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Call options generally sell at a price greater than their exercise value, and the greater the exercise value, the higher the premium on the option is likely to be.

Call options generally sell at a price below their exercise value, and the greater the exercise value, the lower the premium on the option is likely to be.

Call options generally sell at a price below their exercise value, and the lower the exercise value, the lower the premium on the option is likely to be.

Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.

If the underlying stock does not pay a dividend, it does not make good economic sense to exercise a call option prior to its expiration date, even if this would yield an immediate profit.

Call options give investors the right to sell a stock at a certain strike price before a specified date.

Options typically sell for less than their exercise value.

LEAPS are very short-term options that were created relatively recently and now trade in the market.

An option holder is not entitled to receive dividends unless he or she exercises their option before the stock goes ex dividend.

Put options give investors the right to buy a stock at a certain strike price before a specified date.

-$5.10

$19.90

$20.90

$22.50

$27.60

If the underlying stock does not pay a dividend, it does not make good economic sense to exercise a call option prior to its expiration date, even if this would yield an immediate profit.

Call options generally sell at a price greater than their exercise value, and the greater the exercise value, the higher the premium on the option is likely to be.

Call options generally sell at a price below their exercise value, and the greater the exercise value, the lower the premium on the option is likely to be.

Call options generally sell at a price below their exercise value, and the lower the exercise value, the lower the premium on the option is likely to be.

Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.

The higher the strike price on XYZ's options, the higher the option's price will be.

Assuming the same strike price, an XYZ call option that expires in one month will sell at a higher price than one that expires in three months.

If XYZ's stock price stabilizes (becomes less volatile), then the price of its options will increase.

If XYZ pays a dividend, then its option holders will not receive a cash payment, but the strike price of the option will be reduced by the amount of the dividend.

The price of these call options is likely to rise if XYZ's stock price rises.

An investor who writes standard call options against stock held in his or her portfolio is said to be selling what type of options?

Answer

Put

Naked

Covered

Out-of-the-money

In-the-money

You have been hired as a consultant by Feludi Inc.'s CFO, who wants you to help her estimate the cost of capital. You have been provided with the following data: rRF = 4.10%; RPM = 5.25%; and b = 1.30. Based on the CAPM approach, what is the cost of common from reinvested earnings?

Answer

9.67%

9.97%

10.28%

10.60%

10.93%

Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting?

Answer

Accounts payable.

Common stock “raised” by reinvesting earnings.

Common stock raised by new issues.

Preferred stock.

Long-term debt.

Which of the following statements is CORRECT?

Answer

The percentage flotation cost associated with issuing new common equity is typically smaller than the flotation cost for new debt.

The WACC as used in capital budgeting is an estimate of the cost of all the capital a company has raised to acquire its assets.

There is an "opportunity cost" associated with using reinvested earnings, hence they are not "free."

The WACC as used in capital budgeting would be simply the after-tax cost of debt if the firm plans to use only debt to finance its capital budget during the coming year.

The WACC as used in capital budgeting is an estimate of a company's before-tax cost of capital.

Which of the following statements is CORRECT?

Answer

The tax-adjusted cost of debt is always greater than the interest rate on debt, provided the company does in fact pay taxes.

If a company assigns the same cost of capital to all of its projects regardless of each project's risk, then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject.

Because no flotation costs are required to obtain capital as reinvested earnings, the cost of reinvested earnings is generally lower than the after-tax cost of debt.

Higher flotation costs tend to reduce the cost of equity capital.

Since debt capital can cause a company to go bankrupt but equity capital cannot, debt is riskier than equity, and thus the after-tax cost of debt is always greater than the cost of equity.

Which of the following statements is CORRECT?

Answer

The after-tax cost of debt usually exceeds the after-tax cost of equity.

For a given firm, the after-tax cost of debt is always more expensive than the after-tax cost of non-convertible preferred stock.

Retained earnings that were generated in the past and are reported on the firm's balance sheet are available to finance the firm's capital budget during the coming year.

The WACC that should be used in capital budgeting is the firm's marginal, after-tax cost of capital.

The WACC is calculated using before-tax costs for all components.

A company's perpetual preferred stock currently sells for $92.50 per share, and it pays an $8.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm's cost of preferred stock?

Answer

7.81%

8.22%

8.65%

9.10%

9.56%

Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.

Answer

A project's regular IRR is found by discounting the cash inflows at the WACC to find the present value (PV), then compounding this PV to find the IRR.

If a project's IRR is greater than the WACC, then its NPV must be negative.

To find a project's IRR, we must solve for the discount rate that causes the PV of the inflows to equal the PV of the project's costs.

