4. Interest earned on both the initial principal and the interest reinvested from prior periods is called: A. free interest. B. dual interest. C. simp

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1 1. You are investing $100 today in a savings account at your local bank. Which one of the following terms refers to the value of this investment one year from now? A. future value B. present value C. principal amounts D. discounted value E. invested principal 2. Tracy invested $1,000 five years ago and earns 4 percent interest on her investment. By leaving her interest earnings in her account, she increases the amount of interest she earns each year. The way she is handling her interest income is referred to as which one of the following? A. simplifying B. compounding C. aggregation D. accumulation E. discounting 3. Steve invested $100 two years ago at 10 percent interest. The first year, he earned $10 interest on his $100 investment. He reinvested the $10. The second year, he earned $11 interest on his $110 investment. The extra $1 he earned in interest the second year is referred to as: A. free interest. B. bonus income. C. simple interest. D. interest on interest. E. present value interest.

2 4. Interest earned on both the initial principal and the interest reinvested from prior periods is called: A. free interest. B. dual interest. C. simple interest. D. interest on interest. E. compound interest. 5. Sara invested $500 six years ago at 5 percent interest. She spends her earnings as soon as she earns any interest so she only receives interest on her initial $500 investment. Which type of interest is Sara earning? A. free interest B. complex interest C. simple interest D. interest on interest E. compound interest 6. Shelley won a lottery and will receive $1,000 a year for the next ten years. The value of her winnings today discounted at her discount rate is called which one of the following? A. single amount B. future value C. present value D. simple amount E. compounded value 7. Terry is calculating the present value of a bonus he will receive next year. The process he is using is called: A. growth analysis. B. discounting. C. accumulating. D. compounding. E. reducing.

3 8. Steve just computed the present value of a $10,000 bonus he will receive in the future. The interest rate he used in this process is referred to as which one of the following? A. current yield B. effective rate C. compound rate D. simple rate E. discount rate 9. The process of determining the present value of future cash flows in order to know their worth today is called which one of the following? A. compound interest valuation B. interest on interest computation C. discounted cash flow valuation D. present value interest factoring E. complex factoring 10. Andy deposited $3,000 this morning into an account that pays 5 percent interest, compounded annually. Barb also deposited $3,000 this morning into an account that pays 5 percent interest, compounded annually. Andy will withdraw his interest earnings and spend it as soon as possible. Barb will reinvest her interest earnings into her account. Given this, which one of the following statements is true? A. Barb will earn more interest the first year than Andy will. B. Andy will earn more interest in year three than Barb will. C. Barb will earn interest on interest. D. After five years, Andy and Barb will both have earned the same amount of interest. E. Andy will earn compound interest. 11. Sue and Neal are twins. Sue invests $5,000 at 7 percent when she is 25 years old. Neal invests $5,000 at 7 percent when he is 30 years old. Both investments compound interest annually. Both Sue and Neal retire at age 60. Which one of the following statements is correct assuming that neither Sue nor Neal has withdrawn any money from their accounts? A. Sue will have less money when she retires than Neal. B. Neal will earn more interest on interest than Sue. C. Neal will earn more compound interest than Sue. D. If both Sue and Neal wait to age 70 to retire, then they will have equal amounts of savings. E. Sue will have more money than Neal as long as they retire at the same time.

4 12. Samantha opened a savings account this morning. Her money will earn 5 percent interest, compounded annually. After five years, her savings account will be worth $5,600. Assume she will not make any withdrawals. Given this, which one of the following statements is true? A. Samantha deposited more than $5,600 this morning. B. The present value of Samantha's account is $5,600. C. Samantha could have deposited less money and still had $5,600 in five years if she could have earned 5.5 percent interest. D. Samantha would have had to deposit more money to have $5,600 in five years if she could have earned 6 percent interest. E. Samantha will earn an equal amount of interest every year for the next five years. 13. This afternoon, you deposited $1,000 into a retirement savings account. The account will compound interest at 6 percent annually. You will not withdraw any principal or interest until you retire in forty years. Which one of the following statements is correct? A. The interest you earn six years from now will equal the interest you earn ten years from now. B. The interest amount you earn will double in value every year. C. The total amount of interest you will earn will equal $1, D. The present value of this investment is equal to $1,000. E. The future value of this amount is equal to $1,000 (1 + 40) Your grandmother has promised to give you $5,000 when you graduate from college. She is expecting you to graduate two years from now. What happens to the present value of this gift if you delay your graduation by one year and graduate three years from now? A. remains constant B. increases C. decreases D. becomes negative E. cannot be determined from the information provided

