Firms use defensive tactics to fight off undesired mergers. these tactics do not include

FINC 5880 - Final Exam

Multiple Choice Identify the choice that best completes the statement or answers the question

l. Poff lndustries'stock currently sells for $120 a share. You own 100 shares of the stock. The company is contemplating a 2-for-l stock split. Which of the following best describes what your position will be after such a split takes place? a. You will have 200 shares of stock, and the stock will trade at or near $60 a share. b. You will have 100 shares of stock, and the stock will trade at or near $60 a share. c. You will have 50 shares of stock, and the stock will trade at or near $120 a share. d. You will have 50 shares of stock, and the stock will trade at or near $60 a share. e. You will have 200 shares of stock, and the stock will trade at or near $120 a share.

2. Myron Gordon and John Lintner believe that the required return on equity increases as the dividend payout ratio is decreased. Their argument is based on the assumption that a. investors require that the dividend yield and capital gains yield equal a constant. b. capital gains are taxed at a higher rate than dividends. c. investors view dividends as being less risky than potential future capital gains. d. investors value a dollar of expected capital gains more highly than a dollar of expected

dividends because of the lower tax rate on capital gains. e. investors are indifferent between dividends and capital gains.

3. Which of the following should gg! influence a firm's dividend policy decision? a. A strong preference by most shareholders for current cash income versus capital gains. b. Constraints imposed by the firm's bond indenture. c. The fact that much of the firm's equipment has been leased rather than bought and owned. d. The fact that Congress is considering changes in the tax law regarding the taxation of

dividends versus capital gains. e. The firm's ability to accelerate or delay investment projects.

4. Which of the following statements about dividend policies is correct? a. One reason that companies tend to avoid stock repurchases is that dividend payments are

taxed at a lower rate than gains on stock repurchases. b. One advantage of dividend reinvestment plans is that they allow shareholders to avoid

paying taxes on the dividends that they choose to reinvest. c. One key advantage of a residual dividend policy is that it enables a company to follow a

stable dividend policy. d. The clientele effect suggests that companies should follow a stable dividend policy. e. Modigliani and Miller argue that investors prefer dividends to capital gains because

dividends are more certain than capital gains. They call this the "bird-in-the hand" effect.

5. The projected capital budget of Kandell Corporation is $1,000,000, its target capital structure is 60% debt and 40%o equity, and its forecasted net income is $550,000. If the company follows a residual dividend policy, what total dividends, if any, will it pay out? a. $122,176 b. $128,606 c. $135,375 d. $142,500 e. $150,000

6. Based on the information below for Benson Corporation, what is the optimal capital structure? a. Debt: 50%; Equity : 50o/o; EPS : $3.05; Stock price: $28.90. b. Debt : 60%; Equity : 40Yo; EPS : $3. I 8; Stock price : $3 I .20. c. Debt : 80%; Equity :20%; EPS : $3.42; Stock price : $30.40. d. Debt : 7}%;Eqtity :30o/o; EPS : $3.31; Stock price : $30.00. e. Debt : 40%;Equity : 600/o; EPS : $2.95; Stock price: $26.50.

7. Daylight Solutions is considering a recapitalization that would increase its debt ratio and increase its interest expense. The company would issue new bonds and use the proceeds to buy back shares of its common stock. The company's CFO thinks the plan will not change total assets or operating income, but that it will increase earnings per share (EPS). Assuming the CFO's estimates are correct, which of the following statements is CORRECT? a. If the plan reduces the WACC, the stock price is also likely to decline. b. Since the plan is expected to increase EPS, this implies that net income is also expected to

increase. c. If the plan does increase the EPS, the stock price will automatically increase at the same

rate. d. Under the plan there will be more bonds outstanding, and that will increase their liquidity

and thus lower the interest rate on the currently outstanding bonds. e. Since the proposed plan increases Daylight's financial risk, the company's stock price still

might fall even if EPS increases.

8. The firm's target capital structure should be consistent with which of the following statements? a. Minimize the cost of debt (r4). b. Obtain the highest possible bond rating. c. Minimize the cost of equity (r,). d. Minimize the weighted average cost of capital (WACC). e. Maximize the earnings per share (EPS).

