Financial Management Exam 2 Multiple Choice questions and answers well illustrated.

Financial Management Exam 2 Multiple Choice questions and answers well illustrated. What proportion of earnings is being plowed back into the firm if the sustainable growth rate is 8% and the firm's ROE is 20%? a. 60% b. 80% c. 20% d. 40% - correct answers.d. 40% 8% = 20% × plowback; Plowback = 40% A firm has 120,000 shares of stock outstanding, a sustainable rate of growth of 3.8, and $648,200 in free cash flows. What value would you place on a share of this firm's stock if you require a 14% rate of return? a. $61.58 b. $48.09 c. $52.96 d. $54.02 - correct answers.c. $52.96 Price = [$648,200/(.14 - .038)]/120,000 = $52.96 What price would you pay today for a stock if you require a rate of return of 13%, the dividend growth rate is 3.6%, and the firm recently paid an annual dividend of $2.50? a. $27.55 b. $30.28 c. $26.60 d. $31.37 - correct answers.a. $27.55 Price = ($2.50 × 1.036)/(.13 - .036) = $27.55 Which one of the following is more likely to be responsible for a firm having a low PVGO? a. Book value of equity is low. b. ROE exceeds required return. c. Payout is very high. d. Plowback is very high. - correct answers.c. Payout is very high. A firm's liquidation value is the amount: a. realized from selling all assets and paying off all creditors. b. necessary to repurchase all outstanding shares of common stock. c. shown on the balance sheet as total owners' equity. d. a purchaser would pay to acquire all of the firm's assets. - correct answers.a. realized from selling all assets and paying off all creditors. What is the expected constant-growth rate of dividends for a stock currently priced at $50, that just paid a dividend of $4, and has a required return of 18%? a. 9.26% b. 3.41% c. 12.5% d. 5.50% - correct answers.a. 9.26% $50 = $4(1 + g)/(.18 - g); g = 9.26% What can be expected to happen when stocks having the same expected risk do not have the same expected return? a. This is a common occurrence indicating that one stock has more PVGO. b. At least one of the stocks becomes temporarily mispriced. c. This cannot happen if the shares are traded in an auction market. d. The expected risk levels will change until the expected returns are equal. - correct answers.b. At least one of the stocks becomes temporarily mispriced. The sustainable growth rate represents the ____ rate at which a firm can grow: a. minimum; while maintaining a constant debt-equity ratio. b. maximum; based solely on internal financing. c. maximum; while maintaining a constant debt-equity ratio. d. minimum; based solely on internal financing. - correct answers.c. maximum; while maintaining a constant debt-equity ratio. What is the plowback ratio for a firm that has earnings per share of $2.68 and pays out $1.75 per share in dividends? a. 34.70% b. 28.20% c. 71.80% d. 66.67% - correct answers.a. 34.70% Plowback ratio = ($2.68 - 1.75)/$2.68 = .3470, or 34.70% What is the minimum amount shareholders should expect to receive in the event of a complete corporate liquidation? a. Shareholders may be required to pay to be liquidated. b. Market value of equity c. Book value of equity d. Zero - correct answers.d. Zero In the calculation of rates of return on common stock, dividends are _______ and capital gains are ______. a. not guaranteed; guaranteed b. not guaranteed; not guaranteed c. guaranteed; guaranteed d. guaranteed; not guaranteed - correct answers.b. not guaranteed; not guaranteed The value of common stock will likely decrease if: a. the investment horizon decreases. b. dividends are discounted back to the present. c. the growth rate of dividends increases. d. the discount rate increases. - correct answers.d. the discount rate increases. Dani's just paid an annual dividend of $6 per share. What is the dividend expected to be in five years if the growth rate is 4.2%? a. $7.14 b. $7.44 c. $7.37 d. $7.07 - correct answers.c. $7.37 DIV3 = $6 × 1.0425 = $7.37 What should be the price of a stock that offers a $4.32 annual dividend with no prospects of growth, and has a required return of 12.5%? a. $30.24 b. $4.86 c. $34.56 d. $0 - correct answers.c. $34.56 P = $4.32/.125 = $34.56 It is possible to ignore cash dividends that occur far into the future when using a dividend discount model because those dividends: a. have an insignificant present value. b. will most likely not be paid. c. will most likely be paid to a different investor. d. have a minimal, if any, potential rate of growth. - correct answers.a. have an insignificant present value. Which of the following is inconsistent with a firm that sells for very near book value? a. Low current earnings b. Few, if any, intangible assets c. High future earning power d. Low, unstable dividend payment - correct answers.c. High future earning power How much of a stock's $30 price is reflected in PVGO if it expects to earn $4 per share, has an expected dividend of $2.50, and a required return of 20%? a. $8 b. $6 c. $0 d. $10 - correct answers.d. $10 PVGO = $30 - ($4/.2) = $10 What is the profitability index for a project costing $40,000 and returning $15,000 annually for 4 years at an opportunity cost of capital of 12%? a. 0.320 b. 0.861 c. 0.500 d. 0.139 - correct answers.d. 0.139 PI = {-$40,000 + $15,000[(1/0.12) - 1/0.12(1.12)4]}/$40,000 = 0.139 Because of its age, your car costs $4,000 annually in maintenance expense. You could replace it with a newer vehicle costing $8,000. Both vehicles would be expected to last 4 more years. If your opportunity cost is 8%, by how much must maintenance expense decrease on the newer vehicle to justify its purchase? a. $1,584.63 b. $1,469.08 c. $1,625.40 d. $1,409.54 - correct answers.a. $1,584.63 $8,000 = PMT [(1/0.08) - 1/0.08(1.08)^4]; PMT = $2,415.37 Maintenance expense decrease required = $4,000 - 2,415.37 = $1,584.63 Borrowing and lending projects usually can be distinguished by whether: a. they have positive or negative IRRs. b. their IRR increases as the discount rate increases. c. their rate of return is high or low. d. the time-zero cash flow is positive or negative. - correct answers.d. the time-zero cash flow is positive or negative. Which of the following investment criteria takes the time value of money into consideration? a. Net present value only b. Profitability index and net present value only c. Profitability index, internal rate of return, and net present value d. Internal rate of return and net present value only - correct answers.c. Profitability index, internal rate of return, and net present value When hard capital rationing exists, projects may be accurately evaluated by use of: a. a profitability index. b. borrowing, rather than lending, projects. c. mutually exclusive IRRs. d. the payback period. - correct answers.a. a profitability index. Which one of the following should be assumed about a project that requires a $100,000 investment at time zero, then returns $20,000 annually for 5 years? a. The NPV is zero. b. The NPV is negative. c. The profitability index is 1.0. d. The IRR is negative. - correct answers.b. The NPV is negative. The internal rate of return is most reliable when evaluating: