ANSWERS
to
Questions and Problems
Chapter 1
True and False
1.
2.
3.
4.
5.
False. The policies are the strategies used to achieve the goals.
True. This was in Babylon, or earlier.
False. Financial specialists began with the Industrial Revolution and were further developed by the
Great Depression.
False. Shareholder wealth maximization is the approach to use.
False. The term for charging excess interest is “usury”.
Matching
1.
2.
3.
4.
b
d
a
c
Multiple Choice
1.
2.
B
D
3.
C
Usury was considered to be the charging of any interest during the middle ages. Presently it
refers to charging interest at an exorbitant rate.
Interest for the loans was 5%, and paper certificates were not issued.
Chapter 2
True and False
1.
2.
3.
4.
5.
True
True
True
False (auction method)
False (secondary)
Matching
1.
2.
3.
4.
5.
6.
7.
8.
A
G
H
C
D
E
F
B
Problems
1.
Year
1
2
3
50
150
50
150
50
150
200
200
200
4
5
50
0
50
0
50
50
6
50
0
50
50(P/A,8%,6) = 50(4.623)
= $231.15
150(P/A,8%,3) = 150(2.577) =
386.55
Total = $617.70
2.
(P/F,4%,5) = 0.8219
(P/F,6%,5) = 0.7473
1.5692
1.5692 = (P/F,5%5) = 0.7846
The table factor is 0.7835
3.
A.
PN = P0 (1 + i)N
PN = 120 (1 + .055)3
= 140.90897
B.
PN = P0 (1 +
i
m
) m.N
= 120 (1 + .0275)6
= 141.21
4.
(1 + j) = (1 +
j = (1 +
i
m
.07
4
)m
)4 - 1
j = 1.0719 – 1
j = .0719 or 7.19%
Multiple Choice
1.
2.
3.
4.
5.
A
B
C
C
B
Problems
1.
Common unit of trade = $1000
.09
90.00
Chapter 3
True and False
1.
2.
3.
4.
True
True
False
False
Problems
1.
a. 500 x 3 = 1500
1500 – 150 = $270
5
b. (5 – 3 + 1) (1500 – 150) = 3(1350) = $270
½ (5) (6)
15
c. j = ½ (N + 3)
j = ½ (5 + 3)
j = 4 years
Chapter 5
True and False
1.
2.
3.
4.
5.
6.
7.
False
False
True
True
False
True
False
Chapter 6
Multiple Choice
1.
2.
3.
C
C
B
Problems
1.
NPV = (3000 x the factor for a future annuity of 5 years at 10%) – 10,000
NPV = 3000 x 4.1002 – 10,000
NPV = 12,300.60 – 10,000
NPV = 2,300.60
Since NPV is positive this project should be accepted.
2.
PI = 12,300.60
10,000
PI = 1.23
Since PI is greater than 1 this project should be accepted.
3.
1500 = 200 x factor for a future annuity of 10 years at an internal rate of return r.
7.5 = factor for 10 years at a rate of r.
r = 5% factor = 7.7217
r = 6% factor = 7.3601
The internal rate of return is in between 5% and 6%. To find the internal rate of return, interpolate
between 5% and 6%.
7.7217 – 7.3601 = .3616
7.7217 – 7.5000 = .2217
IRR = 5.00 + .2217/.3616
IRR = 5.00 + .61311
IRR = 5.61311
Since 5.61311 is less than the cost of capital of 10%, this project should be rejected.
Chapter 7
True and False
1.
False
A balloon loan is characterized by a cash inflow in period one, followed by a few
small equal payments in a few subsequent periods and finally one large payment on
the entire balance due.
2.
False
It is one of four things needed to use internal rate of return. Specifically, it is used to
determine what period to look at in the present value tables. It is also the n used in
the equation used for internal rate of return.
3.
False
If one project is dependent upon the acceptance of another, these projects are
contingent not mutually exclusive. Mutually exclusive projects are projects in which
only one can be adopted.
4.
False
Depreciation is merely the writing down of an asset and involves no cash. Therefore,
to determine the true cash flow of a business, the amount of depreciation expense
must be added back to the net income after taxes.
