13 and the IRS mandate debt displacement.D. lease financing is all debt and causes an imbalance in the optimal debt to equity ratio which reduces future debt financing.E. None of the above.25. A lease is likely to be most beneficial to both parties when:A. the lessor's tax rate is lower than the lessee's.B. the lessor's tax rate is higher than the lessee's.C. the lessor's tax rate is equal to the lessee's.D. a lease cannot be beneficial to both parties.E. a lease always has zero NPV, so both parties always break even.26. The price or lease payment that the lessee sets as their bound is known as:A. the present value of the tax shields.B. the reservation payment, L MIN.C. the present value of operating savings.D. the reservation payment, L MAX.E. None of the above.27. Which of the following is probably not a good reason for leasing instead of buying?A. Taxes may be reduced by leasing.B. Leasing may reduce transactions costs.C. Leasing may provide a beneficial reduction of uncertainty.D. All of the above are good reasons.E. All of the above are not good reasons.28. Which of the following is probably a good reason for leasing instead of buying?A. Leasing provides 100% financing.B. Leasing is not considered a form of debt financing.C. Leasing may increase EPS relative to buying.D. All of the above are good reasons.E. None of the above is a good reason.29. Some assets are leased more than others because:A. the value of the asset under a lease is not highly affected by term of use or maintenance decisions.B. a lease may be used to fool clients into "buying" high priced assets above market value.C. leasing allows sellers to attract clients with low prices as the basis for setting the contract.D. Both A and B.E. Both A and C.30. To meet IRS guidelines for leasing, the lease should:A. limit the lessee's right to issue debt or pay dividends while the lease is operative.B. not limit the lessee's right to issue debt or pay dividends while the lease is operative.C. pay a very high return to the lessor.D. transfer ownership of the asset at the end of the lease at below fair market value.E. be over 30 years.Your firm is considering leasing a new computer. The lease lasts for 9 years. The lease calls for 10 payments of $1,000 per year with the first payment occurring immediately. The computer would cost $7,650 to buy and would be straight-line depreciated to a zero salvage value over 9 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 8%. The corporate tax rate is 30%.31. What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in years 1-9?A. $-255B. $-955C. $-1,295D. $-1,850E. None of the above32. What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in year 0?A. $-4,865B. $-700C. $6,950D. $7,650E. None of the above33. What is the NPV of the lease relative to the purchase?A. $-1,039.78B. $339.78C. $360.22D. $6,610.22E. None of the above34. What would the after-tax cash flow in year 9 be if the asset had a residual value of $500 (ignoring any possible risk differences)?A. $-605B. $-955C. $-1,455D. $-1,305E. None of the above35. This lease would be classified as a(n):A. operating lease because the asset will be obsolete.B. operating lease because there is no amortization.C. leveraged lease because it is being financed.D. capital lease because the lease life is greater than 75% of the economic life.E. sale and leaseback because the company gets full use of the asset.Your firm is considering leasing a new robotic milling control system. The lease lasts for 5 years. The lease calls for 6 payments of $300,000 per year with the first payment occurring at lease inception. The system would cost $1,050,000 to buy and would be straight-line depreciated to a zero salvage value. The actual salvage value is zero. The firm can borrow at 8%, and the corporate tax rate is 34%.36. What is the appropriate discount rate for valuing the lease?A. 2.72%B. 5.28%C. 8.00%D. 12.12%E. None of the above.37. What is the after-tax cash flow from leasing in year 0?A. $300,000B. $495,000C. $852,000D. $948,000E. None of the above38. What is the after-tax cash flow in years 1 through 5?A. $-126,600B. $-198,000C. $-269,400D. $-287,250E. None of the above39. What is the NPV of the lease?A. $-111,690B. $-295,040C. $-305,388D. $-309,690E. None of the above40. What is the maximum lease payment that you would be willing to make?A. $170,655B. $175,000C. $187,842D. $210,307E. None of the above41. What is the minimum lease payment that the lessor would be willing to accept?A. $161,000B. $176,995C. $217,645D. $237,083E. None of the aboveYour firm is considering leasing a new laser light. The lease lasts for 3 years. The lease calls for 4 payments of $10,000 per year with the first payment occurring immediately. The computer would cost $45,000 to buy and would be straight-line depreciated to a zero salvage value over 3 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 10%. The corporate tax rate is 35%.42. What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in years 1-3?A. $-32,775B. $-11,750C. $-1,750D. $-1,850E. None of the above43. What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in year 0?A. $-35,000B. $-38,500C. $35,000D. $38,500E. None of the above44. What is the NPV of the lease relative to the purchase?A. $-6,500B. $7,380C. $4,678D. $12,400E. None of the above45. What would the after-tax cash flow in year 3 be if the asset had a residual value of $1,000 (ignoring any possible risk differences)?A. $-11,750B. $11,750C. $12,400D. $-12,400E. None of the above46. This lease would be classified as a(n):A. operating lease because the asset will be obsolete.B. operating lease because there is no amortization.C. leveraged lease because it is being financed.D. capital lease because the lease life is greater than 75% of the economic life.E. sale and leaseback because the company gets full use of the asset.Essay Questions47. Sardinas Sardines has assets valued at $10 million and equity of $10 million. The firm recently leased new equipment worth $1 million. Present the balance sheet under two conditions; the lease is judged to be an operating lease, and the lease is judged to be a capital lease.48. The Blank Button Company is considering the purchase of a new machine for $30,000. The machine is expected to save the firm $12,500 per year in operating costs over a 5 year period, and can be depreciated on a straight-line basis to a zero salvage value over its life. Alternatively, the firm can lease the machine for $6,500 per year for 5 years, with the first payment due in 1 year. The firm's tax rate is 34%, and its cost of debt is 10%. Calculate the NPV of the lease versus the purchase decision. Calculate the reservation payment of the lessee.49. The Plastic Iron Company has decided to acquire a new electronic milling machine. Plastic Iron can purchase the machine for $87,000 which has an expected life of 8 years and will be depreciated using 7 class MACRS rates of .1428, .2449, .1749, .125, .0892, .0892, .0892 and any remainder in year 8. Miller Leasing has offered to lease the machine to Plastic Iron for $14,000 a year for 8 years. Plastic Iron has an 18.64% cost of equity, 12% cost of debt, a 1:1 D/E ratio and faces a 34% marginal tax rate. Should they lease or buy? Show all work.50. What are some of the advantages and disadvantages of leasing?Chapter 21 Leasing Answer KeyMultiple Choice Questions1. In a lease arrangement, the owner of the asset is:A. the lesser.B. the lessee.C. the lessor.D. the leaser.E. None of the above.Difficulty level: EasyTopic: LESSORType: DEFINITIONS2. In a lease arrangement, the user of the asset is:A. the lesser.B. the lessee.C. the lessor.D. the leaser.E. None of the above.Difficulty level: EasyTopic: LESSEEType: DEFINITIONS3. Which of the following would not be a characteristic of a financial lease?A. They are not usually fully amortized.B. They usually do not have maintenance necessary for the leased assets.C. They usually do not include a cancellation option.D. The lessee usually has the right to renew the lease at expiration.E. All of the above are characteristics of financial leases.Difficulty level: MediumTopic: FINANCIAL LEASEType: DEFINITIONS4. An independent leasing company supplies ___________ leases versus the manufacturer who supplies ________________ leases.A. leveraged; directB. sales and leaseback; sales-typeC. capital; sales-typeD. direct; sales-typeE. None of the aboveDifficulty level: EasyTopic: TYPES OF LEASESType: DEFINITIONS5. Which of the following is not a financial lease?A. A leveraged leaseB. An operating leaseC. A sale-and-leasebackD. Both A and B.E. None of the above.Difficulty level: EasyTopic: TYPES OF LEASESType: DEFINITIONS6. If the lessor borrows much of the purchase price of a leased asset, the lease is called:A. a leveraged lease.B. a sale-and-leaseback.C. a capital lease.D. a nonrecourse lease.E. None of the above.Difficulty level: EasyTopic: TYPES OF LEASESType: DEFINITIONS7. An operating lease's primary characteristics are:A. fully amortized, lessee maintains equipment and there is no cancellation clause.B. not fully amortized, lessor maintains equipment and there is a cancellation clause.C. fully amortized, lessor maintains equipment and there is a cancellation clause.D. not fully amortized, lessor maintains equipment and there is not cancellation clause.E. fully amortized, lessee maintains equipment and lessee can acquire assets at end of lease for fair market value.Difficulty level: MediumTopic: OPERATING LEASEType: DEFINITIONS8. If a lease is for 35 years, it is regarded as a:A. financial lease.B. operating lease.C. capital lease.D. conditional sale.E. sale and leaseback.Difficulty level: MediumTopic: TYPES OF LEASESType: DEFINITIONS9. The city of Oakland sold some buildings and used the proceeds to improve its financial position. The city then leased the buildings back in order to continue to use these facilities. This is an example of:A. an operating lease.B. a short-term lease.C. a sale and leaseback.D. a fully amortized lease.E. None of the above.Difficulty level: EasyTopic: TYPES OF LEASEType: CONCEPTS10. A financial lease has the