To find a project's IRR, we must find a discount rate that is equal to the WACC.

A project's regular IRR is found by compounding the cash inflows at the WACC to find the terminal value (TV), then discounting this TV at the WACC

Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT?

Answer

A project's NPV increases as the WACC declines.

A project's MIRR is unaffected by changes in the WACC.

A project's regular payback increases as the WACC declines.

A project's discounted payback increases as the WACC declines.

A project's IRR increases as the WACC declines.

Which of the following statements is CORRECT?

Answer

One defect of the IRR method versus the NPV is that the IRR does not take account of the time value of money.

One defect of the IRR method versus the NPV is that the IRR does not take account of the cost of capital.

One defect of the IRR method versus the NPV is that the IRR values a dollar received today the same as a dollar that will not be received until sometime in the future.

One defect of the IRR method versus the NPV is that the IRR does not take proper account of differences in the sizes of projects.

One defect of the IRR method versus the NPV is that the IRR does not take account of cash flows over a project's full life.

Which of the following statements is CORRECT?

Answer

For mutually exclusive projects with normal cash flows, the NPV and MIRR methods can never conflict, but their results could conflict with the discounted payback and the regular IRR methods.

Multiple IRRs can exist, but not multiple MIRRs. This is one reason some people favor the MIRR over the regular IRR.

If a firm uses the discounted payback method with a required payback of 4 years, then it will accept more projects than if it used a regular payback of 4 years.

The percentage difference between the MIRR and the IRR is equal to the project's WACC.

The NPV, IRR, MIRR, and discounted payback (using a payback requirement of 3 years or less) methods always lead to the same accept/reject decisions for independent projects.

Which of the following statements is CORRECT?

Answer

If a project has "normal" cash flows, then its MIRR must be positive.

If a project has "normal" cash flows, then it will have exactly two real IRRs.

The definition of "normal" cash flows is that the cash flow stream has one or more negative cash flows followed by a stream of positive cash flows and then one negative cash flow at the end of the project's life.

If a project has "normal" cash flows, then it can have only one real IRR, whereas a project with "nonnormal" cash flows might have more than one real IRR.

If a project has "normal" cash flows, then its IRR must be positive.

Which of the following statements is CORRECT?

Answer

One drawback of the regular payback is that this method does not take account of cash flows beyond the payback period.

If a project's payback is positive, then the project should be accepted because it must have a positive NPV.

The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem.

One drawback of the discounted payback is that this method does not consider the time value of money, while the regular payback overcomes this drawback.

The shorter a project's payback period, the less desirable the project is normally considered to be by this criterion.

While developing a new product line, Cook Company spent $3 million two years ago to build a plant for a new product. It then decided not to go forward with the project, so the building is available for sale or for a new product. Cook owns the building free and clear(there is no mortgage on it. Which of the following statements is CORRECT?

Answer

If the building could be sold, then the after-tax proceeds that would be generated by any such sale should be charged as a cost to any new project that would use it.

This is an example of an externality, because the very existence of the building affects the cash flows for any new project that Rowell might consider.

Since the building was built in the past, its cost is a sunk cost and thus need not be considered when new projects are being evaluated, even if it would be used by those new projects.

If there is a mortgage loan on the building, then the interest on that loan would have to be charged to any new project that used the building.

Since the building has been paid for, it can be used by another project with no additional cost. Therefore, it should not be reflected in the cash flows for any new project.

Which of the following is NOT a relevant cash flow and thus should not be reflected in the analysis of a capital budgeting project?

Answer

Shipping and installation costs.

Cannibalization effects.

Opportunity costs.

Sunk costs that have been expensed for tax purposes.

Changes in net working capital.

Which of the following statements is CORRECT?

Answer

In comparing two projects using sensitivity analysis, the one with the steeper lines would be considered less risky, because a small error in estimating a variable such as unit sales would produce only a small error in the project's NPV.

The primary advantage of simulation analysis over scenario analysis is that scenario analysis requires a relatively powerful computer, coupled with an efficient financial planning software package, whereas simulation analysis can be done efficiently using a PC with a spreadsheet program or even with just a calculator.

Sensitivity analysis is a type of risk analysis that considers both the sensitivity of NPV to changes in key input variables and the probability of occurrence of these variables' values.

As computer technology advances, simulation analysis becomes increasingly obsolete and thus less likely to be used as compared to sensitivity analysis.

Sensitivity analysis as it is generally employed is incomplete in that it fails to consider the probability of occurrence of the key input variables.