5.
True
The difference in cash inflows and outflows are computed and treated as though it
were a third project. An internal rate of return is then computed for that project and
used in evaluating the two original projects.
General Equations
Internal Rate of Return
5
Original cost =  
n
F
1  r n
F is the cash flow
n is the year
Project A
18,436 = 5,500
3.352 =
5
n
 1/ 1  r 
n 1
5
n
 1/ 1  r 
n 1
Look up in the present value of an annuity in the five year row and find the interest rate corresponding
to 3.352. It is 15%.
Project B
5
n
19,911 = 5,800  ( 1/ 1  r  )
n 1
5
n
3,433 =  1/ 1  r 
n 1
Look up in the present value of an annuity in the five year column and find the interest rate
corresponding to 3.433. It is 14%.
Project C
5
n
1,475 =  1/ 1  r 
n 1
5
n
4,9166 =  1/ 1  r 
n 1
Look up in the present value of an annuity table in the five year column and find the interest rate
corresponding to 4.9166. It is between ½ and ⅔%.
Project yields less than the firm’s 12% cost of capital. Since the projects are mutually exclusive we
can only choose one; therefore, Project A is the best choice.
Problem
A
B
(difference)
C
$18,436
$19,911
$1,475
F1
5,500
5,800
300
F2
5,500
5,800
300
F3
5,500
5,800
300
F4
5,500
5,800
300
F5
5,500
5,800
300
15%
14%
½ to ⅔%
Project
Original Cost
Cash Flow
Internal Rate of Return
Chapter 8
True and False
1.
Simple investment involves at least one change of sign in cash flows.
False. A simple investment involves an initial cash out-flow followed by a series of cash inflows.
2.
Lower Internal Rate of Return is preferable to higher.
False. Higher Internal Rate of Return is preferable to lower.
3.
A non-simple investment may graphically have two internal rates of return.
True. While this is true, a project contains only one internal rate of return.
4.
The project with the maximum expect return may not necessarily be the best project.
True. There are other variables that are not considered in this situation.
Chapter 9
True and False
1.
2.
3.
4.
5.
True
False
True
False
False
Matching
1.
2.
3.
4.
5.
C
A
B
D
E
Multiple Choice
1.
2.
3.
C
D
C
Problem
The present value of the project is calculated as follows:
5
5
5 1000
Rn
1000
 
PV = P0 
n  P0 
n 1 1  i  d 
n 1 1  .06  .04 5 n 1 1.10 5
5
= 1000
1
 1.1
n 1
5
= 1000 (3.7908)
= $3,790.80
Chapter 12
1.
False
A logical strategy without portfolio considerations would be to place all fund into one
security.
2.
True
3.
False
When a distribution is relatively more peaked, it is less risky.
4.
False
The coefficient of variations adjusts riskiness for the expected returns so that high
expected returns will have less measures of risk.
5.
False
A risk taker is an investor who will take an uncertain return with a lower expected
value than that provided by a certain outcome.
6.
True
7.
True
8.
False
9.
True
10.
True
Solution to Problem
Cov xy 


1 N
 X  E x Yt  E y
N t 1 t

Cov xy  [(.12 - .11) (.15 - .14)]
= (.01) (.01)
= (.0001) = Cov xy
Chapter 13
True and False
1.
2.
3.
4.
5.
True
False
True
True
False
Preferred stock has priority over common.
Individual stockholders are not responsible for corporations’ debts; they are responsible
for their personal liabilities only.
Matching
1.
2.
A
D
3.
D
When stock is sold through any means, a record of the number of outstanding shares is
maintained.
Problem
5000  17  1
3000
= 1.33 therefore, one director could be elected.
# of directors possible = (# shares owned – 1) (# directors to be elected + 1)
# shares outstanding
Chapter 14
Multiple Choice
1.
2.
B
C
3.
4.
5.
D
C
B
Semi-strong form test is a part of Efficient Markets Theory.
Louis Bachelor found that a systematic relationship between price and season of
purchase/sale did not exist.
