Section B Questions

Hock P2 2020
Section B - Corporate Finance.

Questions
Risk and Return 32
L-T Financial Management-Financial Instruments 72
L-T Financial Management-Derivatives 24
Cost of Capital 54
Raising Capital 32
Cash and Marketable Securities Management 30
Accounts Receivable Management 27
Inventory Management 26
Trade Credit 13
Short-term Bank Loans and Other S-T Financing 35
Working Capital Policy 24
Corporate Restructuring 6
International Finance 36
411
Risk and Return

1. Question ID: CIA 1191 IV.50 (Topic: Risk and Return)
From the viewpoint of the investor, which of the following securities provides the least
risk?
 A. Income bond.
 B. Mortgage bond.
 C. Debenture.
 D. Subordinated debenture.

Which of the following classes of securities are listed in order from lowest
risk/opportunity for return to highest risk/opportunity for return?
 A. U.S. Treasury bonds; corporate first mortgage bonds; corporate income bonds;
preferred stock.
 B. Common stock; corporate first mortgage bonds; corporate second mortgage bonds;
corporate income bonds.
 C. Corporate income bonds; corporate mortgage bonds; convertible preferred stock;
subordinated debentures.
 D. Preferred stock; common stock; corporate mortgage bonds; corporate debentures.
Hock P2 2020
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An investor is currently holding income bonds, debentures, subordinated debentures,
and first-mortgage bonds. Which of these securities traditionally is considered to have
the least risk?
 A. Subordinated debentures.
 B. Income bonds.
 C. First-mortgage bonds.
 D. Debentures.

A measure that describes the risk of an investment project relative to other investments
in general is the
 A. Expected return.
 B. Standard deviation.
 C. Coefficient of variation.
 D. Beta coefficient.
5. Question ID: HOCK CMA P2 SDV1 (Topic: Risk and Return)

New Company's sales and profits are growing rapidly, and so is its dividend. Its dividend
is growing at an annual rate of 25%. This growth in the dividend is expected to continue
for two years. After that, the rate of growth is expected to slow down to 10% per year.
The investors' required rate of return on the stock is 16%. The next annual dividend is
expected to be $1.00. The beta of New Company's stock is 1.5. The U.S. Treasury bill
rate is 4%.
What is the expected market rate of return?
 A. 16.0%
 B. 10.67%
 C. 12.0%
 D. 14.67%

The difference between the required rate of return on a given risky investment and that
on a riskless investment is the
 A. Standard deviation.
 B. Beta coefficient.
 C. Risk premium for that security.
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 D. Coefficient of variation.
7. Question ID: HOCK RRI 120 (Topic: Risk and Return)

Consider the following graph:
What is the return to the market according to this graph?
 A. 3%
 B. It is impossible to determine the return to the market from the information given.
 C. 9%
 D. 12%
8. Question ID: ICMA 10.P2.113 (Topic: Risk and Return)

Which one of the following would have the least impact on a firm's beta value?
 A. Payout ratio.
 B. Operating leverage.
 C. Debt-to-equity ratio.
 D. Industry characteristics.

All of the following are true about the beta coefficient except
 A. The beta coefficient of an investment measures how sensitive the stock's return is to
changes in the market's return.
 B. The beta coefficient is the slope of the regression line that relates the return of an
individual security to the return of its benchmark index.
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 C. The beta coefficient measures non-market risk.
 D. The beta coefficient is used to measure a stock's market risk.

The slope of a Security Market Line is
 A. the market risk premium.

 B. the graphical representation of the security's risk.
 C. the graphical representation of the security's returns.
 D. the beta.
11. Question ID: CMA 697 1.11 (Topic: Risk and Return)
When purchasing temporary investments, which one of the following best describes the
risk associated with the ability to sell the investment in a short period of time without
significant price concessions?
 A. Interest-rate risk.
 B. Liquidity risk.
 C. Financial risk.
 D. Purchasing-power risk.
The risk that securities cannot be sold at a reasonable price on short notice is called
 A. Interest-rate risk.
 B. Default risk.
 C. Liquidity risk.
 D. Purchasing-power risk.

If Dexter Industries has a beta value of 1.0, then its
 A. volatility is low.
 B. expected return should approximate the overall market's expected return.
 C. price is relatively stable.
 D. return should equal the risk-free rate.
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What is the slope of the Security Market Line?
 A. 4.5%
 B. It is impossible to determine the slope of the Security Market Line from the information
given.
 C. 9%
 D. 3%

A company that prides itself on its innovation revised an existing popular brand without
conducting sufficient market research. By taking this action, the company exposed itself
to what types of risk?
 A. Credit risk and strategic risk.

 B. Hazard risk and credit risk.
 C. Strategic risk and operational risk.
 D. Operational risk and hazard risk.

Systematic risk is
 A. the possibility that an investment cannot be sold (converted into cash) for its market
value.
 B. risk that cannot be diversified away by holding securities in a diversified portfolio.
 C. risk that can be diversified away by holding securities in a diversified portfolio.
 D. risk that can be quantified.
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If a stock with a beta of 1.5 has an expected return of 20%, it means that the stock
 A. is riskier than others that provide the same return.

 B. is undervalued by the market.
 C. is a good investment.
 D. is overvalued by the market.

The systematic risk of an individual security is measured by the
 A. standard deviation of the security's rate of return.

 B. covariance between the security's returns and the general market.
 C. standard deviation of the security's returns and other similar securities.
 D. security's contribution to the portfolio risk.

Based on the assumptions of the Capital Asset Pricing Model, the risk premium on an
investment with a beta of 0.5 is equal to
 A. the risk premium on the market.

 B. twice the risk premium on the market.
 C. the risk-free rate.
 D. half the risk premium on the market.
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Using the capital asset pricing model (CAPM), determine the expected market risk
premium from the following information.
Beta of Investment A 1.4

Risk-free rate 3.0%
Expected return on Investment A 7.4%
 A. 6.14%.
 B. 8.28%.
 C. 7.43%.
 D. 3.14%.

What kind of risk can be eliminated by diversification in a portfolio?
 A. Market risk
 B. Portfolio risk
 C. Unsystematic risk
 D. Systematic risk
rate is 4%.
What is the risk premium of the market?
 A. 4%
 B. 16%
 C. 12%
 D. 8%

An efficient portfolio is a portfolio that is in the feasible set of portfolios and
 A. its historical returns have been above those of its benchmark for 8 of the last 10 years.
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 B. offers the highest possible expected return for a given level of risk or offers the lowest
possible risk for a given level of expected return.
 C. offers the highest possible expected return for the lowest possible level of risk.
 D. offers the lowest possible risk for the highest possible expected return.
The risk of loss because of fluctuations in the relative value of foreign currencies is
called
 A. Multinational beta.
 B. Expropriation risk.
 C. Exchange rate risk.
 D. Undiversifiable risk.
The risk-free rate of interest that is used in the Capital Asset Pricing Model and other
investment analyses is
 A. approximately the return on a perfectly diversified portfolio.

 B. approximately the return on high-grade commercial paper.
 C. approximately the return on short-term U.S. Treasury Bills.
 D. approximately the return on an FDIC-insured savings account.
The U.S. Treasury Bill rate is 2%. The expected return on the market is 11%. OPQ
Corp.'s common stock has a beta of 1.2, and its dividends have an expected growth
rate of 2%. What is the stock's expected risk premium?
 A. 13.2%
 B. 10.8%
 C. 11%
 D. 9%

If the risk-free rate is 4% and the expected return on the market is 9%, the risk premium
for a security with a beta of 0.5 is
 A. 6.5%
 B. 50%
 C. 2.5%
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 D. 5%
rate is 4%.
What is the risk premium that investors require to invest in New Company's stock?
 A. 16%
 B. 10%
 C. 4%
 D. 12%

Using the capital asset pricing model, an analyst has calculated an expected risk-
adjusted return of 17% for the common stock of a company. The company’s stock has a
beta of 2, and the overall expected market return for equities is 10%. The risk-free
return is 3%. All else being equal, the expected risk-adjusted return for the company’s
stock would increase if the
 A. overall expected market return for equities decreases.

 B. volatility of the company's stock decreases.
 C. risk-free return decreases.
 D. beta of the company's stock decreases.
Hock P2 2020
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What is the formula that describes this particular Security Market Line?
 A. r = .03 + .5(.045)
 B. r = .03 + β(.12 − .03)
 C. R = (1 / 12) + .045
 D. R = .03 + β

A German clothing retailer sells its products mainly online to customers worldwide.
Company management believes that its primary risk relates to problems with its online
website. A secondary risk is exchange rate volatility. Which one of the following best
categorizes the company’s primary risk and secondary risk?
 A. Strategic risk, financial risk.

 B. Hazard risk, operational risk.
 C. Operational risk, hazard risk.
 D. Operational risk, financial risk.

The beta coefficient for the market as a whole
 A. is 1.
 B. cannot be determined.
 C. is −1.
 D. is zero.
Hock P2 2020
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L-T Financial Management-Financial Instruments
33. Question ID: CMA 696 1.2 (Topic: L-T Financial Management-Financial
Instruments )
A company's stock was trading rights-on for $50.00, and when it went ex-rights the
market price was $48.00. The subscription price for rights holders is $40.00, and four
rights are required to purchase one share of stock.
The value of a right when the stock was trading ex-rights was
 A. $2.50
 B. $0.40
 C. $2.00
 D. $0.50
34. Question ID: HOCK CFMQ5 (Topic: L-T Financial Management-Financial

Instruments )
A share has a market price of $2.50. It is expected to be able to pay a steady dividend
of 30 cents per share each year starting in one year's time. There will not be any growth
in dividends. Other things being equal, if the expected dividend goes up to 33 cents:
 A. The share price would go up to $2.53.

 B. The share price would go up to $2.75.
 C. The share price would go down to $2.25.
 D. The share price would stay at $2.50.
35. Question ID: ICMA 19.P2.076 (Topic: L-T Financial Management-Financial

Instruments )
Which one of the following entities is most likely to assist investors in assessing the
default risk of a specific corporate bond?
 A. Investment banks.
 B. Credit rating agencies.
 C. Brokerage firms.
 D. Bond dealers.
36. Question ID: CMA 695 P1 Q9 (Topic: L-T Financial Management-Financial

Instruments )
In practice, dividends
 A. tend to be a lower percentage of earnings for mature firms.

 B. fluctuate more widely than earnings.
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 C. usually exhibit greater stability than earnings.
 D. are usually set as a fixed percentage of earnings.
Instruments )
If a firm is to be purchased entirely for cash, which of the following items would the
purchaser consider?
I. The incremental future after-tax cash flow from operations
II. Cash paid to the seller's shareholders
III. The present value of the seller's liabilities
 A. I and III.
 B. I, II, and III.
 C. I and II.
 D. I.
Instruments )
Many states have laws that provide preemptive rights for shareholders. A preemptive
right is when a company must
 A. Give existing shareholders stock warrants equal to their proportionate ownership share
in the company when issuing a new public offering.
 B. Sell shares to existing shareholders equal to their proportionate ownership share in the
company when issuing a new public offering.
 C. Give dividends to the common shareholders first before giving dividends to the
preferred shareholders.
 D. Give existing shareholders the opportunity to maintain their proportionate ownership
share in the company when issuing a new public offering.
39. Question ID: HOCK LTF 112 (Topic: L-T Financial Management-Financial
Instruments )
The current price of Mutts, Inc. stock is $30 per share, and during the current year, the
stock paid a 5% dividend. The stock’s beta is 1.2. The expected return to the market is
9%; and the risk-free rate is 3%. Mutts, Inc.'s cost of retained earnings is 10.2%. What
should the company’s next year’s dividend be?
 A. $1.80 per share

 B. $1.574 per share
 C. $1.545 per share
 D. $2.70 per share
Hock P2 2020
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Instruments )
The best advantage of a zero-coupon bond to the issuer is that the
 A. Interest can be amortized annually by the APR method and need not be shown as an
interest expense to the issuer.
 B. Interest can be amortized annually on a straight-line basis but is a non-cash outlay.
 C. Bond requires no interest income calculation to the holder or issuer until maturity.
 D. Bond requires a low issuance cost.

Instruments )
James Hemming, the chief financial officer of a midwestern machine parts
manufacturer, is considering splitting the company’s stock, which is currently selling at
$80.00 per share. The stock currently pays a $1.00 per share dividend. If the split is
two-for-one, Mr. Hemming may expect the post split price to be
 A. greater than $40.00, if the dividend is changed to $0.45 per new share.
 B. less than $40.00, regardless of dividend policy.
 C. greater than $40.00, if the dividend is changed to $0.55 per new share.
 D. exactly $40.00, regardless of dividend policy.

Instruments )
Protective clauses set forth in an indenture are known as
 A. requirements.
 B. covenants.
 C. addenda.
 D. provisions.
Instruments )
Which one of the following statements is correct regarding the effect preferred stock has
on a company?
 A. Preferred shareholders' claims take precedence over the claims of common

shareholders in the event of liquidation.
 B. The firm's after-tax profits are shared equally by common and preferred shareholders.
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 C. Control of the firm is now shared by the common and preferred shareholders, with
preferred shareholders having greater control.
 D. Nonpayment of preferred dividends places the firm in default, as does nonpayment of
interest on debt.
Instruments )
Which one of the following characteristics distinguishes income bonds from other
bonds?
 A. By promising a return to the bondholder, an income bond is junior to preferred and

common stock.
 B. The bondholder is guaranteed an income over the life of the security.
 C. Income bonds pay interest only if the issuing company has earned the interest.
 D. Income bonds are junior to subordinated debt but senior to preferred and common
stock.

