Finance 101 Sample Questions (Term3A 07/08 Final)

1. When considering a capital budgeting project the financial manager should

consider the:
I. size of the project.
II. timing of the project's cash flows.
III. risk associated with the project's cash flows.
a. I only
b. II only
c. I and III only
d. II and III only
E. I, II, and III

2. Which of the following are advantages of the corporate form of business

ownership?
I. limited liability for firm debt
II. double taxation
III. ability to raise capital
IV. unlimited firm life
a. I and II only
b. III and IV only
c. I, II, and III only
d. II, III, and IV only
E. I, III, and IV only

3. Which of the following represent means by which cash flows from a corporation
back into the financial markets?
I. repayment of long-term debt
II. payment of government taxes
III. payment of loan interest
IV. sale of corporate stock
a. I and II only
B. I and III only
c. II and IV only
d. I, III, and IV only
e. I, II, and III only

4. Which of the following are included in current liabilities?

I. note payable to a supplier in eight months
II. amount due from a customer next month
III. account payable to a supplier that is due next week
IV. loan payable to the bank in fourteen months
A. I and III only
b. II and III only
c. III and IV only
d. II, III, and IV only
e. I, II, and III only
5. As seen on an income statement:
a. interest is deducted from income and increases the total taxes incurred.
b. the tax rate is applied to the earnings before interest and taxes when the firm has
both depreciation and interest expenses.
c. depreciation is shown as an expense but does not affect the taxes payable.
D. depreciation reduces both the taxable income and the net income.
e. interest expense is added to earnings before interest and taxes to get taxable
income.

6. Net capital spending:

a. is equal to ending fixed assets minus beginning fixed assets.
B. is equal to zero if the decrease in the fixed assets account is equal to the
depreciation expense.
c. reflects the net changes in total assets over a stated period of time.
d. is equivalent to the cash flow from assets minus the operating cash flow minus the
change in net working capital.
e. is equal to the change in the inventory balance for the period.

7. Which one of the following must increase the cash flow to creditors?
A. an increase in the cash flow from assets accompanied by a decrease in the cash
flow to stockholders
b. acquiring new long-term debt
c. decreasing the dividend paid
d. a decrease in both the cash flow to stockholders and the cash flow from assets
e. the repayment of an old loan and the acquisition of a new loan
8. What is the change in the net working capital from 2006 to 2007?
a. $1,379
B. $553
c. $1,887
d. $2,280
e. $4,007

9. What is the amount of the net capital spending for 2007?

a. $780
B. $2,238
c. $2,918
d. $3,747
e. $3,841

10. What is the cash flow from assets for 2007?

A. $109
b. $247
c. $508
d. $967
e. $1,215

11. Herman's Bar and Grill paid $1,618 in interest and $265 in dividends last year.
The times interest earned ratio is 1.9 and the depreciation expense is $50. What is the
value of the cash coverage ratio?
a. 1.62
b. 1.87
C. 1.93
d. 1.99
e. 2.11
12. A firm has net working capital of $2,580, net fixed assets of $13,120, sales of
$22,580, and current liabilities of $1,610. How many dollars worth of sales are
generated from every $1 in total assets?
a. $1.27
B. $1.30
c. $1.67
d. $1.72
e. $1.75

13.Your grandmother’s trust fund will pay you $1000 each year for 15 years starting
today. It so happens that, you have to pay for your car loan: 15 annual payments of
$1000 each starting one year from now. What is the NPV of these cash flows?
a. Zero, because positive and negative cash flows offset.
B. Positive, because the cash inflows start first.
c. Negative, because the cash inflows start first.
d. Depends on the interest rate.

