An annuity stream of cash flow payments is a set of:
A. level cash flows occurring each time period for a fixed length of time.
B. level cash flows occurring each time period forever.
C. increasing cash flows occurring each time period for a fixed length of time.
D. increasing cash flows occurring each time period forever.
E. arbitrary cash flows occurring each time period for no more than 10 years.
An annuity stream where the payments occur forever is called a(n):
A. annuity due.
D. amortized cash flow stream.
E. amortization table.
3. Which of the following statements concerning the effective annual rate are correct?
I. When making financial decisions, you should compare effective annual rates rather than annual percentage rates.
II. The more frequently interest is compounded, the higher the effective annual rate.
III. A quoted rate of 6% compounded continuously has a higher effective annual rate than if the rate were compounded daily.
IV. When borrowing and choosing which loan to accept, you should select the offer with the highest effective annual rate.
A. I and II only
B. I and IV only
C. I, II, and III only
D. II, III, and IV only
E. I, II, III, and IV
4. You are the beneficiary of a life insurance policy. The insurance company informs you that you have two options for receiving the insurance proceeds. You can receive a lump sum of $50,000 today or receive payments of $641 a month for ten years. You can earn 6.5% on your money. Which option should you take and why?
A. You should accept the payments because they are worth $56,451.91 today.
B. You should accept the payments because they are worth $56,523.74 today.
C. You should accept the payments because they are worth $56,737.08 today.
D. You should accept the $50,000 because the payments are only worth $47,757.69 today.
E. You should accept the $50,000 because the payments are only worth $47,808.17 today.
5. Janet plans on saving $3,000 a year and expects to earn 8.5%. How much will Janet have at the end of twenty-five years if she earns what she expects?
6. You retire at age 60 and expect to live another 27 years. On the day you retire, you have $464,900 in your retirement savings account. You are conservative and expect to earn 4.5% on your money during your retirement. How much can you withdraw from your retirement savings each month if you plan to die on the day you spend your last penny?
7. The Good Life Insurance Co. wants to sell you an annuity which will pay you $500 per quarter for 25 years. You want to earn a minimum rate of return of 5.5%. What is the most you are willing to pay as a lump sum today to buy this annuity?
8. You are considering an annuity which costs $100,000 today. The annuity pays $6,000 a year. The rate of return is 4.5%. What is the length of the annuity time period?
A. 24.96 years
B. 29.48 years
C. 31.49 years
D. 33.08 years
E. 38.00 years
9. The Robertson Firm is considering a project which costs $123,900 to undertake. The project will yield cash flows of $4,894.35 monthly for 30 months. What is the rate of return on this project?
10. Suzette is going to receive $10,000 today as the result of an insurance settlement. In addition, she will receive $15,000 one year from today and $25,000 two years from today. She plans on saving all of this money and investing it for her retirement. If Suzette can earn an average of 11% on her investments, how much will she have in her account if she retires 25 years from today?
11. You are paying an effective annual rate of 13.8% on your credit card. The interest is compounded monthly. What is the annual percentage rate on your account?
12. What is the effective annual rate if a bank charges you 7.64% compounded quarterly?
What is the effective annual rate of 14.9% compounded continuously?
14. Which one of the following statements concerning net present value (NPV) is correct?
A. An investment should be accepted if, and only if, the NPV is exactly equal to zero.
B. An investment should be accepted only if the NPV is equal to the initial cash flow.
C. An investment should be accepted if the NPV is positive and rejected if it is negative.
D. An investment with greater cash inflows than cash outflows, regardless of when the cash flows occur, will always have a positive NPV and therefore should always be accepted.
E. Any project that has positive cash flows for every time period after the initial investment should be accepted.
15. The discount rate that makes the net present value of an investment exactly equal to zero is called the:
A. external rate of return.
B. internal rate of return.
C. average accounting return.
D. profitability index.
16. The internal rate of return (IRR):
I. rule states that a typical investment project with an IRR that is less than the required rate should be accepted.
II. is the rate generated solely by the cash flows of an investment.
III. is the rate that causes the net present value of a project to exactly equal zero.
IV. can effectively be used to analyze all investment scenarios.
A. I and IV only
B. II and III only
C. I, II, and III only
D. II, III, and IV only
E. I, II, III, and IV
17. Matt is analyzing two mutually exclusive projects of similar size and has prepared the following data. Both projects have 5 year lives.
Matt has been asked for his best recommendation given this information. His recommendation should be to accept:
A. project B because it has the shortest payback period.
B. both projects as they both have positive net present values.
C. project A and reject project B based on their net present values.
D. project B and reject project A based on other criteria not mentioned in the problem.
E. project B and reject project A based on both the payback period and the average accounting return.
18. The elements that cause problems with the use of the IRR in projects that are mutually exclusive are:
A. the discount rate and scale problems.
B. timing and scale problems.
C. the discount rate and timing problems.
D. scale and reversing flow problems.
E. timing and reversing flow problems.
19. What is the net present value of a project with the following cash flows and a required return of 12%?
20. A project will produce cash inflows of $1,750 a year for four years. The project initially costs $10,600 to get started. In year five, the project will be closed and as a result should produce a cash inflow of $8,500. What is the net present value of this project if the required rate of return is 13.75%?
21. You are considering the following two mutually exclusive projects that will not be repeated. The required rate of return is 11.25% for project A and 10.75% for project B. Which project should you accept and why?
A. project A; because its NPV is about $335 more than the NPV of project B.
B. project A; because it has the higher required rate of return.
C. project B; because it has the largest total cash inflow.
D. project B; because it returns all its cash flows within two years.
E. project B; because it is the largest sized project.
22. An investment has the following cash flows. Should the project be accepted if it has been assigned a required return of 9.5%? Why or why not?