Instruments )
of 30 cents per share each year starting in one year's time. There will not be any growth
in dividends. The stock's beta is 0.8, and the risk-free rate is 3%. The investors' required
rate of return on the shares is:
 A. 30%
 B. 10.2%
 C. 12.0%
 D. 15%
46. Question ID: CFM CH19 II.13 (Topic: L-T Financial Management-Financial
Instruments )
The market price of Mulva Corporation's common stock is $60 per share, and each
share gives its owner one subscription right. Four rights are required to purchase an
additional share of common stock at the subscription price of $54 per share.
What is the theoretical value of one share of Mulva common stock when it goes "ex-
rights"?
 A. $59.04
 B. $54.00
 C. $58.50
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 D. $58.80

Instruments )
Which one of the followings is not a relevant factor that influences the dividend policy of
a firm?
 A. The amount of cash not needed for operations.

 B. The dividend income tax rate.
 C. The available investment projects.
 D. The credit policy of the company.
Instruments )
Below is a partial Statement of Financial Position for Monosone, Inc.:
Monosone, Inc.
Statement of Financial Position
December 31, Year 1
Total assets $10,000,000
Current liabilities $ 2,000,000
Long-term debt 3,000,000
Common stock (1,000,000 shares authorized,
500,000
100,000 shares outstanding at $5 par value)
Paid-in capital in excess of par 1,600,000
Retained earnings 2,900,000
Total liabilities and shareholder's equity $10,000,000
Expected dividend payments:
December 31, year 2 $2.00
Expected selling price on:
An investor is considering buying Monosone, Inc.'s common stock on January 1, year 2
and anticipates, with reasonable assurance, selling it December 31, year 4 at $25.00
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per share. What is the approximate intrinsic value on January 1, year 2 of each share
(rounded to the nearest dollar) when the required rate of return is 10%?
 A. $31.
 B. $30.
 C. $24.
 D. $19.

Instruments )
A requirement specified in an indenture agreement which states that a company cannot
acquire or sell major assets without prior creditor approval is known as a
 A. call provision.
 B. protective covenant.
 C. warrant.
 D. put option.
Instruments )
The equity section of Allen Corporation's statement of financial position is presented as
follows.
Preferred stock ($100 par value) $ 8,000,000

Common stock ($5 par value) 5,000,000
Net worth $31,000,000
The common shareholders of Allen Corporation have preemptive rights. If Allen
Corporation issues 200,000 additional shares of common stock at $6 per share, a
current holder of 10,000 shares of Allen Corporation's common stock must be given the
option to buy
 A. 2,000 additional shares.

 B. 2,400 additional shares.
 C. 1,667 additional shares.
 D. 500 additional shares.
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Instruments )
The common stock of a beverage company has a current market price of $34. The
beverage company is estimated to earn $2 per share in the next year. The average
price/earnings ratio of companies in the beverage industry is 15. Using the
price/earnings ratio as the comparable valuation method, the beverage company’s stock
is
 A. $4 overvalued.
 B. $2 overvalued.
 C. $4 undervalued.
 D. $2 undervalued.
52. Question ID: CFM Sample Q. 10 (Topic: L-T Financial Management-Financial

Instruments )
Rogers Inc. operates a chain of restaurants located in the Southeast. The company has
steadily grown to its present size of 48 restaurants. The board of directors recently
approved a large-scale remodeling of the restaurant, and the company is now
considering two financing alternatives.
The first alternative would consist of
 Bonds that would have a 9% effective annual rate and would net $19.2 million after
flotation costs
 Preferred stock with a stated rate of 6% that would yield $4.8 million after a 4%
flotation cost
 Common stock that would yield $24 million after a 5% flotation cost
The second alternative would consist of a public offering of bonds that would have an
11% effective annual rate and would net $48 million after flotation costs.
Rogers' current capital structure, which is considered optimal, consists of 40% long-term
debt, 10% preferred stock, and 50% common stock. The current market value of the
common stock is $30 per share, and the common stock dividend during the past 12
months was $3 per share. Investors are expecting the growth rate of dividends to equal
the historical rate of 6%. Rogers is subject to an effective income tax rate of 40%.
The interest rate on the bonds is greater for the second alternative consisting of pure
debt than it is for the first alternative consisting of both debt and equity because
 A. The combination alternative carries the risk of increasing dividend payments.

 B. The diversity of the combination alternative creates greater risk for the investor.
 C. The pure debt alternative carries the risk of increasing the probability of default.
 D. The pure debt alternative would flood the market and be more difficult to sell.
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Instruments )
Serial bonds are attractive to investors because
 A. investors can choose the maturity that suits their financial needs.
 B. all bonds in the issue mature on the same date.
 C. the coupon rate on these bonds is adjusted to the maturity date.
 D. the yield to maturity is the same for all bonds in the issue.

Instruments )
A publicly-traded corporation in an industry with an average price/earnings ratio of 20
has the following summary financial results.
Sales $1,000,000
Expenses 500,000
Operating income $ 500,000
Taxes 300,000
Net income $ 200,000
Assets $2,500,000
Liabilities $1,000,000
Shareholders' equity $1,500,000
A competitor wishes to make a bid to acquire the stock of the company. What is the
current market value?
 A. $20,000,000.
 B. $10,000,000.
 C. $4,000,000.
 D. $1,500,000.
55. Question ID: CIA 1191 IV.59 (Topic: L-T Financial Management-Financial
Instruments )
Which of the following brings in additional capital to the firm?
 A. Two-for-one stock split.

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 B. Conversion of convertible bonds to common stock.
 C. Exercise of warrants.
 D. Purchase of option through an option exchange.

Instruments )
Morton Starley Investment Banking is working with the management of Kell Inc. in order
to take the company public in an initial public offering. Selected information for the year
just ended for Kell is as follows.
Long-term debt (8% interest rate) $10,000,000

Common equity:
Common stock, par value $1 per share 3,000,000
Additional paid-in capital 24,000,000
Total assets 55,000,000
Net income 3,750,000
Dividend (annual) 1,500,000
If public companies in Kell’s industry are trading at a market to book ratio of 1.5, what is
the estimated value per share of Kell?
 A. $13.50.
 B. $21.50.
 C. $16.50.
 D. $27.50.
Instruments )
All of the following may reduce the coupon rate on a bond issued at par except a
 A. Conversion option.
 B. Call provision.
 C. Sinking fund.
 D. Change in rating from Aa to Aaa.

Instruments )
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Dorsy Manufacturing plans to issue mortgage bonds subject to an indenture. Which of
the following restrictions or requirements are likely to be contained in the indenture?
I. Receiving the trustee's permission prior to selling the property.

II. Maintain the property in good operating condition.
III. Insuring plant and equipment at certain minimum levels.
IV. Including a negative pledge clause.
 A. I, III, and IV only.

 B. I and IV only.
 C. II and III only.
 D. I, II, III and IV.
59. Question ID: HOCK LTF 111 (Topic: L-T Financial Management-Financial
Instruments )
The price of Investors, Inc. stock is $31.25, and its beta is 1.2. The stock’s next annual
dividend will be $1.25, and dividends are expected to grow at the rate of 5% per year.
The risk-free rate is 3%. What is the expected return to the market?
 A. 8.00%
 B. 8.17%
 C. 9.00%
 D. 10.20%

Instruments )
If the yield curve on a term structure of interest rates graph is a flat line with no slope,
which one of the following statements is correct?
 A. The intermediate-term interest rate is lower than the T-bill interest rate.
 B. Long-term rates are the same as short-term rates.
 C. Long-term rates are higher than short-term rates.
 D. Bank borrowing rates will rise.

Instruments )
of $2.50 per share each year starting in one year's time. There will not be any growth in
the dividend. If the investors' required rate of return changes to 8%, the effect would be
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 A. there will be no change in either the dividend or the share price.
 B. the dividend would increase to $4.00.
 C. the share price will go up to $62.50.
 D. the share price will go down to $31.25.

Instruments )
Preferred stock may be retired through the use of any one of the following except a
 A. conversion.
 B. sinking fund.
 C. call provision.
 D. refunding.
Instruments )
The best reason corporations issue Eurobonds rather than domestic bonds is that:
 A. These bonds are denominated in the currency of the country in which they are issued.
 B. Foreign buyers more readily accept the issues of both large and small U.S.
corporations than do domestic investors.
 C. These bonds are normally a less expensive form of financing because of the absence
of government regulation.
 D. Eurobonds carry no foreign exchange risk.
Instruments )
The par value of a common stock represents
 A. the total value of the stock that must be entered in the issuing corporation's records.
 B. the liability ceiling of a shareholder when a company undergoes bankruptcy
proceedings.
 C. a theoretical value of $100 per share of stock with any differences entered in the
issuing corporation's records as discount or premium on common stock.
 D. the estimated market value of the stock when it was issued.
Instruments )
The maximum acquisition value of an inefficiently run corporation is the discounted net
present value of the
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 A. Expected future cash flow.
 B. Current earnings before interest and taxes (EBIT).
 C. Current net profits.
 D. Current market value of the firm.
Instruments )
A sinking fund for a bond issue is a(n)
 A. periodic payment by a debtor to accumulate funds for the retirement of the bonds when
they mature.
 B. periodic payment by a debtor to pay the annual interest costs prescribed by the bond
issue.
 C. alternative to traditional long-term debt financing.
 D. periodic payment by a debtor to pay for the initial issuing costs of the bond issue.
Instruments )
Short-term interest rates are
 A. Lower than long-term rates during periods of high inflation only.

 B. Usually higher than long-term rates.
 C. Not significantly related to long-term rates.
 D. Usually lower than long-term rates.
Instruments )
The formula for determining the value of one stock right when the price of the stock is
rights-on is
(Pon − S)
Ron =
(N + 1)
Where:
Ron = market value of one right when the stock is selling rights-on.
Pon = market value of one share of stock with rights-on.
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Questions
N = number of rights necessary to purchase one share of stock.
S = subscription price per share.
If the market price of a stock is $50 per share, the subscription price is $40 per share,
and three rights are necessary to buy an additional share of stock, the theoretical
market value of one right used to buy the stock prior to the ex-rights date is
 A. $2.50.
 B. $10.00.
 C. $40.00.
 D. $2.00.

Instruments )
Bull & Bear Investment Banking is working with the management of Clark Inc. in order
to take the company public in an initial public offering. Selected financial information for
Clark is as follows.

Common equity:
Common stock, par value $1 per share 3,000,000
Additional paid-in capital 24,000,000
Total assets 55,000,000
Net income 3,750,000
Dividend (annual) 1,500,000
If public companies in Clark’s industry are trading at twelve times earnings, what is the
estimated value per share of Clark?
 A. $24.00.
 B. $9.00.
 C. $12.00.
 D. $15.00.
70. Question ID: CMA 695 P1 Q13 (Topic: L-T Financial Management-Financial
Instruments )
The equity section of Smith Corporation's statement of financial position is presented
below.
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Preferred stock, $100 par $12,000,000
Common stock, $5 par 10,000,000
Net worth $49,000,000
The common shareholders of Smith Corporation have preemptive rights. If Smith
Corporation issues 400,000 additional shares of common stock at $6 per share, a
current holder of 20,000 shares of Smith Corporation's common stock must be given the
option to buy
 A. 3,774 additional shares.

 B. 4,000 additional shares.
 C. 1,000 additional shares.
 D. 3,333 additional shares.
71. Question ID: CFM CH19 II.12 (Topic: L-T Financial Management-Financial
Instruments )
The market price of Mulva Corporation's common stock is $60 per share, and each
share gives its owner one subscription right. Four rights are required to purchase an
additional share of common stock at the subscription price of $54 per share.
If Mulva's common stock is currently selling "rights-on," the theoretical value of a right is
closest to
 A. $6.00
 B. $1.20
 C. $1.50
 D. $0.96
Instruments )
Which of the following scenarios would encourage a company to use short-term loans to
retire its 10-year bonds that have 5 years until maturity, assuming the bonds have a call
provision?
 A. The company is experiencing cash flow problems.

 B. The company expects interest rates to increase over the next 5 years.
 C. Interest rates have increased over the last 5 years.
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 D. Interest rates have declined over the last 5 years.
Instruments )
Gleason Industries is about to issue $3 million of bonds with a coupon rate of 8%. As
inflation is causing interest rates to rise above 8%:
 A. The value of the bonds will be greater than their face value.
 B. The bonds will sell at a discount as the required rate of return devalues the bonds.
 C. The face value of the bonds will decline.
 D. The bonds will sell at a premium to compensate investors for the low stated rate.
Instruments )
If Brewer Corporation's bonds are currently yielding 8% in the marketplace, why is the
firm's cost of debt lower?
 A. Market interest rates have increased.

 B. Interest is deductible for tax purposes.
 C. Additional debt can be issued more cheaply than the original debt.
 D. There should be no difference; cost of debt is the same as the bonds' market yield.

Instruments )
Vega Inc. needs to raise $50,000,000 for expansion. The two available options are to
sell 7%, 10-year bonds at face value or to sell 5% preferred stock at par for which
annual dividends would be paid. Vega’s effective income tax rate is 30%. Which one of
the following best describes the difference in Vega’s cash flow for the second year after
issue?
 A. Cash flow with the stock issue is $525,000 higher.

 B. Cash flow with the bond issue is $50,000 higher.
 C. Cash flow with the bond issue is $225,000 higher.
 D. Cash flow with the stock issue is $700,000 higher.