14. What is the present value of $125 dollars received every second week starting two
weeks from now for six months if the APR is 15.6%?
a. $2,500
b. $2,870
c. $3,250
D. $3,000

15. I have to buy my first Saab on my 33rd birthday. I will start saving next month, so
there are 34 months to go. I expect the price of the car to be $32,017 then. If I set
aside $534 every month at 7% APR, how much will I need to borrow in addition to
my savings when I buy the car?
a. $20,017
B. $12,000
c. $32,017
d. None, savings will be enough

16. Interest rates have fallen. You have the opportunity to refinance your mortgage at
7% compounded monthly. Refinancing will cost $4,000, but will save you $143.07 a
month in interest payments. You plan to live in your home for another 3 years. Is
refinancing worthwhile?
a. Yes, the NPV is + $505.50.
b. No, the NPV is - $505.50.
C. Yes, the NPV is + $633.54.
d. No, the NPV is - $633.54.

17. Bob is saving for retirement. If interest rates rise, Bob

a. does not have to worry since this results in two equal and opposite effects that
cancel each other out.
b. has to save more today to have the same retirement income since the discount
factor increases.
C. will have a larger retirement income by saving the same amount today.
d. None of the above.
18. If a bank offers a deposit with an EAR of 3.725% with monthly compounding,
what is the periodic rate of interest on the deposit?
A. 0.3052%
b. 0.3104%
c. 3.6629%
d. 3.7250%

19. Your student loans will amount to 20,000 when you graduate, and you will have
to pay them off in 60 monthly payments of 386.66. After you have made payments for
two years, what will be the present value (at that time) of the remaining payments?
A. $12,170
b. $20,000
c. $19,000
d. $13,920

20. The internal rate of return for a project will increase if:
a. the initial cost of a project is increased.
b. the total amount of the cash inflows is reduced.
c. each cash inflow is moved such that it occurs one year later than originally
projected.
d. the required rate of return is increased.
E. the salvage value of the assets utilized by the project is increased.

21. Which of the following are elements of the internal rate of return method of
analysis?
I. the timing of the cash flows
II. the cutoff point after which any future cash flows are ignored
III. the rate designated as the minimum acceptable rate of return for a project
IV. the amount of each cash flow
a. I and II only
b. III and IV only
c. I, II, and III only
D. I, III, and IV only
e. II, III, and IV only

22. Consider a project with an initial investment and positive future cash flows. As
the discount rate is decreased
A. IRR remains constant while NPV increases.
b. IRR decreases while NPV remains constant.
c. IRR remains constant while NPV decreases.
d. IRR increases while NPV remains constant.
23. You would like to invest in the following project.

Krista, your boss, insists that only projects returning least $1.08 in today's dollars for
every $1 invested can be accepted. She also insists on applying a 12 percent discount
rate to all cash flows. Based on these criteria, you should:
a. accept the project because the project has positive NPV.
b. accept the project because it has a positive IRR.
c. reject the project because the NPV is negative.
d. reject the project because the IRR is less than the required return.
E. reject the project because the NPV is not high enough to meet your boss’
requirement.

24. You are analyzing the following two mutually exclusive projects and have
developed the following information. At what discount rate you’ll be indifferent
between these two projects?

a. 6.02 percent
b. 7.23 percent
c. 10.92 percent
d. 12.21 percent
E. 14.47 percent

25. Which one of the following statements is correct?

a. Project analysis should only include the cash flows which affect the income
statement.
B. A project can create a positive operating cash flow without affecting sales.
c. For the majority of projects that increase sales, there will be a cash outflow related
to net working capital that occurs at the end of the project.
d. Interest expense should always be included as a cash outflow when analyzing a
project.
e. The opportunity cost of a company-owned building that is going to be used in a
new project should be included as a cash inflow to the project.
26. You spent $600 last week repairing the brakes on your car. Now, the starter is
acting up and you are trying to decide whether to fix the starter or trade the car in for
a newer model. In analyzing the starter situation, the $600 you spent fixing the brakes
is a(n) _____ cost.
a. opportunity
b. fixed
c. incremental
d. erosion
E. sunk

27. All of the following are related to a proposed project. Which should be included in
the cash flow at time zero?
I. initial inventory increase of $2,500
II. loan of $125,000 to commence a project
III. depreciation tax shield of $1,100
IV. initial purchase of $6,500 of fixed assets
a. I and II only
B. I and IV only
c. II and IV only
d. I, II, and IV only
e. I, II, III, and IV