5 15. Luis is going to receive $20,000 six years from now. Soo Lee is going to receive $20,000 nine years from now. Which one of the following statements is correct if both Luis and Soo Lee apply a 7 percent discount rate to these amounts? A. The present values of Luis and Soo Lee's monies are equal. B. In future dollars, Soo Lee's money is worth more than Luis' money. C. In today's dollars, Luis' money is worth more than Soo Lee's. D. Twenty years from now, the value of Luis' money will be equal to the value of Soo Lee's money. E. Soo Lee's money is worth more than Luis' money given the 7 percent discount rate. 16. Which one of the following variables is the exponent in the present value formula? A. present value B. future value C. interest rate D. time E. There is no exponent in the present value formula. 17. You want to have $1 million in your savings account when you retire. You plan on investing a single lump sum today to fund this goal. You are planning on investing in an account which will pay 7.5 percent annual interest. Which of the following will reduce the amount that you must deposit today if you are to have your desired $1 million on the day you retire? I. Invest in a different account paying a higher rate of interest. II. Invest in a different account paying a lower rate of interest. III. Retire later. IV. Retire sooner. A. I only B. II only C. I and III only D. I and IV only E. II and III only

6 18. Which one of the following will produce the highest present value interest factor? A. 6 percent interest for five years B. 6 percent interest for eight years C. 6 percent interest for ten years D. 8 percent interest for five years E. 8 percent interest for ten years 19. What is the relationship between present value and future value interest factors? A. The present value and future value factors are equal to each other. B. The present value factor is the exponent of the future value factor. C. The future value factor is the exponent of the present value factor. D. The factors are reciprocals of each other. E. There is no relationship between these two factors. 20. Martin invested $1,000 six years ago and expected to have $1,500 today. He has not added or withdrawn any money from this account since his initial investment. All interest was reinvested in the account. As it turns out, Martin only has $1,420 in his account today. Which one of the following must be true? A. Martin earned simple interest rather than compound interest. B. Martin earned a lower interest rate than he expected. C. Martin did not earn any interest on interest as he expected. D. Martin ignored the Rule of 72 which caused his account to decrease in value. E. The future value interest factor turned out to be higher than Martin expected.

7 PRACTICE QUESTIONS- BUSINESS FINANCE 1. Financial markets and institutions (a) involve the movement of huge quantities of money. (b) affect the profits of businesses. (c) affect the types of goods and services produced in an economy. (d) do all of the above. (e) do only (a) and (b) of the above.. 2. Financial market activities affect (a) personal wealth. (b) spending decisions by individuals and business firms. (c) the economy s location in the business cycle. (d) all of the above. 3. Markets in which funds are transferred from those who have excess funds available to those who have a shortage of available funds are called (a) commodity markets. (b) funds markets. (c) derivative exchange markets. (d) financial markets. 4. The price paid for the rental of borrowed funds (usually expressed as a percentage of the rental of $100 per year) is commonly referred to as the (a) inflation rate.

8 (b) (c) (d) exchange rate. interest rate. aggregate price level. 5. The bond markets are important because (a) they are easily the most widely followed financial markets in the United States. (b) they are the markets where interest rates are determined. (c) they are the markets where foreign exchange rates are determined. (d) all of the above. 6. Interest rates are important to financial institutions since an interest rate increase the cost of acquiring funds and the income from assets. (a) decreases; decreases (b) increases; increases (c) decreases; increases (d) increases; decreases 7. Typically, increasing interest rates (a) discourage individuals from saving. (b) discourage corporate investments. (c) encourage corporate expansion. (d) encourage corporate borrowing. (e) none of the above.