Statements A, B, and C are true regarding the Efficient Markets Theory.
Fundamental Theory uses a quantitative rather than qualitative approach.
Eugene Fama used tests to measure market efficiency.
True and False
1.
2.
True
True
Chapter 15
Matching
1.
2.
3.
4.
5.
Adjustment
Convertible
Registered
Serial
Debenture
True and False
6.
7.
8.
9.
10.
True
False
False
True
False
11.
False
12.
13.
14.
15.
True
True
False
True
The existence of the secondary market allows the primary market to thrive. Without the
existence of a secondary market, securities would not sell well in the primary market.
The underwriter is responsible for selling those issues purchased.
The originating investment banker normally services as manager.
These are various means of advertising to the public.
Multiple Choice
16.
17.
D
A
18.
B
Issues larger than $500,000 must be registered.
Under best effort there is no commitment, an agency relationship, and the investment banker
takes on no risk.
Only the purchasing group is involved in buying.
Problems
19.
Moody’s
Aaa
Aa
A
Baa
Ba
B
Caa
Ca
C
Standard & Poor’s
AAA
AA
A
BBB
BB
B
CCC
CC
C
20.
Leverage allows for the magnification of earnings. A fixed quantity of earnings is divided among all
debt holders. This enables the firm to reduce the number of common stock shareholders associated
with a given quantity of earning. The cost is a fixed debt service charge (interest) incurred as a result
of issuing a debt.
Chapter 16
True and False
1.
2.
3.
4.
5.
False
False
True
False
True
Multiple Choice
1.
2.
3.
C
B
E
Problem
Using the following information and data, calculate the weighted average cost of capital.
Consider a corporate income tax rate of 50% in your answer.
Sources
Bond Issue
Preferred Stock
Common Stock
Market
Value
Effective
Cost
100,000
500,000
1,000,000
5% (1 - .5)
10%
15%
The Weighted Average Cost of Capital is 12.656.
Weighting
.0625
.3125
.6250
Fractional
Contribution
.156
3.125
9.375
12.656
Chapter 17
True and False
1.
2.
True
False
3.
4.
True
False
5.
False
The capital structure is a subset of the financial structure. The capital structure is the
distribution of a firm’s long-term obligations. The financial structure is the distribution
of a firm’s liabilities and equity.
In the net income approach, the cost of equity is considered independent of the debt
quantity. In the net operating income approach, the cost of equity is considered a
function of the amount of debt.
The cost of debt will remain constant for a while but at some point it will become greater
due to a borrowing limit.
Problem
Option A – Financed with total equity
Option B – Financed with debt and equity
Earnings before interest and taxes
Interest expense
Taxable income
Tax 50%
Earnings after taxes
Option A
Option B
500,000
0
500,000
250,000
250,000
500,000
80,000
420,000
210,000
210,000
(Interest expense – 10% x 800,000 = 80,000)
Option A – Earnings per share
$2,000,000 = 200,000 shares
$10 a share
Net Income = earnings per share
# of shares
250,000 = 1.25 earnings per share
200,000
Option B – Earnings per share
$1,200,000 = 120,000 shares
$10 a share
210,000 = 1.75 earnings per share
120,000
In this particular situation Option B with earnings per share of $1.75 is better than Option A with earnings per
share of $1.25. The firm should use both debt and equity financing.
Degree of Financial Leverage =
DFL 
Earnings before interest and taxes
Earnings before interest and taxes  1 tax pmt
500,000
500,000  80,000
Degree of financial leverage is approximately 1.19.
True and False
1.
2.
3.
4.
5.
False
True
True
False
False
Matching
1.
2.
3.
4.
5.
C
D
A
E
B
Business risk is determined by the type of business.
Tests of the M-M model found evidence to support the M & M model.
The dividend becomes the residual payment under the Passive Dividend Policy.
Chapter 19
True and False
1.
2.
3.
4.
5.
False
True
False
False
True
Matching
1.
2.
3.
4.
5.
E
A
B
C
D
Multiple Choice
1.
2.
3.