28. A project will increase the sales of Joe's Workshop by $50,000 and increase cash
expenses by $36,000. The project will cost $30,000 and be depreciated using straight-
line depreciation to a zero book value over the 3-year life of the project. The company
has a marginal tax rate of 35 percent. What is the operating cash flow of the project
using the tax shield approach?
a. $8,400
b. $9,100
C. $12,600
d. $15,600
e. $17,500

29. Bright Lighting is expanding its product offerings to reach a wider range of
customers. The expansion project includes increasing the floor inventory by $175,000
and increasing its debt to suppliers by 60 percent of that amount. The company will
also spend $180,000 for a building contractor to expand the size of the showroom. As
part of the expansion plan, the company will be offering credit to its customers and
thus expects accounts receivable to rise by $35,000. For the project analysis, what
amount should be used as the initial cash flow for net working capital?

a. $35,000
b. $70,000
C. $105,000
d. $175,000
e. $210,000
The Franklin Co. is analyzing a proposed project. The company expects to sell 3,500
units, give or take 15 percent. The expected variable cost per unit is $6 and the
expected fixed costs are $15,500. Cost estimates are considered accurate within a plus
or minus 5 percent range. The depreciation expense is $6,000. The sales price is
estimated at $21 a unit, give or take 3 percent. The company bases their sensitivity
analysis on the base case scenario.

30. What is the sales revenue under the worst case scenario?
A. $60,600.75
b. $62,474.00
c. $73,500.00
d. $84,525.00
e. $87,060.75

31. What is the amount of the fixed cost per unit under the best case scenario?
a. $3.47
B. $3.66
c. $3.85
d. $4.21
e. $4.43

32. A $1,000 Treasury bond has an asked quote of 100:07 and a bid quote of 100:05.
One bond:
a. can be sold to a dealer at a price of $1,000.70.
b. can be purchased from a dealer at a price of $1,001.56.
c. has a spread of 200 basis points.
d. is trading at a discount between 5 and 7 percent.
E. provides the dealer a profit of $0.625.

33. Beach Combers International has 5.75 percent coupon bonds outstanding with a
current market price of $689.40. The yield to maturity is 11.20 percent and the face
value is $1,000. Interest is paid semiannually. How many years is it until these bonds
mature?
a. 8.64 years
B. 9.33 years
c. 18.66 years
d. 23.25 years
e. 37.32 years

34. A 15-year, 6 percent coupon bond pays interest annually. The bond has a face
value of $1,000. What is the change in the price of this bond if the market yield to
maturity rises to 6.5 percent from the current rate of 6.25 percent?
A. 2.37 percent decrease
b. 2.43 percent decrease
c. 2.37 percent increase
d. 2.50 percent decrease
e. 2.43 percent increase
35. Consider a bond with a 10% coupon rate and a yield to maturity of 8%. If the
bond’s YTM remains constant, then in one year, the bond price will be (higher, lower)
because this is a (discount, premium) bond.
a. higher, premium
b. higher, discount
C. lower, premium
d. lower, discount

36. Which bond would most likely possess the highest degree of interest rate risk?
a. 8% coupon rate, 10 years to maturity
B. 8% coupon rate, 20 years to maturity
c. 10% coupon rate, 10 years to maturity
d. 10% coupon rate, 20 years to maturity

37. John Beere has just issued a $1000 par value, 3-year bond priced at $933.67. The
bond pays a coupon every year of 8.0% and has a discount rate of 10.7%. What is the
duration of this bond?
a. 2.22 years
b. 2.50 years
C. 2.78 years
d. 1.94 years

38. Reading Enterprise preferred stock sells at $23.53 and has a beta of 1.25. If the
risk free rate is 4% and the market risk premium is 7%, how much is Reading
Enterprise’s annual preferred stock dividend?
a. $1.82
b. $2.06
c. $2.59
D. $3.00