9 8. Compared to interest rates on long-term U.S. government bonds, interest rates on fluctuate more and are lower on average. (a) medium-quality corporate bonds (b) low-quality corporate bonds (c) high-quality corporate bonds (d) three-month Treasury bills (e) none of the above 9. Compared to interest rates on long-term U.S. government bonds, interest rates on threemonth Treasury bills fluctuate and are on average. (a) more; lower (b) less; lower (c) more; higher (d) less; higher 10. The stock market is important because (a) it is where interest rates are determined. (b) it is the most widely followed financial market in the United States. (c) it is where foreign exchange rates are determined. (d) all of the above. 11. Every financial market performs the following function: (a) It determines the level of interest rates. (b) It allows common stock to be traded. (c) It allows loans to be made.

10 (d) It channels funds from lenders-savers to borrowers-spenders. 12. Financial markets have the basic function of (a) bringing together people with funds to lend and people who want to borrow funds. (b) assuring that the swings in the business cycle are less pronounced. (c) assuring that governments need never resort to printing money. (d) both (a) and (b) of the above. (e) both (b) and (c) of the above. 13. Which of the following can be described as involving direct finance? (a) A corporation s stock is traded in an over-the-counter market. (b) People buy shares in a mutual fund. (c) A pension fund manager buys commercial paper in the secondary market. (d) An insurance company buys shares of common stock in the over-the-counter markets. (e) None of the above. 14. Which of the following can be described as involving direct finance? (a) A corporation s stock is traded in an over-the-counter market. (b) A corporation buys commercial paper issued by another corporation. (c) A pension fund manager buys commercial paper from the issuing corporation. (d) Both (a) and (b) of the above. (e) Both (b) and (c) of the above. 15. Which of the following can be described as involving indirect finance?

11 (a) (b) (c) (d) (e) A corporation takes out loans from a bank. People buy shares in a mutual fund. A corporation buys commercial paper in a secondary market. All of the above. Only (a) and (b) of the above. 16. Which of the following can be described as involving indirect finance? (a) A bank buys a U.S. Treasury bill from one of its depositors. (b) A corporation buys commercial paper issued by another corporation. (c) A pension fund manager buys commercial paper in the primary market. (d) Both (a) and (c) of the above. 17. Financial markets improve economic welfare because (a) they allow funds to move from those without productive investment opportunities to those who have such opportunities. (b) they allow consumers to time their purchases better. (c) they weed out inefficient firms. (d) they do all of the above. (e) they do (a) and (b) of the above. 18. A country whose financial markets function poorly is likely to (a) efficiently allocate its capital resources. (b) enjoy high productivity. (c) experience economic hardship and financial crises. (d) increase its standard of living.

12 19. Which of the following are securities? (a) A certificate of deposit (b) A share of Texaco common stock (c) A Treasury bill (d) All of the above (e) Only (a) and (b) of the above 20. Which of the following statements about the characteristics of debt and equity are true? (a) They both can be long-term financial instruments. (b) They both involve a claim on the issuer s income. (c) They both enable a corporation to raise funds. (d) All of the above. (e) Only (a) and (b) of the above. 21. The concept of is based on the common-sense notion that a dollar paid to you in the future is less valuable to you than a dollar today. (a) present value (b) future value (c) interest (d) deflation 22. Dollars received in the future are worth than dollars received today. The process of calculating what dollars received in the future are worth today is called (a) more; discounting. (b) less; discounting. (c) more; inflating.

13 (d) less; inflating. 23. The process of calculating what dollars received in the future are worth today is called (a) calculating the yield to maturity. (b) discounting the future. (c) compounding the future. (d) compounding the present. 24. With an interest rate of 5 percent, the present value of $100 received one year from now is approximately (a) $100. (b) $105. (c) $95. (d) $ With an interest rate of 10 percent, the present value of a security that pays $1,100 next year and $1,460 four years from now is approximately (a) $1,000. (b) $2,000 (c) $2,560. (d) $3, With an interest rate of 8 percent, the present value of $100 received one year from now is approximately (a) $93. (b) $96. (c) $100.