following as its primary characteristics:A. is fully amortized, lessee maintains equipment and there is no renewal clause and no cancellation clause.B. is not fully amortized, lessor maintains equipment and there is a renewal clause but no cancellation clause.C. is fully amortized, lessor maintains equipment and there is a renewal clause and a no cancellation clause.D. is not fully amortized, lessor maintains equipment and there is a renewal clause.E. is fully amortized, lessee maintains equipment and there is a renewal clause and a no cancellation clause.Difficulty level: EasyTopic: FINANCIAL LEASEType: CONCEPTS11. An advantage of leasing is that the lessor does not own the asset and can cancel:A. only financial leases.B. only operating leases.C. only capital leases.D. any kind of leases anytime.E. None of the above.Difficulty level: EasyTopic: ADVANTAGE TO LEASINGType: CONCEPTS12. A leveraged lease typically involves a non-recourse loan in which:A. the lessee's payments go directly to the lender in case of default.B. the lessor is not obligated in case of default.C. the third party lenders have a first lien on the assets.D. All of the above.E. None of the above.Difficulty level: MediumTopic: LEVERAGED LEASEType: CONCEPTS13. For accounting purposes, which of the following conditions would automatically cause a lease to be a capital lease?A. The lessee can purchase the asset below fair market value at the end of the lease.B. The lease transfers ownership of the asset to the lessee by the end of the lease.C. The lease term is more than 75% of the asset's economic life.D. The present value of the lease payments is more than 90% of the asset's market value at lease inception.E. All of the above would lead to the lease being considered a capital lease.Difficulty level: MediumTopic: CAPITAL LEASEType: CONCEPTS14. Capital leases would show up on the balance sheet of the firm in which manner for a six year machinery lease worth $700,000?A. Capital leases do not have to be put on the balance sheet; only financial leases do.B. Asset - Machinery $700,000; Liabilities - Long Term debt $700,000 because of debt displacement.C. Asset - Assets under Capital Lease $700,000; Liabilities - Obligations under Capital Lease $700,000.D. Assets - Assets under Capital Lease $700,000; Liabilities - Long Term Debt $700,000 because of debt displacement.E. None of the above.Difficulty level: EasyTopic: CAPITAL LEASEType: CONCEPTS15. Prior to FASB 13, "Accounting for Leases", lease activity was only reported in financial footnotes. This off-balance-sheet-financing made firms with:A. capital leases appear financially stronger than firms that used debt to purchase the asset.B. operating leases appear financially stronger than firms that used debt to purchase the asset.C. leases of any type appear financially stronger than firms that used debt to purchase the asset.D. All of the above.E. None of the above.Difficulty level: ChallengeTopic: FASB 13Type: CONCEPTS16. Which of the following is not an implication of FASB 13, Accounting for Leases?A. FASB 13 requires that the PV of the lease payments appear on the right hand side of the balance sheet.B. FASB 13 requires that the present value of the asset appear on the left hand side of the balance sheet.C. FASB 13 allows for off-balance-sheet financing for operating leases.D. All of the above.E. None of the above.Difficulty level: MediumTopic: FASB 13Type: CONCEPTS17. The reason the IRS is most concerned about lease contracts is:A. firms that lease generally pay no taxes.B. that leasing usually leads to bankruptcy.C. that leases can be set up solely to avoid taxes.D. because leasing leads to off-balance-sheet-financing.E. All of the above.Difficulty level: EasyTopic: TAX IMPLICATIONSType: CONCEPTS18. A lease with high payments early in its life which then decline to termination would:A. provide greater cash flow to the lessee in the beginning years.B. be evidence of tax avoidance and not acceptable to the IRS.C. be qualified as a capital lease under FASB 13.D. provide a lower residual value and thus ensure a bargain-purchase price option.E. All of the above.Difficulty level: MediumTopic: TAX IMPLICATIONSType: CONCEPTS19. In valuing the lease versus purchase option, the relevant cash flows are the:A. tax shield from depreciation.B. investment outlay for the equipment.C. a decrease in the firm's operating costs that are not affected by leasing.D. All of the above are relevant.E. None of the above are relevant.Difficulty level: MediumTopic: LEASE VS. BUYType: CONCEPTS20. The appropriate discount rate for valuing a financial lease is:A. the firm's after-tax weighted average cost of capital.B. the after-tax required return on assets of risks similar to the leased asset.C. the after-tax cost of secured borrowing.D. Either A or B.E. All of the above.Difficulty level: EasyTopic: APPROPRIATE DISCOUNT RATEType: CONCEPTS21. The WACC is not used in the lease versus purchase decision because:A. the WACC was used in the decision to acquire the asset, this is only a financing decision.B. the WACC is used only when a lease alone is considered and not a lease versus purchase.C. the WACC does not include the lease cost of capital and therefore should not be used.D. tax rates of the lessor may be different than the lessee and therefore the WACC is incorrect.E. when a bank arranges a lease they do not consider the lessee's cost of capital.Difficulty level: ChallengeTopic: APPROPRIATE DISCOUNT RATEType: CONCEPTS22. Firms that use financial leases must consider their debt-to-equity ratios as inadequate measures of financial leverage because:A. lenders are concerned about the firm's total liabilities and related cash flow.B. debt displacement occurs with leasing.C. less future debt can be raised for a growing firm when a lease is used.D. All of the above.E. None of the above.Difficulty level: MediumTopic: FINANCIAL LEASEType: CONCEPTS23. ______ would be evidence the lease is being used to avoid taxes and not a legitimate business purpose.A. Early balloon paymentsB. Late balloon paymentsC. Capitalizing a leaseD. Transfer of lease payments to a second ownerE. None of the aboveDifficulty level: MediumTopic: TAX IMPLICATIONSType: CONCEPTS24. Debt displacement is associated with leases because:A. all assets not purchased with equity use debt financing.B. debt is always a cheaper source of financing and preferred to equity financing.C. FASB 13 and the IRS mandate debt displacement.D. lease financing is all debt and causes an imbalance in the optimal debt to equity ratio which reduces future debt financing.E. None of the above.Difficulty level: ChallengeTopic: LEASES AND DEBTType: CONCEPTS25. A lease is likely to be most beneficial to both parties when:A. the lessor's tax rate is lower than the lessee's.B. the lessor's tax rate is higher than the lessee's.C. the lessor's tax rate is equal to the lessee's.D. a lease cannot be beneficial to both parties.E. a lease always has zero NPV, so both parties always break even.Difficulty level: ChallengeTopic: TAX IMPLICATIONSType: CONCEPTS26. The price or lease payment that the lessee sets as their bound is known as:A. the present value of the tax shields.B. the reservation payment, L MIN.C. the present value of operating savings.D. the reservation payment, L MAX.E. None of the above.Difficulty level: MediumTopic: RESERVATION PAYMENTType: CONCEPTS27. Which of the following is probably not a good reason for leasing instead of buying?A. Taxes may be reduced by leasing.B. Leasing may reduce transactions costs.C. Leasing may provide a beneficial reduction of uncertainty.D. All of the above are good reasons.E. All of the above are not good reasons.Difficulty level: MediumTopic: REASON FOR LEASINGType: CONCEPTS。

Chapter 19 Dividends and Other Payouts Answer KeyMultiple Choice Questions1. Payments made out of a firm's earnings to its owners in the form of cash or stock are called:A. dividends.B. distributions.C. share repurchases.D. payments-in-kind.E. stock splits.Difficulty level: EasyTopic: DIVIDENDSType: DEFINITIONS2. Payments made by a firm to its owners from sources other than current or accumulated earnings are called:A. dividends.B. distributions.C. share repurchases.D. payments-in-kind.E. stock splits.Difficulty level: EasyTopic: DISTRIBUTIONSType: DEFINITIONS3. A cash payment made by a firm to its owners in the normal course of business is called a:A. share repurchase.B. liquidating dividend.C. regular cash dividend.D. special dividend.E. extra cash dividend.Difficulty level: EasyTopic: REGULAR CASH DIVIDENDSType: DEFINITIONS4. A cash payment made by a firm to its owners when some of the firm's assets are sold off is called a:A. liquidating dividend.B. regular cash dividend.C. special dividend.D. extra cash dividend.E. share repurchase.Difficulty level: EasyTopic: LIQUIDATING DIVIDENDSType: DEFINITIONS5. The date on which the board of directors passes a resolution authorizing payment of a dividend to the shareholders is the _____ date.A. ex-rightsB. ex-dividendC. recordD. paymentE. declarationDifficulty level: EasyTopic: DECLARATION DATEType: DEFINITIONS6. The date before which a new purchaser of stock is entitled to receive a declared dividend, but on or after which she does not receive the dividend, is called the _____ date.A. ex-rightsB. ex-dividendC. recordD. paymentE. declarationDifficulty level: EasyTopic: EX-DIVIDEND DATEType: DEFINITIONS7. The date by which a stockholder must be registered on the firm's roll as having share ownership in order to receive a declared dividend is called the:A. ex-rights date.B. ex-dividend date.C. date of record.D. date of payment.E. declaration date.Difficulty level: EasyTopic: DATE OF RECORDType: DEFINITIONS8. The date on which the firm mails out its declared dividends is called the:A. ex-rights date.B. ex-dividend date.C. date of record.D. date of payment.E. declaration date.Difficulty level: EasyTopic: DATE OF PAYMENTType: DEFINITIONS9. The ability of shareholders to undo the dividend policy of the firm and create an alternative dividend payment policy via reinvesting dividends or selling shares of