39. Young Consultants maintains a retention ratio of 60% for its earnings to be
invested in new projects. The company’s ROE is 15%. If the next dividend is $0.50
and the required rate of return is 13%, what is Young Consultants stock price today?
a. $3.84
B. $12.50
c. $25.00
d. $7.14

40. You are considering the purchase of a stock that just paid a dividend of $1.00.
Dividends are expected to grow at the rate of 20% per year for the next two years and
then they are expected to have a constant growth rate of 10% forever. If you require a
14% rate of return, how much should you be willing to pay for this stock?
a. $36.30
B. $32.63
c. $42.98
d. $29.86
41. Find the dividend growth rate for a stock with P0=$13.00 and P1=$13.65, and a
required return of 12% (Assume that dividends are growing at a constant rate).
a. 4.0%
B. 5.0%
c. 6.0%
d. not enough information given

42. The larger the variance, the:

I. more the actual returns differ from the average return.
II. larger the standard deviation.
III. greater the risk.
IV. higher the expected return.
a. I and III only
b. II, III, and IV only
c. I, III, and IV only
D. I, II, and III only
e. I, II, III, and IV

43. Which one of the following is indicative of a totally efficient stock market?
a. extraordinary returns earned on a routine basis
b. positive net present values over the long-term
C. zero net present values for all stocks
d. arbitrage opportunities which develop on a routine basis
e. realizing negative returns on a routine basis

44. Individuals who continually monitor the financial markets seeking mispriced
securities:
a. earn excess profits over the long-term.
B. make the markets increasingly more efficient.
c. are never able to find a security that is temporarily mispriced.
d. are overwhelmingly successful provided they trade within five minutes of their
discovery.
e. are always quite successful using only historical price information as their basis of
evaluation.

45. One year ago, you purchased a stock at a price of $40 a share. Today, you sold the
stock and realized a total return of 30 percent. Your capital gain was $8 a share. What
was your dividend yield on this stock?
A. 10 percent
b. 20 percent
c. 30 percent
d. 40 percent
e. 50 percent
46. Over the past twenty years, the common stock of Leases, Inc. has produced an
arithmetic average return of 14.6 percent and a geometric average return of 12.9
percent. What is the projected return on this stock for the next five years according to
Blume's formula?
a. 13.48 percent
b. 13.83 percent
c. 14.01 percent
D. 14.24 percent
e. 14.33 percent

47. A stock had returns of 5 percent, 16 percent, 10 percent, and 18 percent over
the past four years. What is the geometric average return for this time period?
a. 5.3 percent
B. 6.6 percent
c. 7.3 percent
d. 9.7 percent
e. 12.1 percent

48. Which one of the following statements is correct?

a. The unexpected return is always negative.
b. The expected return minus the unexpected return is equal to the total return.
c. Over time, the average return is equal to the unexpected return.
d. The expected return includes the surprise portion of news announcements.
E. Over time, the average unexpected return will be zero.

49. Which of the following statements are correct concerning diversifiable risks?
I. Diversifiable risks can be essentially eliminated by investing in fifty unrelated
securities.
II. The market rewards investors for diversifiable risk by paying a risk premium.
III. Diversifiable risks are generally associated with an individual firm or industry.
IV. Beta measures diversifiable risk.
A. I and III only
b. II and IV only
c. I and IV only
d. II and III only
e. I, II, and III only

50. You want your portfolio beta to be 1.10. Currently, your portfolio consists of
$3,000 invested in stock A with a beta of 1.65 and $2,000 in stock B with a beta of
.72. You have another $5,000 to invest and want to divide it between an asset with a
beta of 1.48 and a risk-free asset. How much should you invest in the risk-free asset?
a. $0
b. $775
C. $1,885
d. $3,115
e. $5,000
51. The rate of return on the common stock of FIDF is expected to be 15 percent in a
boom economy, 12 percent in a normal economy, and only 7 percent in a recessionary
economy. The probabilities of these economic states are 15 percent for a boom, 80
percent for a normal economy, and 5 percent for a recession. What is the variance of
the returns on this common stock?
a. .000118
B. .000256
c. .001876
d. .003492
e. .016000

