Need help with 25 Questions in Finance with profits

timer Asked: Mar 26th, 2016

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1. The CEO of High Tech International decides to change an accounting method at the end of

the current year. The change results in reported profits increasing by 5%, but the company’s

cash flows are not changed. If capital markets are efficient, then:

a. The stock price will increase only if the accounting change will also result in higher

profits in the next year.

b. The stock price will increase due to higher profits.

c. The stock price will decrease because accounting method changes are not permitted

under generally accepted accounting principles.

d. The stock price will not be affected by the accounting change.

2. S-type corporations have all of the following advantages EXCEPT

a. The owners have limited liability.

b. All owners must be people, no corporations.

c. Distributions are taxed twice, similar to corporate dividend payments.

d. They are taxed as partnerships.

3. Assume that you went to Las Vegas and hit the jackpot for $5 million. Further assume that

you were offered a choice to receive the $5 million today, or receive it in two years. According

to one of the principles of finance, which would you take?

a. You would be indifferent as to when you would receive the $5 million.

b. $5 million in two years because you would be afraid of spending it all right away

c. $5 million today because it would be worth more than if you would receive it in two years

d. $5 million in two years because it would be worth more than if you would receive it today

4. In terms of the costs to organize each, which of the following sequences is correct, moving

from highest to lowest cost?

a. corporation, limited partnership, general partnership, sole proprietorship

b. sole proprietorship, general partnership, corporation, limited partnership

c. general partnership, sole proprietorship, limited partnership, corporation

d. sole proprietorship, general partnership, limited partnership, corporation

5. Which form of organization is free of initial legal requirements?

a. general partnership

b. sole proprietorship

c. corporation

d. both a and b

6. Which of the statements below are true?

a. The sole proprietorship and the general partnership both feature unlimited liability.

b. The corporation and the limited partnership both provide at least some owners with

limited liability.

c. A corporation is the business form that is typically the most complicated (legally) to


d. all of the above

7. Capital budgeting is concerned with:

a. planning sales of a corporation’s equity capital

b. what long-term investments a firm should undertake

c. whether a company’s assets should be financed with debt or equity

d. managing a firms cash budgeting procedures

8. Which of the following is an advantage of organized stock exchanges?

a. increased stock price volatility

b. only profitable companies may issue new securities on an organized exchange

c. screening companies to ensure only low risk stocks are sold

d. providing a continuous market

9. What is the term for a graphical representation of the relationship between interest rates and

the maturities of debt securities?

a. yield curve

b. maturity chart

c. term curve

d. inflationary expectations

10. The one-year interest rate is 4%. The interest rate for a two-year security is 6%. The one-year

interest rate one year from now is 8.34%. According to the liquidity preference theory, the

risk premium for the second one-year investment is:

a. 0.34%

b. 1.66%

c. 0.30%

d. 0.50%

11. An example of a primary market transaction involving a money market security is:

a. a new issue of a security with a very long maturity

b. the transfer of a previously-issued security with a very long maturity

c. a new issue of a security with a very short maturity

d. the transfer of a previously-issued security with a very short maturity

12. You are considering an investment in a U.S. Treasury bond but you are not sure what rate of

interest it should pay. Assume that the real risk-free rate of interest is 1.0%; inflation is

expected to be 1.5%; the maturity risk premium is 2.5%; and, the default risk premium for

AAA rated corporate bonds is 3.5%. What rate of interest should the U.S. Treasury bond pay?

a. 8.5%

b. 2.5%

c. 6.0%

d. 5.0%

13. A life insurance company purchases $1 billion of corporate bonds from premiums collected

on its life insurance policies. Therefore:

a. the corporate bonds are direct securities and the life insurance policies are direct


b. the corporate bonds are direct securities and the life insurance policies are indirect


c. the corporate bonds are indirect securities and the life insurance policies are direct


d. the corporate bonds are indirect securities and the life insurance policies are indirect


