1. Portfolio diversification reduces the variability of the returns
on each security

held in the portfolio.

a. True

b. False

2. A stock's beta is more relevant as a measure of risk to an investor
with a

well-diversified portfolio than to an investor who holds only one stock.

a. True

b. False

3. You are an investor in common stock, and you currently hold a well-diversified

portfolio which has an expected return of 12 percent, a beta of 1.2,
and a total

value of $9,000. You plan to increase your portfolio by buying 100
shares of AT&E at

$10 a share. AT&E has an expected return of 20 percent with a beta
of 2.0. What

will be the expected return and the beta of your portfolio after you
purchase the new

stock?

^

a. k _{p} = 20.0%; b_{ p} = 2.00

^

b. k_{ p }= 12.8%; b_{ p} = 1.28

^

c. k _{p} = 12.0%; b_{ p} = 1.20

^

d. k_{ p} = 13.2%; b_{ p} = 1.40

^

e. k _{p }= 14.0%; b _{p} = 1.32

4. Calculate the standard deviation of the dollar returns for Ditto
Copier Center, given

the following distribution of returns:

Probability Return

0.2
$50

0.5
$20

0.3
-$15

a. $36.0

b. $23.0

c. $18.0

d. $13.0

e. $30.0

5. You have determined the profitability of a planned project by finding
the present

value of all the cash flows from that project. Which of the following
would cause

the project to look more appealing in terms of the present value of
those cash flows?

a. The discount rate decreases.

b. The cash flows are extended over a longer period of time, but the
total amount of

the cash flows remains the same.

c. The discount rate increases.

d. Answers b and c above.

e. Answers a and b above.

6. As the winning contestant in a television game show, you are considering
the prizes

to be awarded. You must indicate to the sponsor which of the following
two choices

you prefer, assuming you want to maximize your wealth. Assume it is
now January 1,

and there is no danger whatever that the sponsor won't pay off.

(1) $1,000 now and another $1,000 at the beginning of each of the 11
subsequent

months during the remainder of the year, to be deposited in an account
paying a

12 percent nominal annual rate, but compounded monthly (to be left
on deposit for

the year).

(2) $12,750 at the end of the year.

Which one would you choose?

a. Choice 1.

b. Choice 2.

c. Choice 1, if the payments were made at the end of each month.

d. The choice would depend on how soon you need the money.

e. Either one, since they have the same present value.

7. Assume you are to receive a 20-year annuity with annual payments
of $50. The first

payment will be received at the end of Year 1, and the last payment
will be received

at the end of Year 20. You will invest each payment in an account that
pays 10

percent. What will be the value in your account at the end of Year
30?

a. $6,354.81

b. $7,427.83

c. $7,922.33

d. $8,591.00

e. $6,752.46

8. Other things held constant, an increase in the cost of capital discount
rate will

result in a decrease of a project's IRR.

a. True

b. False

9. As the director of capital budgeting for Denver Corporation, you
are evaluating two

mutually exclusive projects with the following net cash flows:

Year Project X Project Z

0
-$100,000 -$100,000

1
50,000
10,000

2
40,000
30,000

3
30,000
40,000

4
10,000
60,000

If Denver's cost of capital is 15 percent, which project would you choose?

a. Neither project.

b. Project X, since it has the higher IRR.

c. Project Z, since it has the higher NPV.

d. Project X, since it has the higher NPV.

e. Project Z, since it has the higher IRR.

10. Los Angeles Lumber Company (LALC) is considering a project with
a cost of $1,000 at

time = 0 and inflows of $300 at the end of Years 1 - 5. LALC's cost
of capital is 10

percent. What is the project's modified IRR (MIRR)?

a. 10.0%

b. 12.9%

c. 15.2%

d. 18.3%

e. 20.7%

11. Financial risk refers to the extra risk stockholders bear as a result
of the use of

debt as compared with the risk they would bear if no debt were used.

a. True

b. False

12. Two firms, although they operate in different industries, have the
same expected

earnings per share and the same standard deviation of expected EPS.
Thus, the two

firms must have the same business risk .

a. True

b. False

13. Business risk is concerned with the operations of the firm. Which
of the following is

not associated with (or not a part of) business risk?

a. Demand variability.

b. Sales price variability.

c. The extent to which operating costs are fixed.

d. Changes in required returns due to financing decisions.

e. The ability to change prices as costs change.

