Question 1

Refer to Exhibit 7A.1. What is the expected after-tax cost of this debt issue?

Accepted Answer

A)  5.76% 
B)  6.06% 
C)  6.38% 
D)  6.72% 
E)  7.06% 
A)  5.76% 
B)  6.06% 
C)  6.38% 
D)  6.72% 
E)  7.06% D

Question 2

A 2-year, zero coupon Treasury bond with a maturity value of $1,000 has a price of $873.4387. A 1-year, zero coupon Treasury bond with a maturity value of $1,000 has a price of $938.9671. If the pure expectations theory is correct, for what price should 1-year, zero coupon Treasury bonds sell one year from now?

Accepted Answer

A)  $797.54 
B)  $839.52 
C)  $883.70 
D)  $930.21 
E)  $976.72 
A)  $797.54 
B)  $839.52 
C)  $883.70 
D)  $930.21 
E)  $976.72 D

Question 3

Your firm's EPS last year was $1.00. You expect sales to increase by 15% during the coming year. If your firm has a degree of operating leverage equal to 1.25 and a degree of financial leverage equal to 3.50, then what is its expected EPS?

Accepted Answer

A)  $1.66 
B)  $1.83 
C)  $1.92 
D)  $1.74 
E)  $1.57 
A)  $1.66 
B)  $1.83 
C)  $1.92 
D)  $1.74 
E)  $1.57 A

Question 4

Which of the following statements is CORRECT?

Accepted Answer

A)  An increase in fixed costs, (holding sales and variable costs constant) will reduce the company's degree of operating leverage. 
B)  If a firm's degree of operating leverage increases, its degree of financial leverage must also have increased. 
C)  An increase in interest expense will reduce the company's degree of financial leverage. 
D)  If the company has no debt outstanding, then its degree of total leverage equals its degree of operating leverage. 
E)  If the company has no debt outstanding, then its degree of total leverage equals its degree of financial leverage. 
A)  An increase in fixed costs, (holding sales and variable costs constant) will reduce the company's degree of operating leverage. 
B)  If a firm's degree of operating leverage increases, its degree of financial leverage must also have increased. 
C)  An increase in interest expense will reduce the company's degree of financial leverage. 
D)  If the company has no debt outstanding, then its degree of total leverage equals its degree of operating leverage. 
E)  If the company has no debt outstanding, then its degree of total leverage equals its degree of financial leverage.

Question 5

Assume you are the director of capital budgeting for an all-equity firm. The firm's current cost of equity is 16%; the risk-free rate is 10%; and the market risk premium is 5%. You are considering a new project that has 50% more beta risk than your firm's assets currently have, that is, its beta is 50% larger than the firm's existing beta. The expected return on the new project is 18%. Should the project be accepted if beta risk is the appropriate risk measure? Choose the correct statement.

Accepted Answer

A)  Yes; its expected return is greater than the firm's WACC. 
B)  Yes; the project's risk-adjusted required return is less than its expected return. 
C)  No; a 50% increase in beta risk gives a risk-adjusted required return of 24%. 
D)  No; the project's risk-adjusted required return is 2% above its expected return. 
E)  No; the project's risk-adjusted required return is 1% above its expected return. 
A)  Yes; its expected return is greater than the firm's WACC. 
B)  Yes; the project's risk-adjusted required return is less than its expected return. 
C)  No; a 50% increase in beta risk gives a risk-adjusted required return of 24%. 
D)  No; the project's risk-adjusted required return is 2% above its expected return. 
E)  No; the project's risk-adjusted required return is 1% above its expected return.

Question 6

Assume that a firm has a degree of financial leverage of 1.25. If sales increase by 20%, the firm will experience a 60% increase in EPS, and it will have an EBIT of $100,000. What will be the EBIT for this firm if sales do not increase?