Instruments )
Frasier Products has been growing at a rate of 10% per year and expects this growth to
continue and produce earnings per share of $4.00 next year. The firm has a dividend
payout ratio of 35% and a beta value of 1.25. If the risk-free rate is 7% and the return on
Hock P2 2020
Questions
the market is 15%, what is the expected current market value of Frasier's common
stock?
 A. $14.00.
 B. $28.00.
 C. $20.00.
 D. $16.00.
Instruments )
Wilton Corporation has 5,000 shares of 6% cumulative, $100 par value, preferred stock
outstanding and 175,000 shares of common stock outstanding. No dividends have been
paid by the company since May 31, year 2. For the year ended May 31, year 4, Wilton
had net income of $1,450,000 and wishes to pay common shareholders a dividend
equivalent to 25% of net income. The total amount of dividends to be paid by Wilton
Corporation at May 31, year 4 is:
 A. $407,500.
 B. $362,500.
 C. $422,500.
 D. $392,500.
Instruments )
A downward-sloping yield curve depicting the term structure of interest rates implies
that:
 A. Prevailing short-term interest rates are higher than prevailing long-term interest rates.
 B. Interest rates have declined over recent years.
 C. Prevailing short-term interest rates are lower than prevailing long-term interest rates.
 D. Interest rates have increased over recent years.

Instruments )
Which one of the following best describes the record date as it pertains to common
stock?
 A. The date that is chosen to determine the ownership of shares.

 B. The 52-week high for a stock published in the Wall Street Journal.
 C. Four business days prior to the payment of a dividend.
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 D. The date on which a prospectus is declared effective by the Securities and Exchange
Commission.
Instruments )
Assume that nominal interest rates just increased substantially but that the expected
future dividends for a company over the long run were not affected. As a result of the
increase in nominal interest rates, the company's stock price should
 A. Decrease.
 B. Stay constant.
 C. Increase.
 D. Change, but in no obvious direction.
Instruments )
A financial manager usually prefers to issue preferred stock rather than debt because
 A. The cost of fixed debt is less expensive since it is tax deductible even if a sinking fund
is required to retire the debt.
 B. Payments to preferred stockholders are not considered fixed payments.
 C. In a legal sense, preferred stock is equity; therefore, dividend payments are not legal
obligations.
 D. The preferred dividend is often cumulative, whereas interest payments are not.
Instruments )
If a $1,000 bond sells for $1,125, which of the following statements are correct?
I. The market rate of interest is greater than the coupon rate on the bond.
II. The coupon rate on the bond is greater than the market rate of interest.
III. The coupon rate and the market rate are equal.
IV. The bond sells at a premium.
V. The bond sells at a discount.
 A. II and IV.
 B. I and V.
 C. I and IV.
 D. II and V.
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Instruments )
Each share of non-participating, 8%, cumulative preferred stock in a company that
meets its dividend obligations has all of the following characteristics except
 A. Voting rights in corporate elections.

 B. A superior claim to common stock equity in the case of liquidation.
 C. Dividend payments that are not tax deductible by the company.
 D. No principal repayments.
84. Question ID: HOCK CMA P2 SDV4 (Topic: L-T Financial Management-Financial
Instruments )
rate is 4%.
What is an appropriate market price for New Company's stock?
 A. $4.00
 B. $13.80
 C. $18.88
 D. $23.00
Instruments )
A company's stock trades rights-on for $50.00 and ex-rights for $48.00. The
subscription price for rights holders is $40.00, and four rights are required to purchased
one share of stock.
The value of a right while the stock is still trading rights-on is
 A. $2.00
 B. $1.60
 C. $0.40
 D. $0.50

Instruments )
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Preferred stock with a par value of $100 pays an annual dividend of 5%. If investors
require a 3.75% rate of return, what is the price of the preferred stock?
 A. $103.75
 B. $100.00
 C. $98.75
 D. $133.33

Instruments )
The call provision in some bond indentures allows
 A. the bondholder to exchange the bond, at no additional cost, for common shares.
 B. the issuer to exercise an option to redeem the bonds.
 C. the issuer to pay a premium in order to prevent bondholders from redeeming bonds.
 D. the bondholder to redeem the bond early by paying a call premium.
Instruments )
A stockholder owns 10 shares of Shudo Corporation common stock at a current market
price of $10 per share. The corporation will allow each shareholder to buy proportional
new shares of stock at $9 per share. Currently, there are 5,000 shares outstanding and
500 new shares will be issued. What is the value of one right (rounded to the nearest
cent)?
 A. $.91.
 B. $.09.
 C. $10.00.
 D. $9.09.

Instruments )
Which one of the following provides the best measure of interest rate risk for a
corporate bond?
 A. Maturity.
 B. Yield to maturity.
 C. Bond rating.
 D. Duration.
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90. Question ID: CMA 695 1.8.5 Adapted (Topic: L-T Financial Management-
Financial Instruments )
Below is a Statement of Financial Position for Martin Corporation:
Martin Corporation
(Dollars in millions)
Assets:
Current Assets $ 75
Plant and Equipment 250
Total Assets $325
Liabilities and shareholders' equity:
Liabilities:
Current Liabilities $ 46
Long-term debt (12%) 64
Common equity:
Common stock, $1 par $ 10
Additional paid in capital 100
Retained earnings 105
Total liabilities and shareholders' equity $325
Additional Data:
 The long term debt was originally issued at par ($1,000 per bond) and is currently
trading at $1,250 per bond.
 Martin Corporation can now issue debt at 150 basis points over U.S. treasury
bonds.
 The current risk-free rate (U.S. Treasury bonds) is 7%.
 The expected market return is currently 15%.
 The beta for Martin is 1.25.
 Martin's effective corporate income tax rate is 40%.
 Martin paid a dividend of $1.00 per share last year.
 Martin's dividend is expected to grow at the rate of 5% per year.
What price should Martin's common stock sell for currently?
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 A. $8.33
 B. $10.50
 C. $6.67
 D. $8.75
Instruments )
Which one of the following statements is correct when comparing bond financing
alternatives?
 A. A call provision is generally considered detrimental to the investor.

 B. A convertible bond must be converted to common stock prior to its maturity.
 C. A call premium requires the investor to pay an amount greater than par at the time of
purchase.
 D. A bond with a call provision typically has a lower yield to maturity than a similar bond
without a call provision.
Instruments )
A major use of warrants in financing is to
 A. lower the cost of debt.

 B. avoid dilution of earnings per share.
 C. maintain managerial control.
 D. permit the buy-back of bonds before maturity.

Instruments )
What variable is measured on the horizontal axis of the yield curve?
 A. Yield of the bonds.

 B. Par value of the bonds.
 C. Duration of the bonds.
 D. Years to maturity of the bonds.
Instruments )
A call provision
 A. lowers the investors' required rate of return.

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 B. protects investors against margin calls.
 C. provides an organization flexibility in financing if interest rates fall.
 D. allows bondholders to require the organization to retire the bond before original
maturity.
Instruments )
The market value of a share of stock is $50, and the market value of one right prior to
the ex-rights date is $2.00 after the offering is announced but while the stock is still
selling rights-on. The offer to the shareholder is that it will take three rights to buy an
additional share of stock at a subscription price of $40 per share. If the theoretical value
of the stock when it goes ex-rights is $47.50, then the shareholder
 A. Receives an additional benefit from a rights offering.

 B. Merely receives a return of capital.
 C. Does not receive any additional benefit from a rights offering.
 D. Should redeem the right and purchase the stock before the ex-rights date.
Instruments )
A call provision in a bond indenture
 A. allows the issuer to call in the bonds before maturity, usually along with payment of an
additional sum called a call premium.
 B. requires the issuer to call in its bonds if interest rates rise above a predetermined level
to allow bondholders the opportunity for higher rates.
 C. allows the bondholder the option to buy shares of the company's common stock at a
specified price within a specified period.
 D. permits bondholders to call for additional bond issuances at predetermined intervals.
Instruments )
Which of the following is directly applied in determining the value of a stock when using
the dividend growth model?
 A. The investors' required rate of return on the firm's stock.

 B. The firm's cash flows.
 C. The firm's liquidity.
 D. The firm's capital structure.
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Instruments )
Which one of the following describes a disadvantage to a firm that issues preferred
stock?
 A. Most preferred stock is owned by corporate investors.

 B. Preferred stock typically has no maturity date.
 C. Preferred stock is usually sold on a higher yield basis than bonds.
 D. Preferred stock dividends are legal obligations of the corporation.

Instruments )
Which one of the following is a debt instrument that generally has a maturity of ten
years or more?
 A. A chattel mortgage.
 B. A note.
 C. A bond.
 D. A lease.

Instruments )
All of the following are characteristics of preferred stock except that
 A. its dividends are tax deductible to the issuer.

 B. it may be converted into common stock.
 C. it usually has no voting rights.
 D. it may be callable at the option of the corporation.

Instruments )
Which one of the following statements concerning debt instruments is correct?
 A. A 25-year bond with a coupon rate of 9% and one year to maturity has more interest
rate risk than a 10-year bond with a 9% coupon issued by the same firm with one year to
maturity.
 B. A bond with one year to maturity would have more interest rate risk than a bond with 15
years to maturity.
 C. The coupon rate and yield of an outstanding long-term bond will change over time as
economic factors change.
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 D. For long-term bonds, price sensitivity to a given change in interest rates is greater the
longer the maturity of the bond.

Instruments )
An analyst is in the process of determining what the current share price should be for
PaperToy Inc. In early January, the analyst collected the following information on
PaperToy Inc.
 Dividend at end of current year = $1.00

 Yearly dividend increase = 5%
 Expected investor return = 10%
Based on the data provided, the current share price for PaperToy Inc. should be
 A. $21.00.
 B. $20.00.
 C. $6.67.
 D. $7.00.
Instruments )
Debentures are
 A. income bonds that require interest payments only when earnings permit.
 B. subordinated debt and rank behind convertible bonds.
 C. bonds secured by the full faith and credit of the issuing firm.
 D. a form of lease financing similar to equipment trust certificates.

Instruments )
Which one of the following rights is ordinarily sacrificed by the holders of preferred stock
in exchange for other preferences received over common shareholders?
 A. The right to share in the periodic earnings of the company through the receipt of
dividends.
 B. The right to share in the residual assets of the company upon liquidation.
 C. The right to vote for members of the board of directors and in other matters requiring a
vote.
 D. The right to accrue dividend payments in arrears when payments are not made for a
period of time.
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L-T Financial Management-Derivatives

105. Question ID: HOCK RRI 103 (Topic: L-T Financial Management-Derivatives )
All of the following statements about the intrinsic value of an option are true except
 A. The intrinsic value of an option is equal to its market value.

 B. The intrinsic value of an option is only one part of its market value.
 C. The intrinsic value of an option is its value, before transaction costs, to an investor who
would buy the option and exercise it immediately.
 D. The intrinsic value of an option is the amount by which it is "in the money."
106. Question ID: ICMA 19.P2.084 (Topic: L-T Financial Management-Derivatives )

An example of a hedging approach to financing is
 A. using five-year bonds to finance inventory acquisition.

 B. increasing earnings by purchasing stock puts.
 C. matching assets with liabilities of the same maturity.
 D. financing building projects with accounts payable.

All of the following are differences between forward contracts and futures
contracts except
 A. Forward contracts have no standard conditions; futures contracts are standardized.

 B. Forward contracts are used by a wide variety of firms; futures contracts are limited to
large firms.
 C. Forward contracts have credit risk; futures contracts have no credit risk because
futures exchanges guarantee all transactions.
 D. Forward contracts are agreements between two parties negotiated by dealers; futures
contracts are traded on exchanges.

Which of the following is not a way to exit an option position?
 A. The option may be allowed to expire on the expiration date.

 B. The option may be returned to the party it was purchased from.
 C. The option may be exercised.
 D. The option may be offset, to reverse the original transaction.

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Buying a wheat futures contract to protect against price fluctuation of wheat would be
classified as a
 A. swap.
 B. foreign currency hedge.
 C. fair value hedge.
 D. cash flow hedge.
The long party to a futures contract is
 A. the party who is committing to sell the underlying asset as a protection against a
possible declining price of the actual asset.
 B. the party who has the choice to exercise or not exercise the contract.
 C. the party who has no choice but who must comply with the will of the other party to the
contract.
 D. the party who is committing to buy the underlying asset as a protection against a
possible increasing price of the actual asset.

On July 14, an investor goes short on a put option for 100 shares of OSC, Inc. common
stock with a strike price of $9.00, expiring on August 16, at an option premium of $1.50
per share. The market price of OSC on July 14 is $8.00. On August 16, the market price
of OSC is $6.00. How much has the investor gained or lost on the option transaction?
Disregard any brokerage commissions involved.
 A. Gain of $450.
 B. Gain of $300.
 C. Loss of $150.
 D. Gain of $150.

On July 14, an investor goes long on a put option for 100 shares of ZXY Corporation
common stock with a strike price of $33.00, expiring on August 16, at an option
premium of $1.25 per share. The market price of ZXY on July 14 is $32.50. On August
16, the market price of ZXY is $30.00. How much has the investor gained or lost on the
option transaction? Disregard any brokerage commissions involved.
 A. Gain of $175.
 B. Gain of $300.
 C. Loss of $175.
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 D. Gain of $75.

On July 14, an investor goes long on a put option for 100 shares of ZXY Corporation
premium of $1.25 per share. The market price of ZXY on July 14 is $32.50. On August
16, the market price of ZXY is $35.00. How much has the investor gained or lost on the
 A. Loss of $125.
 B. Gain of $125.
 C. Loss of $175.
 D. Gain of $250.
114. Question ID: CIA 590 IV.57 (Topic: L-T Financial Management-Derivatives )
A company has recently purchased some stock of a competitor. However, it is
somewhat concerned that the market price of this stock could decrease over the short
run. The company could hedge against the possible decline in the stock's market price
by
 A. Purchasing a put option on that stock.

