Name __________________________ Section _____ ID # ____________________

(Prof. Alagurajahs section A; Prof. Kings section G; Prof. Kohens section E; Prof. Lis
section D; Prof. Pattersons section B; Prof. Tahanis section C)

AK/ADMS 3530 Final Exam

Fall 2008

February 28, 2009

12 - 3 pm

Exam - Solution

This exam consists of 50 multiple choice questions. 2 points each for a total of 100
points. Choose the response which best answers each question. Circle your answers
below, and fill in your answers on the bubble sheet. Only the bubble sheet is used to
determine your exam score. BE SURE TO BLACKEN THE BUBBLES
CORRESPONDING TO YOUR STUDENT NUMBER.

Please note the following eight points:

1) Please use your time efficiently and start with the questions that you are most
comfortable with first. Remember: every question carries the same weight, so
please do NOT spend too much time on one particular question;
2) Read the exam questions carefully;
3) Choose the answers that are closest to yours, because of possible rounding;
4) Keep at least 2 decimal places in your calculations and final answers, and at least
4 decimal places for interest rates;
5) Interest rates are annual unless otherwise stated;
6) Bonds pay semi-annual coupons unless otherwise stated;
7) Bonds have a par value (or face value) of $1,000;
8) Assume cash flows or payments occur at the end of a period or year, unless
otherwise stated; and
9) You may use the back of the exam paper as your scrap paper.
10) Non-programmable financial and/or scientific calculators are allowed.

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Numerical Questions

1. (Q. 4 in B) You are planning to establish a 30-year scholarship fund for the top 3530
student at York University. The fund will pay $11,000 at the end of the first year and
then increase by 1.50% per year. The manager expects that the fund will earn a
5.75% annual rate of return. How much should you donate to York today in order to
maintain this scholarship?

A) $50,346
B) $146,509
C) $183,214
D) $258,824

Solution
This is a growing annuity:
PV = $11,000/(0.0575 - 0.015) x [1 - (1.015/1.0575)30] = $183,214

2. (Q. 5 in B) You want to buy a house in Collingwood that costs $300,000. You make
a 20% down payment and finance the rest with a 15 year mortgage. The mortgage
has a five year renewal term for which the annual mortgage rate is 6.5%
compounded semi-annually. What will the remaining principal of the loan be at the
end of the 5-year term?

A) $162,117
B) $183,831
C) $204,514
D) $229,789

Solution
is = 6.5%/2 = 3.25%
EAR = (1+.0325) 2 -1 = 6.605625%
Monthly rate is r = (1+0.06605625) 1/12- 1 = 0.005345 = 0.5345%.
Number of months = 15 years x 12 = 180 = n
Monthly Payment using your calculator:
N=180, I/Y=0.5345%, PV=-$240,000, FV=0, COMP PMT
PMT=$2,079.33

Remaining principal at the end of 5-year term is the PV of remaining payments:

N=120, I/Y=0.5345%, PMT=$2,079.33, FV=0, COMP PV=$ 183,831

3. (Q. 6 in B) Research In Motion recently issued a five-year, zero-coupon bond

($1,000 maturity value) for $600. How much will the bond be worth in three years
from issue date if interest rates (and required returns) remain stable? (Assume
annual compounding)

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 A) $736.02
B) $757.86
C) $815.19
D) $925.65

Solution

Step 1: Find the current YTM or i:

Note: there is No PMT and no semi-annual compounding for a zero-coupon
bonds:
n = 5 annual periods remaining
PV = -$600 (dont forget the negative sign!)
FV = $1,000
COMP i (or I/Y) You should get i = 10.7566%

Step 2: Find the Price at end of Year 3 (Two years remaining on bond and
market rates stay at 10.7566%!
i = 10.7566
n=2
FV = $1,000
COMP PV You should get PV = -$815.19

4. (Q. 1 in B) Two years ago the Bank of Montreal issued bonds with 10 years until
maturity, selling at par, and a 7% coupon. If interest rates for that grade of bond are
currently 12.5%, what is the current market price of these bonds? (Assume semi-
annual payments)

A) $690.88
B) $726.80
C) $895.30
D) $1,000.00

Solution
n = 8 x 2 = 16 semi-annual periods (8 years remaining!)
PMT= $70/2 = $35 every six months
FV = $1000
I = 12.5/2 = 6.25%
COMP PV = -$726.80

5. (Q. 2 in B) Which of the following statements is correct about a stock currently

selling for $42 per share that has a 12% expected return and an 8% expected capital
appreciation?