Accepted Answer

A)  $60,980 
B)  $70,946 
C)  $67,568 
D)  $57,931 
E)  $64,189 
A)  $60,980 
B)  $70,946 
C)  $67,568 
D)  $57,931 
E)  $64,189

Question 7

Coats Corp. generates $10,000,000 in sales. Its variable costs equal 85% of sales and its fixed costs are $500,000. Therefore, the company's operating income (EBIT) equals $1,000,000. The company estimates that if its sales were to increase 10%, its net income and EPS would increase 17.5%. What is the company's interest expense?

Accepted Answer

A)  $150,000 
B)  $142,857 
C)  $128,929 
D)  $135,714 
E)  $122,482 
A)  $150,000 
B)  $142,857 
C)  $128,929 
D)  $135,714 
E)  $122,482

Question 8

Assume one bank offers you a nominal annual interest rate of 6% compounded daily while another bank offers you continuous compounding at a 5.9% nominal annual rate. You decide to deposit $1,000 with each bank. Exactly two years later you withdraw your funds from both banks. What is the difference in your withdrawal amounts between the two banks?

Accepted Answer

A)  $2.24 
B)  $2.35 
C)  $2.47 
D)  $2.59 
E)  $2.72 
A)  $2.24 
B)  $2.35 
C)  $2.47 
D)  $2.59 
E)  $2.72

Question 9

McGwire Company's pension fund projects that most of its employees will take advantage of an early retirement program the company plans to offer in 5 years. Anticipating the need to fund these pensions, the firm bought zero coupon U.S. Treasury Trust Certificates maturing in 5 years. When these instruments were originally issued, they were 12% coupon, 30-year U.S. Treasury bonds. The stripped Treasuries are currently priced to yield 10%. Their total maturity value is $6,000,000. What is their total cost (price) to McGwire today?

Accepted Answer

A)  $3,366,714 
B)  $3,453,040 
C)  $3,541,580 
D)  $3,632,390 
E)  $3,725,528 
A)  $3,366,714 
B)  $3,453,040 
C)  $3,541,580 
D)  $3,632,390 
E)  $3,725,528

Question 10

In six years' time, you are scheduled to receive money from a trust established by your grandparents. When the trust matures there will be $100,000 in the account. If the account earns 9% compounded continuously, how much is in the account today?

Accepted Answer

A)  $55,361.08 
B)  $58,274.83 
C)  $61,188.57 
D)  $64,247.99 
E)  $67,460.39 
A)  $55,361.08 
B)  $58,274.83 
C)  $61,188.57 
D)  $64,247.99 
E)  $67,460.39

Question 11

The degree of operating leverage has which of the following characteristics?

Accepted Answer

A)  A change in quantity demanded will produce the same percentage change in EBIT as an identical change in price per unit of output, other things held constant. 
B)  The DOL relates the change in net income to the change in operating income. 
C)  If the firm has no debt, the DOL will equal 1. 
D)  The closer the firm is operating to the breakeven quantity, the smaller the DOL. 
E)  The DOL is not a fixed number for a given firm, but will depend upon the time zero values of the economic variable Q (Quantity), P (Price), and V (Volume). 
A)  A change in quantity demanded will produce the same percentage change in EBIT as an identical change in price per unit of output, other things held constant. 
B)  The DOL relates the change in net income to the change in operating income. 
C)  If the firm has no debt, the DOL will equal 1. 
D)  The closer the firm is operating to the breakeven quantity, the smaller the DOL. 
E)  The DOL is not a fixed number for a given firm, but will depend upon the time zero values of the economic variable Q (Quantity), P (Price), and V (Volume).

Question 12

Company D has a 50% debt ratio, whereas Company E has no debt financing. The two companies have the same level of sales and the same degree of operating leverage. Which of the following statements is most CORRECT?