 B. Obtaining a warrant option on that stock.
 C. Purchasing a call option on that stock.
 D. Selling a put option on that stock.
The difference between an American option and a European option is
 A. an American option is a covered option, whereas a European option is not.

 B. a European option is binding on both parties, whereas the long party in an American
option has the right but not the obligation to exercise the option.
 C. a European option is binding on both parties, whereas the short party in an American
option has the right but not the obligation to exercise the option.
 D. a European option can be exercised only on its maturity date, whereas an American
option can be exercised anytime up to and including its expiration date.

On July 14, an investor goes short on a call option for 100 shares of CDM Corporation
premium of $3.00 per share. The market price of CDM on July 14 is $68.00. On August
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16, the market price of CDM is $75.00. How much has the investor gained or lost on the
 A. $200 gain.
 B. Loss of $500.
 C. Loss of $200.
 D. Gain of $300.
117. Question ID: CMA 696 1.8 (Topic: L-T Financial Management-Derivatives )
The current market price of ActionPharmaceutical's common stock is $34. A 6-month
call option has been written on the stock. The option has an exercise price of $40 and a
market value of $4. A financial analyst estimates that, at the end of 6 months, the
expected value of the stock is $42.
What is the value just prior to expiration of the option if the stock closes at $42 at the
end of 6 months?
 A. $0
 B. $4.00
 C. $6.00
 D. $2.00

A gold mining company expects to sell 10,000 ounces of gold 6 months from today. The
revenue risk of selling the gold can be hedged by
 A. buying a gold futures contract for 5,000 ounces today that expires in 6 months, and
selling a gold futures contract for 5,000 ounces today that expires in 6 months.
 B. selling the gold in the spot market 6 months from today.
 C. selling a gold futures contract for 10,000 ounces today that expires in 6 months.
 D. buying a gold futures contract for 10,000 ounces today that expires in 6 months.
119. Question ID: CMA 696 1.9 (Topic: L-T Financial Management-Derivatives )
The current market price of ActionPharmaceutical's common stock is $34. A 6-month
call option has been written on the stock. The option has an exercise price of $40 and a
market value of $4. A financial analyst estimates that, at the end of 6 months, the
expected value of the stock is $42.
What is the theoretical value of exercising the option on the date it is written?
 A. $6.00
 B. $0
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 C. $4.00
 D. $8.00

An agreement to exchange a fixed interest rate on a loan with a floating interest rate on
a loan is called a(n)
 A. basis swap.
 B. interest rate swap.
 C. interest rate guarantee.
 D. swaption.

On July 14, an investor goes long on a call option for 100 shares of AMB Corporation
premium of $4.50 per share. The market price of AMB on July 14 is $31.00. On August
16, the market price of AMB is $35.00. How much has the investor gained or lost on the
 A. $800 gain.
 B. $350 loss.
 C. $350 gain.
 D. $450 loss.

A technique for managing interest rate risk based on measuring a bond's price
sensitivity to changes in interest rates is
 A. a forward contract.
 B. duration.
 C. interest rate futures.
 D. maturity matching.
123. Question ID: ICMA 1603.P2.031 (Topic: L-T Financial Management-

Derivatives )
A Bangladeshi wholesale export company publishes a price list in Euros for the
products sold by its European Union business unit. The management of the export
company has determined that even if there are fluctuations in exchange rates between
the Bangladeshi Taka and European Euro, it is not practical for it to change its product
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prices every six months. Which one of the following is the most appropriate solution
available to the export company to managing this risk?
 A. Establishing operational sales limits.

 B. Diversifying its product offerings.
 C. Hedging the risk through financial instruments.
 D. Disposing of the business unit.

How is a futures contract closed out?
 A. The contract is returned to the party it was purchased from.

 B. Buyers and sellers usually offset their positions on or before the delivery date.
 C. On the maturity date, the underlying asset is purchased and delivery taken, or sold and
delivery made, by the holder of the contract.
 D. The contract expires on the maturity date, and there is no need to do anything to close
it out.

On July 14, an investor goes short on a put option for 100 shares of OSC, Inc. common
stock with a strike price of $9.00, expiring on August 16, at an option premium of $1.50
per share. The market price of OSC on July 14 is $8.00. On August 16, the market price
of OSC is $11.00. How much has the investor gained or lost on the option transaction?
Disregard any brokerage commissions involved.
 A. Gain of $150.
 B. Gain of $200.
 C. Loss of $150.
 D. Loss of $50.

On July 14, an investor goes short on a call option for 100 shares of CDM Corporation
premium of $3.00 per share. The market price of CDM on July 14 is $68.00. On August
16, the market price of CDM is $65.00. How much has the investor gained or lost on the
 A. Gain of $200.
 B. Loss of $200.
 C. Gain of $300.
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 D. Loss of $300.

How is a forward contract closed out?
 A. The contract expires on the maturity date, and there is no need to do anything to close
it out.
 B. The contract is returned to the party it was purchased from.
 C. Buyers and sellers usually offset their positions on or before the delivery date.
 D. On the maturity date, the underlying asset is purchased and delivery taken or sold and
delivery made by the holder of the contract.

On July 14, an investor goes long on a call option for 100 shares of AMB Corporation
premium of $4.50 per share. The market price of AMB on July 14 is $31.00. On August
16, the market price of AMB is $25.00. How much has the investor gained or lost on the
 A. Loss of $250.
 B. Loss of $450.
 C. Gain of $150.
 D. Gain of $450.
Cost of Capital
129. Question ID: CMA 692 1.2 (Topic: Cost of Capital )
Williams, Inc. is interested in measuring its overall cost of capital and has gathered the
following data. Under the terms described as follows, the company can sell unlimited
amounts of all instruments.
 Williams can raise cash by selling $1,000, 8%, 20-year bonds with annual interest
payments. In selling the issue, an average premium of $30 per bond would be
received, and the firm must pay flotation costs of $30 per bond. The after-tax cost
of funds is estimated to be 4.8%.
 Williams can sell $8 preferred stock at par value, $100 per share. The cost of
issuing and selling the preferred stock is expected to be $5 per share.
 Williams' common stock is currently selling for $100 per share. The firm expects to
pay cash dividends of $7 per share next year, and the dividends are expected to
remain constant. The stock will have to be underpriced by $3 per share, and
flotation costs are expected to amount to $5 per share.
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 Williams expects to have available $100,000 of retained earnings in the coming
year. Once these retained earnings are exhausted, the firm will use new common
stock as the form of common stock equity financing.
 The capital structure that Williams would like to use for any future financing is:
o Long-term debt: 30%
o Preferred stock: 20%
o Common stock: 50%
The cost of funds from retained earnings for Williams, Inc. is
 A. 7.4%.
 B. 8.1%.
 C. 7.0%.
 D. 7.6%.
130. Question ID: ICMA 10.P2.121 (Topic: Cost of Capital )

Which one of the following situations would prompt a firm to issue debt, as opposed to
equity, the next time it raises external capital?
 A. Low fixed-charge coverage.

 B. Significant percentage of assets under lease.
 C. High breakeven point.
 D. High effective tax rate.

Joint Products Inc., a corporation with a 40% marginal tax rate, plans to issue
$1,000,000 of 8% preferred stock in exchange for $1,000,000 of its 8% bonds currently
outstanding. The firm’s total liabilities and equity are equal to $10,000,000. The effect
of this exchange on the firm’s weighted average cost of capital is likely to be
 A. no change, since it involves equal amounts of capital in the exchange and both
instruments have the same rate.
 B. a decrease, since a portion of the debt payments are tax deductible.
 C. an increase, since a portion of the debt payments are tax deductible.
 D. a decrease, since preferred stock payments do not need to be made each year,
whereas debt payments must be made.

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Osgood Products has announced that it plans to finance future investments so that the
firm will achieve an optimum capital structure. Which one of the following corporate
objectives is consistent with this announcement?
 A. Minimize the cost of equity.

 B. Maximize earnings per share.
 C. Maximize the net worth of the firm.
 D. Minimize the cost of debt.

An accountant for Stability Inc. must calculate the weighted average cost of capital of
the corporation using the following information.
Rate
Accounts payable $35,000,000 -0-
Long-term debt 10,000,000 8%
Preferred stock 10,000,000 15%
Retained earnings 5,000,000 18%
What is the weighted average cost of capital of Stability?
 A. 6.88%.
 B. 8.00%.
 C. 10.25%.
 D. 12.80%.

Cox Company has sold 1,000 shares of $100 par, 8% preferred stock at an issue price
of $92 per share. Stock issue costs were $5 per share. Cox pays taxes at the rate of
40%. What is Cox's cost of preferred stock capital?
 A. 8.70%.
 B. 8.25%.
 C. 9.20%.
 D. 8.00%.

A firm has $10 million in equity and $30 million in long-term debt to finance its
operations. The firm’s beta is 1.125, the risk-free rate is 6%, and the expected market
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return is 14%. The firm issued long-term debt at the market rate of 9%. Assume the firm
is at its optimal capital structure. The firm’s effective income tax rate is 40%. What is the
firm’s weighted average cost of capital?
 A. 10.5%.
 B. 7.8%.
 C. 8.6%.
 D. 9.5%.

Angela Company's capital structure consists entirely of long-term debt and common
equity. The cost of capital for each component is shown below.
Long-term debt 8%
Common equity 15%
Angela pays taxes at a rate of 40%. If Angela's weighted average cost of capital is
10.41%, what proportion of the company's capital structure is in the form of long-term
debt?
 A. 45%.
 B. 66%.
 C. 55%.
 D. 34%.

The management of Old Fenske Company (OFC) has been reviewing the company's
financing arrangements. The current financing mix is $750,000 of common stock,
$200,000 of preferred stock ($50 par) and $300,000 of debt. OFC currently pays a
common stock cash dividend of $2. The common stock sells for $38, and dividends
have been growing at about 10% per year. Debt currently provides a yield to maturity to
the investor of 12%, and preferred stock pays a dividend of 9% to yield 11%. Any new
issue of securities will have a flotation cost of approximately 3%. OFC has retained
earnings available for the equity requirement. The company's effective income tax rate
is 40%. Based on this information, the cost of capital for retained earnings is
 A. 9.5%.
 B. 14.2%.
 C. 15.8%.
 D. 16.0%.
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 Williams can sell $8 preferred stock at par value, which is $100 per share. The cost
of issuing and selling the preferred stock is expected to be $5 per share.
o Common stock: 50%
If Williams, Inc. needs a total of $200,000, the firm's weighted marginal cost of capital
would be
 A. 6.9%.
 B. 4.8%.
 C. 20.2%.
 D. 6.6%.

By using the dividend growth model, estimate the cost of equity capital for a firm with a
stock price of $30.00, an estimated dividend at the end of the first year of $3.00 per
share, and an expected growth rate of 10%.
 A. 10.0%
 B. 11.0%
 C. 21.0%
 D. 20.0%
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140. Question ID: HOCK RRI 111 (Topic: Cost of Capital )

A negative beta means
 A. that the security is risk-free.

 B. that the price of the security has tended to move in the opposite direction to that of the
market.
 C. that the security is less volatile than the market as a whole.
 D. that the security's return is negative.

A company is in the process of considering various methods of raising additional capital
to grow the company. The current capital structure is 25% debt totaling $5 million with a
pre-tax cost of 10%, and 75% equity with a current cost of equity of 10%. The marginal
income tax rate is 40%. The company’s policy is to allow a total debt to total capital ratio
of up to 50% and a maximum weighted-average cost of capital (WACC) of 10%. The
company has the following options.
Option 1: Issue debt of $15 million with a pre-tax cost of 10%.
Option 2: Offer shares to the public to generate $15 million. The cost of equity is 10%.
Which option should the company select?
 A. Option 1 because it has the lower WACC of 7.72%.

 B. Either Option 1 or 2 because both will yield a WACC of 10%.
 C. Option 2 because the equity to total capital ratio will be 86%.
 D. Option 1 because the equity to total capital ratio will be 43%.

Kielly Machines Inc. is planning an expansion program estimated to cost $100 million.
Kielly is going to raise funds according to its target capital structure shown below.
Debt 0.30
Preferred stock 0.24
Equity 0.46
Kielly had net income available to common shareholders of $184 million last year of
which 75% was paid out in dividends. The company has a marginal tax rate of 40%.
Additional data:
 The before-tax cost of debt is estimated to be 11%.

 The market yield of preferred stock is estimated to be 12%.
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 The after-tax cost of common stock is estimated to be 16%.
What is Kielly's weighted average cost of capital?
 A. 13.00%.
 B. 14.00%.
 C. 13.54%.
 D. 12.22%.

A preferred stock is sold for $101 per share, has a face value of $100 per share,
underwriting fees of $5 per share, and annual dividends of $10 per share. If the tax rate
is 40%, the cost of funds (capital) for the preferred stock is:
 A. 10.4%
 B. 10.0%
 C. 6.25%
 D. 4.2%

The Hatch Sausage Company is projecting an annual growth rate for the foreseeable
future of 9%. The most recent dividend paid was $3.00 per share. New common stock
can be issued at $36 per share. Using the constant growth model, what is the
approximate cost of capital for retained earnings?
 A. 19.88%.
 B. 18.08%
 C. 17.33%.
 D. 9.08%.

Four zero-coupon bonds each will pay $1,000 at maturity. The bonds mature in either
10 years or 20 years, and have a price today of either $300 or $500. The bond with the
largest yield to maturity is the bond that has the
 A. $300 price and matures in 10 years.

