Part I: True/False
1. Pfizer's spending of $7.6 billion in 2006 on research and development of new drugs is
a financing decision but not a capital budgeting decision.
2. The separation of ownership and management is one distinctive feature of both
corporations and partnerships.
3. Zero-coupon bonds are issued at prices considerably below face value, and the
investor's return comes from the difference between the purchase price and the
payment of face value at maturity.
4. Net working capital is determined from the difference between current assets and
current liabilities.
5. The more frequent the compounding, the higher the future value, other things equal.
6. When the market interest rate exceeds the coupon rate, bonds sell for less than face
value to provide enough compensation to bond issuer.
1. Which of the following statements is correct for a 10% coupon bond that has a
current yield of 7%?
A. The face value of the bond has decreased.
B. The bond's maturity value exceeds the bond's price.
C. The bond's internal rate of return is 7%.
D. The bond's maturity value is lower than the bond's price.
2. A bond's yield to maturity takes ____________ into consideration:
A. current yield but not price changes of a bond.
B. price changes but not current yield of a bond.
C. both current yield and price changes of a bond.
D. neither current yield nor price changes of a bond.
3. What is the rate of return for an investor who pays $1,054.47 for a three-year bond
with a 7% coupon and sells the bond one year later for $1,037.19?
A. 5.00%
B. 5.33%
C. 6.46%
D. 7.00%
4. What is the relationship between an investment's rate of return and its yield to
maturity for an investor that does not hold a bond until maturity?
A. Rate of return is lower than yield to maturity.
B. Rate of return is higher than yield to maturity.
C. Rate of return equals yield to maturity.
D. There is no predetermined relationship.
5. If an investor purchases a bond when its current yield is higher than the coupon rate,
then the bond's price will be expected to:
A. decline over time, reaching par value at maturity.
B. increase over time, reaching par value at maturity.
C. be less than the face value at maturity.
D. exceed the face value at maturity.
6. Which of the following is correct for a bond currently selling at a premium to par?
A. Its current yield is higher than its coupon rate.
B. Its current yield is lower than its coupon rate.
C. Its yield to maturity is higher than its coupon rate.
D. Its default risk is extremely low.
7. What happens to the coupon rate of a bond with a face value of $1,000 that pays $80
annually in interest if interest rates change from 9% to 10%?
A. The coupon rate increases to 10%.
B. The coupon rate remains at 9%.
C. The coupon rate remains at 8%.
D. The coupon rate decreases to 8%.
8. Assume the total expense for your current year in college equals $20,000.
Approximately how much would your parents have needed to invest 21 years ago in
an account paying 8% compounded annually to cover this amount?
A. $ 952
B. $1,600
C. $1,728
D. $3,973
$20,000 = x(1.08)21
$20,000 = 5.0338x
$3,973.12 = x
9. Which of the following is not a typical reason for differences between profit and cash
flow?
A. Depreciation expense
B. Income taxes
C. Changing levels of accounts receivable
D. Accrual accounting practices
Part III: Problem Solving
1. What is the present value of a five period annuity of $3,000, paid every year, if the
interest rate is 12% and the first payment is made today?
2. What is the present value of a four-period annuity of $100 per year that begins two
years from today if the discount rate is 9%?
3. What is the marginal tax rate for a corporation with $60,000 taxable income and an
average tax rate of 16.67% if the next-lowest marginal tax rate of 15% covers taxable
incomes up to $50,000?
4. Your car loan requires payments of $200 per month for the first year and payments of
$400 per month during the second year. The annual interest rate is 12% and payments
begin in one month. What is the present value of this two-year loan?
5. How much would an investor lose if she purchased a 30-year zero-coupon bond with
a $1,000 par value and 10% yield to maturity, only to see market interest rates
increase to 12% one year later?