A. yes; because the IRR exceeds the required return by about 0.39%.
B. yes; because the IRR is less than the required return by about 3.9%.
C. yes; because the IRR is positive.
D. no; because the IRR exceeds the required return by about 3.9%.
E. no; because the IRR is 9.89%.
23. You are considering two independent projects with the following cash flows. The required return for both projects is 10%. Given this information, which one of the following statements is correct?
A. You should accept project B since it has the higher IRR and reject project A because you can not accept both projects.
B. You should accept project A because it has the lower NPV and reject project B.
C. You should accept project A because it has the higher NPV and you can not accept both projects.
D. You should accept project B because it has the higher IRR and reject project A.
E. You should accept both projects if the funds are available to do so since both NPV’s are > 0.
24. You are analyzing two mutually exclusive projects and have developed the following information. What is the incremental IRR?
25. An asset characterized by cash flows that increase at a constant rate forever is called a:
A. growing perpetuity.
B. growing annuity.
C. common annuity.
D. perpetuity due.
E. preferred stock.
26. The rate of return required by investors in the market for owning a bond is called the:
B. face value.
D. yield to maturity.
E. coupon rate.
27. The relationship between nominal interest rates on default-free, pure discount securities and the time to maturity is called the:
A. liquidity effect.
B. Fisher effect.
C. term structure of interest rates.
D. inflation premium.
E. interest rate risk premium.
28. A bond that pays interest annually yields a 7.25% rate of return. The inflation rate for the same period is 3.5%. What is the real rate of return on this bond?
29. Aspens is preparing a bond offering with an 8% coupon rate. The bonds will be repaid in 10 years. The company plans to issue the bonds at par value and pay interest semiannually. Given this, which of the following statements are correct?
I. The initial selling price of each bond will be $1,000.
II. After the bonds have been outstanding for 1 year, you should use 9 as the number of compounding periods when calculating the market value of the bond.
III. Each interest payment per bond will be $40.
IV. The yield to maturity when the bonds are first issued is 8%.
A. I and II only
B. II and III only
C. II, III, and IV only
D. I, II, and III only
E. I, III, and IV only
30. The yield to maturity is:
A. the rate that equates the price of the bond with the discounted cash flows.
B. the expected rate to be earned if held to maturity.
C. the rate that is used to determine the market price of the bond.
D. equal to the current yield for bonds priced at par.
E. All of these.
31. Consider a bond which pays 8% semiannually and has 8 years to maturity. The market requires an interest rate of 10% on bonds of this risk. What is this bond’s price?
E. None of these
32. The bonds issued by Manson & Son bear a 6% coupon, payable semiannually. The bond matures in 8 years and has a $1,000 face value. Currently, the bond sells at par. What is the yield to maturity?
33. Chocolate and Rum, Inc. offers a 7% coupon bond with semiannual payments and a yield to maturity of 7.73%. The bonds mature in 9 years. What is the market price of a $1,000 face value bond?
34. A 12-year, 5% coupon bond pays interest annually. The bond has a face value of $1,000. What is the change in the price of this bond if the market yield rises to 6% from the current yield of 4.5%?
A. 11.11% decrease
B. 12.38% decrease
C. 12.38% increase
D. 14.13% decrease
E. 14.13% increase
35. A form of equity which receives no preferential treatment in either the payment of dividends or in bankruptcy distributions is called _____ stock.
A. dual class
36. Assume that you are using the dividend growth model to value stocks. If you expect the market rate of return to increase across the board on all equity securities, then you should also expect the:
A. market values of all stocks to increase, all else constant.
B. market values of all stocks to remain constant as the dividend growth will offset the increase in the market rate.
C. market values of all stocks to decrease, all else constant.
D. stocks that do not pay dividends to decrease in price while the dividend-paying stocks maintain a constant price.
E. dividend growth rates to increase to offset this change.
37. The Robert Phillips Co. currently pays no dividend. The company is anticipating dividends of $0, $0, $0, $.10, $.20, and $.30 over the next 6 years, respectively. After that, the company anticipates increasing the dividend by 4% annually. The first step in computing the value of this stock today, is to compute the value of the stock when it reaches constant growth in year:
38. Differential growth refers to a firm that increases its dividend by:
A. three or more percent per year.
B. a rate which is most likely not sustainable over an extended period of time.
C. a constant rate of two or more percent per year.
D. $.10 or more per year.
E. an amount in excess of $.10 a year.
39. The net present value of a growth opportunity, NPVGO, can be defined as:
A. the initial investment necessary for a new project.
B. the net present value per share of an investment in a new project.
C. a continual reinvestment of earnings when r < g.
D. a single period investment when r > g.
E. None of these.
40. Angelina’s made two announcements concerning its common stock today. First, the company announced that its next annual dividend has been set at $2.16 a share. Secondly, the company announced that all future dividends will increase by 4% annually. What is the maximum amount you should pay to purchase a share of Angelina’s stock if your goal is to earn a 10% rate of return?
41. Martha’s Vineyard recently paid a $3.60 annual dividend on its common stock. This dividend increases at an average rate of 3.5% per year. The stock is currently selling for $62.10 a share. What is the market rate of return?
42. Turnips and Parsley common stock sells for $39.86 a share at a market rate of return of 9.5%. The company just paid its annual dividend of $1.20. What is the rate of growth of its dividend?
43. The Bell Weather Co. is a new firm in a rapidly growing industry. The company is planning on increasing its annual dividend by 20% a year for the next four years and then decreasing the growth rate to 5% per year. The company just paid its annual dividend in the amount of $1.00 per share. What is the current value of one share if the required rate of return is 9.25%?