14 (d) $ With an interest rate of 6 percent, the present value of $100 received one year from now is approximately (a) $106. (b) $100. (c) $94. (d) $ The interest rate that equates the present value of the cash flow received from a debt instrument with its market price today is the (a) simple interest rate. (b) discount rate. (c) yield to maturity. (d) real interest rate. 29. The interest rate that financial economists consider to be the most accurate measure is the (a) current yield. (b) yield to maturity. (c) yield on a discount basis. (d) coupon rate. 30. For a simple loan, the simple interest rate equals the (a) real interest rate. (b) nominal interest rate. (c) current yield. (d) yield to maturity.

15 31. Which one of the following is the financial statement that shows the accounting value of a firm's equity as of a particular date? A. income statement B. creditor's statement C. balance sheet D. statement of cash flows E. dividend statement 32. Net working capital is defined as: A. total liabilities minus shareholders' equity. B. current liabilities minus shareholders' equity. C. fixed assets minus long-term liabilities. D. total assets minus total liabilities. E. current assets minus current liabilities. 33. The common set of standards and procedures by which audited financial statements are prepared is known as the: A. matching principle. B. cash flow identity. C. Generally Accepted Accounting Principles. D. Financial Accounting Reporting Principles. E. Standard Accounting Value Guidelines. 34. Which one of the following is the financial statement that summarizes a firm's revenue and expenses over a period of time? A. income statement B. balance sheet C. statement of cash flows D. tax reconciliation statement E. market value report 35. Noncash items refer to: A. accrued expenses. B. inventory items purchased using credit. C. the ownership of intangible assets such as patents. D. expenses which do not directly affect cash flows. E. sales which are made using store credit. 36. The percentage of the next dollar you earn that must be paid in taxes is referred to as the tax rate. A. mean B. residual C. total D. average E. marginal 37. The tax rate is equal to total taxes divided by total taxable income. A. deductible B. residual C. total D. average E. marginal

16 38. The cash flow of a firm which is available for distribution to the firm's creditors and stockholders is called the: A. operating cash flow. B. net capital spending. C. net working capital. D. cash flow from assets. E. cash flow to stockholders.

17 39. Which term relates to the cash flow which results from a firm's ongoing, normal business activities? A. operating cash flow B. capital spending C. net working capital D. cash flow from assets E. cash flow to creditors 40. Cash flow from assets is also known as the firm's: A. capital structure. B. equity structure. C. hidden cash flow. D. free cash flow. E. historical cash flow. 41. Jones & Co. is funded by a group of individual investors for the sole purpose of providing funding for individuals who are trying to convert their new ideas into viable products. What is this type of funding called? A. green shoe funding B. tombstone underwriting C. venture capital D. red herring funding E. life cycle capital 42. What is the form called that is filed with the SEC and discloses the material information on a securities issuer when that issuer offers new securities to the general public? A. prospectus B. red herring C. indenture D. public disclosure statement E. registration statement 43. Miller & Chase is offering $4 million of new securities to the general public. Which SEC regulation governs this offering? A. Regulation A B. Regulation C C. Regulation G D. Regulation Q E. Regulation R

18 44. What is a prospectus? A. a letter issued by the SEC authorizing a new issue of securities B. a report stating that the SEC recommends a new security to investors C. a letter issued by the SEC that outlines the changes required for a registration statement to be approved D. a document that describes the details of a proposed security offering along with relevant information about the issuer E. an advertisement in a financial newspaper that describes a security offering 45. Which one of the following is a preliminary prospectus? A. tombstone B. green shoe C. registration statement D. rights offer E. red herring 46. Advertisements in a financial newspaper announcing a public offering of securities, along with a list of the investment banks handling the offering, are called: A. red herrings. B. tombstones. C. Green Shoes. D. registration statements. E. cash offers. 47. What is an issue of securities that is offered for sale to the general public on a direct cash basis called? A. best efforts underwriting B. firm commitment underwriting C. general cash offer D. rights offer E. herring offer 48. Tony currently owns 12,000 shares of GL Tools. He has just been notified that the firm is issuing additional shares of stock and that he is being given a chance to purchase some of these shares prior to the shares being offered to the general public. What is this type of an offer called? A. best efforts offer B. firm commitment offer C. general cash offer D. rights offer E. priority offer