 B. $500 price and matures in 20 years.
 C. $300 price and matures in 20 years.
 D. $500 price and matures in 10 years.

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In general, it is more expensive for a company to finance with equity capital than with
debt capital because
 A. the interest on debt is a legal obligation.

 B. long-term bonds have a maturity date and must therefore be repaid in the future.
 C. investors are exposed to greater risk with equity capital.
 D. equity capital is in greater demand than debt capital.
147. Question ID: CIA 1191 IV.57 (Topic: Cost of Capital )

A firm seeking to optimize its capital budget has calculated its marginal cost of capital
and projected rates of return on several potential projects. The optimal capital budget is
determined by
 A. Calculating the point at which marginal cost of capital meets the projected rate of
return, assuming that the most profitable projects are accepted first.
 B. Accepting all potential projects with projected rates of return lower than the highest
marginal cost of capital.
 C. Calculating the point at which average marginal cost meets average projected rate of
return, assuming the largest projects are accepted first.
 D. Accepting all potential projects with projected rates of return exceeding the lowest
marginal cost of capital.

Colt, Inc. is planning to use retained earnings to finance anticipated capital
expenditures. The beta coefficient for Colt's stock is 1.15, the risk-free rate of interest is
8.5%, and the market return is estimated at 12.4%. If a new issue of common stock
were used in this model, the flotation costs would be 7%. By using the Capital Asset
Pricing Model (CAPM) equation:
R = RF + β(RM - RF)
The cost of using retained earnings to finance the capital expenditures is:
 A. 12.99%.
 B. 14.71%.
 C. 13.96%.
 D. 12.40%.

Enert, Inc.'s current capital structure is shown below. This structure is optimal, and the
company wishes to maintain it.
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Debt 25%
Preferred equity 5%
Common equity 70%
Enert's management is planning to build a $75 million facility that will be financed
according to this desired capital structure. Currently, $15 million of cash is available for
capital expansion. The percentage of the $75 million that will come from a new issue of
common stock is:
 A. 52.50%.
 B. 56.00%.
 C. 70.00%.
 D. 50.00%.

In calculating the component costs of long-term funds, the appropriate cost of retained
earnings, ignoring flotation costs, is equal to
 A. the cost of common stock.

 B. the same as the cost of preferred stock.
 C. the weighted average cost of capital for the firm.
 D. zero, or no cost.

DQZ Telecom is considering a project for the coming year that will cost $50 million.
DQZ plans to use the following combination of debt and equity to finance the
investment.
 Issue $15 million of 20-year bonds at 101, with a coupon rate of 8%, and flotation
costs of 2% of par.
 Use $35 million of funds generated from earnings.
 The equity market is expected to earn 12%. U.S. Treasury bonds are currently
yielding 5%. The beta coefficient for DQZ is estimated to be 0.60. DQZ is subject to
an effective corporate income tax rate of 40%.
The capital asset pricing model (CAPM) computes the expected return on a security by
adding the risk-free rate of return to the incremental yield of the expected market return,
which is adjusted by the company's beta. Compute DQZ's expected rate of return.
 A. 7.20%
 B. 12.20%
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 C. 9.20%
 D. 12.00%

The capital structure of an airline company is comprised of 50% common stock, 30%
preferred stock, and 20% debt. The company’s cost of common stock is 12%, and the
cost of preferred stock is 10%. The company’s pretax cost of debt is 5%. The company
has an effective income tax rate of 30%. What is the company’s weighted average cost
of capital?
 A. 9.7%.
 B. 18.9%.
 C. 8.8%.
 D. 10.0%.

The DCL Corporation is preparing to evaluate the capital expenditure proposals for the
coming year. Because the firm employs discounted cash flow methods of analyses, the
cost of capital for the firm must be estimated. The following information for DCL
Corporation is provided:
 Market price of common stock is $50 per share.

 The dividend next year is expected to be $2.50 per share.
 Expected growth in dividends is a constant 10%.
 New bonds can be issued at face value with a 13% coupon rate.
 The current capital structure of 40% long-term debt and 60% equity is considered
to be optimal.
 Anticipated earnings to be retained in the coming year are $3 million.
 The firm has a 40% marginal tax rate.
If the firm must assume a 10% flotation cost on new stock issuances, what is the cost of
new common stock?
 A. 15.56%.
 B. 15.00%.
 C. 16.11%.
 D. 15.05%.

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Using the Capital Asset Pricing Model (CAPM), the required rate of return for a firm with
a beta of 1.25 when the market return is 14% and the risk-free rate is 6% is:
 A. 16.0%.
 B. 7.5%.
 C. 6.0%.
 D. 17.5%.
155. Question ID: CMA 1288 1.2 H1 (Topic: Cost of Capital )

When calculating a firm's cost of capital, all of the following are true except that
 A. The time value of money should be incorporated into the calculations.

 B. All costs should be expressed as after-tax costs.
 C. The calculation of the cost of capital should focus on the historical costs of alternative
forms of financing rather than market or current costs.
 D. The cost of capital of a firm is the weighted average cost of its various financing
components.
156. Question ID: CFM Sample Q. 9 (Topic: Cost of Capital )

flotation costs
flotation cost
The after-tax weighted marginal cost of capital for Rogers' second financing alternative
consisting solely of bonds would be
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 A. 5.40%
 B. 5.13%
 C. 6.60%
 D. 6.27%

The yield curve shows the relationship between bond yields that differ by the
 A. credit risk of the issuer of the bonds.

 B. par value of the bonds.
 C. dividend yield of the issuer of the bonds.
 D. years to maturity of the bonds.

Below is a Statement of Financial Position for Martin Corporation:
Martin Corporation
(Dollars in millions)
Assets:
Current Assets $ 75
Plant and Equipment 250
Total Assets $325
Liabilities and shareholders' equity:
Liabilities:
Current Liabilities $ 46
Long-term debt (12%) 64
Common equity:
Common stock, $1 par $ 10
Additional paid in capital 100
Retained earnings 105
Total liabilities and shareholders' equity $325
Additional Data:
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 The long term debt was originally issued at par ($1,000 per bond) and is currently
trading at $1,250 per bond.
 Martin Corporation can now issue debt at 150 basis points over U.S. treasury
bonds.
 The current risk-free rate (U.S. Treasury bonds) is 7%.
 The expected market return is currently 15%.
 The beta for Martin is 1.25.
 Martin's effective corporate income tax rate is 40%.
Using the Capital Asset Pricing Model (CAPM), Martin Corporation's current cost of
common equity is:
 A. 8.75%
 B. 15.00%
 C. 10.00%
 D. 17.00%

A firm's optimal capital structure
 A. minimizes the firm's risk.

 B. maximizes the price of the firm's stock.
 C. minimizes the firm's tax liability.
 D. maximizes the firm's degree of financial leverage.

Acme Corporation is selling $25 million of cumulative, non-participating preferred stock.
The issue will have a par value of $65 per share with a dividend rate of 6%. The issue
will be sold to investors for $68 per share, and issuance costs will be $4 per share. The
cost of preferred stock to Acme is:
 A. 6.00%.
 B. 6.09%.
 C. 5.42%.
 D. 5.74%.

When calculating the cost of capital, the cost assigned to retained earnings should be
 A. Lower than the cost of external common equity.

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 B. Zero.
 C. Equal to the cost of external common equity.
 D. Higher than the cost of external common equity.

Newmass, Inc. paid a cash dividend to its common shareholders over the past 12
months of $2.20 per share. The current market value of the common stock is $40 per
share, and investors are anticipating the common dividend to grow at a rate of 6%
annually. The cost to issue new common stock will be 5% of the market value. The cost
of a new common stock issue will be
 A. 11.79%.
 B. 11.50%.
 C. 12.14%.
 D. 11.83%.

Following is an excerpt from Albion Corporation's balance sheet.

Preferred stock (100,000 shares, 12% dividend) 10,000,000
Common stock (5,000,000 shares outstanding) 60,000,000
Albion's bonds are currently trading at $1,083.34, reflecting a yield to maturity of 8%.
The preferred stock is trading at $125 per share. Common stock is selling at $16 per
share, and Albion's treasurer estimates that the firm's cost of equity is 17%. If Albion's
effective income tax rate is 40%, what is the firm's cost of capital?
 A. 13.1%
 B. 12.6%
 C. 13.9%
 D. 14.1%

An investor is evaluating the common stock of a technology company which has a beta
of 1.8. The expected return for the securities market as a whole is 8%. The investor
could receive a risk- free return of 2% on a U.S. Treasury bill. Based on the capital
asset pricing model (CAPM), what is the expected risk adjusted return of the technology
company’s common stock?
 A. 16.4%.
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 B. 20.0%.
 C. 10.8%.
 D. 12.8%.

o Common stock: 50%
The cost of funds from the sale of common stock for Williams, Inc. is
 A. 7.4%.
 B. 7.0%.
 C. 7.6%.
 D. 8.1%

The explicit cost of debt financing is the interest expense. The implicit cost(s) of debt
financing is (are) the
 A. Increase in the cost of debt as the debt-to-equity ratio increases.

 B. Decrease in the cost of equity as the debt-to-equity ratio increases.
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 C. Increase in the cost of equity as the debt-to-equity ratio decreases.
 D. Increases in the cost of debt and equity as the debt-to-equity ratio increases.

 - Bonds that would have a 9% coupon rate and would net $19.2 million after
flotation costs
 - Preferred stock with a stated rate of 6% that would yield $4.8 million after a 4%
flotation cost
 - Common stock that would yield $24 million after a 5% flotation cost
11% coupon rate and would net $48 million after flotation costs.
Assuming the after-tax cost of common stock is 15%, the after-tax weighted marginal
cost of capital for Rogers' first financing alternative consisting of bonds, preferred stock,
and common stock would be
 A. 7.285%
 B. 8.725%
 C. 10.285%
 D. 11.725%

Which one of a firm's sources of new capital usually has the lowest after-tax cost?
 A. Bonds.
 B. Retained earnings.
 C. Common stock.
 D. Preferred stock.
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o Common stock: 50%
If Williams, Inc. needs a total of $1,000,000, the firm's weighted marginal cost of capital
would be
 A. 27.8%.
 B. 6.6%.
 C. 6.9%.
 D. 4.8%.

Thomas Company's capital structure consists of 30% long-term debt, 25% preferred
stock, and 45% common equity. The cost of capital for each component is shown
below.
Long-term debt 8%
Preferred stock 11%
Common equity 15%
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If Thomas pays taxes at the rate of 40%, what is the company's after-tax weighted
average cost of capital?
 A. 9.84%.
 B. 7.14%.
 C. 11.90%.
 D. 10.94%.

Datacomp Industries, which has no current debt, has a beta of 0.95 for its common
stock. Management is considering a change in the capital structure to 30% debt and
70% equity. This change would increase the beta on the stock to 1.05, and the after-tax
cost of debt will be 7.5%. The expected return on equities is 16%, and the risk-free rate
is 6%. Should Datacomp's management proceed with the capital structure change?
 A. No, because the weighted average cost of capital will increase.

 B. Yes, because there will be no effect on the weighted average cost of capital.
 C. Yes, because the weighted average cost of capital will decrease.
 D. No, because the cost of equity capital will increase.

Which of the following, when considered individually, would generally have the effect of
increasing a firm's cost of capital?
I. The firm reduces its operating leverage.

II. The corporate tax rate is increased.
III. The firm pays off its only outstanding debt.
IV. The Treasury Bond yield increases.
 A. I and III.
 B. III and IV.
 C. I, III and IV.
 D. II and IV.

A public company’s shareholders expect to receive a dividend one year from now of $20
per share. Immediately after the dividend payout, analysts are expecting that the stock
will trade at $244 per share. If the investors have a required rate of return of 20%, what
is the current value of the stock?
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 A. $244.
 B. $264.
 C. $220.
 D. $224.

investment.
 Issue $15 million of 20-year bonds at a price of 101, with a coupon rate of 8%, and
flotation costs of 2% of par.
yielding 5%. The beta coefficient for DQZ is estimated to be .60. DQZ is subject to
Assume that the after-tax cost of debt is 7% and the cost of equity is 12%. Determine
the weighted-average cost of capital.
 A. 10.50%
 B. 8.50%
 C. 6.30%
 D. 9.50%

The firm's marginal cost of capital
 A. is inversely related to the firm's required rate of return used in capital budgeting.
 B. should be the same as the firm's rate of return on equity.
 C. is a weighted average of the investors' required returns on debt and equity.
 D. is unaffected by the firm's capital structure.

investment.
 Issue $15 million of 20-year bonds at a price of 101, with a coupon rate of 8%, and
flotation costs of 2% of par.
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yielding 5%. The beta coefficient for DQZ is estimated to be 0.60. DQZ is subject to
The before-tax cost of DQZ's planned debt financing, net of flotation costs, in the first
year is
 A. 11.80%
 B. 8.08%
 C. 10.00%
 D. 7.92%

A firm's target or optimal capital structure is consistent with which one of the following?
 A. Maximum earnings per share.

 B. Minimum risk.
 C. Minimum cost of debt.
 D. Minimum weighted average cost of capital.

Wiley's new financing will be in proportion to the market value of its present financing,
shown below.
Book Value
($000 Omitted)
Long-term debt $7,000
Preferred stock (100 shares) 1,000
Common stock (200 shares) 7,000
The firm's bonds are currently selling at 80% of par, generating a current market yield of
9%, and the corporation has a 40% tax rate. The preferred stock is selling at its par
value and pays a 6% dividend. The common stock has a current market value of $40
and is expected to pay a $1.20 per share dividend this fiscal year. Dividend growth is
expected to be 10% per year. Wiley's weighted average cost of capital is (round your
calculations to tenths of a percent).
 A. 11.0%.
 B. 9.0%.
 C. 9.6%.
 D. 10.8%.
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flotation costs
flotation cost
The after-tax cost of the common stock proposed in Rogers' first financing alternative
would be
 A. 17.16%
 B. 16.00%
 C. 16.53%
 D. 16.60%

Which one of the following factors might cause a firm to increase the debt in its financial
structure?
 A. An increase in the Federal funds rate.