52. What is the portfolio variance if 55 percent is invested in stock S and 45 percent is
invested in stock T?

A. .001314
b. .003148
c. .009128
d. .036250
e. .056106

53. The common stock of PDS has a beta of .98 and an expected return of 12.34
percent. The risk-free rate of return is 4.1 percent and the market rate of return is
11.65 percent. Which one of the following statements is true given this information?
a. The return on PDS stock will graph below the Security Market Line.
B. PDS stock is underpriced.
c. The expected return on PDS stock based on the Capital Asset Pricing Model is
15.52 percent.
d. PDS stock has more systematic risk than the overall market.
e. PDS stock is correctly priced.

54. Which of the following factors do not affect risk free rates:
a. The time value of money
b. Expected inflation
c. Expected taxes
D. Beta

55. You hold a portfolio of 500 stocks. The average expected return is 7%, the
average standard deviation is 14% and the average covariance is 0.0071. What should
the variance of the portfolio be?
A. 0.0071
b. 0.0841
c. 0.1400
d. 0.3610
56 Green Hills Software, Inc. common stock has a beta of 0.789. The risk-free rate is
4.03% and the expected return on the market is 18.01%. A reliable investment analyst
predicts that the stock's return next year will be 20.11%. Should you buy or sell this
stock?
A. Buy
b. Sell
c. You are indifferent
d. Cannot be determined

57. Which of the following is not true for CAPM:

a. CAPM relates required returns and risk.
b. The correct measure of risk in CAPM is beta.
c. CAPM shows what investors who hold large well diversified portfolios should
require for returns.
D. CAPM allows multiple risk factors.

58. Typically, the beta of a company’s stock is higher than that of its bond because:
a. The projects financed by stock issues are generally riskier than those financed by
bonds.
b. Equity holders typically finance a larger portion of the company than debt holders.
c. The firm receives a tax write-off for interest payments to debt holders, but not for
dividend payments to equity holders.
D. Equity holders are residual claimants on the firm’s cash flows.

59. If a firm uses its WACC as the discount rate for all of the projects it undertakes
then the firm will tend to:
I. reject some positive net present value projects.
II. accept some negative net present value projects.
III. favor high risk projects over low risk projects.
IV. maintain its current level of risk.
a. I and III only
b. III and IV only
C. I, II, and III only
d. I, II, and IV only
e. I, II, III, and IV
60. Wayne's of New York specializes in clothing for female executives living and
working in the financial district of New York City. Allen's of PA. specializes in
clothing for women who live and work in the rural areas of Western Pennsylvania.
Both firms are currently considering expanding their clothing line to encompass
working women in the rural upstate region of New York state (similar to W.
Pennsylvania). Wayne's currently has a cost of capital of 11 percent while Allen's cost
of capital is 9 percent. The expansion project has a projected net present value of
$36,900 at a 9 percent discount rate and a net present value of $13,200 at an 11
percent discount rate. Which firm or firms should expand into rural New York state?
a. Wayne's only
b. Allen's only
C. both Wayne's and Allen's
d. neither Wayne's nor Allen's
e. cannot be determined from the information provided

61. The Collection Co. has a current beta of 1.6. The market risk premium is 7 percent
and the risk-free rate of return is 3 percent. By how much will the cost of equity
increase if the company expands their operations such that their company beta rises to
1.9?
a. 0.30 percent
b. 0.90 percent
c. 1.50 percent
D. 2.10 percent
e. 2.70 percent

62. Madeline's Miniatures has a zero coupon bond issue outstanding that matures in
eleven years. The bonds are selling at 53 percent of par value. The company's tax rate
is 35 percent. What is the company's aftertax cost of debt?
a. 2.99 percent
B. 3.86 percent
c. 4.16 percent
d. 5.94 percent
e. 7.72 percent

