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Financial Management Practice Questions and Answers

## Stock Valuation Question

1. You own 300 shares of Abco stock. The firms plans on issuing a dividend of \$2.10 a share one year from today and then issuing a final liquidating dividend of \$36.45 a share two years from today. Your required rate of return is 14.5 percent. Ignoring taxes, what is the value of one share of this stock to you today?

Select one or more:

a.\$33.93

b.\$31.05

c. \$27.80

d. \$26.62

e. \$29.64

2. There is a 25 percent probability the economy will boom; otherwise, it will be normal. Stock Q is expected to return 18 percent in a boom and 9 percent otherwise. Stock R is expected to return 9 percent in a boom and 5 percent otherwise. What is the standard deviation of a portfolio that is invested 40 percent in Stock Q and 60 percent in Stock R?

Select one or more:

a.8.1%

b..7%

c.6.8%

d. 1.4%

e.2.6%

3. Samuel's has shares of stock outstanding with a par value of \$1 per share and a market-to-book ratio of 2.1. The balance sheet shows \$5,000 in the common stock account, \$58,000 in the capital in excess of par account, and \$32,500 in the retained earnings account. The firm just announced a 50 percent stock dividend. What is the value of the common stock account after the dividend?

Select one or more:

a.\$10,000

b. \$9,000

c. \$8,500

d. \$7,500

e. \$5,000

4. MM Proposition II is the proposition that:

Select one or more:

a. supports the argument that the size of the pie does not depend on how the pie is sliced

b. the cost of levered equity depends solely on the return on debt, the debt-equity ratio, and the tax rate

c. the cost of equity is equivalent to the required return on the total assets of a levered firm

d. a firm's cost of equity capital is a positive linear function of the firm's capital structure

e. supports the argument that the capital structure of a firm is irrelevant to the value of the firm

5. Assume the corporate tax rate is 34 percent, the personal tax rate on interest income is 15 percent, and the personal tax rate on dividends is 10 percent. If the firm earns \$5 per share in taxable income and pays out 40 percent of its earnings, how much will a shareholder receive in aftertax income?

Select one or more:

a.\$1.188

b. \$1.782

## Portfolio Diversification Question

c.\$1.470

d. \$1.096

e. \$1.232

6. The primary purpose of portfolio diversification is to:

Select one or more:

a. eliminate asset-specific risk

b. eliminate all risks.

c. lower both returns and risks

d. eliminate systematic risk

e.increase returns and risks.

7. Which one of these is most related to a positive covenant?

Select one or more:

a.furnishing financial statements to the firm’s lenders

b.not issuing any additional long-term debt

c.limiting the amount of the firm’s dividends

d.selling any major assets without lender approval

e.avoiding a merger while a debt remains unpaid

7. Edie's Health Supply has 125,000 shares of stock outstanding with a par value of \$1 per share and a market value of \$5 a share. The company has retained earnings of \$76,500 and capital in excess of par of \$340,000. The company just announced a 1-for-5 reverse stock split. What will be the par value per share after the split?

Select one or more:

a. \$5.00

b.\$.20

c.\$.25

d. \$2.50

e. \$10.00

8. The information content effect implies that stock prices will rise when dividends are increased provided that the dividend increase:

Select one or more:

a. is substantial in both dollar amount and percentage terms

b. causes stockholders to increase their expectations of future cash flows

c. is combined with a stock repurchase

d. is greater than the average historical dividend increase

9. A firm has an equity beta of 1.2, the risk-free rate of return is 3.4 percent, the market return is 15.7 percent, and the pretax cost of debt is 9.4 percent. The debt-equity ratio is .47. If you apply the common beta assumptions, what is the firm’s asset beta?

Select one or more:

a. .646

b. .667

c. .582

d..609

e..816

10. All else held constant, which one of these is most apt to increase the WACC of a leveraged firm?

Select one or more:

a.a decrease in the tax rate

b.an increase in the weight of debt

c.a decrease in the dividend growth rate

d.an increase in the risk-free rate when the equity beta > 1

e.a decrease in a firm’s equity beta

11. A firm has a debt-equity ratio of .64, a cost of equity of 13.04 percent, and a cost of debt of 8 percent. The corporate tax rate is 35 percent. What would be the cost of equity if the firm were all-equity financed?

Select one or more:

a. 12.07%

b. 11.11%

## Stock Dividend Question

c. 12.42%

d. 13.33%

e. 11.56%

13. Financial executives place the greatest importance on which one of these factors when setting dividend policy?

Select one or more:

a. attracting institutional investors

b. maintaining a consistent dividend policy

c. reducing dividends anytime future earnings are in doubt

d. increasing dividends even if they need to be lowered in the near future

e. setting a high-dividend payout ratio even when earnings are unstable

14. According to the pecking-order theory, a firm’s leverage ratio is determined by:

Select one or more:

a. equating the tax benefit of debt to the financial distress costs of debt.

b.the profitability of the firm.

c.the value of the tax benefit of debt.

d.the market rate of interest.

e. the firm’s financing needs.

15. The interest tax shield is a key reason why:

Select one or more:

a. firms prefer equity financing over debt financing

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 required rate of return on assets rises when debt is added to the capital structure.

e. the cost of debt is equal to the cost of equity for a levered firm

16. Assume a firm’s debtholders are promised payments in one year of \$35 if the firm does well and \$20 if the firm does poorly. There is a 50/50 chance of the firm doing well or poorly. If bondholders are willing to pay \$25.50, what is the promised return to those bondholders?

Select one or more:

a. 6.87%

b. 8.26%

c. 7.39%

d.7.33%

e. 7.84%

17. Which one of these is a con of paying dividends?

Select one or more:

a. Paying dividends reduces agency costs when excess cash is available

b. Dividends can be used to signal a firm’s optimistic outlook

c. Managers can pay dividends to keep cash from bondholders

d. Dividends appeal to income-seeking investors

e. Dividends are frequently taxed as ordinary income

18. A stock with an actual return that lies above the security market line has:

Select one or more:

a.yielded a return equivalent to the level of risk assumed.

b. yielded a higher return than expected for the level of risk assumed.

c.more systematic risk than the overall market.

d. less systematic risk than the overall market.

e.more risk than warranted based on the realized rate of return.

19.The Cameron Co. is paying a dividend of \$.82 a share today. There are 120,000 shares outstanding with a par value of \$1 per share. As a result of this dividend, the:

Select one or more:

a. common stock account will increase by \$120,000

b. capital in excess of par value account will decrease by \$21,600

c. common stock account will decrease by \$98,400

d. retained earnings will decrease by \$98,400

e. retained earnings will decrease by \$120,000

20. Uptown Interior Designs is an all-equity firm that has 40,000 shares of stock outstanding. The company has decided to borrow \$74,000 to buy out the 2,100 shares of a deceased stockholder. What is the total value of this firm if you ignore taxes?

Select one or more:

a.\$2,008,157

b.\$1,409,524

c. \$2,630,620

d. \$1,388,056

e. \$3,885,000