stock is called (a):A. perfect foresight model.B. MM Proposition I.C. capital structure irrelevancy.D. homemade leverage.E. homemade dividends.Difficulty level: MediumTopic: HOMEMADE DIVIDENDSType: DEFINITIONS10. The market's reaction to the announcement of a change in the firm's dividend payout is likely the:A. information content effect.B. clientele effect.C. efficient markets hypothesis.D. MM Proposition I.E. MM Proposition II.Difficulty level: MediumTopic: INFORMATION CONTENT EFFECTType: DEFINITIONS11. The observed empirical fact that stocks attract particular investors based on the firm's dividend policy and the resulting tax impact on investors is called the:A. information content effect.B. clientele effect.C. efficient markets hypothesis.D. MM Proposition I.E. MM Proposition II.Difficulty level: EasyTopic: CLIENTELE EFFECTType: DEFINITIONS12. A _____ is an alternative method to cash dividends which is used to pay out a firm's earnings to shareholders.A. mergerB. acquisitionC. payment-in-kindD. stock splitE. share repurchaseDifficulty level: EasyTopic: SHARE REPURCHASEType: DEFINITIONS13. A payment made by a firm to its owners in the form of new shares of stock is called a _____ dividend.A. stockB. normalC. specialD. extraE. liquidatingDifficulty level: EasyTopic: STOCK DIVIDENDSType: DEFINITIONS14. An increase in a firm's number of shares outstanding without any change in owners' equity is called a:A. special dividend.B. stock split.C. share repurchase.D. tender offer.E. liquidating dividend.Difficulty level: EasyTopic: STOCK SPLITSType: DEFINITIONS15. The difference between the highest and lowest prices at which a stock has traded is called its:A. average price.B. bid-ask spread.C. trading range.D. opening price.E. closing price.Difficulty level: EasyTopic: TRADING RANGEType: DEFINITIONS16. In a reverse stock split:A. the number of shares outstanding increases and owners' equity decreases.B. the firm buys back existing shares of stock on the open market.C. the firm sells new shares of stock on the open market.D. the number of shares outstanding decreases but owners' equity is unchanged.E. shareholders make a cash payment to the firm.Difficulty level: EasyTopic: REVERSE SPLITSType: DEFINITIONS17. The last date on which you can purchase shares of stock and still receive the dividend is the date _____ business day(s) prior to the date of record.A. zeroB. oneC. threeD. fiveE. sevenDifficulty level: EasyTopic: DIVIDEND PAYMENTSType: CONCEPTS18. Leslie purchased 100 shares of GT, Inc. stock on Wednesday, June 7th. Marti purchased 100 shares of GT, Inc. stock on Thursday, July 8th. GT declared a dividend on June 20th to shareholders of record on July 12th and payable on August 1st. Which one of the following statements concerning the dividend paid on August 1st is correct given this information?A. Neither Leslie nor Marti are entitled to the dividend.B. Leslie is entitled to the dividend but Marti is not.C. Marti is entitled to the dividend but Leslie is not.D. Both Marti and Leslie are entitled to the dividend.E. Both Marti and Leslie are entitled to one-half of the dividend amount.Difficulty level: MediumTopic: DIVIDEND PAYMENTSType: CONCEPTS19. All else equal, the market value of a stock will tend to decrease by roughly the amount of the dividend on the:A. dividend declaration date.B. ex-dividend date.C. date of record.D. date of payment.E. day after the date of payment.Difficulty level: MediumTopic: DIVIDEND PAYMENTSType: CONCEPTS20. Which one of the following is an argument in favor of a low dividend policy?A. the tax on capital gains is deferred until the gain is realizedB. few, if any, positive net present value projects are available to the firmC. a preponderance of stockholders have minimal taxable incomeD. a majority of stockholders have other investment opportunities that offer higher rewards with similar risk characteristicsE. corporate tax rates exceed personal tax ratesDifficulty level: MediumTopic: FACTORS FOR LOW DIVIDENDSType: CONCEPTS21. The fact that flotation costs can be significant is justification for:A. a firm to issue larger dividends than its closest competitors.B. a firm to maintain a constant dividend policy even if it frequently has to issue new shares of stock to do so.C. maintaining a constant dividend policy even when profits decline significantly.D. maintaining a high dividend policy.E. maintaining a low dividend policy and rarely issuing extra dividends.Difficulty level: MediumTopic: FACTORS FOR LOW DIVIDENDSType: CONCEPTS22. Which of the following may tend to keep dividends low?I. a state law restricting dividends in excess of retained earningsII. a term contained in bond indenture agreementsIII. the desire to maintain constant dividends over timeIV. flotation costsA. II and III onlyB. I and IV onlyC. II, III, and IV onlyD. I, II, and III onlyE. I, II, III, and IVDifficulty level: MediumTopic: FACTORS FOR LOW DIVIDENDSType: CONCEPTS23. Ignoring capital gains as an alternative, the tax law changes in 2003 tend to favor a:A. lower dividend policy.B. constant dividend policy.C. zero-dividend policy.D. higher dividend policy.E. restrictive dividend policy.Difficulty level: EasyTopic: FACTORS FOR HIGH DIVIDENDSType: CONCEPTS24. Which of the following are factors that favor a high dividend policy?I. stockholders desire for current incomeII. tendency for higher stock prices for high dividend paying firmsIII. investor dislike of uncertaintyIV. high percentage of tax-exempt institutional stockholdersA. I and III onlyB. II and IV onlyC. I, III, and IV onlyD. II, III, and IV onlyE. I, II, III, and IVDifficulty level: MediumTopic: FACTORS FOR HIGH DIVIDENDSType: CONCEPTS25. An investor is more likely to prefer a high dividend payout if a firm:A. has high flotation costs.B. has few, if any, positive net present value projects.C. has lower tax rates than the investor.D. has a stock price that is increasing rapidly.E. offers high capital gains which are taxed at a favorable rate.Difficulty level: EasyTopic: FACTORS FOR HIGH DIVIDENDSType: CONCEPTS26. The information content of a dividend increase generally signals that:A. the firm has a one-time surplus of cash.B. the firm has few, if any, net present value projects to pursue.C. management believes that the future earnings of the firm will be strong.D. the firm has more cash than it needs due to sales declines.E. future dividends will be lower.Difficulty level: MediumTopic: INFORMATION CONTENTType: CONCEPTS27. Of the following factors, which one is considered to be the primary factor affecting a firm's dividend decision?A. personal taxes of company stockholdersB. consistent dividend policyC. attracting retail investorsD. attracting institutional investorsE. sustainable changes in earningsDifficulty level: MediumTopic: DIVIDEND SURVEY RESULTSType: CONCEPTS28. Financial managers:A. are reluctant to cut dividends.B. tend to ignore past dividend policies.C. tend to prefer cutting dividends every time quarterly earnings decline.D. prefer cutting dividends over incurring flotation costs.E. place little emphasis on dividend policy consistency.Difficulty level: EasyTopic: DIVIDEND SURVEY RESULTSType: CONCEPTS29. If you ignore taxes and transaction costs, a stock repurchase will:I. reduce the total assets of a firm.II. increase the earnings per share.III. reduce the PE ratio more than an equivalent stock dividend.IV. reduce the total equity of a firm.A. I and III onlyB. II and IV onlyC. I, II, and IV onlyD. I, III, and IV onlyE. I, II, III, and IVDifficulty level: MediumTopic: STOCK REPURCHASEType: CONCEPTS30. From a tax-paying investor's point of view, a stock repurchase:A. is equivalent to a cash dividend.B. is more desirable than a cash dividend.C. has the same tax effects as a cash dividend.D. is more highly taxed than a cash dividend.E. creates a tax liability even if the investor does not sell any of the shares he owns.Difficulty level: MediumTopic: STOCK REPURCHASEType: CONCEPTS31. All else equal, a stock dividend will _____ the number of shares outstanding and _____ the value per share.A. increase; increaseB. increase; decreaseC. not change; increaseD. decrease; increaseE. decrease; decreaseDifficulty level: EasyTopic: STOCK DIVIDENDSType: CONCEPTS32. A small stock dividend is defined as a stock dividend of less than _____%.A. 10 to 15B. 15 to 20C. 20 to 25D. 25 to 30E. 30 to 35Difficulty level: EasyTopic: STOCK DIVIDENDSType: CONCEPTS33. Nu Tech, Inc. is a technology firm with good growth prospects. The firm wishes to do something to acknowledge the loyalty of its shareholders but needs all of its available cash to fund its rapid growth. The market price of its stock is currently trading in the middle of its preferred trading range. The firm could consider:A. issuing a liquidating dividend.B. a stock split.C. a reverse stock split.D. issuing a stock dividend.E. a special cash dividend.Difficulty level: MediumTopic: STOCK DIVIDENDType: CONCEPTS34. Which of the following are valid reasons for a firm to reduce or eliminate its cash dividends?I. The firm is on the verge of violating a bond restriction which requires a current ratio of 1.8 or higher.II. A firm has just received a patent on a new product for which there is strong market demand and it needs the funds to bring the product to the marketplace.III. The firm can raise new capital easily at a very low cost.IV. The tax laws have recently changed such that dividends are taxed at an investor's marginal rate while capital gains are tax exempt.A. I and III onlyB. II and IV onlyC. II, III, and IV onlyD. I, II, and IV onlyE. I, II, III, and IVDifficulty level: MediumTopic: STOCK DIVIDENDSType: CONCEPTS35. A stock split:A. increases the total value of the common stock account.B. decreases the value of the retained earnings account.C. does not affect the total value of any of the equity accounts.D. increases the value of the capital in excess of par account.E. decreases the total owners' equity on the balance sheet.Difficulty level: MediumTopic: STOCK SPLITSType: CONCEPTS36. Stock splits are often used to:A. adjust the market price of a stock such that