Accepted Answer

A)  If sales increase 10% for both companies, then Company D will have a larger percentage increase in its operating income (EBIT). 
B)  The two companies have the same degree of total leverage. 
C)  If sales increase 10% for both companies, then Company D will have a larger percentage increase in its net income. 
D)  If EBIT increases 10% for both companies, then Company D's net income will rise by more than 10%, while Company E's net income will rise by less than 10%. 
E)  Company E has a higher degree of financial leverage. 
A)  If sales increase 10% for both companies, then Company D will have a larger percentage increase in its operating income (EBIT). 
B)  The two companies have the same degree of total leverage. 
C)  If sales increase 10% for both companies, then Company D will have a larger percentage increase in its net income. 
D)  If EBIT increases 10% for both companies, then Company D's net income will rise by more than 10%, while Company E's net income will rise by less than 10%. 
E)  Company E has a higher degree of financial leverage.

Question 13

The Quick Company expects its sales to increase by 50% in the coming year. The firm's current EPS is $3.25. Its degree of operating leverage is 1.6, while its degree of financial leverage is 2.1. What is the firm's projected EPS for the coming year using the DTL approach?

Accepted Answer

A)  $7.86 
B)  $7.47 
C)  $9.15 
D)  $8.27 
E)  $8.71 
A)  $7.86 
B)  $7.47 
C)  $9.15 
D)  $8.27 
E)  $8.71

Question 14

At the beginning of the year, you purchased a 5-year zero coupon bond with a yield to maturity of 6.8% and a face value of $1,000. Your tax rate is 30%. What is the total tax that you will have to pay on the bond during the first year?

Accepted Answer

A)  $13.95 
B)  $14.68 
C)  $15.42 
D)  $16.19 
E)  $17.00 
A)  $13.95 
B)  $14.68 
C)  $15.42 
D)  $16.19 
E)  $17.00

Question 15

You have $5,436.60 in an account that pays 10% interest, compounded continuously. If you deposited some funds 10 years ago, how much was your original deposit?

Accepted Answer

A)  $1,900 
B)  $2,000 
C)  $2,100 
D)  $2,205 
E)  $2,315 
A)  $1,900 
B)  $2,000 
C)  $2,100 
D)  $2,205 
E)  $2,315

Question 16

Alvarez Technologies has sales of $3,000,000. The company's fixed operating costs total $500,000 and its variable costs equal 60% of sales, so the company's current operating income is $700,000. The company's interest expense is
$500,000. What is the company's degree of total leverage (DTL)?

Accepted Answer

A)  6.0000 
B)  5.4150 
C)  5.7000 
D)  4.8870 
E)  5.1443 
A)  6.0000 
B)  5.4150 
C)  5.7000 
D)  4.8870 
E)  5.1443

Question 17

If a firm uses debt financing (Debt ratio = 0.40) and sales change from the current level, which of the following statements is CORRECT?

Accepted Answer

A)  The percentage change in EBIT will equal the percentage change in net income. 
B)  Since debt is used, the degree of operating leverage must be greater than 1. 
C)  The percentage change in operating income will be less than the percentage change in net income. 
D)  The percentage change in operating income (EBIT) resulting from the change in sales will exceed the percentage change in net income. 
E)  The percentage change in net income relative to the percentage change in sales (and in EBIT) will not depend on the interest rate paid on the debt. 
A)  The percentage change in EBIT will equal the percentage change in net income. 
B)  Since debt is used, the degree of operating leverage must be greater than 1. 
C)  The percentage change in operating income will be less than the percentage change in net income. 
D)  The percentage change in operating income (EBIT) resulting from the change in sales will exceed the percentage change in net income. 
E)  The percentage change in net income relative to the percentage change in sales (and in EBIT) will not depend on the interest rate paid on the debt.

Question 18

Which of the following statements is CORRECT?