19 49. Soup Galore is a partnership that was formed three years ago for the purpose of creating, producing, and distributing healthy soups in a dried form. The firm has been extremely successful thus far and has decided to incorporate and offer shares of stock to the general public. What is this type of an equity offering called? A. venture capital offering B. shelf offering C. private placement D. seasoned equity offering E. initial public offering 50. What is a seasoned equity offering? A. an offering of shares by shareholders for repurchase by the issuer B. shares of stock that have been recommended for purchase by the SEC C. equity securities held by a firm's founder that are being offered for sale to the general public D. sale of newly issued equity shares by a firm that is currently publicly owned E. a set number of equity shares that are issued and offered to the public annually 51. Gerold invested $6,200 in an account that pays 5 percent simple interest. How much money will he have at the end of ten years? A. $8,710 B. $9,000 C. $9,300 D. $9,678 E. $10, Alex invested $10,500 in an account that pays 6 percent simple interest. How much money will he have at the end of four years? A. $12,650 B. $12,967 C. $13,020 D. $13,256 E. $13, You invested $1,650 in an account that pays 5 percent simple interest. How much more could you have earned over a 20-year period if the interest had compounded annually? A. $ B. $ C. $ D. $1, E. $1,077.94

20 54. Travis invested $9,250 in an account that pays 6 percent simple interest. How much more could he have earned over a 7-year period if the interest had compounded annually? A. $ B. $ C. $ D. $ E. $ What is the future value of $7,189 invested for 23 years at 9.25 percent compounded annually? A. $22, B. $27, C. $38, D. $51, E. $54, Today, you earn a salary of $36,000. What will be your annual salary twelve years from now if you earn annual raises of 3.6 percent? A. $55, B. $57, C. $58, D. $59, E. $59, You own a classic automobile that is currently valued at $147,900. If the value increases by 6.5 percent annually, how much will the automobile be worth ten years from now? A. $244, B. $251, C. $270, D. $277, E. $291, You hope to buy your dream car four years from now. Today, that car costs $82,500. You expect the price to increase by an average of 4.8 percent per year over the next four years. How much will your dream car cost by the time you are ready to buy it? A. $98, B. $98, C. $99, D. $99, E. $100,023.16

21 59. This morning, TL Trucking invested $80,000 to help fund a company expansion project planned for 4 years from now. How much additional money will the firm have 4 years from now if it can earn 5 percent rather than 4 percent on its savings? A. $2, B. $3, C. $4, D. $4, E. $4, You just received $225,000 from an insurance settlement. You have decided to set this money aside and invest it for your retirement. Currently, your goal is to retire 25 years from today. How much more will you have in your account on the day you retire if you can earn an average return of 10.5 percent rather than just 8 percent? A. $417,137 B. $689,509 C. $1,050,423 D. $1,189,576 E. $1,818, A project has an initial cost of $27,400 and a market value of $32,600. What is the difference between these two values called? A. net present value B. internal return C. payback value D. profitability index E. discounted payback 62. Which one of the following methods of project analysis is defined as computing the value of a project based upon the present value of the project's anticipated cash flows? A. constant dividend growth model B. discounted cash flow valuation C. average accounting return D. expected earnings model E. internal rate of return 63. The length of time a firm must wait to recoup the money it has invested in a project is called the: A. internal return period. B. payback period. C. profitability period. D. discounted cash period. E. valuation period.

22 64. The length of time a firm must wait to recoup, in present value terms, the money it has in invested in a project is referred to as the: A. net present value period. B. internal return period. C. payback period. D. discounted profitability period. E. discounted payback period. 65. A project's average net income divided by its average book value is referred to as the project's average: A. net present value. B. internal rate of return. C. accounting return. D. profitability index. E. payback period. 66. The internal rate of return is defined as the: A. maximum rate of return a firm expects to earn on a project. B. rate of return a project will generate if the project in financed solely with internal funds. C. discount rate that equates the net cash inflows of a project to zero. D. discount rate which causes the net present value of a project to equal zero. E. discount rate that causes the profitability index for a project to equal zero. 67. You are viewing a graph that plots the NPVs of a project to various discount rates that could be applied to the project's cash flows. What is the name given to this graph? A. project tract B. projected risk profile C. NPV profile D. NPV route E. present value sequence 68. There are two distinct discount rates at which a particular project will have a zero net present value. In this situation, the project is said to: A. have two net present value profiles. B. have operational ambiguity. C. create a mutually exclusive investment decision. D. produce multiple economies of scale. E. have multiple rates of return.