it falls within a preferred trading range.B. decrease the excess cash held by a firm.C. increase both the number of shares outstanding and the market price per share simultaneously.D. increase the total equity of a firm.E. adjust the debt-equity ratio such that it falls within a preferred range.Difficulty level: EasyTopic: STOCK SPLITSType: CONCEPTS37. Which of the following tend to increase the appeal of a firm's stock to the average investor?I. a cessation of dividends by a firm which has a long history of increasing dividendsII. the distribution of a special dividend by a dividend-paying firmIII. a reverse stock split for a low-priced stockIV. the declaration of a stock dividend by a growth firmA. I and III onlyB. II and IV onlyC. I, II, and IV onlyD. II, III, and IV onlyE. I, II, III, and IVDifficulty level: MediumTopic: STOCK SPLITSType: CONCEPTS38. Wydex, Inc. stock is currently trading at $82 a share. The firm feels that its primary clientele can afford to spend between $2,000 and $2,500 to purchase a round lot of 100 shares. The firm should consider a:A. reverse stock split.B. liquidating dividend.C. stock dividend.D. stock split.E. special dividend.Difficulty level: MediumTopic: STOCK SPLITType: CONCEPTS39. A one-for-four reverse stock split will:A. increase the par value by 25%.B. increase the number of shares outstanding by 400%.C. increase the market value but not affect the par value per share.D. increase a $1 par value to $4.E. increase a $1 par value by $4.Difficulty level: MediumTopic: REVERSE STOCK SPLITSType: CONCEPTS40. A reverse stock split is sometimes used as a means of:A. decreasing the liquidity of a stock.B. decreasing the market value per share of stock.C. increasing the number of stockholders.D. keeping a firm's stock eligible for trading on a stock exchange.E. raising cash from current stockholders.Difficulty level: EasyTopic: REVERSE STOCK SPLITSType: CONCEPTS41. Which of the following lists events in chronological order from earliest to latest?A. date of record, declaration date, ex-dividend date.B. date of record, ex-dividend date, declaration date.C. declaration date, date of record, ex-dividend date.D. declaration date, ex-dividend date, date of record.E. ex-dividend date, date of record, declaration date.Difficulty level: MediumTopic: DIVIDEND DATESType: CONCEPTS42. In an efficient market, ignoring taxes and time value, the price of stock should:A. decrease by the amount of the dividend immediately on the declaration date.B. decrease by the amount of the dividend immediately on the ex-dividend date.C. increase by the amount of the dividend immediately on the declaration date.D. increase by the amount of the dividend immediately on the ex-dividend date.E. Both B and C.Difficulty level: MediumTopic: EX-DIVIDEND DATESType: CONCEPTS43. On the date of record the stock price drop is:A. a full adjustment for the dividend payment.B. a partial adjustment for the dividend payment because of the tax effect.C. zero because it happens on the ex-dividend date.D. zero because it happens on the payment date.E. None of the above.Difficulty level: MediumTopic: DATE OF RECORDType: CONCEPTS44. The use of homemade dividends allows stockholders to change the:A. return pattern of the firm by leveraging their position like the firm.B. cash payout received by selling off shares to receive current dividends or purchasing additional shares with the dividends, as desired.C. value of the company by sending dividend requirement letters to the home office of the corporation.D. Both A and C.E. Both B and C.Difficulty level: MediumTopic: HOMEMADE DIVIDENDSType: CONCEPTS45. Homemade dividends are described by Modigliani and Miller to be the:A. dividend one pays oneself to avoid risky stocks.B. re-arrangement of the firm's dividend stream as management needs.C. re-arrangement of the firm's dividend stream by investors buying or selling their holdings in the stock.D. present value of all dividends to be paid.E. None of the above.Difficulty level: MediumTopic: HOMEMADE DIVIDENDSType: CONCEPTS46. The dividend-irrelevance proposition of Miller and Modigliani depends on the following relationship between investment policy and dividend policy:A. The level of investment does not influence or matter to the dividend decision.B. Once dividend policy is set the investment decision can be made as desired.C. The investment policy is set before the dividend decision and not changed by dividend policy.D. Since dividend policy is irrelevant there is no relationship between investment policy and dividend policy.E. Miller and Modigliani were only concerned about capital structure.Difficulty level: MediumTopic: DIVIDEND IRRELEVANCEType: CONCEPTS47. Dividends are relevant and dividend policy irrelevant when:A. cash dividends are always constant and dividend policy is changed as management needs.B. cash dividends are increased for one year while others are held constant, thus causing an increase in stock price, and dividend policy establishes the trade-off between dividends at different dates.C. cash dividends are always constant and dividend policy establishes the trade-off between dividends at different dates.D. cash dividends are increased for one payment while others are held constant and dividend policy is changed as management needs.E. None of the above.Difficulty level: MediumTopic: DIVIDEND RELEVANCEType: CONCEPTS48. A reverse split is when:A. the stock price gets too high for investors to purchase in round lots.B. the stock becomes too liquid and highly marketable.C. the stock price moves into the popular trading range.D. several old shares, such as 4, are replaced by 1 new share.E. None of the above.Difficulty level: EasyTopic: REVERSE SPLITType: CONCEPTS49. A firm announces that it is willing to purchase a number of shares back at various prices and shareholders have the option to indicate how many shares they are willing to sell at various prices. This process is called a:A. dividend creation model.B. secondary market transaction.C. free market sale.D. Dutch auction.E. None of the above.Difficulty level: EasyTopic: DUTCH AUCTIONType: CONCEPTS50. Characteristics of a sensible dividend policy include:A. over time pay out all free cash flowsB. set the current regular dividend consistent with a long-run target payout ratioC. use repurchases to distribute transitory cash flow increasesD. A and BE. All of the aboveDifficulty level: EasyTopic: CHARACTERISTICS OF SENSIBLE DIVIDEND POLICYType: CONCEPTS51. You owned 200 shares last year and received a stock dividend of 5% at the end of last year. The number of shares you now have is _____ and your wealth has increased by ______%.A. 10; 5B. 210; 5C. 210; 0D. 50,000; 5E. 50,000; 0# shares = 200(1.05) = 210The only change is in value per share.Difficulty level: EasyTopic: STOCK DIVIDENDSType: PROBLEMS52. The Rent It Company declared a dividend of $.60 a share on October 20th to holders of record on Monday, November 1st. The dividend is payable on December 1st. You purchased 100 shares of Rent It Company stock on Wednesday, October 27th. How much dividend income will you receive on December 1st from the Rent It Company?A. $0B. $1.50C. $6.00D. $15.00E. $60.00Dividend received = $.60 ⨯ 100 = $60.00Difficulty level: MediumTopic: STOCK DIVIDENDType: PROBLEMS53. You purchased 200 shares of ABC stock on July 15th. On July 20th, you purchased another 100 shares and then on July 22st you purchased your final 200 shares of ABC stock. The company declared a dividend of $1.10 a share on July 5th to holders of record on Friday, July 23rd. The dividend is payable on July 31st. How much dividend income will you receive on July 31st from ABC?A. $0B. $220C. $330D. $440E. $550Dividend received = $1.10 ⨯ (200 + 100) = $330Difficulty level: MediumTopic: STOCK DIVIDENDType: PROBLEMS54. The KatyDid Co. is paying a $1.25 per share dividend today. There are 120,000 shares outstanding with a par value of $1.00 per share. As a result of this dividend, the:A. retained earnings will decrease by $150,000.B. retained earnings will decrease by $120,000.C. common stock account will decrease by $150,000.D. common stock account will decrease by $120,000.E. capital in excess of par value account will decrease by $120,000.Decrease in retained earnings = $1.25 ⨯ 120,000 = $150,000Difficulty level: MediumTopic: STOCK DIVIDENDType: PROBLEMS55. On May 18th, you purchased 1,000 shares of BuyLo stock. On June 5th, you sold 200 shares of this stock for $21 a share. You sold an additional 400 shares on July 8th at a price of $22.50 a share. The company declared a $.50 per share dividend on June 25th to holders of record as of Thursday, July 10th. This dividend is payable on July 31st. How much dividend income will you receive on July 31st as a result of your ownership of BuyLo stock?A. $100B. $200C. $300D. $400E. $500Dividend received = $.50 ⨯ (1,000 - 200) = $400Difficulty level: MediumTopic: STOCK DIVIDENDType: PROBLEMS56. You own 300 shares of Abco, Inc. stock. The company has stated that it plans on issuing a dividend of $.60 a share one year from today and then issuing a final liquidating dividend of $2.20 a share two years from today. Your required rate of return is 9%. Ignoring taxes, what is the value of one share of this stock today?A. $2.36B. $2.40C. $2.62D. $2.80E. $2.85Value per share = ($.60 ÷ 1.091) + ($2.20 ÷ 1.092) = $2.40Difficulty level: MediumTopic: HOMEMADE DIVIDENDSType: PROBLEMS57. Priscilla owns 500 shares of Delta stock. It is January 1, 2006, and the company recently issued a statement that it will pay a $1.00 per share dividend on December 31, 2006 and a $.50 per share dividend on December 31, 2007. Priscilla does not want any dividend this year but does want as much dividend income as possible next year. Her required return on this stock is 12%. Ignoring taxes, what will Priscilla's homemade dividend per share be in 2007?A. $0B. $.50C. $1.50D. $1.62E. $1.68Homemade dividend = ($1.00 ⨯ 1.12) + $.50 = $1.62Difficulty level: MediumTopic: HOMEMADE DIVIDENDSType: PROBLEMS58. A firm has a market value equal to its book value. Currently, the firm has excess cash of $600 and other assets of $5,400. Equity is worth $6,000. The firm has 500 shares of stock outstanding and net income of $900. What will the new earnings per share be if the firm uses its excess cash to complete a stock repurchase?A. $1.20B. $1.50C. $1.80D. $2.00E. $2.40Price per share = $6,000 ÷ 500 = $12; Number of shares repurchased = $600 ÷ $12 = 50 shares; New EPS = $900 ÷ (500 - 50) = $2.00Difficulty level: MediumTopic: STOCK REPURCHASEType: PROBLEMS59. A firm has a market value equal to its book value. Currently, the firm has excess cash of $800 and other assets of $5,200. Equity is worth $6,000. The firm has 600 shares of stock outstanding and net income of $700. The firm has decided to spend all of its excess cash on a share repurchase program. How many shares of stock will be outstanding after the stock repurchase is completed?A. 480 sharesB. 