A
D
B and D
Problem
Current Ratio = Current Assets/Current Liabilities
Current Assets
Cash
A/R
Inventory
4,000
10,000
15,000
29,000
Current Liabilities
Acc/Pay
12,000
12,000
Cr = 29,000/12,000
= 2.42
Chapter 20
True and False
1.
2.
3.
4.
5.
True
True
False
False
True
Matching
1.
2.
3.
4.
5.
C
E
A or D
B
D or A
Multiple Choice
1.
2.
3.
A
C
B
Problem
Inventory Turnover = Cost of goods sold/Average Inventory
Average Inventory = Beginning + Ending Inventory/2
Cost of goods sold = 41,000
Average Inventory = 15,200 + 13,500/2 = 14,350
Inventory Turnover = 41,000/14,350 = 2.8471
Chapter 21
True and False
1.
2.
3.
4.
5.
6.
7.
True
True
False
False
True
True
False
Matching
1.
2.
3.
4.
5.
6.
7.
8.
B
F
D
C
E
G
H
A
Multiple Choice
1.
2.
C
D
Chapter 22
True and False
1.
2.
3.
4.
5.
False
False
True
False
True
The majority of firms practice the conservative policy.
This is the definition of net working capital.
The working capital requirements are dependent on sales level.
Chapter 23
True and False
1.
2.
3.
4.
False
False
True
True
Multiple Choice
1.
2.
3.
4.
D
D
B
B
Chapter 24
Matching
1.
2.
3.
4.
5.
E – revolving credit
C – floating lien
A – terminal warehousing
H - trade acceptance
L – compensating balance
Multiple Choice
1.
2.
3.
D
E
D
True and False
1.
2.
3.
4.
5.
False
False
True
False
False
Chapter 25
Multiple Choice
1.
2.
3.
F
C
E
Problem
Straight loan repayment:
Year
1
2
3
4
5
Principal
$
Interest
Total Payment
0
0
0
0
10,000
$ 900
900
900
900
900
$
900
900
900
900
10,900
Year
Principal
Interest
Total Payment
1
2
3
4
5
$10,000
8,000
6,000
4,000
2,000
$ 900
720
540
360
180
2,900
2,720
2,540
2,360
2,180
Straight loan reduction:
Chapter 26
True and False
1.
2.
3.
4.
False
True
True
False
5.
6.
True
False
7.
8.
9.
10.
True
False
True
False
The assets of a firm represent the net uses of funds.
Cash flow analysis does involve near term situations and problems within a firm.
A net increase in any liability does result in an increase of cash for a firm.
The result of matching the production schedule to the sale demand is a low inventory and a
low inventory cost.
The use of pro forma statements is due to a firm’s interest in long-range planning.
One of the disadvantages of the Delphi Forecasting Method is that it cannot be demonstrated
and done over again.
The % of sales technique assumes that the other elements will vary directly with sales.
A transformation could be used to transform a sales figure into the amount of inventory that
would be required.
Multiple Choice
1.
2.
3.
4.
5.
D
C
D
B
A
all of the above
funds from operations
sources will equal uses
Matching
1.
2.
3.
4.
5.
C
A
B
E
D
Problem
Toy Cars produced
(in thousands)
Production costs
(in thousands)
7
8
9
10
11
The points plotted on the graph can be
represented by means of a straight line.
The data could be interpreted through
the use of Linear Regression.
14
17
23
26
30
costs
30
25
20
15
7
8
9
10
11
Chapter 27
Problem
1.
Equations
 
 
C = MN d1  XN d 2 /e it
d1 


n M/X   i  0.5σ 2 t
σt
d 2  d1  σ t
Substitutions
d1 
d1 
n 100/110   0.08  0.5 * 0.01 90/360
0.1 90/360
 0.09531  0.085 1/4
0.1 1/4
d 2  1.4812  0.1 90/360
d 2  1.5312
N(d1) = 0.0695
N(d2) = 0.0631
eit = 1.0202
C = 100 * 0.0695 – 110 * 0.0631/1.0202
= 6.95 – 6.80 = $0.15