14. If you know that your firm is facing relatively poor prospects but
needs new capital,

and you know that investors do not have this information, signaling
theory would

predict that you would

a. Issue debt to maintain the returns of equity holders.

b. Issue equity to share the burden of decreased equity returns between
old and new

shareholders.

c. Be indifferent between issuing debt and equity.

d. Postpone going into capital markets until your firm's prospects
improve.

e. Convey your inside information to investors using the media to eliminate
the

information asymmetry.

15. Copybold Corporation is a start-up firm considering two alternative
capital structures

C one is conservative and
the other aggressive. The conservative capital structure

calls for a D/A ratio = 0.25, while the aggressive strategy call for
D/A = 0.75 . Once the

firm selects its target capital structure it envisions two possible
scenarios for its

operations : Feast or Famine. The Feast scenario has a 60 percent probability
of

occurring and forecast EBIT in this state is $60,000 . The Famine state
has a 40

percent chance of occurring and the EBIT is expected to be $20,000
. Further, if the

firm selects the conservative capital structure its cost of debt will
be 10 percent, while

the aggressive capital structure its debt cost will be 12 percent.
The firm will have

$400,000 in total assets, it will face a 40 percent marginal tax rate,
and the book

value of equity per share under either scenario is $10.00 per share.

What is the difference between the EPS forecasts for Feast and Famine
under the

aggressive capital structure?

a. $ 0

b. $1.48

c. $0.62

d. $0.98

e. $2.40

16. According to today's Wall Street Journal, the spot exchange
rate for the Deutsche mark is

DM 1 = $.83. The six-month forward exchange rate is DM 1 = $.67. Which
statement

below is true?

I. The Deutsche mark is selling at a discount relative to the dollar.

II. The Deutsche mark is selling at a premium relative to the dollar.

III. The dollar is selling at a discount relative to the Deutsche mark.

IV. The dollar is selling at a premium relative to the Deutsche mark.

A. I only

B. II and IV only

C. I and III only

D. I and IV only

E. II and III only

17. Suppose you are reviewing the exchange rates for the Irish Punt
(P), the Swiss France (SF)

and the U.S. Dollar ($). You see the following quotes: P6 per $1; SF
.5 per $1. What is

the cross-rate for Punts per Swiss France?

A. P.083 per SF1
D. P7.50 per SF1

B. P.50 per SF1
E. P12.00 per SF1

C. P4 per SF1

18. Suppose U.S. inflation is predicted to be 4% next year. The Barnes
group tells you that

inflation in England is expected to be 10%. The current exchange rate
is ,1.2 pounds per

$1.00. What is your best guess as to next year's exchange rate?

a.. 1.001 pounds per $1.00

B. 1.038 pounds per $1.00

C. 1.117 pounds per $1.00

D. 1.272 pounds per $1.00

E. 1.480 pounds per $1.00

19. The current exchange rate between the U.S. and Mexico is Ps800 per
$1.00. The nominal

risk-free rate in the U.S. is 4 %, while the Mexican rate is 17 %.
What is the only possible

forward rate that could prevail that would eliminate any arbitrage
opportunities?

A. Ps455.00 per $1.00

B. Ps558.72 per $1.00

C. Ps645.00 per $1.00

D. Ps885.00 per $1.00

E. Ps900.00 per $1.00

20. The 60-day forward rate for Japanese Yen is -112.16
per $1.00. The spot rate is -103.9

per $1.00. In 60 days you expect to receive -500,000.
If you agree to a forward contract,

how many dollars will you receive in 60 days?

A. $4,458

B. $4,812

C. $5,312

D. $51.95 million

E. $56.08 million

1. b

2. a

3. b

^

k P + 0.9(12%) + 0.1(20%) = 12.8%.

b p = 0.9(1.2) + 0.1(2.0) = 1.28.

4. b. $23.0

^

k = 0.2($50) + 0.5($20) + 0.3(-$15) = $15.50.

= ($50 - $15.5) (0.2) + ($20 - $15.5) (0.5) + (-$15 -

$15.5) (0.3) = 527.25.

= 527.25 = $22.96 $23.0.

5. a. The discount rate decreases.

6. a. Choice 1.

tabular solution:

PV Choice 1 = $1,000(PVIFA 1%,11 + 1.0) = $1,000(11.3676) = $11,367.60.