A) It is expected to pay $1.68 in annual dividends.

B) It is expected to pay $5.04 in annual dividends.
C) Its expected dividend exceeds the actual dividend.

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 D) Its expected return will exceed the actual return.

Solution
r = DIV1/P0 + (P1 P0)/P0
Expected return = expected dividend yield + expected capital appreciation
12% = expected dividend yield + 8%
4% = expected dividend yield
$42 share price x 4% = $1.68 expected dividend payment

6. (Q. 3 in B) XYZ common stock is expected to have extraordinary growth of 20% per
year for two years, at which time the growth rate will settle into a constant 6%. If the
discount rate is 15% and the most recent dividend was $2.50, what should be the
current share price?

A) $31.16
B) $33.23
C) $37.39
D) $47.73

Solution
DIV0 = $2.50
g1 and g2 (the growth rates for year 1 and 2) = 20%
g3 to ginfinity = 6%
r = 15%

DIV1 = DIV0 x (1 + g1) = $2.50 x (1.20) = $3.00

DIV2 = DIV1 x (1 + g2) = $3.00 x (1.20) = $3.60
DIV3 = DIV2 x (1 + g3) = $3.60 x (1.06) = $3.816

In this case growth becomes constant at year 3, so we calculate P2

That is P2 = DIV3/(r-g) = $3.816/ (0.15 - 0.06) = $42.40

P0= 3.00/(1.15) + 3.60/(1.15)2 + 42.40/(1.15)2

= 2.6087 + 2.7221 + 32.0605 = $37.39

7. (Q. 9 in B) Which mutually exclusive project would you select, if both cost $14,000
and your discount rate is 15%:
- Project A: annual cash flows of $8,000 at the end of each year for the next three
years
- Project B: annual cash flows of $7,000 for each of four years where the first cash
flow starts in two years from now?

A) Project A.
B) Project B.
C) You are indifferent since the NPVs are equal.

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 D) Neither project should be selected.

Solution
As long as funds are not limited, for mutually-exclusive projects you choose the
project which gives you the highest positive NPV.

NPVA = 18,265.80 14,000 = $4,265.80

NPVB = 19,984.85/(1.15) 14,000 = $3,378.13

Therefore you would choose Project A

8. (Q. 10 in B) A firm is facing a hard capital rationing with $20,000. Given the firms
required rate of return of 9%, which project would you accept?

Year Project I Cash Flow Project II Cash Flow

0 -20,000 -12,000
1 9,000 5,500
2 9,000 5,500
3 9,000 5,500

A) Neither project should be accepted.

B) More information is needed before a decision can be made.
C) Project I
D) Project II

Solution
Hard Rationing Need to calculate Profitability Index
PI = NPV / Initial Investment

NPVI = 2,781.65
PII = 2,781.65 / 20,000 = 0.1391

NPVII = 1,922.12
PI II = 1,922.12 / 12,000 = 0.1602

So choose Project II since its PI is higher.

9. (Q. 7 in B) The profitability index (PI) for a project costing $40,000 and returning
$15,000 annually for four years at an opportunity cost of capital of 12% is:

A) 0.139
B) 0.320
C) 0.500
D) 0.861

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 Solution
PV = $15,000 x PVAF(12%,4)
= $15,000 3.0373
= $45,560.

NPV = $45,560 - $40,000 = $5,560.

Profitability index = $5,560 / $40,000 = 0.139.

10. (Q. 8 in B) You can continue to use your old machine at a cost of $8,000 annually for
the next five years. Alternatively, you can purchase a new machine for $12,000 plus
$5,000 annual maintenance for the next five years. At a cost of capital of 15%, you
should:

A) Buy the new machine and save $388 in equivalent annual costs.
B) Buy the new machine and save $600 in equivalent annual costs.
C) Keep the old machine and save $388 in equivalent annual costs.
D) Keep the old machine and save $580 in equivalent annual costs.

Solution
The PV of total cost of the new machine is $28,760.78, which translates into an
EAC of $8,579.79, which is $579.79 higher than the annual cost associated
with the old machine.

11. (Q. 14 in B) A firm has calculated the expected annual cash flows on a new 4-year
project, whose expected initial cost is $8,000, to be $7,000, $7,500, $8,000, and
$8,500, respectively. What is the discounted payback period of the project? Assume
a discount rate of 12%.