9. Which of the following will cause an increase in net working capital, other things held constant? a. ' A cash dividend is declared and paid. b. Merchandise is sold at a profit, but the sale is on credit. c. Long-term bonds are retired with the proceeds of a preferred stock issue. d. Missing inventory is written off against retained earnings. e. Cash is used to buy marketable securities.

10. Firms generally choose to finance temporary current operating assets with short-term debt because a. short-term interest rates have traditionally been more stable than long-term interest rates. b. a firm that borrows heavily on a long-term basis is more apt to be unable to repay the debt

than a firm that borrows short term. c. the yield curve is normally downward sloping. d. short-term debt has a higher cost than equity capital. e. matching the maturities of assets and liabilities reduces risk under some circumstances, and

also because short-term debt is often less expensive than long-term capital.

1 l. Which of the following actions should Reece Windows take if it wants to reduce its cash conversion cycle? a. Take steps to reduce the DSO. b. Start paying its bills sooner, which would reduce the average accounts payable but not affect

sales. c. Sell common stock to retire long-term bonds. d. Sell an issue of long-term bonds and use the proceeds to buy back some of its common

stock.

e. Increase average inventory without increasing sales.

12. Which of the following is NOT a reason why companies move into international operations? a. To develop new markets for the firm's products. b. To better serve their primary customers. c. Because important raw materials are located abroad. d. To increase their inventory levels. e. To take advantage of lower production costs in regions where labor costs are relatively low.

13. If 1.64 Canadian dollars can purchase one U.S. dollar, how many U.S. dollars can you purchase for one Canadian dollar? a. 0.37 b. 0.61 c. 1.00 d. 1.64 e. 3.28

14. Which of the following is generally NOT true and an advantage of going public? a. Increases the liquidity of the firm's stock. b. Makes it easier to obtain new equity capital. c. Establishes a market value for the firm. d. Makes it easier for owner-managers to engage in profitable self-dealings. e. Facilitates stockholder diversification.

15. Which of the following statements about listing on a stock exchange is most CORRECT? a. Any firm can be listed on the NYSE as long as it pays the listing fee. b. Listing provides a company with some "free" advertising, and it may enhance the firm's

prestige and help it do more business. c. Listing reduces the reporting requirements for firms, because listed firms file reports with

the exchange rather than with the SEC. d. The OTC is the second largest market for listed stock, and it is exceeded only by the NYSE. e. Listing is a decision of more significance to a firm than going public.

16. Operating leases often have terms that include a. full amortization over the life of the lease. b. very high penalties if the lease is canceled. c. restrictions on how much the leased property can be used. d. much longer lease periods than for most financial leases. e. maintenance of the equipment by the lessor.

17. Financial Accounting Standards Board (FASB) Statement #13 requires that for an unqualified audit report, financial (or capital) leases must be included in the balance sheet by reporting the a. residual value as a liability. b. present value of future lease payments as an asset and also showing this same amount as an

offsetting Iiability. c. undiscounted sum of future lease payments as an asset and as an offsetting liability. d. undiscounted sum of future lease payments, less the residual value, as an asset and as an

offsetting liability. e. residual value as a fixed asset.

18. Heavy use of off-balance sheet lease financing will tend to a. make a company appear less risky than it actually is because its stated debt ratio will appear

lower.

b. affect a company's cash flows but not its degree of risk. c. have no effect on either cash flows or risk because the cash flows are already reflected in the

income statement. d. affect the lessee's cash flows but only due to tax effects. e. make a company appear more risky than it actually is because its stated debt ratio will be

increased.

19. A lease versus purchase analysis should compare the cost of leasing to the cost of owning, assuming that the asset purchased a. is financed with long-term debt. b. is financed with debt whose maturity matches the term of the lease. c. is financed with a mix of debt and equity based on the firm's target capital structure, i.e., at

the WACC. d. is financed with retained earnings. e. is financed with short-term debt.