23 69. If a firm accepts Project A it will not be feasible to also accept Project B because both projects would require the simultaneous and exclusive use of the same piece of machinery. These projects are considered to be: A. independent. B. interdependent. C. mutually exclusive. D. economically scaled. E. operationally distinct. 70. The present value of an investment's future cash flows divided by the initial cost of the investment is called the: A. net present value. B. internal rate of return. C. average accounting return. D. profitability index. E. profile period. 71. An ordinary annuity is best defined by which one of the following? A. increasing payments paid for a definitive period of time B. increasing payments paid forever C. equal payments paid at regular intervals over a stated time period D. equal payments paid at regular intervals of time on an ongoing basis E. unequal payments that occur at set intervals for a limited period of time 72. Which one of the following accurately defines a perpetuity? A. a limited number of equal payments paid in even time increments B. payments of equal amounts that are paid irregularly but indefinitely C. varying amounts that are paid at even intervals forever D. unending equal payments paid at equal time intervals E. unending equal payments paid at either equal or unequal time intervals 73. Which one of the following terms is used to identify a British perpetuity? A. ordinary annuity B. amortized cash flow C. annuity due D. discounted loan E. consol 74. The interest rate that is quoted by a lender is referred to as which one of the following? A. stated interest rate B. compound rate C. effective annual rate D. simple rate E. common rate

24 75. A monthly interest rate expressed as an annual rate would be an example of which one of the following rates? A. stated rate B. discounted annual rate C. effective annual rate D. periodic monthly rate E. consolidated monthly rate 76. What is the interest rate charged per period multiplied by the number of periods per year called? A. effective annual rate B. annual percentage rate C. periodic interest rate D. compound interest rate E. daily interest rate 77. A loan where the borrower receives money today and repays a single lump sum on a future date is called a(n) loan. A. amortized B. continuous C. balloon D. pure discount E. interest-only 78. Which one of the following terms is used to describe a loan that calls for periodic interest payments and a lump sum principal payment? A. amortized loan B. modified loan C. balloon loan D. pure discount loan E. interest-only loan 79. Which one of the following terms is used to describe a loan wherein each payment is equal in amount and includes both interest and principal? A. amortized loan B. modified loan C. balloon loan D. pure discount loan E. interest-only loan

25 80. Which one of the following terms is defined as a loan wherein the regular payments, including both interest and principal amounts, are insufficient to retire the entire loan amount, which then must be repaid in one lump sum? A. amortized loan B. continuing loan C. balloon loan D. remainder loan E. interest-only loan 81. A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith, Inc. What is the return that these individuals require on this investment called? A. dividend yield B. cost of equity C. capital gains yield D. cost of capital E. income return 82. Textile Mills borrows money at a rate of 13.5 percent. This interest rate is referred to as the: A. compound rate. B. current yield. C. cost of debt. D. capital gains yield. E. cost of capital. 83. The average of a firm's cost of equity and aftertax cost of debt that is weighted based on the firm's capital structure is called the: A. reward to risk ratio. B. weighted capital gains rate. C. structured cost of capital. D. subjective cost of capital. E. weighted average cost of capital. 84. When a manager develops a cost of capital for a specific project based on the cost of capital for another firm which has a similar line of business as the project, the manager is utilizing the approach. A. subjective risk B. pure play C. divisional cost of capital D. capital adjustment E. security market line