A) 1.20 years
B) 1.30 years
C) 1.50 years
D) 1.67 years

Solution

Year DCFs Cumulative DCFs

0 -$8,000.00 -$8,000.00
1 $6,250.00 -$1,750.00
2 $5,978.95 $4,228.95
3 $5,694.24 $9,923.20
4 $5,401.90 $15,325.10

Discounted payback = 1 + (1,750/5,978.95) = 1.30

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12. (Q. 15 in B) At what discount rate would you be indifferent between accepting and
rejecting a project which costs $6,000 today with annual cash flows of $1,200 for the
next nine years?

A) 13.50%
B) 13.60%
C) 13.70%
D) 13.80%

Solution IRR = 13.70%

13. (Q. 11 in B) Estimate the annual after tax cash flow for a project with forecasted
annual sales of 10 million units at a price of $1 each, variable cost per unit of $0.50,
annual fixed cost of $2 million and annual depreciation of $2 million. Assume the
corporate tax rate is 30%.

A) $0.6 million
B) $1 million
C) $2 million
D) $2.7 million

Solution
Sales revenues (Selling Price x Units) $10,000,000
Total Variable Costs (VC per unit x Units) 5,000,000
Fixed Costs 2,000,000
Depreciation 2,000,000
Operating income before taxes $ 1,000,000
Taxes (30%) 300,000
Operating income after taxes $ 700,000
Add back depreciation 2,000,000
After tax cash flow $ 2,700,000

14. (Q. 12 in B) Joshua Company acquires a depreciable asset at a cost of $830,000

that has a useful life of 5 years and a salvage value of $110,000. The company has
a tax rate of 37% and the asset falls into a 30% CCA class. The acquisition of the
asset would result in annual pre-tax savings of $355,000 in each of the 5 years
starting in year 1. The acquisition of the asset requires an investment in working
capital of $37,500 at t=0 which is fully recovered in year 5. If the company is required
to earn a minimum rate of return of 12%, what is the NPV of acquiring this asset?

A) $213,514
B) $267,121
C) $440,615
D) $444,983

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 Solution
Cash flow year 0 (investing in asset and NWC) = -830,000 - 37,500 = -$867,500
Cash flow savings years 1 to 5 = 355,000(1 .37) = $223,650
Cash flow in year 5 (recovering w/c and salvage) = 110,000 + 37,500 = $147,500

PV of CCATS = 830,000(.3)(.37) x (1 + .5(.12))

.12 + .3 1 + .12

- 110,000(.3)(.37) x 1
.12 + .3 (1.12)5 = $191,110

NPV = -867,500 + 223,650 x PVIFA(5, 12%) + (147,500)/(1.12)5 + 191,110

= $213,514

15. (Q. 13 in B) A consulting firm purchases 8 new pc computers in year 1 at $2,000

each. Computers belong to CCA class 45 with 45% CCA rate. In year 3, the
company sells 4 pc computers at $1,000 each and buys 6 new Apple computers at
$3,000 each. The firms tax rate is 40%. The half-year rule applies. What is the
value of the CCA tax shield in year 3?

A) $1,874
B) $2,488
C) $4,685
D) $6,219

Solution
The net acquisition in year 3 is: 6x3,000 4x1,000 = 14,000. The CCA in year 3
is $6,219 and the CCA tax shield is $2,488.

Year Net Acquisition UCC Start CCA UCC End

1 16,000.00 3,600.00 12,400.00
2 12,400.00 5,580.00 6,820.00
3 14,000.00 6,820.00 6,219.00 14,601.00

16. (Q. 19 in B) You invest in a project that generates pre-tax cash flows of $16,666.66
at the end of year one. These cash flows grow annually at the rate of inflation of 5%
for the following 4 years. Calculate the real present value of the five-year after-tax
cash flows if you use a nominal discount rate of 15%. Assume that the corporate tax
rate is 40%.

A) $33,522
B) $38,374
C) $43,294
D) $55,000

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 Solution
The real discount rate = (1 + nominal rate) - 1 = (1.15/1.05) 1 = 9.5238%.
(1 + rate of inflation)

After tax cash flow = pretax cash-flow x (1 tax rate)

= 16,666.66 x (1 0.40) = $10,000

Present Value = $10,000 x PVAF(9.5238%,5) = $38,373.57

17. (Q. 20 in B) ABC Corp. uses scenario analysis in order to determine its expected
NPV. The base case, best case, and worst case scenarios and their probabilities are
provided below. What is ABCs expected NPV and standard deviation of NPV?