500 sharesC. 520 sharesD. 540 sharesE. 560 sharesPrice per share = $6,000 ÷ 600 = $10; Number of shares repurchased = $800 ÷ $10 = 80; New number of shares outstanding = 600 - 80 = 520Difficulty level: MediumTopic: STOCK REPURCHASEType: PROBLEMS60. A firm has a market value equal to its book value. Currently, the firm has excess cash of $500 and other assets of $9,500. Equity is worth $10,000. The firm has 250 shares of stock outstanding and net income of $1,400. What will the stock price per share be if the firm pays out its excess cash as a cash dividend?A. $36B. $38C. $40D. $42E. $44Price per share = ($10,000 - $500) ÷ 250 = $38Difficulty level: MediumTopic: CASH DIVIDENDType: PROBLEMS61. A firm has a market value equal to its book value. Currently, the firm has excess cash of $400 and other assets of $7,600. Equity is worth $8,000. The firm has 200 shares of stock outstanding and net income of $900. The firm has decided to pay out all of its excess cash as a cash dividend. What will the earnings per share be after the dividend is paid?A. $0.25B. $0.45C. $2.50D. $3.80E. $4.50Earnings per share = $900 ÷ 200 = $4.50Difficulty level: MediumTopic: CASH DIVIDENDType: PROBLEMS62. Murphy's, Inc. has 10,000 shares of stock outstanding with a par value of $1.00 per share. The market value is $8 per share. The balance sheet shows $32,500 in the capital in excess of par account, $10,000 in the common stock account, and $42,700 in the retained earnings account. The firm just announced a 10% (small) stock dividend. What will the balance in the retained earnings account be after the dividend?A. $34,700B. $35,700C. $42,700D. $49,700E. $50,700Retained earnings = [(10,000 shares ⨯ .10) ⨯ $8 ⨯ -1] + $42,700 = $34,700Difficulty level: MediumTopic: SMALL STOCK DIVIDENDType: PROBLEMS63. Murphy's, Inc. has 10,000 shares of stock outstanding with a par value of $1.00 per share. The market value is $8 per share. The balance sheet shows $32,500 in the capital in excess of par account, $10,000 in the common stock account and $42,700 in the retained earnings account. The firm just announced a 10% (small) stock dividend. What will the market price per share be after the dividend?A. $7.20B. $7.27C. $7.33D. $8.00E. $8.80Market price per share = (10,000 shares ⨯ $8) ÷ (10,000 shares ⨯ 1.10) = $7.27; Note that the total market value of the firm does not change.Difficulty level: MediumTopic: SMALL STOCK DIVIDENDType: PROBLEMS。

Chapter 23 Options and Corporate Finance: Extensions and Applications Answer KeyMultiple Choice Questions1. The option to abandon is:A. a real option.ually of little value because of the cost associated with abandonment.C.irrelevant in capital budgeting analysis.D.nearly always less relevant the option to expand.E.All of the above.Difficulty level: MediumTopic: OPTION TO ABANDONType: DEFINITIONS2. An example of a special option is:A.an executive stock option.B.the embedded option in a start-up company.C.the option in simple business contracts.D.the option to shut down and reopen a project.E.All of the above.Difficulty level: MediumTopic: SPECIAL OPTIONType: DEFINITIONS3. Executives can not exercise their options for a fixed period of time. This is the:A.investing period.B.freeze-out period.C.valuation period.D.guaranteed growth period.E.strike period.Difficulty level: MediumTopic: FREEZE-OUT PERIODType: DEFINITIONS4. The NPV approach must be:A.augmented by added analysis if there are a few embedded options.B.augmented by added analysis if a decision has significant embedded options.C.jettisoned if there are any embedded options.puted carefully to identify the options.E.None of the above.Difficulty level: MediumTopic: EMBEDDED OPTIONSType: CONCEPTS5. Options are granted to top corporate executives because:A.executives will make better business decisions in line with benefiting the shareholders.B.executive pay is at risk and linked to firm performance.C.options are tax-efficient and taxed only when they are exercised.D.All of the above.E.None of the above.Difficulty level: MediumTopic: EXECUTIVE OPTIONSType: CONCEPTS6. The call option on a dividend paying stock compared to a non-dividend paying stock is:A.more valuable because of the extra dividend payment.B.equal in value because cash dividends are paid on stock only.C.less valuable because cash dividends are paid on stock only.D.less valuable if the dividend paying stock is in-the-money while the non-dividend paying stock if out-of-the-money.E.None of the above.Difficulty level: ChallengeTopic: CALL OPTION ON DIVIDEND PAYING STOCKType: CONCEPTS7. The value of the options awarded executives is much less than face value to the executives because:A.the value to the executive depends on the stock price being greater than the exercise price.B.the options must be held beyond the freeze-out period.C. a highly undiversified portfolio can have a large drop in value with high variance stocks.D.All of the above.E.None of the above.Difficulty level: MediumTopic: EXECUTIVE OPTIONSType: CONCEPTS8. By rewarding executives with large option positions, corporations:A.cause the executives to hold highly undiversified portfolios.B.put the firm in a risky position to pay off the options.C.cause the value of the stock to fall because the options are theft.D.are really valueless because most options are never exercised.E.None of the above.Difficulty level: ChallengeTopic: EXECUTIVE OPTIONSType: CONCEPTS9. Investing in a negative NPV project today is a feasible choice if:A.there are future option alternatives.B.investing is sequentially limited.C.the discount rate is low.D.Both A and B.E.Both A and C.Difficulty level: MediumTopic: NEGATIVE NPV PROJECTS AND REAL OPTIONSType: CONCEPTS10. The opportunity to defer investing to a later date may have value because:A.the cost of capital may decline in the near future.B.certainty may be reduced in the future.C.investment costs fluctuate in time.D.All of the above.E.None of the above.Difficulty level: EasyTopic: OPTION TO DEFERType: CONCEPTS11. Rejecting an investment today forever may not be a good choice because:A.the size of the firm will decline.B.there are always errors in the estimation of NPVs.C.the option value is negative.D.the company's foregoing the future rights or option to the investment.E.None of the above.Difficulty level: MediumTopic: REAL OPTIONSType: CONCEPTS12. A financial manager who does not follow the general constraints of the NPV rule may:A.accept a negative NPV project for fear of losing an investment opportunity.B.accept a marginally acceptable NPV project limiting the corporation's ability to choose a competing project.C.not consider all options available in a capital budgeting decision.D.not take a positive NPV project even if the NPV is adequate reward to forego the option.E.All of the above.Difficulty level: MediumTopic: REAL OPTIONSType: CONCEPTS13. The volatility of interest rates can affect the value of the project by:A.increasing the value as volatility increases.B.increasing the value as volatility decreases.C.decreasing the value as volatility increases.D.interest rate volatility does not affect value.E.None of the above.Difficulty level: MediumTopic: INTEREST RATE VOLATILITYType: CONCEPTS14. Which of the following statements is true?A.The Black Scholes model is the simplest to use and best used for complex situations.B.The binomial model does not handle options with dividend payments prior to expiration date.C.The Black Scholes model adequately handles the valuation of an American put.D.The binomal model is better for complex situations and is the simplest tool to use.E.The Black Scholes model is simpler to use, but for complex situations, the binomial model is the necessary tool.Difficulty level: MediumTopic: OPTION PRICING TOOLSType: CONCEPTS15. If a project has optionality:A.the shorter the available life of the project the less valuable the project is.B.the longer the available life of the project the less valuable the project is.C.the shorter the available life of the project the more valuable the project is.D.available project life does not change optionality.E.None of the above.Difficulty level: EasyTopic: OPTIONALITYType: CONCEPTS16. The equal rate of price change from each subsequent up state and fixed rate price change from each subsequent down state are reasonable if:A.there is a constant variability.B.any new information impacting prices is similar period to period.C.interest or discount rates are constant.D.Both A and C.E.Both A and B.Difficulty level: MediumTopic: VARIABILITY AND INFORMATIONType: CONCEPTS17. The most correct method to determine the current value of future payoffs would be to:A.take the discounted expected value at the risk-free rate.B.take the expected value using the probabilities.C.take the discounted expected value using the risk-neutral probabilities and the risk free rate.D.sum the payoffs discounted at the risk free rate.E.None of the above.Difficulty level: MediumTopic: VALUATION OF FUTURE PAYOFFSType: CONCEPTS18. The risk-neutral probabilities for an asset, with a current value equal to the present value of future payoffs are:A.given by the probability of each state occurring.B.given by the value of the underlying asset under good news and the risk free rate.C.given by the value