PV Choice 2 = $12,750(PVIF 1%,12 ) = $12,750(0.8874) = $11,314.35.

Financial calculator solution:

Choice 1

BEGIN mode, Inputs: N = 12; I = 1; PMT = 1,000; FV = 0.

Output: PV = -$11,367.63.

Choice 2

END mode, Inputs: N = 12; I = 1; PMT = 0; FV = 12,750.

Output: PV = -$11,314.98.

7. b. $7,427.83

Tabular solution:

FV Year 20 = $50(FVIFA 10%,20 ) = $50(57.275) = $2,863.75.

FV Year 30 = $2,863.75(FVIF 10%,10 ) = $2,863.75(2.5937) = $7,427.71.

Financial calculator solution:

Calculate FV at Year 20, then take that lump sum forward 10 years to Year 30 at 10%.

Inputs: N = 20; I = 10; PV = 0; PMT = -50. Output Year 20 : FV = $2,863.75.

At Year 30

Inputs: N = 10; I = 10; PV = -2,863.75; PMT = 0.

Output Year 30 : FV = $7,427.83.

8. b

9. a. Neither project.

Project X (In thousands)

0 k = 15% 1 2 3 4 Years

CF x -100 50 40 30 10

k = 15%

NPV X = -0.833 = -$833.

Project Z (In thousands)

0 k = 15% 1 2 3 4 Years

CF Z -100 10 30 40 60

k = 15%

NPV Z = -8.014 = -$8,014.

At a cost of capital of 15%, both projects have negative NPVs and, thus,
both would

be rejected.

Tabular solution: (In thousands)

NPV X = -100 + 50(PVIF 15%,1 ) + 40(PVIF 15%,2 ) + 30(PVIF 15%,3 ) +

10(PVIF 15%,4 )

= -100 + 50(0.8696) + 40(0.7561) + 30(0.6575) + 10(0.5718)

= -0.833 = -$833.

NPV Z = -100 + 10(PVIF 15%,1 ) + 30(PVIF 15%,2 ) + 40(PVIF 15%,3 ) +

60(PVIF 15%,4 )

= -100 + 10(0.8696) + 30(0.7561) + 40(0.6575) + 60(0.5718)

= -8.013 = -$8,013.

Financial calculator solution: In thousands

Project X Inputs: CF = -100; CF = 50; CF = 40; CF = 30;

CF = 10; I = 15.

Output: NPV X = -0.833 = -$833.

Project Z Inputs: CF = -100; CF = 10; CF = 30; CF = 40;

CF = 60; I = 15.

Output: NPV Z = -8.014 = -$8,014.

10. b. 12.9%

Tabular/Numerical solution:

TV = $300(FVIFA 10%,5 ) = $300(6.1051) = $1,831.53.

$1,000 = TV/(1 + MIRR)

$1,000 = $1,831.53/(1 + MIRR)

(1 + MIRR) = 1.83153

MIRR = 0.12866 12.9%.

Financial calculator solution: Using cash flows

Inputs: CF = 0; CF = 300; N j = 5; I = 10.

Output: NFV = 1,831.53.

Inputs: N = 5; PV = -1,000; FV = 1,831.53.

Output: I = 12.866% = MIRR 12.9%.

11. a

12. b

:

13. d. Changes in required returns due to financing decisions.

:

14. b. Issue equity to share the burden of decreased equity returns
between old and new

shareholders.

15. e. $2.40

Debt = 75% = $300,000; Equity = 25% = $100,000; Total assets = $400,000.

Feast Famine

Probability 0.6 0.4

EBIT
$60,000 $20,000

Less: Interest
36,000 36,000

_______ ______

EBT
$24,000 ($16,000)

Less: Taxes
9,600 (6,400)

-------- ---------

NI
$14,400 ($ 9,600)

# shares
10,000 10,000

EPS
$1.44 -$0.96

Difference in EPS for aggressive capital structure:

EPS Feast - EPS Famine = $1.44 - ($0.96) = $2.40.

16. D

17. E (6p/1$)(1$/.5sf)= 12p/1$

18. D 1.2[1 + (.10 - .04)] = 1.272 pounds per $1

19. E F = 800 (1.17 / 1.04 ) = Ps900 per $

20. A 500,000 / 112.16 = $4458