Scenario Probability NPV

Worst case 0.3 -6,000
Base case 0.5 13,000
Best case 0.2 28,000

A) Expected NPV = $35,000; Std. Dev NPV = 17,500.

B) Expected NPV = $35,000; Std. Dev NPV = 11,667.
C) Expected NPV = $10,300; Std. Dev NPV = 12,083.
D) Expected NPV = $13,900; Std. Dev NPV = 8,476.

Solution
Worst case 0.3(-6,000) = -1,800
Base case 0.5(13,000) = 6,500
Best case 0.2(28,000) = 5,600
Expected NPV = $10,300

Worst Case 0.3 x (- 6,000 10,300)2 = 79,707,000

Base case 0.5 x (13,000 10,300)2 = 3,645,000
Best case 0.2 x (28,000 10,300)2 = 62,658,000
Variance = 146,010,000

Std Dev = (146,010,000) = 12,083.

18. (Q. 16 in B) Given the following project data: Selling Price per unit $65; Variable cost
per unit $33; Fixed cost $4,000; rate of return 16%; Initial investment of $9,000
depreciable over the project life of 3 yrs (straight line). What is the Accounting break-
even in sales dollars.

A) 13,650
B) 14,219
C) 15,535
D) 16,120

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 Solution
Break Even Sales = (Fixed Cost + Depreciation) / (Net profit per $1 sales)
= [$4,000 + ($9,000/3)] / (1 33/65) = $14,218.75

19. (Q. 17 in B) What would be the after-tax profits of a firm that has a degree of
operating leverage of 5; variable cost per unit of $3.50; fixed costs excluding
depreciation of $300,000 and depreciation of $300,000? Assume that the tax rate is
23%.

A) $115,500
B) $150,000
C) $1,200,000
D) $1,500,000

Solution
DOL = 1 + [(fixed costs + depreciation)]/( pre-tax profits)

5 = 1+ [300,000 + 300,000] / pre tax profits

Pre-tax profits = 600,000 / 4 = $150,000

After-tax profits = 150,000 x (1 0.23) = $115,500

20. (Q. 18 in B) Approximately how much was paid to invest in a project that has an
NPV break-even level of sales of $5 million, annual cash flows determined by: 0.1
sales $300,000, a six-year life, and an 8% discount rate?

A) $416,667
B) $924,576
C) $1,016,678
D) $2,311,450

Solution
Investment = PV (cash flows)
= (0.1 x $5 million $300,000) x PVAF(8%,6)
= 4.6229 ($200,000)
= $924,576

Use the following information for Questions 21 and 22.

State Probability Security Return

Boom 0.40 0.3
Normal 0.25 0.17
Recession 0.25 0.0
Depression 0.10 -0.3

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21. (Q. 24 in B) What is the risk premium of the above security, if the risk-free rate is
5%?

A) 8.25%
B) 13.25%
C) 15.50%
D) 18.25%

Solution
E(R) = 0.40*0.3 + 025*0.17 + 0.25*0 + 0.10*(-0.3) = 0.1325
Risk Premium: 0.1325 0.05 = 0.0825

22. (Q. 25 in B) What is the total risk of the security in percentage terms?

A) 6.3%
B) 10.7%
C) 12.4%
D) 18.6%

Solution
Var = 0.40*(0.3-0.1325)2 + 0.25(0.17-0.1325)2 + 0.25*(0.0-0.1325)2
+ 0.10(-0.3-0.1325)2
= 0.0112225 + 0.00035156 + 0.00438906 + 0.01870563
= 0.03466875
Std Dev = (0.03466875)1/2 = 0.18619545 = 18.6%

23. (Q. 21 in B) If an asset's expected return is 14%, which represents a 20% return in a
good economy and a 4% loss in a bad economy, what is the probability of a good
economy?

A) 33.33%
B) 50%
C) 75%
D) 86.36%

Solution
Denote the probability of a good economy with p. It follows that:
14% = 20% p + (-4%) (1- p) = 0.20p 0.04 + 0.04p
or 0.18 = 0.24p p = 75%

24. (Q. 22 in B) What is the approximate variance of returns (in percentages squared or
in decimal form) if over the past three years an investment returned 5%, -12.5% and
16.2% respectively?

A) 51 (0.0051)

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 B) 131 (0.0131)
C) 139 (0.0139)
D) 209 (0.0209)

Solution
Mean = (5.0 -12.5 + 16.2)/3 = 2.9%.

