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Week 4 : Business Valuation and Stock Valuation - Exam


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1. (TCO A) Which of the following statements is CORRECT? (Points : 10)
One of the disadvantages of incorporating a business is that the owners then become subject to
liabilities in the event the firm goes bankrupt.
Sole proprietorships are subject to more regulations than corporations.
In any type of partnership, every partner has the same rights, privileges, and liability exposure as
every other partner.
Sole proprietorships and partnerships generally have a tax advantage over many
corporations, especially large ones.
Corporations of all types are subject to the corporate income tax.

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) A security analyst obtained the following information from Prestopino Products financial
statements:

Retained earnings at the end of 2009 were $700,000, but retained earnings at the end of 2010 had
declined to $320,000.
The company does not pay dividends.
The companys depreciation expense is its only non-cash expense; it has no amortization charges.
The company has no non-cash revenues.
The companys net cash flow (NCF) for 2010 was $150,000.

On the basis of this information, which of the following statements is CORRECT? (Points : 10)
Prestopino had negative net income in 2010.
Prestopinos depreciation expense in 2010 was less than $150,000.
Prestopino had positive net income in 2010, but its income was less than its 2009 income.
Prestopino's NCF in 2010 must be higher than its NCF in 2009.
2

Prestopinos cash on the balance sheet at the end of 2010 must be lower than the cash it had on
the balance sheet at the end of 2009.

3. (TCO G) LeCompte Corp. has $312,900 of assets, and it uses only common equity capital (zero
debt). Its sales for the last year were $620,000, and its net income after taxes was $24,655.
Stockholders recently voted in a new management team that has promised to lower costs and get the
return on equity up to 15%. What profit margin would LeCompte need in order to achieve the 15%
ROE, holding everything else constant? (Points : 10)
7.57%
7.95%
8.35%
8.76%
9.20%

3. (TCO G) Beranek Corp. has $410,000 of assets, and it uses no debtit is financed only with common
equity. The new CFO wants to employ enough debt to bring the debt/assets ratio to 40%, using the
proceeds from the borrowing to buy back common stock at its book value. How much must the firm
borrow to achieve the target debt ratio? (Points : 10)
$155,800
$164,000
$172,200
$180,810
$189,851

4. (TCO B) You want to buy a new sports car three years from now, and you plan to save $4,200 per
year, beginning one year from today. You will deposit your savings in an account that pays 5.2%
interest. How much will you have just after you make the third deposit, three years from now? (Points :
10)
$11,973
$12,603
$13,267
$13,930
$14,626

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)
$2,245.08
$2,363.24
3

$2,481.41
$2,605.48
$2,735.75

5. (TCO B) At a rate of 6.5%, what is the future value of the following cash flow stream?
Years: 0 1 2 3 4
|--------|-----------|----------|---------|
CFs: $0 $75 $225 $0 $300 (Points : 10)
$526.01
$553.69
$582.83
$613.51
$645.80

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)
$5,987
$6,286
$6,600
$6,930
$7,277

6. (TCO B) Farmers Bank offers to lend you $50,000 at a nominal rate of 5.0%, simple interest, with
interest paid quarterly. Merchants Bank offers to lend you the $50,000, but it will charge 6.0%, simple
interest, with interest paid at the end of the year. What's the difference in the effective annual rates
charged by the two banks? (Points : 10)
1.56%
1.30%
1.09%
0.91%
0.72%

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)
$3,704.02
4

$3,889.23
$4,083.69
$4,287.87
$4,502.26

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 bonds coupon rate exceeds its current yield.
The bonds current yield exceeds its yield to maturity.
The bonds yield to maturity is greater than its coupon rate.
The bonds current yield is equal to its coupon rate.
If the yield to maturity stays constant until the bond matures, the bonds price will remain at $850.

7. (TCO D) Which of the following statements is CORRECT? (Points : 10)
If a bond is selling at a discount, the yield to call is a better measure of return than the yield to
maturity.
On an expected yield basis, the expected capital gains yield will always be positive because an
investor would not purchase a bond with an expected capital loss.
On an expected yield basis, the expected current yield will always be positive because an investor
would not purchase a bond that is not expected to pay any cash coupon interest.
If a coupon bond is selling at par, its current yield equals its yield to maturity.
The current yield on Bond A exceeds the current yield on Bond B; therefore, Bond A must have a
higher yield to maturity than Bond B.

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)
6.20%
6.53%
6.87%
7.24%
7.62%

9. (TCO C) Keys Corporation's five-year bonds yield 7.00%, and five-year T-bonds yield 5.15%. The
real risk-free rate is r* = 3.0%, the inflation premium for five-year bonds is IP = 1.75%, the liquidity
premium for Keys' bonds is LP = 0.75% versus zero for T-bonds, 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 default risk premium (DRP) on Keys' bonds? (Points : 10)
5

0.99%
1.10%
1.21%
1.33%
1.46%

9. (TCO C) Niendorf Corporation's five-year bonds yield 6.75%, and five-year T-bonds yield 4.80%. The
real risk-free rate is r* = 2.75%, the inflation premium for five-year bonds is IP = 1.65%, the default risk
premium for Niendorf's bonds is DRP = 1.20% versus zero for T-bonds, 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 liquidity premium (LP) on Niendorf's bonds? (Points : 10)
0.49%
0.55%
0.61%
0.68%
0.75%

10. (TCO C) Assume that the risk-free rate remains constant, but the market risk premium declines.
Which of the following is most likely to occur? (Points : 10)
The required return on a stock with beta = 1.0 will not change.
The required return on a stock with beta > 1.0 will increase.
The return on "the market" will remain constant.
The return on "the market" will increase.
The required return on a stock with beta < 1.0 will decline.

10. (TCO C) Assume that investors have recently become more risk averse, so the market risk premium
has increased. Also, assume that the risk-free rate and expected inflation have not changed. Which of
the following is most likely to occur? (Points : 10)
The required rate of return for an average stock will increase by an amount equal to the
increase in the market risk premium.
The required rate of return will decline for stocks whose betas are less than 1.0.
The required rate of return on the market, rM, will not change as a result of these changes.
The required rate of return for each individual stock in the market will increase by an amount equal
to the increase in the market risk premium.
The required rate of return on a riskless bond will decline.