63. Cruiseliners, Inc. has 230,000 shares of common stock outstanding at a market
price of $40 a share. Next quarter, Cruiseliners' is expected to pay an annual dividend
in the amount of $1.80 per share. The dividend growth rate is 3 percent. Cruiseliners'
also has 8,000 bonds outstanding with a face value of $1,000 per bond. The bonds
carry a 9 percent coupon, pay interest annually, and mature in 5.093 years. The bonds
are selling at 102 percent of face value. The company's tax rate is 35 percent. What is
Cruiseliners' weighted average cost of capital?
a. 5.4 percent
B. 6.6 percent
c. 7.5 percent
d. 8.5 percent
e. 9.6 percent
64. Choice Golf Equipment has a beta of 1.2 and a cost of equity of 13 percent. The
risk-free rate of return is 4 percent. Choice is considering a project with a beta of .8.
An appropriate discount rate for the project is:
a. 7.2 percent.
b. 8.0 percent.
c. 9.0 percent.
D. 10.0 percent.
e. 10.8 percent.

65. Orson, Inc. uses one-third common stock and two-thirds debt to finance their
operations. The aftertax cost of debt is 6 percent and the cost of equity is 12 percent.
The management of Orson, Inc. is considering a project that will produce a cash
inflow of $48,000 in the first year. The cash inflows will then grow at 4 percent per
year thereafter. What is the maximum amount the firm can initially invest in this
project to avoid a negative net present value for the project?
a. $800,000
b. $900,000
c. $1,000,000
d. $1,100,000
E. $1,200,000

66. Parker United is considering a project which requires an initial investment of

$380,000. The firm maintains a debt-equity ratio of .40. The flotation cost of debt is 6
percent and the flotation cost of equity is 11 percent. Parker United has sufficient
internally generated equity to cover the equity cost of this project. What is the initial
cost of the project including the flotation costs?
A. $386,628
b. $396,048
c. $411,009
d. $420,221
e. $433,333

67. You run an all equity finance gold mining company with a WACC of 5%. You
are thinking about issuing debt to purchase a retail jewelry chain that is currently
financed with 50% debt at a cost of 7% and 50% equity at a cost of 11%. To analyze
this takeover, you should use a discount rate of:
a. 5%
b. 7%
C. 9%
d. 11%
e. Cannot be determined because the correlation between gold mining and retail
jewelry returns is not given.
68. Cooper Enterprises sells outdoor swimming pools and currently has an aftertax
cost of capital of 12 percent. Reinhold's sells pool decks and has an aftertax cost of
capital of 9 percent. Cooper Enterprises is considering adding pool decks as part of
their sales lineup. They estimate that sales from these decks could become 15 percent
of their overall sales. The initial cash outlay for this project is $75,000. The expected
net cash inflows are $14,000 a year for eight years. What is the net present value of
this project to Cooper Enterprises?
a. -12,177.50
b. -$5,453.04
C. $2,487.47
d. $4,979.00
e. $14,110.59

69. Matt invested in Dynamo stock when the firm was unlevered. Since then, Dynamo
has become levered. To unlever his position, Matt needs to:
a. borrow some money and purchase additional shares of Dynamo stock.
b. maintain his current position as the debt of the firm did not affect his personal
leverage position.
c. sell some shares of Dynamo stock and hold the proceeds in cash.
D. sell some shares of Dynamo stock and loan out the sale proceeds.
e. create a personal debt-equity ratio that is equal to exactly 50 percent of the debt-
equity ratio of the firm.

70. Which of the following statements are correct in relation to M&M Proposition II
with no taxes?
I. The 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 only
b. II and IV only
C. I and II only
d. III and IV only
e. I and IV only

71. The business risk of a firm:

a. depends on the level of unsystematic risk associated with the assets of the firm.
b. is inversely related to the required return on the firm's assets.
c. is dependent upon the relative weights of the debt and equity used to finance the
firm.
D. has a positive relationship with the cost of equity for that firm.
e. has no relationship with the required return on a firm's assets according to M&M
Proposition II.
72. Which of the following statements correctly state implications of the pecking-
order theory?
I. Firms stockpile internally-generated cash.
II. There appears to be an inverse relationship between profits and debt levels of
firms.
III. Firms avoid external debt at all costs.
IV. A firm's capital structure is dictated by its need for external financing.
a. I and III only
b. II and IV only
c. I, III, and IV only
D. I, II, and IV only
e. I, II, III, and IV