of the underlying asset under good news and bad news.D.given by the value of the underlying asset under good news, bad news, and the risk free rate.E.None of the above.Difficulty level: ChallengeTopic: VALUATION OF FUTURE PAYOFFSType: CONCEPTS19. A branching tree for the binomial model:A.should capture all possible futures paths for the asset.B.has a move down followed by a move up on a subsequent branch to end at the same value as the reverse path.C.has a move down followed by a move up on a subsequent branch to end at a lower value than a move up then a move down.D.Both A and C.E.Both A and B.Difficulty level: ChallengeTopic: BINOMIAL MODELType: CONCEPTS20. Increasing the number of intervals in the binomial model causes the price shift parameters to change. New estimates are related to:A.the standard deviation of the underlying asset.B.the up state multiplier equals the standard deviation divided by root n.C.the number of intervals in a year.D.All of the above.E.None of the above.Difficulty level: MediumTopic: BINOMIAL MODELType: CONCEPTS21. Which of the following is not part of the Black Scholes option pricing model?A.Standard deviationB.Time to maturityC.Exercise priceD.Par value of the company's stockE.Interest rateDifficulty level: MediumTopic: BLACK SCHOLES OPTION PRICING MODELType: CONCEPTS22. What are the u, the up state multiplier, and d, the down state multiplier, if there are monthly intervals and the standard deviation is .38?A. 1.1159; .8961B..0317; 31.5789C..0317; .9683D..2193; .7807E.None of the aboveDifficulty level: MediumTopic: BLACK SCHOLES OPTION PRICING MODELType: CONCEPTS23. On the notion of embedded options, which of the following is/are true?A.If virtually all projects have embedded options, ignoring options is likely to lead to serious undervaluation.B.There are at least two possible outcomes for virtually every business idea.C.Virtually every business has both the option to abandon and the option to expand.D.All of the above.E.Both B and C.Difficulty level: MediumTopic: EMBEDDED OPTIONSType: CONCEPTS24. A firm in the extraction industry whose major assets are cash, equipment and a closed facility may appear to have extraordinary value. This value can be primarily attributed to:A.the potential sale of the company.B.the low exercise price held by the shareholders.C.the option to open the facility when prices rise dramatically.D.All of the above.E.None of the above.Difficulty level: MediumTopic: REAL OPTIONSType: CONCEPTSNote: Correct answers to later questions are dependent on correct answers to earlier questions.Ima Greedy, the CFO of Financial Saving Techniques has been granted options on 200,000 shares. The stock is currently trading at $22 a share and the options are at the money. The variance of the stock has been about .07 on an annual basis over the last several years. The options mature in 3 years and the risk free rate is 4%.25. What is d?1A..1842B..4102C..4583D..4909E..5412= [ln(22/22) + [.04 + (.50x.07)(3)]/ (.07)3 d1= .225/.4583 = .4909d1Difficulty level: MediumTopic: BLACK SCHOLES OPTION PRICING MODELType: PROBLEMS26. What is d2?A..0121B..0252C..0326D..0452E..0525d 2 = d1- √σ2t = .4909 - √(.07)(3) = .4909 - .4583 = .0326Difficulty level: MediumTopic: BLACK SCHOLES OPTION PRICING MODEL Type: PROBLEMS27. What is e-rt?A..6087B..7087C..7952D..8476E..8869e-.04(3) = .8869Difficulty level: MediumTopic: BLACK SCHOLES OPTION PRICING MODEL Type: PROBLEMS28. Calculate N(d).1A..5054B..6508C..6882D..7047E..8096) = .50 + .1882 = .6882 N(d1Difficulty level: MediumTopic: BLACK SCHOLES OPTION PRICING MODEL Type: PROBLEMS29. Calculate N(d).2A..5130B..5578C..6085D..7085E..7142) = .50 + .0130 = .5130N(d2Difficulty level: MediumTopic: BLACK SCHOLES OPTION PRICING MODELType: PROBLEMS30. What is the value of a call option?A.$4.14B.$4.86C.$5.13D.$5.62E.$6.16。

Chapter 20Issuing Securities to the Public Multiple Choice Questions1. An equity issue sold directly to the public is called:A. a rights offer.B. a general cash offer.C. a restricted placement.D. a fully funded sales.E. a standard call issue.2. An equity issue sold to the firm's existing stockholders is called:A. a rights offer.B. a general cash offer.C. a private placement.D. an underpriced issue.E. an investment banker's issue.3. Management's first step in any issue of securities to the public is:A. to file a registration form with the SEC.B. to distribute copies of the preliminary prospectus.C. to distribute copies of the final prospectus.D. to obtain approval from the board of directors.E. to prepare the tombstone advertisement.4. A rights offering is:A. the issuing of options on shares to the general public to acquire stock.B. the issuing of an option directly to the existing shareholders to acquire stock.C. the issuing of proxies which are used by shareholders to exercise their voting rights.D. strictly a public market claim on the company which can be traded on an exchange.E. the awarding of special perquisites to management.5. Companies use tombstone advertisements in the financial press to:A. announce the death of the company.B. announce the failure of a financial strategy.C. announce the availability of a new issue of a corporate security.D. notify the public of foreclosure.E. None of the above.6. The first public equity issue made by a company is a(n):A. initial private offering.B. initial public offering.C. secondary offering.D. seasoned new issue.E. None of the above.7. The first public equity issue that is made by a company is referred to as:A. a rights issue.B. a general cash offer.C. an initial public offering.D. an unseasoned issue.E. Both C and D.8. A new public equity issue from a company with equity previously outstanding is called a(n):A. initial public offering.B. seasoned equity issue.C. unseasoned equity issue.D. private placement.E. syndicate.9. The green shoe option is used to:A. cover oversubscription.B. cover excess demand.C. provide additional reward to the investment bankers for a risky issue.D. provide additional reward to the issuing firm for a risky issue.E. Both A and B.10. Dilution refers to:A. the increase in stock value due to wider ownership of stock.B. the loss in existing shareholder's equity.C. the loss in new shareholder's equity.D. the loss in all shareholder's equity, both existing shareholders and new shareholders.E. None of the above.11. During the SEC waiting period the potential issuing company can issue a preliminary prospectus which contains:A. exactly the same information as the final prospectus except an indication of SEC approval.B. all the information as the final prospectus including red writing stating it is a red herring.C. very limited financial information and red writing stating it is preliminary.D. only a description of what the funds are to be used for.E. information very similar to the final prospectus without a price nor with SEC approval.12. A company must file a registration statement with the SEC providing various financial and company history information. The registration statement does not need to be filed if:A. the issue is less than $50 million.B. the loan matures within 9 months.C. the issue is less than $5.0 million.D. Both A and B.E. Both B and C.13. Regulation A security issues are exempt from full SEC registration filing and use only a brief offering statement if:A. the issue is for less than $5,000,000.B. insiders sell no more than $1,500,000 of stock.C. insiders sell no more than 100,000,000 shares.D. Both A and C.E. Both A and B.14. Potential investors learn of the information concerning the firm and its new issue from the:A. pre-underwriting negotiating meeting.B. red herring.C. letter of commitment.D. emails from their former finance professor.E. rights offering.15. A registration statement is effective on the 20th day after filing unless:A. the SEC is backlogged with statements.B. a tombstone ad is issued indicating its demise.C. a letter of comment suggesting changes is issued by the SEC.D. a syndicate can be formed sooner.E. None of the above.16. Investment banks perform which of the following services for corporate issuers:A. formulating the method used to issue the securities.B. pricing the new securities.C. selling the new securities.D. All of the above.E. None of the above.17. A group of investment bankers who pool their efforts to underwrite a security are known as a(n):A. amalgamate.B. conglomerate.C. green shoe group.D. klatch.E. syndicate.18. A firm commitment arrangement with an investment banker occurs when:A. the syndicate is in place to handle the issue.B. the spread between the buying and selling price is less than one percent.C. the issue is solidly accepted in the market evidenced by a large price increase.D. when the investment banker buys the securities for less than the offering price and accepts the risk of not being able to sell them.E. when the investment banker sells as much of the security as the market can bear without a price decrease.19. Which of the following is not normally an example of the services offered by investment bankers?A. Aiding in the sale of securitiesB. Facilitating mergersC. Acting as brokers to both individuals and institutional clientsD. Offering checking accounts to corporationsE. Both C and D20. In a best efforts offering the investment banker makes their money primarily by:A. earning the spread between the buying and offering price.B. earning a commission on each share sold.C. earning the discount between the buying and offering price.D. charging a flat fee for all services.E. None of the above.21. Under the _____ method, the underwriter buys the securities for less than the offering price and accepts the risk of not selling the issue, while under the _____ method, the underwriter does not purchase the shares but merely acts as an agent.A. best efforts; firm commitmentB. firm commitment; best effortsC. general cash offer; best effortsD. competitive offer; negotiated offerE. seasoned; unseasoned22. Professor Jay Ritter found best-efforts offerings are:A. reserved for the premier customers because they deserve 'best-efforts'.B. used most often with seasoned equity