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FI515 Financial Management
Week 4 Quiz (10 MCQs)
1. (TCO A) Which of the following statements is CORRECT? (Points: 10)
It is generally more expensive to form a proprietorship than a corporation because, with a proprietorship, extensive legal documents are required.
Corporations face fewer regulations than sole proprietorships.
One disadvantage of operating a business as a sole proprietorship is that the firm is subject to double taxation, at both the firm level and the owner level.
One advantage of forming a corporation is that equity investors are usually exposed to less liability than in a regular partnership.
If a regular partnership goes bankrupt, each partner is exposed to liabilities only up to the amount of his or her investment in the business.
2. (TCO G) Which of the following statements is CORRECT? (Points: 10)
The statement of cash flows reflects cash flows from operations, but it does not reflect the effects of buying or selling fixed assets.
The statement of cash flows shows where the firm’s cash is located; indeed, it provides a listing of all banks and brokerage houses where cash is on deposit.
The statement of cash flows reflects cash flows from continuing operations, but it does not reflect the effects of changes in working capital.
The statement of cash flows reflects cash flows from operations and from borrowings, but it does not reflect cash obtained by selling new common stock.
The statement of cash flows shows how much the firm’s cash—the total of currency, bank deposits, and short-term liquid securities (or cash equivalents)—increased or decreased during a given year.
3. (TCO G) An investor is considering starting a new business. The company would require $475,000 of assets, and it would be financed entirely with common stock. The investor will go forward only if she thinks the firm can provide a 13.5% return on the invested capital, which means that the firm must have a ROE of 13.5%. How much net income must be expected to warrant starting the business? (Points: 10)
4. (TCO B) You deposit $1,000 today in a savings account that pays 3.5% interest, compounded annually. How much will your account be worth at the end of 25 years? (Points: 10)
5. (TCO B) You sold a car and accepted a note with the following cash flow stream as your payment. What was the effective price you received for the car assuming an interest rate of 6.0%?
Years: 0 1 2 3 4
CFs: $0 $1,000 $2,000 $2,000 $2,000 (Points: 10)
6. (TCO B) Suppose you borrowed $12,000 at a rate of 9.0% and must repay it in four equal installments at the end of each of the next four years. How large would your payments be? (Points: 10)
7. (TCO D) A 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT? (Points: 10)
The bond’s coupon rate exceeds its current yield.
The bond’s current yield exceeds its yield to maturity.
The bond’s yield to maturity is greater than its coupon rate.
The bond’s current yield is equal to its coupon rate.
If the yield to maturity stays constant until the bond matures, the bond’s price will remain at $850.
8. (TCO D) Ezzell Enterprises’ noncallable bonds currently sell for $1,165. They have a 15-year maturity, an annual coupon of $95, and a par value of $1,000. What is their yield to maturity? (Points: 10)
9. (TCO C) Crockett Corporation’s five-year bonds yield 6.85%, and five-year T-bonds yield 4.75%. The real risk-free rate is r* = 2.80%, the default risk premium for Crockett’s bonds is DRP = 0.85% versus zero for T-bonds, the liquidity premium on Crockett’s bonds is LP = 1.25%, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) x 0.1%, where t = number of years to maturity. What is the inflation premium (IP) on five-year bonds? (Points: 10)
10. (TCO C) Assume that to cool off the economy and decrease expectations for inflation, the Federal Reserve tightened the money supply, causing an increase in the risk-free rate, rRF. Investors also became concerned that the Fed’s actions would lead to a recession, and that led to an increase in the market risk premium, (rM – rRF). Under these conditions, with other things held constant, which of the following statements is most correct? (Points: 10)
The required return on all stocks would increase by the same amount.
The required return on all stocks would increase, but the increase would be greatest for stocks with betas of less than 1.0.
Stocks’ required returns would change, but so would expected returns, and the result would be no change in stocks’ prices.
The prices of all stocks would decline, but the decline would be greatest for high-beta stocks.
The prices of all stocks would increase, but the increase would be greatest for high-beta stocks.