Variance = (5.0 - 2.9)2 + (-12.5 2.9)2 + (16.2 2.9)2

2
= (4.41 + 237.16 + 176.89)/ 2 = 209.23 percentages squared.

25. (Q. 23 in B) An investor was expecting a 12% return on a portfolio with a beta of
1.35 before the market risk premium increased from 6% to 8%. Based on this
change, what return will now be expected on the portfolio?

A) 14.7%
B) 18.5%
C) 20.5%
D) 22%

Solution
Old: 12% = rf + 1.35 x 6%
12% = rf + 8.1%
3.9% = rf
New: Expected return = 3.9% + 1.35 x 8% = 14.7%

Use the following information for Questions 26-28:

Stock Return Std Dev Beta

Wild One 17% 20% 2.5
Mr. Stable 8% 6% 0.4

26. (Q. 27 in B) If you were to form a portfolio consisting of 25% of Wild One and 75% of
Mr. Stable, what would be the value of the systematic risk measure for the portfolio?

A) 0.85
B) 0.925
C) 1.975
D) 9.5

Solution
p = 0.25x2.5 + 0.75x0.4 = 0.925

27. (Q. 28 in B) If the market risk premium is 5.5% and the risk-free return is 5%, are
Wild One and Mr. Stable stocks, overpriced, under-priced or fairly priced?

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 A) Wild One is under-priced; Mr. Stable is overpriced
B) Both stocks are both fairly priced
C) Wild One and Mr. Stable are both overpriced
D) Wild One is overpriced; Mr. Stable is under-priced

Solution
E(R) Wild One = 0.05 + 2.5*0.055 = 18.75% Wild One is overpriced
E(R) Mr. Stable = 0.05 + 0.4*0.055 = 7.2% Mr. Stable is under-priced

28. (Q. 26 in B) If the covariance of the returns between Wild One and Mr. Stable stocks
is 0.0025, what is the correlation coefficient between the two stocks?

A) -0.26
B) 0.21
C) 0.46
D) 0.87

Solution
= Cov(rWild One, rMr. Stable)/(Wild One X Mr. Stable) = 0.0025/(0.20x0.06) = 0.21

29. (Q. 31 in B) The WACC for a firm with only debt and equity in its capital structure, a
debt-to-equity-ratio of 3/2, 8% before-tax cost of debt, 15% cost of equity, and a 35%
tax rate is:

A) 7.02%
B) 9.12%
C) 10.80%
D) 13.80%

Solution
It is straightforward to find that the weights of debt and equity in the firms capital
structure are 60% and 40%, respectively. So we have:

WACC = 0.6 (1 0.35) 0.08 + 0.4 0.15 = 0.0912.

30. (Q. 32 in B) What proportion of a firm is equity financed if the WACC is 14%, the
after-tax cost of debt is 7%, the tax rate is 35%, and the required return on equity is
18%? Assume the firm only uses debt and equity in its financing.

A) 36.36%
B) 63.64%
C) 70.26%
D) 77.78%

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 Solution
WACC = (1 x) 7% + x 18% = 14% ( Note : 7% is the after tax cos t of debt.)
0.14 = 0.07 0.07 x + 0.18 x = 0.07 + 0.11x
0.14 0.07 = 0.11x 0.07 = 0.11x
x = 63.64%.

31. (Q. 29 in B) What is the after-tax cost of capital raised by selling preferred stock for
$10 per share in the market, has a book value of $8 per share, and offers a $1.2
dividend per share when the tax rate is 35%?

A) 7.80%
B) 9.75%
C) 12.00%
D) 15.00%

Solution
Cost of preferred stock = $1.2 / $10 = 12%. Taxes have no impact on the cost of
preferred stock.

32. (Q. 30 in B) A firm is financed 60% with equity and 40% with debt. Currently, its
before-tax cost of debt is 12%. The firms common stock trades at $15 per share and
its most recent dividend was $1. Future dividends are expected to grow by 4%
infinitely. If the tax rate is 34%, what is the firms WACC?

A) 9.57%
B) 9.73%
C) 11.20%
D) 11.36%

Solution
DIV1 $1 (1 + 0.04)
requity = +g= + 0.04 = 0.1093.
P0 $15
WACC = 0.4 (1 0.34) 0.12 + 0.6 0.1093 = 0.09726 0.0973.

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Conceptual Questions
33. (Q. 45 in B) Reinvesting earnings into a firm will not increase the stock price unless:

A) The new paradigm of stock pricing is maintained.