Which one of the following would NOT result in incremental cash flows and thus should NOT be included in the capital budgeting analysis for a new product?

Answer

A new product will generate new sales, but some of those new sales will be from customers who switch from one of the firm's current products.

A firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery.

A firm has spent $2 million on R&D associated with a new product. These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected.

A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm's other products.

A firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for agricultural purposes.

Which of the following statements is CORRECT?

Answer

One advantage of sensitivity analysis relative to scenario analysis is that it explicitly takes into account the probability of specific effects occurring, whereas scenario analysis cannot account for probabilities.

Well-diversified stockholders do not need to consider market risk when determining required rates of return.

Market risk is important, but it does not have a direct effect on stock prices because it only affects beta.

Simulation analysis is a computerized version of scenario analysis where input variables are selected randomly on the basis of their probability distributions.

Sensitivity analysis is a good way to measure market risk because it explicitly takes into account diversification effects.

Which of the following should be considered when a company estimates the cash flows used to analyze a proposed project?

Answer

Since the firm's director of capital budgeting spent some of her time last year to evaluate the new project, a portion of her salary for that year should be charged to the project's initial cost.

The company has spent and expensed $1 million on R&D associated with the new project.

The company spent and expensed $10 million on a marketing study before its current analysis regarding whether to accept or reject the project.

The firm would borrow all the money used to finance the new project, and the interest on this debt would be $1.5 million per year.

The new project is expected to reduce sales of one of the company's existing products by 5%.

Which of the following statements is CORRECT?

Answer

The AFN equation for forecasting funds requirements requires only a forecast of the firm's balance sheet. Although a forecasted income statement may help clarify the results, income statement data are not essential because funds needed relate only to the balance sheet.

Dividends are paid with cash taken from the accumulated retained earnings account, hence dividend policy does not affect the AFN forecast.

A negative AFN indicates that retained earnings and spontaneous liabilities are far more than sufficient to finance the additional assets needed.

If the ratios of assets to sales and spontaneous liabilities to sales do not remain constant, then the AFN equation will provide more accurate forecasts than the forecasted financial statements method.

Any forecast of financial requirements involves determining how much money the firm will need, and this need is determined by adding together increases in assets and spontaneous liabilities and then subtracting operating income.

Last year National Aeronautics had a FA/Sales ratio of 40%, comprised of $250 million of sales and $100 million of fixed assets. However, its fixed assets were used at only 75% of capacity. Now the company is developing its financial forecast for the coming year. As part of that process, the company wants to set its target Fixed Assets/Sales ratio at the level it would have had had it been operating at full capacity. What target FA/Sales ratio should the company set?

Answer

28.5%

30.0%

31.5%

33.1%

34.7%

Which of the following statements is CORRECT?

Answer

When fixed assets are added in large, discrete units as a company grows, the assumption of constant ratios is more appropriate than if assets are relatively small and can be added in small increments as sales grow.

Firms whose fixed assets are "lumpy" frequently have excess capacity, and this should be accounted for in the financial forecasting process.

For a firm that uses lumpy assets, it is impossible to have small increases in sales without expanding fixed assets.

There are economies of scale in the use of many kinds of assets. When economies occur the ratios are likely to remain constant over time as the size of the firm increases. The Economic Ordering Quantity model for establishing inventory levels demonstrates this relationship.

When we use the AFN equation, we assume that the ratios of assets and liabilities to sales (A0*/S0 and L0*/S0) vary from year to year in a stable, predictable manner.

The capital intensity ratio is generally defined as follows:

Answer

The percentage of liabilities that increase spontaneously as a percentage of sales.

The ratio of sales to current assets.

The ratio of current assets to sales.

The amount of assets required per dollar of sales, or A0*/S0.

Sales divided by total assets, i.e., the total assets turnover ratio.

Which of the following assumptions is embodied in the AFN equation?

Answer

Accounts payable and accruals are tied directly to sales.

Common stock and long-term debt are tied directly to sales.

Fixed assets, but not current assets, are tied directly to sales.

Last year's total assets were not optimal for last year's sales.

None of the firm's ratios will change.

Spontaneous funds are generally defined as follows:

Answer

A forecasting approach in which the forecasted percentage of sales for each item is held constant.

Funds that a firm must raise externally through short-term or long-term borrowing and/or by selling new common or preferred stock.

Funds that arise out of normal business operations from its suppliers, employees, and the government, and they include immediate increases in accounts payable, accrued wages, and accrued taxes.

The amount of cash raised in a given year minus the amount of cash needed to finance the additional capital expenditures and working capital needed to support the firm's growth.

Assets required per dollar of sales.