Accepted Answer

A)  If interest rates increase, a 10-year zero coupon bond's price will drop by a greater percentage than will a 10-year, 8% coupon bond. 
B)  One nice thing about zero coupon bonds is that individual investors do not have to pay any taxes on a zero coupon bond until it matures, even if they are not holding the bonds as part of a tax-deferred account. 
C)  If a bond with a sinking fund provision has a yield to maturity greater than its coupon rate, the issuing company would prefer to comply with the sinking fund by calling the bonds in at par rather than buying the bonds back in the open market. 
D)  Because of the IRS's tax treatment of zero coupon bonds, pension funds and other tax-exempt entities rarely, if ever, invest in zero coupon bonds. 
E)  Interest must be paid on a zero coupon bond's accrued value, but while the first year's interest is taxable at the ordinary income tax rate, subsequent years are taxed at the long-term capital gains rate (since they are received after more than a year). 
A)  If interest rates increase, a 10-year zero coupon bond's price will drop by a greater percentage than will a 10-year, 8% coupon bond. 
B)  One nice thing about zero coupon bonds is that individual investors do not have to pay any taxes on a zero coupon bond until it matures, even if they are not holding the bonds as part of a tax-deferred account. 
C)  If a bond with a sinking fund provision has a yield to maturity greater than its coupon rate, the issuing company would prefer to comply with the sinking fund by calling the bonds in at par rather than buying the bonds back in the open market. 
D)  Because of the IRS's tax treatment of zero coupon bonds, pension funds and other tax-exempt entities rarely, if ever, invest in zero coupon bonds. 
E)  Interest must be paid on a zero coupon bond's accrued value, but while the first year's interest is taxable at the ordinary income tax rate, subsequent years are taxed at the long-term capital gains rate (since they are received after more than a year).

Question 19

Wilson Co. is considering two mutually exclusive projects. Both require an initial investment of $10,000, and their risks are average for the firm. Project X has an expected life of 2 years with after-tax cash inflows of $6,000 and $8,785 at the end of Years 1 and 2, respectively. Project Y has an expected life of 4 years with after-tax cash inflows of $4,750 at the end of each of the next 4 years. The firm's WACC is 11%. Determine the equivalent annual annuity of the most profitable project.

Accepted Answer

A)  $1,112.99 
B)  $1,236.66 
C)  $1,374.06 
D)  $1,526.74 
E)  $1,679.41 
A)  $1,112.99 
B)  $1,236.66 
C)  $1,374.06 
D)  $1,526.74 
E)  $1,679.41

Question 20

Consider each of the following bonds: Bond A: $\quad 8$ -year maturity with a $7 \%$ annual coupon.
Bond B: $\quad 10$-year maturity with a $9 \%$ annual coupon.
Bond C: $\quad 12$ -year maturity with a zero coupon. Each bond has a face value of $1,000 and a yield to maturity of 8%. Which of the following statements is NOT correct?

Accepted Answer

A)  Bond A sells at a discount, while Bond B sells at a premium. 
B)  If the yield to maturity on each bond falls to 7%, Bond C will have the largest percentage increase in its price. 
C)  Bond C has the most reinvestment risk. 
D)  Bond C has the most price risk. 
E)  If the yield to maturity is constant, the price of Bond A will continue to increase over its life until it finally sells at par. 
A)  Bond A sells at a discount, while Bond B sells at a premium. 
B)  If the yield to maturity on each bond falls to 7%, Bond C will have the largest percentage increase in its price. 
C)  Bond C has the most reinvestment risk. 
D)  Bond C has the most price risk. 
E)  If the yield to maturity is constant, the price of Bond A will continue to increase over its life until it finally sells at par.

Refer to Exhibit 7A.1. What is the expected after-tax cost of this debt issue?

Your firm's EPS last year was $1.00. You expect sales to increase by 15% during the coming year. If your firm has a degree of operating leverage equal to 1.25 and a degree of financial leverage equal to 3.50, then what is its expected EPS?

Which of the following statements is CORRECT?

Assume that a firm has a degree of financial leverage of 1.25. If sales increase by 20%, the firm will experience a 60% increase in EPS, and it will have an EBIT of $100,000. What will be the EBIT for this firm if sales do not increase?

In six years' time, you are scheduled to receive money from a trust established by your grandparents. When the trust matures there will be $100,000 in the account. If the account earns 9% compounded continuously, how much is in the account today?

The degree of operating leverage has which of the following characteristics?

Company D has a 50% debt ratio, whereas Company E has no debt financing. The two companies have the same level of sales and the same degree of operating leverage. Which of the following statements is most CORRECT?