73. United Landscaping is an all equity firm that has 140,000 shares of stock
outstanding. The company is in the process of borrowing $1.2 million at 8 percent
interest to repurchase 30,000 shares of the outstanding stock. What is the value of this
firm if you ignore taxes and bankruptcy costs?
a. $2.57 million
b. $4.14 million
C. $5.60 million
d. $7.00 million
e. $8.13 million

74. Thompson Feed has a cost of equity of 11.9 percent and a pre-tax cost of debt of 9
percent. The required return on the assets is 11 percent. What is the firm's debt-equity
ratio based on M&M II with no taxes?
a. .40
B. .45
c. .50
d. .55
e. .60

75. Uptown Appliances has an unlevered cost of capital of 14 percent, a tax rate of 35
percent, and expected earnings before interest and taxes of $8,200. The company has
$15,000 in bonds outstanding that have a 7.5 percent coupon and pay interest
annually. The bonds are selling at par value. What is the cost of equity?
a. 16.03 percent
b. 16.11 percent
C. 16.24 percent
d. 16.48 percent
e. 16.97 percent
76. The Pizza Palace has a cost of equity of 14.4 percent and an unlevered cost of
capital of 10 percent. The company has $18,000 in debt that is selling at par value.
The levered value of the firm is $32,000 and the tax rate is 35 percent. What is the
pre-tax cost of debt?
A. 4.73 percent
b. 6.18 percent
c. 6.59 percent
d. 7.38 percent
e. 9.92 percent

77. Joe's BBQ Grill has $21,000 of debt outstanding that is selling at par and has a
coupon rate of 6.5 percent. The tax rate is 35 percent. What is the present value of the
tax shield?
a. $478
b. $790
c. $1,365
d. $4,780
E. $7,350

78. Arguments that have been presented to support IPO underpricing include:
I. counteracting the "winner's curse".
II. rewarding institutional investors for sharing their opinion of a stock's market value.
III. diminishing the risk to the underwriters who have agreed to a firm commitment
underwriting.
IV. reducing the probability that investors will sue the investment banks involved in
the IPO offering.
a. I and III only
b. II and IV only
c. I and II only
d. I, II, and III only
E. I, II, III, and IV

79. Which one of the following statements concerning venture capital financing is
correct?
a. Venture capitalists desire shares of common stock but avoid preferred stock.
b. Venture capital fund is good investment b/c its high return and low risk.
c. Venture capitalists rarely assume active roles in the management of the financed
firm.
D. Venture capitalists often require at least a forty percent equity position as a
condition of financing.
e. Venture capital is relatively inexpensive in today's competitive markets.
80. Two financial contracts aaplH and aaplL are designed based on the price
movements of APPLE. The payoffs of the two contracts two days from now are
defined as follows: aaplH=$1 if the price of APPLE is above $180 per share two days
from now, and zero otherwise; aaplL=$1 if the price of APPLE is below $180 per
share two days from now, and zero otherwise. The current price for aaplH is $.75, and
for aaplL $0.25. What’s the most reasonable guess of the APPLE price two days from
now?
A. 185
b. 175
c. 165
d. 155
e. Not enough information

81. Suppose in question 80, you can always buy or sell a bundle of the two contracts
(unit portfolio) at $1. You observe the following bids and asks in the market:
contract bid ask
aaplH $.821 $.825
aaplL $.193 $.197

You can make an arbitrage profit by:

a. buying the unit portfolio and buying aaplH and aaplL.
b. buying the unit portfolio and selling aaplH and aaplL.
c. selling the unit portfolio and buying aaplH and aaplL.
d. selling the unit portfolio and selling aaplH and aaplL.
e. cannot make an arbitrage profit.