issues.C. used with small IPO issues.D. attractive because of price stability.E. None of the above.23. Empirical evidence suggests that new equity issues are generally:A. priced efficiently by the market.B. overpriced by investor excitement concerning a new issue.C. overpriced resulting from SEC regulation.D. underpriced, in part, to counteract the winner's curse.E. underpriced resulting from SEC regulation.24. The diagonal listing of investment bankers on tombstone advertisements reflects their ____ relative to the other investment bankers listed below.A. prestigeB. ability to manage selling syndicatesC. role as a firm commitment buyerD. role as a best efforts sellerE. None of the above25. The reputational capital of investment bankers is based on their roles as intermediaries with more in-depth knowledge of the issuer. Investment bankers maintain their reputation by:A. certifying the issue.B. monitoring the issuing firm's management and performance.C. pricing issues fairly.D. All of the above.E. None of the above.26. The key difference between a negotiated offer and a competitive offer is that:A. the underwriters can not set the spread in a negotiated bid but can in a competitive offer.B. the issuing firm can offer its securities to the highest bidder in a competitive bid but in a negotiated bid only one investment banker is used.C. the issuing firm works the underwriter for the best spread in a negotiated bid which will be less than that available in a competitive offer.D. the underwriter will not do a full investigation in a negotiated bid because the company is at their mercy, while in a competitive bid the underwriter must be extra diligent.E. None of the above.27. The offering price is set to make an issue attractive to the market and provide a good price to the issuer. Which of the following is/are true?A. Empirical studies by Ritter have shown that the average firm commitments have had a17.8% underpricing on the first day of trading.B. Empirical studies have shown that best efforts sales have underpricing on the first day of trading.C. Some issues which rose dramatically on the first day of trading were viewed as successfully priced by the underwriter because it helped build a long-term investment base.D. All of the above.E. None of the above.28. Empirical evidence suggests that upon announcement of a new equity issue, current stock prices generally:A. drop, perhaps because the new issue reflects management's view that common stock is currently overvalued.B. remain about the same since an efficient market anticipates a new equity issue.C. increase, perhaps because the issues are associated with positive NPV projects.D. increase, because the market supply is always less than demand.E. increase, because underwriters exercise their green shoe option.29. Underpricing can possibly be explained by:A. oversubscription of an issue.B. strong demand by investors.C. undersubscription of an issue.D. Both B and C.E. Both A and B.30. Debt capacity is often given as a reason for the value of the stock falling when equity is issued. The reason for this is:A. the high issue costs of a debt offering must be paid by the shareholders.B. the priority position of the equity is lowered.C. management has information that the probability of default has risen, limiting the debt capacity and causing the firm to raise equity capital.D. All of the above.E. None of the above31. A study by Lee, Lockhead, Ritter, and Zhao that examined the underwriting discount and other direct costs of going public with a debt or equity offering, found:A. the direct expenses are higher for equity than debt offerings.B. substantial economies of scale are prevalent.C. underpricing, on average, is similar in magnitude to total direct expenses.D. All of the above.E. None of the above.32. The six components that make up the total costs of new issues are:A. the spread; other direct expenses such as filing fees; indirect expenses such as management time; economies of scale; abnormal returns and the Green Shoe option.B. the discount; other direct expenses such as filing fees; indirect expenses such as management time; due diligence costs; abnormal returns and the Green Shoe option.C. the spread; other direct expenses such as filing fees; indirect expenses such as management time; abnormal returns; underpricing and the Green Shoe option.D. the spread; other direct expenses such as filing fees; economies of scale; due diligence costs; abnormal returns and underpricing.E. None of the above.33. In comparison to debt issuance expenses, the total direct costs of equity issues are:A. considerably less.B. about the same.C. meaningless.D. considerably greater.E. None of the above.34. To determine the value of a rights offering, the stockholder needs to know the following two pieces of information in addition to the current stock price:A. the subscription price and the number of rights needed to acquire a new share.B. the amount of new equity to be raised and the number of rights needed to acquire a new share.C. the amount of new equity to be raised and standby fee.D. the detachment date and the subscription price.E. None of the above.35. Assuming everything else is constant, when a stock goes ex-rights its price should:A. decrease since the stockholder is losing an option.B. increase since the corporation no longer has the right to force the stockholder to convert.C. remain the same since an efficient market would anticipate this change.D. move up or down depending on whether a small investor wanted to exercise his/his rights.E. None of the above.36. If a shareholder or investor wants to acquire new stock under a rights plant they must:A. acquire new stock in the market to get a controlling fraction of shares to be eligible for rights.B. simply pay a registration fee and turn in the subscription price.C. acquire the correct rights per share desired, then turn the rights and the total subscription price into the subscription agent.D. acquire the correct rights and wait for the company to send you the stock.E. call their broker and sell some CBOE options to make any money.37. Which of the following statements is true?A. The subscription price is generally above the old stock price.B. The subscription price is generally above the ex-rights price.C. The subscription price is generally below the old stock price.D. Both A and B.E. Both B and C.38. A shareholder who has rights is:A. always better off to exercise the rights.B. always better off to sell the rights into the market.C. able to exercise their rights or sell them.D. never in the same ownership position again with rights.E. None of the above.39. A standby underwriting arrangement provides the:A. company with methods to cancel the offering.B. company with an alternate investment banker if there is conflict between the issuer and the agent.C. investment banker with an oversubscription privilege to ensure profits are earned.D. company with an alternative avenue of sale to ensure success of the rights offering.E. investment bankers with an added syndication for the rights offering.40. Professor Clifford W. Smith, in evaluating issuance costs from underwritten issues, rights issues with standby underwriting, and a pure rights issues, found that 90% of the issues are underwritten, which was the most expensive method. This is done because:A. investment bankers know more than CFOs and they may buy the issue at an agreed upon price and disburse the funds sooner.B. investment bankers can increase the price received by increasing confidence in the issue, and they will buy the issue at an agreed upon price and disburse the cash sooner.C. investment bankers provide other services including price counseling, increasing public confidence, and providing funds to the issuer sooner.D. investment bankers know how to price the issue, and would not need to set as low as a price as the subscription price and provide price counseling.E. None of the above.41. Corporations use the shelf registration method of security sales because:A. preregistered securities can be quickly brought to market.B. the main registration process is eliminated for up to two years.C. their stock is below investment grade.D. Both A and B.E. Both B and C.42. In terms of costs of issuing equity, Professor Clifford W. Smith finds that the ranking of methods, from cheapest to most expensive, is:A. rights issue with standby underwriting, equity issue with underwriting, pure rights issue.B. pure rights issue, rights issue with standby underwriting, equity issue with underwriting.C. pure rights issue, preferred stock and debt issue with underwriting for an IPO, rights issue with standby underwriting.D. equity issue with underwriting, rights issue with standby underwriting, pure rights issue.E. equity issue with underwriting, pure rights issue, rights issue with standby underwriting.43. Arguments to explain why most equity issues are underwritten versus sold through a rights offering are:A. underwriters buy at an agreed upon price and bear some risk of selling the issue.B. cash proceeds are available sooner in underwriting and the issue is available to a wider market.C. investment bankers can provide market advice and certify the issue for potential investors.D. All of the above.E. None of the above.44. Corporations are allowed to use the shelf registration method if they:A. are rated investment grade and have aggregate market stock value of more than $150 million.B. have not violated the 1934 Securities Act in the past 12 months.C. have not defaulted on its debt in the past 3 years.D. All of the above.E. None of the above.45. Arguments against the use of the shelf-registration are:A. only technology and manufacturing-based firms can use it.B. less current information available to investors might raise the cost of debt.C. possible market overhang from future issues depressing price.D. Both A and C.E. Both B and C.46. The market for venture capital refers to the:A. private financial marketplace for servicing small, young firms.B. bond markets.C. market for selling rights to individuals who already own shares.D. market for selling