B) True depreciation is less than reported depreciation.
C) The firm's dividends are growing also.
D) The ROE of new investments exceeds the firm's required return.

34. (Q. 46 in B) Stocks that have the same expected risk should

A) Offer the same dividend payment.

B) Have the same sustainable growth rate.
C) Have the same price.
D) Have the same expected rate of return.

35. (Q. 47 in B) What happens to the NPV of a project as the opportunity cost of capital
decreases?

A) It always increases.
B) It always decreases.
C) It is not affected.
D) It depends on the cash flows.

36. (Q. 48 in B) If no capital rationing has been imposed, which project should be
selected between two mutually exclusive investments?

A) Select the project with the higher profitability index.

B) Select the project with the lower profitability index.
C) Both projects can be selected.
D) Select by NPV method.

37. (Q. 49 in B) Which of the following represents a common reason for increases in net
working capital with new projects?

A) Inventory can now be held at lower levels.

B) Accounts receivable are often not paid on time.
C) Inventory increases more than accounts payable increase.
D) Accounts payable must be increased.

38. (Q. 50 in B) A tax shield is equal to the reduction in:

A) Tax liability resulting from a deductible expense.

B) Taxable income resulting from a deductible expense.
C) Cash flow from an expense.
D) Net income.

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39. (Q. 33 in B) Which of the following descriptions is representative of scenario
analysis?

A) One variable at a time is allowed to change.

B) It isolates the unknowns that belong in the model.
C) Different combinations of variables are analyzed.
D) It represents the "top-down" approach.

40. (Q. 34 in B) The difference between an NPV break-even level of sales and an
Accounting break-even level of sales is:

A) The consideration of the opportunity cost of capital.

B) The consideration of depreciation expense.
C) Allowing the sales level to vary in response to changes in demand.
D) The inclusion of the inflation rate.

41. (Q. 35 in B) The benefits of portfolio diversification are highest when the individual
securities have returns that:

A) Vary positively with the rest of the portfolio.

B) Vary negatively with the rest of the portfolio.
C) Are uncorrelated with the rest of the portfolio.
D) Are countercyclical.

42. (Q. 36 in B) If the slope of the line measuring a stock's historic returns against the
market's historic returns is positive, then the stock:

A) Has a beta greater than 1.0.

B) Has no unique risk.
C) Has a positive beta.
D) Plots above the security market line.

43. (Q. 37 in B) Why would a stock market investor not be concerned with unique risks
when calculating expected rates of return?

A) There is no method to quantify unique risks.

B) Unique risks are assumed to be diversified away.
C) Unique risks are compensated by the risk-free rate.
D) Beta includes a component to compensate unique risk.

44. (Q. 38 in B) Why is debt financing said to include a tax shield for the company?

A) Taxes are reduced by the amount of the debt.

B) Taxes are reduced by the amount of the interest.
C) Taxable income is reduced by the amount of the debt.
D) Taxable income is reduced by the amount of the interest.

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45. (Q. 39 in B) What decision should be made on a project of above-average risk if the
project's IRR exceeds the WACC?

A) Accept the project; NPV is positive.

B) Reject the project; NPV is negative.
C) Decide after discounting at the IRR.
D) Decide after discounting at an appropriate rate.

46. (Q. 40 in B) The company cost of capital:

A) Measures what investors want from the company.

B) Depends on current profits and cash flows.
C) Is measured using security book values.
D) Depends on historical profits and cash flows.

47. (Q. 41 in B) Which of the following statements is correct concerning stock dividends?

A) Common stock dividends cannot be paid if preferred stock dividends

are in arrears.
B) Preferred stock dividends cannot be paid if common stock dividends are in
arrears.
C) Neither common nor preferred dividends can be paid if accrued interest is in
arrears.
D) No stock dividends can be paid if the firm has no cash.

48. (Q. 42 in B) Market value is usually greater than book value because:

A) Inflation drives market value above original costs.

B) Inflation drives book value below original costs.
C) Firms tend to invest in projects with very high book values.
D) The cost of capital drives market value up.

49. (Q. 43 in B) Which of the following forms of debt would be likely to offer debt holders
the lowest interest rate?

A) Subordinated debt
B) Subordinated debt that is callable
C) Secured debt with a sinking fund
D) Secured debt that is not callable

50. (Q. 44 in B) If a firms tax rate is zero, increasing the firms debt/equity ratio will:

A) Increase the WACC

B) Decrease the WACC
C) Not affect the WACC
D) A or B above

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