20. Which of the following statements concerning warrants is correct? a. Warrants are long-term put options that have value because holders can sell the firm's

common stock at the exercise price regardless of how low the market price drops. b. Warrants are long-term call options that have value because holders can buy the firm's

common stock at the exercise price regardless of how high the stock's price has risen. c. A firm's investors would generally prefer to see it issue bonds with warrants than straight

bonds because the warrants dilute the value of new shareholders, and that value is transferred to existing shareholders.

d. A drawback to using warrants is that if the firm is very successful, investors will be less likely to exercise the warrants, and this will deprive the firm of receiving any new capital.

e. Bonds with warrants and convertible bonds both have option features that their holders can exercise if the underlying stock's price increases. However, if the option is exercised, the issuing company's debt declines if warrants were used but remains the same if it used convertibles

21. Which of the following statements is most CORRECT? a. One important difference between warrants and convertibles is that convertibles bring in

additional funds when they are converted, but exercising warrants does not bring in any additional funds.

b. The coupon rate on convertible debt is normally set below the coupon rate that would be set on otherwise similar straight debt even though investing in convertibles is more risky than investing in straight debt.

c. The value of a warrant to buy a safe, stable stock should exceed the value of a warrant to buy a risky, volatile stock, other things held constant.

d. Warrants can sometimes be detached and traded separately from the debt with which they were issued, but this is unusual.

e. Warrants have an option feature but convertibles do not.

22. The major contribution of the Miller model is that it demonstrates that a. personal taxes decrease the value ofusing corporate debt. b. financial distress and agency costs reduce the value ofusing corporate debt. c. equity costs increase with financial leverage. d. debt costs increase with financial leverage. e. personal taxes increase the value ofusing corporate debt.

23. Which of the following are legal and acceptable reasons for the high level of merger activity in the U.S. during the 1980s? a. A profitable firm acquires a firm with large accumulated tax losses that may be carried

forward. b. Attempts to stabilize earnings by diversifuing. c. Purchase of assets below their replacement costs. d. Reduction in competition resulting from mergers. e. Synergistic benefits arising from mergers.

24. Firms use defensive tactics to fight off undesired mergers. These tactics do not include a. getting a white squire to purchase stock in the firm. b. getting white knights to bid for the firm. c. repurchasing their own stock. d. changing the bylaws to eliminate supermajority voting requirements. e. raising antitrust issues.

25. Which of the following statements about interest rate and reinvestment rate risk is CORRECT? a. Interest rate price risk exists because fixed-rate debt securities lose value when interest rates

rise, while reinvestment rate risk is the risk of earning less than expected when interest payments or debt principal are reinvested.

b. Interest rate price risk can be eliminated by holding zero coupon bonds. c. Reinvestment rate risk can be eliminated by holding variable (or floating) rate bonds. d. lnterest rate risk can never be reduced. e. Variable (or floating) rate securities have more interest rate (price) risk than fixed rate

securities.

26. A commercial bank recognizes that its net income suffers whenever interest rates increase. Which of the following strategies would protect the bank against rising interest rates? a. Entering into an interest rate swap where the bank receives a fixed payment stream, and in

return agrees to make payments that float with market interest rates.' b. Purchase principal only (PO) strips that decline in value whenever ihterest rates rise. c. Enter into a short hedge where the bank agrees to sell interest rate futures. d. Sell some of the bank's floating-rate loans and use the proceeds to make fixed-rate loans. e. Buying inverse floaters.

27. Chapter 7 of the Bankruptcy Act is designed to do which of the following? a. Establish the rules of reorganization for firms with projected cash flows that eventually will

be sufficient to meet debt payments. b. Ensure that the firm is viable after emerging from bankruptcy. c. Allow the firm to negotiate with each creditor individually. d. Provide safeguards against the withdrawal of assets by the owners of the bankrupt firm and

allow insolvent debtors to discharge all of their obligations and to start over unhampered by a burden ofprior debt.

e. Protect shareholders against creditors. 28. Which ofthe following statements is most CORRECT?

a. Federal bankruptcy law deals only with corporate bankruptcies. Municipal and personal bankruptcy are governed solely by state laws.