equity securities for firms with equity already outstanding.E. None of the above.47. Rule 144A provides the framework for the issuance of private securities to qualified institutional investors. To buy private securities, institutional investors:A. must be willing to hold a less liquid security and manage a fund.B. must be willing to make a market in the security and be a primary market dealer.C. must be a limited partner in the issue and willing to reduce the illiquidity of the security.D. must be willing to hold a less liquid security and have $100 million under management.E. None of the above.48. Venture capitalists provide financing for new firms from the seed and start-up stage all the way to mezzanine and bridge financing. In exchange for financing, entrepreneurs give:A. a high interest rate debt instrument and control.B. an equity position and usually board of director positions.C. up the right to have an initial public offering.D. control to a court appointed trustee.E. the venture capitalists jobs as CEOs and CFOs.49. An IPO of a firm formerly financed by venture capital is carried out for what primary purposes?A. Insiders can sell their shares or cash outB. Generate cash to pay down bank indebtednessC. To establish a market value for the equity and provide funds for operationsD. All of the above.E. None of the above.50. Which of the following is not one of the four main functions that underwriters provide?A. Risk bearingB. MarketingC. Auditing the financial statementsD. CertificationE. Monitoring51. Types of dilution include:A. dilution of percentage ownershipB. dilution of market shareC. dilution of book value and earnings per shareD. A and CE. All of the above52. The Wordsmith Corporation has 10,000 shares outstanding at $30 each. They expect to raise $150,000 by a rights offering with a subscription price of $25. How many rights must you turn in to get a new share?A. 0.60B. 1.20C. 1.67D. 2.00E. Insufficient data to determine53. Assuming everything else is constant, if a stock's old price is $25 and the ex-rights or new stock price is $19, then the value of the right is:A. $-6.B. $6.C. impossible to determine without the subscription price.D. impossible to determine without the number of rights needed to buy one share.54. The LaPorte Corporation has a new rights offering that allows you to buy one share of stock with 3 rights and $20 per share. The stock is now selling ex-rights for $26. The price rights-on is:A. $22.00B. $24.00C. $26.00D. $28.00E. impossible to determine without the cum-rights price.55. Regional Power wants to raise $10 million in new equity. The subscription price is $20. There are currently 3 million shares outstanding, each with 1 right. How many rights are needed to purchase 1 share?A. 1B. 3C. 5D. 6E. 856. The Overland Corporation intends to issue 50,000 new shares to raise funds for expansion of current plant facilities. The current share price is $40 and there are 500,000 shares outstanding. The number of rights needed to buy a share of stock should be:A. 1B. 10C. 40D. 400E. indeterminate without the subscription price.57. The Schroeder Corporation has 20,000 shares outstanding at $20 each. They expect to raise $200,000 by a rights offering with a subscription price of $25. How many rights must you turn in to get a new share?A. 1.25B. 1.50C. 2.00D. 2.50E. Insufficient data to determine58. Assuming everything else is constant, if a stock's old price is $40 and the ex-rights or new stock price is $32, then the value of the right is:A. $-8.B. $8.C. impossible to determine without the subscription price.D. impossible to determine without the number of rights needed to buy one share.59. The Holly Corporation has a new rights offering that allows you to buy one share of stock with 4 rights and $25 per share. The stock is now selling ex-rights for $30. The price rights-on is:A. $21.00B. $25.00C. $30.00D. $31.25E. impossible to determine without the cum-rights price.60. Bradley Power wants to raise $40 million in new equity. The subscription price is $25. There are currently 5 million shares outstanding, each with 1 right. How many rights are needed to purchase 1 share?A. 1.000B. 3.000C. 3.125D. 4.525E. 6.52561. The Shields Corporation intends to issue 100,000 new shares to raise funds for expansion of current plant facilities. The current share price is $20 and there are 500,000 shares outstanding. The number of rights needed to buy a share of stock should be:A. 1B. 5C. 20D. 50E. indeterminate without the subscription price.62. For a particular stock the old stock price is $20, the ex-rights price is $15, and the number of rights needed to buy a new share is 2. Assuming everything else constant, the subscription price is ______ .A. $5B. $13C. $17D. $18E. $20Essay QuestionsThe Holyoke Corporation has 120,000 shares outstanding with a current market price of $8.10 per share. The company needs to raise an additional $36,000 to finance new expenditures, and has decided on a rights issue. The issue will allow current stockholders to purchase one additional share for 20 rights at a subscription price of $6 per share.63. Calculate the ex-rights price that would make a new stockholder indifferent between buying shares at the old stock price and exercising the rights or buying the shares ex-rights.64. If the ex-rights price were set at $7.90, would you as a potential new stockholder choose to buy shares ex-rights or buy shares at the old price and exercise your rights?65. Suppose that the company was also considering structuring the rights issue to allow for an additional share to be purchased for 10 rights at a subscription price of $3. Prove that a stockholder with 100 shares would be indifferent between purchasing a new share for 10 rights at $3 or purchasing a new share for 20 rights at $6.66. Explain the advantages of a shelf-registration to an issuer. How can timeliness of disclosure and a potential market overhang work against a shelf-registration?67. The evidence on IPO sales is varied from issue to issue, but there are three common themes; underpricing, underperformance, and the reasons for going public. Explain these three themes.68. The Direct Interactive Publishing Company is planning to raise $200 million dollars in new capital. There are currently 50 million shares outstanding with an estimated market price of $60 each. The corporate officers are debating whether to use a rights offering (with or without a standby underwriting) or have the issue fully underwritten. The company is currently listed on a regional exchange and plans to list on a national exchange after the security issue. List and explain three advantages/disadvantages of each method.69. Discuss what a Dutch auction is and how it works.70. Lamar Inc. is attempting to raise $5,000,000 in new equity with a rights offering. The subscription price will be $40 per share. The stock currently sells for $50 per share and there are 250,000 shares outstanding. How many rights are needed to buy a new share?71. Lamar Inc. is attempting to raise $5,000,000 in new equity with a rights offering. The subscription price for the 125,000 new shares will be $40 per share. The stock currently sells for $50 per share and there are 250,000 shares outstanding. What will the price per share be if all rights are exercised?Chapter 20 Issuing Securities to the Public Answer KeyMultiple Choice Questions1. An equity issue sold directly to the public is called:A. a rights offer.B. a general cash offer.C. a restricted placement.D. a fully funded sales.E. a standard call issue.Difficulty level: EasyTopic: EQUITY ISSUEType: DEFINITIONS2. An equity issue sold to the firm's existing stockholders is called:A. a rights offer.B. a general cash offer.C. a private placement.D. an underpriced issue.E. an investment banker's issue.Difficulty level: EasyTopic: RIGHTS OFFERType: DEFINITIONS3. Management's first step in any issue of securities to the public is:A. to file a registration form with the SEC.B. to distribute copies of the preliminary prospectus.C. to distribute copies of the final prospectus.D. to obtain approval from the board of directors.E. to prepare the tombstone advertisement.Difficulty level: EasyTopic: SECURITY ISSUANCEType: DEFINITIONS4. A rights offering is:A. the issuing of options on shares to the general public to acquire stock.B. the issuing of an option directly to the existing shareholders to acquire stock.C. the issuing of proxies which are used by shareholders to exercise their voting rights.D. strictly a public market claim on the company which can be traded on an exchange.E. the awarding of special perquisites to management.Difficulty level: MediumTopic: RIGHTS OFFERINGType: DEFINITIONS5. Companies use tombstone advertisements in the financial press to:A. announce the death of the company.B. announce the failure of a financial strategy.C. announce the availability of a new issue of a corporate security.D. notify the public of foreclosure.E. None of the above.Difficulty level: EasyTopic: NEW ISSUANCEType: DEFINITIONS6. The first public equity issue made by a company is a(n):A. initial private offering.B. initial public offering.C. secondary offering.D. seasoned new issue.E. None of the above.Difficulty level: EasyTopic: INITIAL PUBLIC OFFERINGType: DEFINITIONS7. The first public equity issue that is made by a company is referred to as:A. a rights issue.B. a general cash offer.C. an initial public offering.D. an unseasoned issue.E. Both C and D.Difficulty level: MediumTopic: INITIAL PUBLIC OFFERINGType: DEFINITIONS8. A new public equity issue from a company with equity previously outstanding is called a(n):A. initial public offering.B. seasoned equity issue.C. unseasoned equity issue.D. private placement.E. syndicate.Difficulty level: EasyTopic: SEASONED EQUITY OFFERINGType: DEFINITIONS9. The green shoe option is used to:A. cover oversubscription.B. cover excess demand.C. provide additional reward to the investment bankers for a risky issue.D. provide additional reward to the issuing firm for a risky issue.E. Both A and B.Difficulty level: MediumTopic: GREEN SHOE PROVISIONType: DEFINITIONS。