 B. An increase in the price-earnings (PE) ratio.
 C. An increase in the corporate income tax rate.
 D. Increased economic uncertainty.
181. Question ID: CMA 1288 1.2 H2 (Topic: Cost of Capital )

Which of the following is true regarding the calculation of a firm's cost of capital?
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 A. The time value of money should be excluded from the calculations.
 B. The cost of capital is the cost of equity.
 C. All costs should be expressed as pre-tax costs.
 D. The cost of capital of a firm is the weighted-average cost of its various financing
components.

The theory underlying the cost of capital is primarily concerned with the cost of
 A. Short-term funds and new funds.

 B. Short-term funds and old funds.
 C. Long-term funds and old funds.
 D. Long-term funds and new funds.
Raising Capital
183. Question ID: CMA 1291 1.10 (Topic: Raising Capital)
A firm's dividend policy may treat dividends either as the residual part of a financing
decision or as an active policy strategy.
Treating dividends as the residual part of a financing decision assumes that
 A. Dividend payments should be consistent.

 B. Dividends are relevant to a financing decision.
 C. Dividends are important to shareholders, any earnings left over after paying dividends
should be invested in high-return assets.
 D. Earnings should be retained and reinvested as long as profitable projects are available.

A firm's dividend policy may treat dividends either as the residual part of a financing
decision or as an active policy strategy.
Treating dividends as an active policy strategy assumes that
 A. Dividends are irrelevant.

 B. The firm should pay dividends only after investing in all investment opportunities having
an expected return greater than the cost of capital.
 C. Dividends provide information to the market.
 D. Dividends are costly, and the firm should retain earnings and issue stock dividends.
185. Question ID: ICMA 13.P2.033 (Topic: Raising Capital)

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Monroe Company needs an additional machine that will be used for the next five years
at which time the machine will be obsolete and have zero salvage value. Monroe has
two options available: purchase the asset for the list price of $300,000 cash, or lease
the asset, requiring five annual lease payments of $68,000 with the first payment due
immediately. The lease payments include 6% interest. Excluding depreciation
considerations, the best alternative is to
 A. lease the asset for a $13,584 advantage.

 B. purchase the asset for a $3,620 advantage.
 C. lease the asset for a $45,918 advantage.
 D. purchase the asset for a $40,000 advantage.

Essex Corporation is evaluating a lease that takes effect on March 1. The company
must make eight equal payments, with the first payment due on March 1. The concept
most relevant to the evaluation of the lease is
 A. The future value of an annuity due.

 B. The present value of an ordinary annuity.
 C. The future value of an ordinary annuity.
 D. The present value of an annuity due.
187. Question ID: CIA 1191 IV.58 (Topic: Raising Capital)

A firm must select from among several methods of financing arrangements when
meeting its capital requirements. To acquire additional growth capital while attempting
to minimize its cost of capital, a firm should normally
 A. Discontinue dividends and use current cash flow, which avoids the cost and risk of
increased debt and the dilution of current common shareholders' ownership caused by
increased equity.
 B. Attempt to increase both debt and equity in equal proportions, which preserves a stable
capital structure and maintains investor confidence.
 C. Select equity over debt initially, which minimizes risk and avoids interest costs.
 D. Select debt over equity initially, even though increased debt is accompanied by interest
costs and a degree of risk.
188. Question ID: CMA 695 P2 Q17 (Topic: Raising Capital)

Corporations purchase their outstanding stock for all of the following reasons except to
 A. use the shares for a stock dividend.

 B. improve short-term cash flow.
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 C. increase earnings per share by reducing the number of shares outstanding.
 D. meet employee stock compensation contracts.

The residual theory of dividends argues that dividends
 A. are necessary to maintain the market price of the common stock.

 B. can be paid if there is income remaining after funding all attractive investment
opportunities.
 C. can be foregone unless there is an excess demand for cash dividends.
 D. are irrelevant.

When determining the amount of dividends to be declared, the most important factor to
consider is the
 A. future planned uses of retained earnings.

 B. future planned uses of cash.
 C. expectations of the shareholders.
 D. impact of inflation on replacement costs.

Which of the following financing vehicles would a commercial bank be likely to offer to
its customers?
I. Discounted notes
II. Term loans
III. Lines of credit
IV. Self-liquidating loans
 A. I, II, III and IV.

 B. I and II.
 C. III and IV.
 D. I, III and IV.

Brady Corporation has 6,000 shares of 5% cumulative, $100 par value preferred stock
outstanding and 200,000 shares of common stock outstanding. Brady's board of
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directors last declared dividends for the year ended May 31, 20X0, and there were no
dividends in arrears at that time. For the year ended May 31, 20X2, Brady had net
income of $1,750,000. The board of directors is declaring a dividend for common
shareholders equivalent to 20% of net income. The total amount of dividends to be paid
by Brady at May 31, 20X2 is:
 A. $206,000
 B. $350,000
 C. $410,000
 D. $380,000

The date when the right to a dividend expires is called the
 A. Ex-dividend date.
 B. Closing date.
 C. Holder-of-record date.
 D. Payment date.

Junk bonds are
 A. securities rated at less than investment grade.

 B. securities that are highly risky but offer only low yields.
 C. worthless securities.
 D. considered illegal.

An agreement in which the underwriter attempts to sell as much as possible of an initial
public offering, but does not guarantee the sale of the entire offering is a
 A. carve-out deal.
 B. best-efforts deal.
 C. firm commitment deal.
 D. syndicate deal.

The best reason for financial managers to use shelf registration for debt or equity
offerings is because:
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 A. Corporations do not have to register new securities with the Securities and Exchange
Commission.
 B. Issuers are spared the expense of filing several registrations by registering offerings in
advance and then issuing them quickly under favorable market conditions.
 C. This technique provides businesses more flexibility in selection of an investment
banker.
 D. Smaller, regional underwriters are used more frequently to distribute the new issues,
saving firms issuance costs.

An issue of securities for which the investment bank handling the transaction gives no
guarantee that the securities will be sold is a(n)
 A. Competitive bid issue.

 B. Best efforts issue.
 C. Negotiated issue.
 D. Underwritten issue.

Underhall Inc.’s common stock is currently selling for $108 per share. Underhall is
planning a new stock issue in the near future and would like to stimulate interest in the
company. The Board, however, does not want to distribute capital at this
time. Therefore, Underhall is considering whether to offer a 2-for-1 common stock split
or a 100% stock dividend on its common stock. The best reason for opting for the stock
split is that
 A. it will not impair the company's ability to pay dividends in the future.
 B. it will not decrease shareholders' equity.
 C. the par value per share will remain unchanged.
 D. the impact on earnings per share will not be as great.

Topka Inc. needs to borrow $500,000 to meet its working capital requirements for next
year. The Merchant Bank has offered the company a 9.5% simple interest loan that has
a 16% compensating balance requirement. Determine the effective interest rate for the
loan.
 A. 12.75%.
 B. 11.02%.
 C. 19.00%.
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 D. 11.31%

The treasurer of a company plans to raise $500 million to finance its new business
expansion into the Asia Pacific region. The treasurer is analyzing initial public offerings.
All of the following are correct except that
 A. it is necessary for the company to file a registration statement with the SEC if it decides
to launch an initial public offering.
 B. one of the advantages of an initial public offering is that stock price can accurately
reflect the true net worth of the company after it goes public.
 C. an initial public offering will increase the liquidity of the company's stock and establish
the company's value in the market.
 D. under an underwritten offering, the investment bank will guarantee the sale of stock at
an offering price, however, the commission charged to the company will be higher
compared to a best efforts offering.

In capital markets, the primary market is concerned with the provision of new funds for
capital investments through
 A. Exchanges of existing bond and stock securities.

 B. New issues of bond and stock securities and exchanges of existing bond and stock
securities.
 C. New issues of bond and stock securities.
 D. The sale of forward or future commodities contracts.

A sound justification for a firm's repurchase of its own stock, such as treasury stock, is
to
 A. increase the firm's total assets.

 B. lower the debt to equity ratio of the firm.
 C. meet the stock needs of a potential merger.
 D. reduce the idle cash and increase marketable securities.

The characteristics of venture capital include all of the following except
 A. Initial private placement for the majority of issues.

 B. A lack of liquidity for a period of time.
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 C. The use of common stock for most placements.
 D. A minimum holding period of 5 years for new securities.

Kalamazoo Inc. has issued 25,000 shares of its authorized 50,000 shares of common
stock. There are 5,000 shares of common stock that have been repurchased and are
classified as treasury stock. Kalamazoo has 10,000 shares of preferred stock. If a $0.60
per share dividend has been authorized on its common stock, what will be the total
common stock dividend payment?
 A. $21,000
 B. $15,000
 C. $30,000
 D. $12,000

OldTime Inc. is a mature firm operating in a very stable market. Earnings growth has
averaged about 3.2% for the last dozen years, just staying in line with inflation. The
firm’s weighted average cost of capital is 8%, much lower than most firms'. John Storms
has just been hired as OldTime’s new CEO and wants to turn what he calls a “cash
cow” into a “growth company.” Storms wants to reduce the dividend pay-out and use the
resulting retained earnings to fund the firm’s expansion into new product lines.
OldTime’s historical beta has been about 0.6. With the CEO’s changes, what will most
likely happen to OldTime’s beta and the required return on investment in its shares?
 A. The beta will fall and the required return will fall.
 B. The beta will fall and the required return will rise.
 C. The beta will rise and the required return will rise.
 D. The beta will rise and the required return will fall.
206. Question ID: CIA 593 P4 Q46 (Topic: Raising Capital)

The policy decision that by itself is least likely to affect the value of the firm is the
 A. Distribution of stock dividends to shareholders.

 B. Investment in a project with a large net present value.
 C. Sale of a risky division that will now increase the credit rating of the entire company.
 D. Use of a more highly leveraged capital structure that resulted in a lower cost of capital.

A 10% stock dividend most likely
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 A. increases the size of the firm.
 B. increases shareholders' wealth.
 C. decreases net income.
 D. decreases future earnings per share.

A stock dividend
 A. decreases the size of the firm.

 B. increases shareholders' wealth.
 C. increases the debt-to-equity ratio of a firm.
 D. decreases future earnings per share.

Mason Inc. is considering four alternative opportunities. Required investment outlays
and expected rates of return for these investments are given below.
Project Investment Cost Rate of Return

A $200,000 12.5%
B $350,000 14.2%
C $570,000 16.5%
D $390,000 10.6%
The investments will be financed through 40% debt and 60% common equity. Internally
generated funds totaling $1,000,000 are available for reinvestment. If the cost of capital
is 11%, and Mason strictly follows the residual dividend policy, how much in dividends
would the company likely pay?
 A. $120,000
 B. $650,000
 C. $328,000
 D. $430,000

Shelf registration of a security is a procedure allowing a firm to
 A. Register a security for a specified period of time and then sell the securities on a
piecemeal basis.
 B. Freeze the market price of its new issues of securities for a specified period of time.
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 C. Register an issue price on its securities for a specified period of time.
 D. Control both the issue price and the secondary market price of its securities by
registering these prices for a specified period of time.

Bell Delivery Co. is financing a new truck with a loan of $30,000, to be repaid in five
annual installments of $7,900 at the end of each year. What is the approximate annual
interest rate Bell is paying?
 A. 10%
 B. 16%
 C. 4%
 D. 5%

A company can finance an equipment purchase through a loan. Alternatively, it often
can obtain the same equipment through a lease arrangement. A factor that
would not be considered when comparing the lease financing with the loan financing is:
 A. Whether the lessor has a higher cost of capital than the lessee.
 B. Whether the lessor and lessee have different tax reduction opportunities.
 C. The capacity of the equipment.
 D. Whether the property category has a history of rapid obsolescence.

The term "underwriting spread" refers to the
 A. Difference between the price the investment banker pays for a new security issue and
the price at which the securities are resold.
 B. Commission percentage an investment banker receives for underwriting a security
issue.
 C. Discount investment bankers receive on securities they purchase from the issuing
company.
 D. Commission a broker receives for either buying or selling a security on behalf of an
investor.

When a company desires to increase the market value per share of common stock, the
company will
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 A. Implement a reverse stock split.
 B. Sell treasury stock.
 C. Sell preferred stock.
 D. Split the stock.
Cash and Marketable Securities Management

215. Question ID: CMA 694 1.19 (Topic: Cash and Marketable Securities
Management)
A company has daily cash receipts of $150,000. The treasurer of the company has
investigated a lockbox service whereby the bank that offers this service will reduce the
company's collection time by four days at a monthly fee of $2,500. If money market
rates average 4% during the year, the additional annual income (loss) from using the
lockbox service would be
 A. $(12,000)
 B. $(6,000)
 C. $12,000
 D. $6,000
216. Question ID: ICMA 19.P2.081 (Topic: Cash and Marketable Securities
Management)
A company holding cash for a speculative motive is holding cash to
 A. pay bills.
 B. take advantage of future investment opportunities.
 C. provide a safety margin.
 D. protect against uncollectible receivables.
Management)
The best example of a marketable security with minimal risk would be
 A. The commercial paper of an Aaa-rated company.

