Multiple Choice Questions

1. You just inherited a trust that will pay you $100,000 per year in perpetuity. However, the first
payment will not occur for exactly five more years. Assuming a 10% annual interest rate, what is the
value of this trust?

A. $850,729
B. $918,787
C. $1,000,000
D. $1,250,000

Ans: A (nearest)

2. Mr. Williams expects to retire in 30 years and would like to accumulate $1 million in his pension
fund. If the annual interest rate is 12% per annum, how much should Mr. Williams put into his pension
fund each month in order to achieve his goal? (Assume that Mr. Williams will deposit the same amount
each month into his pension fund, using monthly compounding.)

A. $286.13
B. $771.61
C. $345.30
D. $437.30

Ans: A

3. Ottocell Motor Company just paid a dividend of $1.40. Analysts expect its dividend to grow at a rate
of 10% next year, 8% for the following two years, and then a constant rate of 5% thereafter. What is
the expected dividend per share at the end of year 5?

A. $2.08
B. $1.98
C. $1.80
D. $0.99

Ans: B

4. Galaxy Air, previously a no-growth firm, has two million shares outstanding. Until now, it
consistently earned $20 million per year on its assets. (It has no debt and pays out all earnings as
dividends. Its cost of capital is 10%.) Due to its newly appointed CEO, Galaxy Air is now able to enjoy
1% annual growth by plowing back (retaining) 5% of earnings. Calculate its stock price per share.

A. $200.00
B. $106.61
C. $100.00
D. $213.22

Ans: B

5. A company forecasts growth of free cash flows to be 6% for the next five years and 3% thereafter.
Given that last year's free cash flow was $100, what is the expected (intrinsic) value of the company at
the end of 5 years if it discounts its expected free cash flows with a cost of capital of 8%?

A. Cannot determine
B. $0
C. $1672
D. $2676
Ans: D

6. Generally high growth stocks are most likely to follow which of the following dividend policy:

A. pay low or no dividends.

B. pay high, steadily growing dividends.
C. pay dividends that are erratic and volatile.
D. pay decreasing dividends.

Ans: A

7. Accountants do not depreciate investment in net working capital because:

A. it is not a cash flow.

B. it is a sunk cost.
C. it appears on the balance sheet, not the income statement.
D. None of the above

Ans: D

8. A company understates year-end depreciation. As compared to the properly stated year-end results,
what effect will this understatement have on the company's asset turnover ratio?
A. No impact
B. Decrease
C. Increase

Ans: B

9. For the last few years, firms in an expanding industry have found it more difficult to keep up with
consumer demand despite steadily increasing inventory levels. The consumer price index (CPI) has
been at a level of 1060, 1060, and 1087 in the last three years. Given this situation, a firm in this
industry that seeks to report higher net income would prefer which inventory accounting method?
A. LIFO
B. FIFO
C. Average cost

Ans: B

10. Cheryl Flynn is preparing her recommendation for the stock of Garrett Company. Flynn believes
Garrett's reported sales are of poor quality because its managers recognize revenue too aggressively. To
show that her opinion has a reasonable basis, she is least likely to:
A. compare relevant financial statement data and ratios for Garrett to those of other firms in its
industry.
B. examine the disclosures of significant accounting policies that are included with Garrett's financial
statements.
C. contrast the billings and collections on Garrett's general ledger with the amounts reported on its
financial statements.

Ans: C

11. An analyst is analyzing Collins Footwear Inc. and obtains the following data for the company's
major geographic segments:
Asia Europe North America
Sales (million US Dollars) 200 300 500
Net profit margin 4.5% 3.0% 1.5%
Asset turnover ratio 1.5 2.5 4.0

Based on these data he should conclude that Collins's:

A. smallest segment by assets is Asia.
B. most profitable segment by return on assets is Europe.
C. most profitable segment by net income is North America.
Ans: B

12. At the end of last year, Manhattan Corporation had a quick ratio of 1.2. If Manhattan reduces its
accounts payable with a cash payment of $2 million, its quick ratio will:
A. be unchanged
B. increase
C. decrease

Ans: B

13. A company's excess cash balances can most appropriately be invested in:
A. common stock.
B. corporate bonds.
C. commercial paper.

Ans: C (considered to be short-term, low risk, and highly liquid paper)

14. Mr. X has been nominated to serve on the board of directors of CoMedia, an entertainment
conglomerate. His experience most likely qualifies him to serve the best interests of CoMedia's
shareowners if he:
A. served on the board of a pharmaceutical company for the past eight years.
B. has a long standing professional relationship with several CoMedia executives.
C. adheres to a policy of not owing shares of companies for which he serves as a director.

Ans: A (the question pertains to qualification / prior experience)

15. Inverness Corporation is considering investing in one of two mutually exclusive capital projects.
The firm's cost of capital is 15%. Project A's NPV profile crosses the Y axis at $1.8 million and crosses
the X-axis at 25%. Project B's NPV profile crosses the Y-axis at $1.2 million and crosses the X-axis at
33%. For the two projects the crossover rate is 18%. Which of the following is most likely correct?

A. Project A and Project B have equal NPVs at a discount rate of 15%.

B. Inverness should choose Project B since it has a higher IRR.
C. Inverness should choose project A since it has a higher NPV

Ans: C

16. With regard to the internal rate of return (IRR), which of the following statements is most accurate?

A. the IRR is the discount rate that maximizes a project's net present value.
B. a proper decision rule is to accept the project if IRR is less than the required rate of return.
C. IRR is the discount rate at which the present value of expected future after-tax cash flows is equal to
the investment outlay.

Ans: C

17. Refer to the below table to make project investment decision in projects if the firm has $4 million
cash for investment. All projects are independent:
Project Investment outlay Rate of return (%)
A $1,000,000 8
B $1,000,000 20
C $2,000,000 4
D $3,000,000 30

A. A, B, C
B. A, D
C. A, B, D
D. D, B
Ans: D

18. A risk-averse investor prefers the lowest -risk investment:

A. for any given level of expected return.
B. when presented with three investment alternatives.
C. with an expected return at least equal to her threshold rate of return.

Ans: A

19. An investor is fully invested in the market portfolio. He desires to increase the expected return from
his portfolio. According to capital market theory, he can meet his return objective best by:
A. allocating a higher proportion of the portfolio to higher risk assets.
B. borrowing at a risk-free rate to invest in the risky market portfolio.
C. owning the risky market portfolio and lending at risk-free rate.

Ans: B

20. An analyst predicts that both stock X and Y will return 20% next year. The Treasury bill rate is 5%
and the market risk premium is 8%. The beta for stock X is 1.5 and for stock Y is 2. The standard
deviation for stock X is 20% and for stock Y is 30%. She believes that:
A. Stock X is overvalued and stock Y is undervalued.
B. Stock X is undervalued and stock Y is overvalued.
C. Both stock X and Y are overvalued.

Ans: B