b. All bankruptcy petitions are filed by creditors seeking to protect their claims against firms in financial distress. Thus, all bankruptcy petitions are involuntary as viewed from the perspective of the firm's management.

c. Chapters 11 and 7 arethe most important bankruptcy chapters for financial management

purposes. Ifa reorgani zation plan cannot be worked out under Chapter I l, then the company will be liquidated as prescribed in Chapter 7 of the Act.

d. "Restructuring" a firm's debt can involve forgiving a certain portion of the debt, but it cannot call for changing the debt's maturity or its contractual interest rate.

e. Our bankruptcy laws were enacted in the 1800s, revised in the 1930s, and have remained unaltered since that time.

29. What would be the priority of the claims as to the distribution of assets in a liquidation under Chapter 7 of the Bankruptcy Act? I is the highest claim, 5 is the lowest.

(l) Trustees'costs to administer and operate the firm. (2) Commonstockholders. (3) General, or unsecured, creditors. (4) Secured creditors, who have a claim to the proceeds from the sale of specific property

pledged to secure a loan. (5) Taxes due to federal and state governments.

a.5,4,1,3,2 b. 4, 1,5,3,2 c.5,1,4,2,3 d. 1,5,4,3,2 e.1,4,3,5,2

30. You have the following data on three stocks:

Stock Standard Deviation Beta A 0.15 0.79 B 0.25 0.61 c 0.20 1.29

As a risk mirimizer, you would choose Stock

-

if it is to be held in isolation and Stock

-)f

it is to be held

as part of a well-diversified portfolio. a. A;B. b. B;C. c. C; A. d. C; B. e. A; A.

3 I . Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true about these securities? (Assume market equilibrium.) a- Stock B must be a more desirable addition to a portfolio than Stock A. b. Stock A must be a more desirable addition to a portfolio than Stock B. c. The expected return on Stock A should be greater than that on Stock B. d. The expected return on Stock B should be greater than that on Stock A. e. When held in isolation, Stock A has greater risk than Stock B.

32. Whether to invest in a project today or to postpone the decision until next year is a decision facing the CEO of the Aaron Co. The project has a positive expected NPV, but its cash flows could be less than expected, in which case the NPV could be negative. No competitors are likely to invest in a similar project if Aaron decides to wait. Which of the following statements best describes the issues that Aaron faces when considering this investment timing option? a. The more uncertainty about the future cash flows, the more logical it is for Aaron to go

ahead with this project today. b. Since the project has a positive expected NPV today, this means that its expected NPV will

be even higher if it chooses to wait ayear. c. Since the project has a positive expected NPV today, this means that it should be accepted in

order to lock in that NPV. d. Waiting would probably reduce the project's risk. e. The investment timing option does not affect the cash flows and will therefore have no

impact on the project's risk.

33. Which one ofthe following is an example of a "flexibility" option? a. A company has an option to close down an operation if it turns out to be unprofitable. b. A company agrees to pay more to build a plant in order to be able to change the plant's

inputs and/or outputs at a later date ifconditions change. c. A company invests in a project today to gain knowledge that may enable it to expand into

different markets at a later date. d. A company invests in a jet aircraft so that its CEO, who must travel frequently, can arrive

for distant meetings feeling less tired than if he had to fly commercial. e. A company has an option to invest in a project today or to wait ayear.

34. A firm's credit policy consists of which of the following items? a. Credit period, cash discounts, credit standards, collection policy. b. Credit period, cash discounts, receivables monitoring, collection policy. c. Cash discounts, credit standards, receivables monitoring, collection policy. d. Credit period, receivables monitoring, credit standards, collection policy. e. Credit period, cash discounts, credit standards, receivables monitoring.

35. Which of the following is not correct? a. A more aggressive collection policy will reduce bad debt expenses, but may also decrease

sales.

b. Collection policy usually has little impact on sales since collecting past-due accounts occurs only after the customer has alre'ady purchased.

c. Typically a firm will turn over an account to a collection agency only after it has tried several times on its own to collect the account.

d. A lax collection policy will frequently lead to an increase in accounts receivable. e. Collection policy is how a firm goes about collecting past-due accounts.

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