The Quick Company expects its sales to increase by 50% in the coming year. The firm's current EPS is $3.25. Its degree of operating leverage is 1.6, while its degree of financial leverage is 2.1. What is the firm's projected EPS for the coming year using the DTL approach?

At the beginning of the year, you purchased a 5-year zero coupon bond with a yield to maturity of 6.8% and a face value of $1,000. Your tax rate is 30%. What is the total tax that you will have to pay on the bond during the first year?

You have $5,436.60 in an account that pays 10% interest, compounded continuously. If you deposited some funds 10 years ago, how much was your original deposit?

Alvarez Technologies has sales of $3,000,000. The company's fixed operating costs total $500,000 and its variable costs equal 60% of sales, so the company's current operating income is $700,000. The company's interest expense is $500,000. What is the company's degree of total leverage (DTL)?

If a firm uses debt financing (Debt ratio = 0.40) and sales change from the current level, which of the following statements is CORRECT?

Which of the following statements is CORRECT?

An Overview of Financial Management

Financial Markets and Institutions

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

The Value of Money

Interest Rates

Bonds and Their Valuation

Risk and Rates of Return

Stocks and Their Valuation

The Cost of Capital

The Basics of Capital Budgeting

Cash Flow Estimation and Risk Analysis

Capital Structure and Leverage

Distributions to Shareholders: Dividends and Share Repurchases

Working Capital Management

Financial Planning and Forecasting

Multinational Financial Management

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Exam 18: Financial and Operating Leverage: Analysis and Calculation

Refer to Exhibit 7A.1. What is the expected after-tax cost of this debt issue?

Your firm's EPS last year was $1.00. You expect sales to increase by 15% during the coming year. If your firm has a degree of operating leverage equal to 1.25 and a degree of financial leverage equal to 3.50, then what is its expected EPS?

Which of the following statements is CORRECT?

Assume that a firm has a degree of financial leverage of 1.25. If sales increase by 20%, the firm will experience a 60% increase in EPS, and it will have an EBIT of $100,000. What will be the EBIT for this firm if sales do not increase?

In six years' time, you are scheduled to receive money from a trust established by your grandparents. When the trust matures there will be $100,000 in the account. If the account earns 9% compounded continuously, how much is in the account today?

The degree of operating leverage has which of the following characteristics?

Company D has a 50% debt ratio, whereas Company E has no debt financing. The two companies have the same level of sales and the same degree of operating leverage. Which of the following statements is most CORRECT?

The Quick Company expects its sales to increase by 50% in the coming year. The firm's current EPS is $3.25. Its degree of operating leverage is 1.6, while its degree of financial leverage is 2.1. What is the firm's projected EPS for the coming year using the DTL approach?

At the beginning of the year, you purchased a 5-year zero coupon bond with a yield to maturity of 6.8% and a face value of $1,000. Your tax rate is 30%. What is the total tax that you will have to pay on the bond during the first year?

You have $5,436.60 in an account that pays 10% interest, compounded continuously. If you deposited some funds 10 years ago, how much was your original deposit?

Alvarez Technologies has sales of $3,000,000. The company's fixed operating costs total $500,000 and its variable costs equal 60% of sales, so the company's current operating income is $700,000. The company's interest expense is $500,000. What is the company's degree of total leverage (DTL)?

If a firm uses debt financing (Debt ratio = 0.40) and sales change from the current level, which of the following statements is CORRECT?

Which of the following statements is CORRECT?

An Overview of Financial Management

Financial Markets and Institutions

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

The Value of Money

Interest Rates

Bonds and Their Valuation

Risk and Rates of Return

Stocks and Their Valuation

The Cost of Capital

The Basics of Capital Budgeting

Cash Flow Estimation and Risk Analysis

Capital Structure and Leverage

Distributions to Shareholders: Dividends and Share Repurchases

Working Capital Management

Financial Planning and Forecasting

Multinational Financial Management

Filters