14. A commitment fee is:

a. paid by investors to guarantee that a company will borrow from them

b. paid by bondholders to secure the right to convert bonds into common stock

c. an amount paid by an investment banker to ensure the sale of securities

d. an amount paid on the unused portion of a loan in a private placement

15. You plan to go to Asia to visit friends in three years. The trip is expected to cost a total of

$10,000 at that time. Your parents have deposited $5,000 for you in a Certificate of Deposit

paying 6% interest annually, maturing three years from now. Uncle Lee has agreed to pay for

all remaining expenses. If you are going to put Uncle Lee’s gift in an investment earning

10% over the next three years, how much must he deposit today, so you can visit your

friends three years from today?

a. $3,039

b. $3,345

c. $5,801

d. $3,757

16. What is the present value of an annuity of $120 received at the end of each year for 11

years? Assume a discount rate of 7%. The first payment will be received one year from today

(round to nearest $1).

a. $570

b. $900

c. $400

d. $250

17. You won the lottery and can receive either (1) $60,000 today, or (2) $10,000 one year from

today plus $25,000 two years from today plus $35,000 three years from today. You plan to

use the money to pay for your child’s college education in 15 years. You should:

a. take option two because you get $70,000 rather than $60,000 regardless of current

interest rates.

b. take the $60,000 today because of the time value of money regardless of current

interest rates

c. take the $60,000 today only if the current interest rate is at least 16.67%

d. take the $60,000 today if you can earn 6.81% per year or more on your investments

18. You deposit $5,000 per year at the end of each of the next 25 years into an account that

pays 8% compounded annually. How much could you withdraw at the end of each of the 20

years following your last deposit if all withdrawals are the same dollar amount? (The

twenty-fifth and last deposit is made at the beginning of the 20-year period. The first

withdrawal is made at the end of the first year in the 20-year period.)

a. $37,230

b. $43,289

c. $18,276

d. $27,832

19. Your son is born today and you want to make him a millionaire by the time he is 50 years

old. You deposit $10,700 in an investment account and want to know what annual interest

rate must you earn in order to have the account value equal to $1,000,000 on your son’s

50th birthday.

a. 6.2%

b. 9.5%

c. 17.8%

d. 12.4%

20. You sell valuable artifacts from your household estate for $200,000 and want to use the

money to supplement your retirement. You receive the money on your 60th birthday, the day

you retire. You want to withdraw equal amounts at the end of each of the next 25 years.

What constant amount can you withdraw each year and have nothing remaining at the end of

20 years if you are earning 7% interest per year?

a. $28,318

b. $17,162

c. $37,574

d. $49,113

Stock W has the following returns for various states of the economy:

State of the Economy                   Probability                       Stock W’s Return

Recession                                         9%                                      -72%

Below Average                                 16%                                    -15%

Average                                            51%                                     16%

Above Average                                 14%                                     35%

Boom                                                 10%                                     85%


21. Stock W’s standard deviation of returns is:

a. 29%

b. 12%

c. 37%

d. 43%

22. Which of the following types of risk is diversifiable?

a. betagenic, or ecocentric risk

b. unsystematic, or company-unique risk

c. systematic risk

d. market risk

23. You are considering buying some stock in Continental Grain. Which of the following are

examples of non-diversifiable risks?

I. Risk resulting from a general decline in the stock market.

II. Risk resulting from a possible increase in income taxes.

III. Risk resulting from an explosion in a grain elevator owned by Continental.

IV. Risk resulting from a pending lawsuit against Continental.

a. II, III, and IV

b. I and II

c. III and IV

d. I only

24. Decker Corp. common stock has a required return of 17.5% and a beta of 1.75. If the

expected risk free return is 3%, what is the expected return for the market based on the


a. 14.29%

b. 13.35%

c. 15.27%

d. 11.29%

25. The return on the market portfolio is currently 12%. Mobile Phone Corporation stockholders

require a rate of return of 30% and the stock has a beta of 3.2. According to CAPM,

determine the risk-free rate.

a. 3.82%

b. 9.80%

c. 4.64%

d. 6.50%

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