26 85. A firm's cost of capital: A. will decrease as the risk level of the firm increases. B. for a specific project is primarily dependent upon the source of the funds used for the project. C. is independent of the firm's capital structure. D. should be applied as the discount rate for any project considered by the firm. E. depends upon how the funds raised are going to be spent. 86. The weighted average cost of capital for a wholesaler: A. is equivalent to the aftertax cost of the firm's liabilities. B. should be used as the required return when analyzing a potential acquisition of a retail outlet. C. is the return investors require on the total assets of the firm. D. remains constant when the debt-equity ratio changes. E. is unaffected by changes in corporate tax rates. 87. Which one of the following is the primary determinant of a firm's cost of capital? A. debt-equity ratio B. applicable tax rate C. cost of equity D. cost of debt E. use of the funds 88. Scholastic Toys is considering developing and distributing a new board game for children. The project is similar in risk to the firm's current operations. The firm maintains a debt-equity ratio of 0.40 and retains all profits to fund the firm's rapid growth. How should the firm determine its cost of equity? A. by adding the market risk premium to the aftertax cost of debt B. by multiplying the market risk premium by (1-0.40) C. by using the dividend growth model D. by using the capital asset pricing model E. by averaging the costs based on the dividend growth model and the capital asset pricing model 89. All else constant, which one of the following will increase a firm's cost of equity if the firm computes that cost using the security market line approach? Assume the firm currently pays an annual dividend of $1 a share and has a beta of 1.2. A. a reduction in the dividend amount B. an increase in the dividend amount C. a reduction in the market rate of return D. a reduction in the firm's beta E. a reduction in the risk-free rate

27 90. A firm's overall cost of equity is: A. is generally less that the firm's WACC given a leveraged firm. B. unaffected by changes in the market risk premium. C. highly dependent upon the growth rate and risk level of the firm. D. generally less than the firm's aftertax cost of debt. E. inversely related to changes in the firm's tax rate. 91. All else equal, the market value of a stock will tend to decrease by roughly the aftertax value 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. 92. Which one of the following statements related to dividend policy is correct? A. The primary question related to dividend policy is whether or not a firm should ever pay a dividend. B. Both dividends and dividend policy are irrelevant. C. Dividend policy focuses on the timing of dividend payments. D. Homemade dividends increase the importance of a firm's dividend policy decisions. E. Whether or not a firm ever pays a dividend is irrelevant to equity valuation. 93. Automatic dividend reinvestment plans: I. require that stockholders reinvest all of the dividends to which they are entitled. II. sometimes grant shareholders the privilege of purchasing additional shares at a discounted price. III. help shareholders create their own homemade dividend policies. IV. help make corporate dividend policies irrelevant to individual stockholders. A. II only B. III only C. II and III only D. II, III, and IV only E. I, II, III, and IV

28 94. Which of the following tends to increase the ability of a shareholder to create his or her own homemade dividend policy? I. low taxes on capital gains II. dividend reinvestment plans III. large holdings of shares IV. low cost equity purchases A. II only B. II and III only C. I, II, and III only D. II, III, and IV only E. I, II, III, and IV 95. Which one of the following favors a low dividend policy? A. the tax on capital gains is deferred until the gain is realized B. few, if any, positive net present value projects are available to a firm C. a majority of the shareholders has a low relevant tax rate D. a majority of the shareholders has better investment opportunities with similar risks E. corporate tax rates exceed personal tax rates 96. The fact that flotation costs can be significant is an argument 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 C. shares. D. maintaining a constant dividend policy even when profits decline significantly. E. maintaining a high dividend policy. F. maintaining a low dividend policy and rarely issuing extra dividends 97. Which of the following tend to keep dividends low? I. shareholders desiring current income II. terms contained in bond indenture agreements III. the desire to maintain constant dividends over time IV. flotation costs A. II and III only B. I and IV only C. II, III, and IV only D. I, II, and III only E. I, II, III, and IV

29 98. Which of the following shareholders tend to favor a high dividend policy? I. retired individuals II. endowment funds III. corporate investors IV. investors with high dividend tax rates but low capital gains tax rates A. I and III only B. II and IV only C. I, II, and III only D. II, III, and IV only E. I, II, III, and IV 99. 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 substantial gains on its equities, which are taxed at a favorable rate 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 earnings growth will be strong going forward. D. the firm has more cash than it needs due to a decline in future orders. E. dividends thereafter will be lower.