 B. Gold.
 C. Municipal bonds.
 D. The common stock of an Aaa-rated company.
Management)
The following information applies to Brandon Company:
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Purchases Sales
January $160,000 $100,000
February 160,000 200,000
March 160,000 240,000
April 140,000 300,000
May 140,000 260,000
June 120,000 240,000
A cash payment equal to 40% of purchases is made at the time of purchase, and 30%
is paid in each of the next 2 months. Purchases for the previous November and
December were $150,000 per month. Payroll is 10% of sales in the month it occurs, and
operating expenses are 20% of the following month's sales (July sales were $220,000).
Interest payments were $20,000 paid quarterly in January and April. Brandon's cash
disbursements for the month of April were
 A. $200,000.
 B. $152,000.
 C. $254,000.
 D. $140,000.
Management)
All of the following are alternative marketable securities suitable for short-term
investment except
 A. Commercial paper.
 B. Convertible bonds.
 C. U.S. Treasury bills.
 D. Eurodollar time deposits.
Management)
Foster Inc. is considering implementing a lock-box collection system at a cost of
$80,000 per year. Annual sales are $90 million, and the lockbox system will reduce
collection time by 3 days. If Foster can invest funds at 8%, should it use the lockbox
system? Assume a 360-day year.
 A. Yes, producing savings of $140,000 per year.

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 B. No, producing a loss of $60,000 per year.
 C. Yes, producing savings of $60,000 per year.
 D. No, producing a loss of $20,000 per year.
Management)
Newman Products has received proposals from several banks to establish a lockbox
system to speed up receipts. Newman receives an average of 700 checks per day
averaging $1,800 each, and its cost of short-term funds is 7% per year. Assuming that
all proposals will produce equivalent processing results and using a 360-day year,
which one of the following proposals is optimal for Newman?
 A. A $0.50 fee per check.

 B. A fee of 0.03% of the amount collected.
 C. A flat fee of $125,000 per year.
 D. A compensating balance of $1,750,000.
Management)
Commercial paper
 A. Is usually sold only through investment banking dealers.

 B. Ordinarily does not have an active secondary market.
 C. Has a maturity date greater than 1 year.
 D. Has an interest rate lower than Treasury bills.
Management)
All of the following are reasons for holding cash except for the
 A. motive to meet future needs.

 B. precautionary motive.
 C. transaction motive.
 D. motive to make a profit.
Management)
Kemple is a newly established janitorial firm, and the owner is deciding what type of
checking account to open. Kemple is planning to keep a $500 minimum balance in the
account for emergencies and plans to write roughly 80 checks per month. The bank
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charges $10 per month plus a $0.10 per check charge for a standard business checking
account with no minimum balance. Kemple also has the option of a premium business
checking account that requires a $2,500 minimum balance but has no monthly fees or
per check charges. If Kemple's cost of funds is 10%, which account should Kemple
choose?
 A. Premium account, because the savings is $34 per year.

 B. Standard account, because the savings is $34 per year.
 C. Standard account, because the savings is $16 per year.
 D. Premium account, because the savings is $16 per year.
Management)
All of the following are valid reasons for a business to hold cash and marketable
securities except to
 A. Maintain adequate cash needed for transactions.

 B. Meet future needs.
 C. Earn maximum returns on investment assets.
 D. Satisfy compensating balance requirements.
Management)
The Rolling Stone Corporation, an entertainment ticketing service, is considering the
following means of speeding cash flow for the corporation.
 Lock Box System. This would cost $25 per month for each of its 170 banks and
would result in interest savings of $5,240 per month.
 Drafts. Drafts would be used to pay for ticket refunds based on 4,000 refunds per
month at a cost of $2.00 per draft, which would result in interest savings of $6,500
per month.
 Bank Float. Bank float would be used for the $1,000,000 in checks written each
month. The bank would charge a 2% fee for this service, but the corporation will
earn $22,000 in interest on the float.
 Electronic Transfer. Items over $25,000 would be electronically transferred; it is

estimated that 700 items of this type would be made each month at a cost of $18
each, which would result in increased interest earnings of $14,000 per month.
Which of these methods of speeding cash flow should Rolling Stone Corporation adopt?
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 A. Lock box, bank float, and electronic transfer only.
 B. Lock box, drafts, and electronic transfer only.
 C. Lock box and electronic transfer only.
 D. Bank float and electronic transfer only.
Management)
A firm uses the following model to determine the optimal average cash balance (Q).
An increase in which one of the following would result in a decrease in the optimal
cash balance?
 A. Uncertainty of cash outflows.

 B. Cost of a security trade.
 C. Cash requirements for the year.
 D. Return on marketable securities.
Management)
Assume that each day a company writes and receives checks totaling $10,000. If it
takes 2 days for the checks to clear and be deducted from the company's account and
only 1 day for the deposits to clear, what is the net float?
 A. $(10,000)
 B. $20,000
 C. $10,000
 D. $0
Management)
Obligations issued by federal agencies other than the U.S. Treasury Department are
 A. Guaranteed by the U.S. government but not by the agency issuing the security.
 B. Guaranteed by the agency issuing the security but not by the U.S. government.
 C. Guaranteed neither by the agency issuing the security nor by the U.S. government.
 D. Not easily marketed.
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Management)
Garner Products is considering a new accounts payable and cash disbursement
process which is projected to add 3 days to the disbursement schedule without having
significant negative effects on supplier relations. Daily cash outflows average
$1,500,000. Garner is in a short-term borrowing position for 8 months of the year and in
an investment position for 4 months. On an annual basis, bank lending rates are
expected to average 7% and marketable securities yields are expected to average 4%.
What is the maximum annual expense that Garner could incur for this new process and
still break even?
 A. $180,000.
 B. $270,000.
 C. $90,000.
 D. $315,000.
Management)
When managing cash and short-term investments, a corporate treasurer is primarily
concerned with
 A. Minimizing taxes.
 B. Maximizing rate of return.
 C. Investing in Treasury bonds since they have no default risk.
 D. Liquidity and safety.
232. Question ID: CMA Sample Q1.6 (Topic: Cash and Marketable Securities
Management)
Cleveland Masks and Costumes Inc. (CMC) has a majority of its customers located in
the states of California and Nevada. Keystone National Bank, a major west coast bank,
has agreed to provide a lockbox system to CMC at a fixed fee of $50,000 per year and
a variable fee of $0.50 for each payment processed by the bank. On average, CMC
receives 50 payments per day, each averaging $20,000. With the lockbox system, the
company's collection float will decrease by 2 days. The annual interest rate on money
market securities is 6%.
If CMC makes use of the lockbox system, what would be the net benefit to the
company? Use 365 days per year.
 A. $120,000
 B. $59,125
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 C. $50,000
 D. $60,875
Management)
When a company is evaluating whether the ratio of cash and marketable securities to
total assets should be high or low, its decision will be based upon
 A. Risk-profitability trade-off considerations.

 B. Flotation cost considerations.
 C. Financial leverage considerations.
 D. Operating leverage considerations.
Management)
JKL Industries requires its branch offices to transfer cash balances once per week to
the central corporate account. A wire transfer costs $12 and assures the cash is
available the same day. A depository transfer check (DTC) costs $1.50 and generally
results in funds being available in 2 days. JKL’s cost of short-term funds averages 9%,
and they use a 360-day year in all calculations. What is the minimum transfer amount
that would justify the cost of a wire transfer as opposed to a DTC?
 A. $42,000.
 B. $21,000.
 C. $27,000.
 D. $24,000.
Management)
Which one of the following is not a characteristic of a negotiable certificate of deposit?
Negotiable certificates of deposit
 A. Are regulated by the Federal Reserve System.

 B. Have yields considerably greater than bankers' acceptances and commercial paper.
 C. Have a secondary market for investors.
 D. Are usually sold in denominations of a minimum of $100,000.
Management)
Assuming a 360-day year, the current price of a $100,000 U.S. Treasury bill due in 180
days on a 6% discount basis is
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 A. $93,000
 B. $97,000
 C. $100,000
 D. $94,000
Management)
Troy Toys is a retailer operating in several cities. The individual store managers deposit
daily collections at a local bank in a non-interest bearing checking account. Twice per
week, the local bank issues a depository transfer check (DTC) to the central bank at
headquarters. The controller of the company is considering using a wire transfer
instead. The additional cost of each transfer would be $25; collections would be
accelerated by 2 days; and the annual interest rate paid by the central bank is 7.2%
(0.02% per day). At what amount of dollars transferred would it be economically feasible
to use a wire transfer instead of the DTC? Assume a 360-day year.
 A. $125,000 or above.
 B. Any amount greater than $62,500.
 C. It would never be economically feasible.
 D. Any amount greater than $173.
238. Question ID: CIA 593 IV.52 (Topic: Cash and Marketable Securities
Management)
Determining the amount and timing of conversions of marketable securities to cash is a
critical element of a financial manager's performance. In terms of the rate of return
forgone on converted securities and the cost of such transactions, the optimal amount
of cash to be raised by selling securities is
 A. Inversely related to the rate of return forgone and directly related to the cost of the
transaction.
 B. Directly related to the rate of return forgone and inversely related to the cost of the
transaction.
 C. Inversely related to the rate of return forgone and inversely related to the cost of the
transaction.
 D. Directly related to the rate of return forgone and directly related to the cost of the
transaction.
Management)
Average daily cash outflows are $3 million for Evans Inc. A new cash management
system can add 2 days to the disbursement schedule. Assuming Evans earns 10% on
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excess funds, how much should the firm be willing to pay per year for this cash
management system?
 A. $1,500,000
 B. $600,000
 C. $3,000,000
 D. $6,000,000
Management)
The marketable securities with the least amount of default risk are:
 A. Repurchase agreements.
 B. Federal government agency securities.
 C. Commercial paper.
 D. U.S. treasury securities.
Management)
Which one of the following instruments would be least appropriate for a corporate
treasurer to utilize for temporary investment of cash?
 A. Municipal bonds.
 B. Commercial paper.
 C. Money market mutual funds.
 D. U.S. Treasury bills.
Management)
The Texas Corporation is considering the following opportunities to purchase an
investment at the following amounts and discounts.
Term Amount Discount

90 days $80,000 5%
180 days 75,000 6%
270 days 100,000 5%
360 days 60,000 10%
Which opportunity offers the Texas Corporation the highest annual yield?
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 A. 90-day investment.
 B. 360-day investment.
 C. 180-day investment.
 D. 270-day investment.
Management)
Money market funds generally invest in all of the following except
 A. bankers’ acceptances.
 B. treasury bonds.
 C. certificates of deposit.
 D. commercial paper.
Management)
A lock-box system
 A. Reduces the risk of having checks lost in the mail.

 B. Reduces the need for compensating balances.
 C. Provides security for late night deposits.
 D. Accelerates the inflow of funds.
Accounts Receivable Management

245. Question ID: CMA 1295 1.8 (Topic: Accounts Receivable Management)
Shown below is a forecast of sales for Cooper Inc. for the first 4 months of the year (all
amounts are in thousands of dollars).
January February March April

Cash sales $15 $24 $18 $14
Sales on credit $100 $120 $90 $70
On average, 50% of credit sales are paid for in the month of sale, 30% in the month
following the sale, and the remainder is paid 2 months after the month of sale.
Assuming there are no bad debts, the expected cash inflow for Cooper in March is:
 A. $122,000
 B. $108,000
 C. $138,000
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 D. $119,000
246. Question ID: ICMA 10.P2.152 (Topic: Accounts Receivable Management)

Northville Products is changing its credit terms from net 30 to 2/10, net 30.
The least likely effect of this change would be a(n)
 A. increase in short-term borrowings.

 B. lower number of days' sales outstanding.
 C. increase in sales.
 D. shortening of the cash conversion cycle.
Lawson Company has the opportunity to increase annual sales $100,000 by selling to a
new, riskier group of customers. Based on sales, the uncollectible expense is expected
to be 15%, and collection costs will be 5%. The company's manufacturing and selling
expenses are 70% of sales, and its effective tax rate is 40%. If Lawson accepts this
opportunity, the company's after-tax profit will increase by
 A. $9,000.
 B. $10,000.
 C. $6,000.
 D. $4,000.

Computer Services is an established firm that sells computer hardware, software and
services. The firm is considering a change in its credit policy. It has been determined
that such a change would not change the payment patterns of the current customers.
To determine whether such a change would be beneficial, the firm has identified the
proposed new credit terms, the expected additional sales, the expected contribution
margin on the sales, the expected bad debt losses, and the investment in additional
receivables and the period of the investment. What additional information, if any, does
the firm require to determine the profitability of the proposed new policy as compared to
the current credit policy?
 A. The opportunity cost of funds.

 B. The credit standards that presently exist.
 C. The new credit standards.
 D. No additional information is needed.
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A change in credit policy has caused an increase in sales, an increase in discounts
taken, a decrease in the amount of bad debts, and a decrease in the investment in
accounts receivable. Based upon this information, the company's
 A. Average collection period has decreased.

 B. Percentage discount offered has decreased.
 C. Working capital has increased.
 D. Accounts receivable turnover has decreased.

Harson Products currently has a conservative credit policy and is in the process of
reviewing three other credit policies. The current credit policy (Policy A) results in sales
of $12 million per year. Policies B and C involve higher sales, accounts receivable and
inventory balances, as well as higher bad debt and collection costs. Policy D grants
longer payment terms than Policy C but charges customers interest if they take
advantage of the lengthy payment terms. The policies are outlined below.
P o l i c y (000)
A B C D
Sales $12,000 $13,000 $14,000 $14,000
Average accounts receivable 1,500 2,000 3,500 5,000
Average inventory 2,000 2,300 2,500 2,500
Interest income 0 0 0 500
Bad debt expense 100 125 300 400
Collection cost 100 125 250 350
If the direct cost of products is 80% of sales and the cost of short-term funds is 10%,
what is the optimal policy for Harson?
 A. Policy A.
 B. Policy B.
 C. Policy D.
 D. Policy C.

A company offers all customers trade credit terms of 2/15, net 60. Currently, 30% of
sales receipts are paid with the discount applied. If the company were to change its
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credit terms, a change to which one of the following terms is most likely to cause the
company’s average collection period to decrease?
 A. 1/15, net 90.

 B. 1/15, net 60.
 C. 2/15, net 30.
 D. 1/15, net 30.

A credit manager considering whether to grant trade credit to a new customer
is most likely to place primary emphasis on
 A. valuation ratios.
 B. growth ratios.
 C. profitability ratios.
 D. liquidity ratios.

Foster Products is reviewing its trade credit policy with respect to the small retailers to
which it sells. Four plans have been studied and the results are as follows.
Annual Bad Collection Accounts

Plan Revenue Debt Costs Receivable Inventory
A $200,000 $ 1,000 $1,000 $20,000 $40,000
B 250,000 3,000 2,000 40,000 50,000
C 300,000 6,000 5,000 60,000 60,000
D 350,000 12,000 8,000 80,000 70,000
The information shows how various annual expenses such as bad debts and the cost of
collections change as sales change. The average balance of accounts receivable and
inventory have also been projected. The cost of the product to Foster is 80% of the
selling price, after-tax cost of capital is 15%, and Foster's effective income tax rate is
30%. What is the optimal plan for Foster to implement?
 A. Plan A.
 B. Plan B.
 C. Plan D.
 D. Plan C.
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The sales manager at Ryan Company feels confident that, if the credit policy at Ryan's
were changed, sales would increase and, consequently, the company would utilize
excess capacity. The two credit proposals being considered are as follows:
Proposal A Proposal B
Increase in sales $500,000 $600,000
Contribution margin 20% 20%
Bad debt percentage 5% 5%
Increase in operating profits $75,000 $90,000
Desired return on sales 15% 15%
Currently, payment terms are net 30. The proposed payment terms for Proposal A and
Proposal B are net 45 and net 90, respectively. An analysis to compare these two
proposals for the change in credit policy would include all of the following factors except
the
 A. Current bad debt experience.

 B. Cost of funds for Ryan.
 C. Impact on the current customer base of extending terms to only certain customers.
 D. Bank loan covenants on days' sales outstanding.

Snug-fit, a maker of bowling gloves, is investigating the possibility of liberalizing its
credit policy. Currently, payment is made on a cash-on-delivery basis. Under a new
program, sales would increase by $80,000. The company has a gross profit margin of
40%. The estimated bad debt loss rate on the incremental sales would be 6%. Ignoring
the cost of money, what would be the return on sales before taxes for the new sales?
 A. 36.2%.
 B. 40.0%.
 C. 42.5%.
 D. 34.0%.
Dartmoor Company's budgeted sales for the coming year are $40,500,000, of which
80% are expected to be credit sales at terms of n/30. Dartmoor estimates that a
proposed relaxation of credit standards will increase credit sales by 20% and increase
the average collection period from 30 days to 40 days. Based on a 360-day year, the
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proposed relaxation of credit standards will result in an expected increase in the
average accounts receivable balance of
 A. $1,620,000.
 B. $2,700,000.
 C. $540,000.
 D. $900,000.

Powell Industries deals with customers throughout the country and is attempting to
more efficiently collect its accounts receivable. A major bank has offered to develop and
operate a lock-box system for Powell at a cost of $90,000 per year. Powell averages
300 receipts per day at an average of $2,500 each. Its short-term interest cost is 8%
per year. Using a 360-day year, what reduction in average collection time would be
needed in order to justify the lock-box system?
 A. 1.20 days.
 B. 1.50 days.
 C. 1.25 days.
 D. 0.67 days.
Price Publishing is considering a change in its credit terms from n/30 to 2/10, n/30. The
company's budgeted sales for the coming year are $24,000,000, of which 90% are
expected to be made on credit. If the new credit terms are adopted, Price estimates that
discounts will be taken on 50% of the credit sales; however, uncollectible accounts will
be unchanged. The new credit terms will result in expected discounts taken in the
coming year of
 A. $240,000.
 B. $216,000.
 C. $432,000.
 D. $480,000.

Clauson Inc. grants credit terms of 1/15, net 30 and projects gross sales for the year of
$2,000,000. The credit manager estimates that 40% of customers pay on the 15th day,
40% of the 30th day and 20% on the 45th day. Assuming uniform sales and a 360-day
year, what is the projected amount of overdue receivables?
 A. $400,000
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 B. $50,000
 C. $83,333
 D. $116,676
Best Computers believes that its collection costs could be reduced through modification
of collection procedures. This action is expected to result in a lengthening of the
average collection period from 28 days to 34 days; however, there will be no change in
uncollectible accounts. The company's budgeted credit sales for the coming year are
$27,000,000, and short-term interest rates are expected to average 8%. To make the
changes in collection procedures cost beneficial, the minimum savings in collection
costs (using a 360-day year) for the coming year would have to be
 A. $360,000.
 B. $180,000.
 C. $30,000.
 D. $36,000.
Jackson Distributors sells to retail stores on credit terms of 2/10, net 30. Daily sales
average 150 units at a price of $300 each. Assuming that all sales are on credit and
60% of customers take the discount and pay on day 10 while the rest of the customers
pay on day 30, the amount of Jackson's accounts receivable is
 A. $810,000
 B. $900,000
 C. $1,350,000
 D. $990,000
A firm averages $4,000 in sales per day and is paid, on an average, within 30 days of
the sale. After they receive their invoice, 55% of the customers pay by check, while the
remaining 45% pay by credit card. Approximately how much would the company show
in accounts receivable on its balance sheet on any given date?
 A. $4,000
 B. $54,000
 C. $120,000
 D. $48,000
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An organization would usually offer credit terms of 2/10, net 30 when
 A. The organization can borrow funds at a rate less than the annual interest cost.
 B. The cost of capital approaches the prime rate.
 C. The organization can borrow funds at a rate exceeding the annual interest cost.
 D. Most competitors are offering the same terms, and the organization has a shortage of
cash.

The Philadelphia Corporation has been advised by their accountant, Phyllis Brown, that
the following four sales volumes could be achieved along with the following receivable
payment patterns and bad debts, depending on the company's credit policy (in
thousands).
Sales 30 60 90 120 Bad

Volume Days Days Days Days Debts
I. $520 $300 $100 $100 $0 $ 20
II. 630 200 200 100 100 30
III. 770 200 100 200 200 70
IV. 900 100 200 200 300 100
Assuming that the firm's cost of capital is 20% and that all payments are made on the
first possible day of the aging month, which sales volume will maximize profit?
 A. III.
 B. II.
 C. I.
 D. IV.
A company plans to tighten its credit policy. The new policy will decrease the average
number of days in collection from 75 to 50 days and will reduce the ratio of credit sales
to total revenue from 70% to 60%. The company estimates that projected sales will be
5% less if the proposed new credit policy is implemented. If projected sales for the
coming year are $50 million, calculate the dollar impact on accounts receivable of this
proposed change in credit policy. Assume a 360-day year.
 A. $3,333,300 decrease.
 B. $3,819,445 decrease.
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 C. $6,500,000 decrease.
 D. $18,749,778 increase.

Consider the following factors affecting a company as it is reviewing its trade credit
policy.
I. Operating at full capacity.

II. Low cost of borrowing.
III. Opportunity for repeat sales.
IV. Low gross margin per unit.
Which of the above factors would indicate that the company should liberalize its credit
policy?
 A. II and III only.

 B. III and IV only.
 C. I and II only.
 D. I, II and III only.
The average collection period for a firm measures the number of days
 A. beyond the end of the credit period before a typical customer payment is received.
 B. for a typical check to "clear" through the banking system.
 C. after a typical credit sale is made until the firm receives the payment.
 D. before a typical account becomes delinquent.
An aging of accounts receivable measures the
 A. Amount of receivables that have been outstanding for given lengths of time.
 B. Average length of time that receivables have been outstanding.
 C. Ability of the firm to meet short-term obligations.
 D. Percentage of sales that have been collected after a given time period.
Which one of the following statements is most correct if a seller extends credit to a
purchaser for a period of time longer than the purchaser's operating cycle? The seller
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 A. will have a lower level of accounts receivable than those companies whose credit
period is shorter than the purchaser's operating cycle.
 B. can be certain that the purchaser will be able to convert the inventory into cash before
payment is due.
 C. is, in effect, financing more than just the purchaser's inventory needs.
 D. has no need for a stated cash discount rate or credit period.
Which of the following represents a firm's average gross receivables balance?
I. Days' sales in receivables × accounts receivable turnover.
II. Average daily credit sales × average collection period.
III. Net sales ÷ average gross receivables.
 A. II only.
 B. I and II only.
 C. I only.
 D. II and III only.
Clauson Inc. grants credit terms of 1/15, net 30 and projects gross sales for next year of
$2,000,000. The credit manager estimates that 40% of their customers pay on the
discount date, 40% on the net due date, and 20% pay 15 days after the net due date.
Assuming uniform sales and a 360-day year, what is the projected days' sales
outstanding (rounded to the nearest whole day)?
 A. 30 days.
 B. 27 days.
 C. 24 days.
 D. 20 days.
Inventory Management
272. Question ID: ICMA 10.P2.170 (Topic: Inventory Management)
Moss Products uses the Economic Order Quantity (EOQ) model as part of its inventory
management process. A decrease in which one of the following variables would
increase the EOQ?
 A. Annual sales.
 B. Cost per order.
 C. Safety stock level.
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 D. Carrying costs.

During inflationary periods, last-in, first-out inventory accounting will generally have a
 A. lower cost of goods sold and lower inventory value.

 B. higher cost of goods sold and lower inventory value.
 C. higher cost of goods sold and higher inventory value.
 D. lower cost of goods sold and higher inventory value.

Which one of the following statements concerning the economic order quantity (EOQ)
is correct?
 A. Increasing the EOQ is the best way to avoid stockouts.

 B. The EOQ results in the minimum ordering cost and minimum carrying cost.
 C. The EOQ model assumes constantly increasing usage over the year.
 D. The EOQ model assumes that order delivery times are consistent.
275. Question ID: CMA 1294 1.21 (Topic: Inventory Management)

An example of a carrying cost is
 A. Handling costs.
 B. Quantity discounts lost.
 C. Spoilage.
 D. Disruption of production schedules.
276. Question ID: CMA Sample Q1.8 (Topic: Inventory Management)

A major supplier has offered Alpha Corporation a year-end special purchase whereby
Alpha could purchase 180,000 cases of sport drink at $10 per case. Alpha normally
orders 30,000 cases per month at $12 per case. Alpha's cost of capital is 9%. In
calculating the overall opportunity cost of this offer, the cost of carrying the increased
inventory would be
 A. $81,000
 B. $32,400
 C. $40,500
 D. $64,800

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The optimal level of inventory is affected by all of the following except the
 A. Cost per unit of inventory.

 B. Current level of inventory.
 C. Usage rate of inventory per time period.
 D. Cost of placing an order for merchandise.

Which one of the following items is not directly reflected in the basic economic order
quantity (EOQ) model?
 A. Public warehouse rental charges.

 B. Interest on invested capital.
 C. Quantity discounts lost on inventory purchases.
 D. Inventory obsolescence.

The result of the economic order quantity formula indicates the
 A. Annual usage of materials during the year.

 B. Annual quantity of inventory to be carried.
 C. Safety stock plus estimated inventory for the year.
 D. Quantity of each individual order during the year.

Which one of the following is not explicitly considered in the standard calculation of
Economic Order Quantity (EOQ)?
 A. Quantity discounts.
 B. Level of sales.
 C. Carrying costs.
 D. Ordering costs.

The level of safety stock in inventory management depends on all of the following
except the:
 A. Level of uncertainty of the sales forecast.

 B. Cost to reorder stock.
 C. Cost of running out of inventory.
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 D. Level of customer dissatisfaction for back orders.

Carnes Industries uses the Economic Order Quantity (EOQ) model as part of its
inventory control program. An increase in which one of the following variables would
increase the EOQ?
 A. Ordering costs.
 B. Carrying cost rate.
 C. Purchase price per unit.
 D. Safety stock level.
283. Question ID: ICMA 10.P2.164-ADAPTED (Topic: Inventory Management)

A review of the inventories of Cedar Grove Company shows the following cost data for
entertainment centers.
Invoice price $380.00 per unit

Freight and insurance on shipment 20.00 per unit
Insurance on inventory 15.00 per unit
Unloading 140.00 per order
Cost of placing orders 10.00 per order
Cost of capital 9% per annum
On average, an entertainment center remains in inventory for one month before it is
sold. What are the total carrying costs of inventory for an entertainment center?
 A. $18.00.
 B. $17.85.
 C. $49.20.
 D. $400.00.
284. Question ID: CIA 593 IV.53 (Topic: Inventory Management)

A company serves as a distributor of products by ordering finished products once a
quarter and using that inventory to accommodate the demand over the quarter. If it
plans to ease its credit policy for customers, the amount of products ordered for its
inventory every quarter will be
 A. Increased to accommodate higher sales levels.

 B. Unaffected if the JIT inventory control system is used.
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 C. Unaffected if safety stock is part of the current quarterly order.
 D. Reduced to offset the increased cost of carrying accounts receivable.

Which one of the following would not be considered a carrying cost associated with
inventory?
 A. Cost of capital invested in the inventory.

 B. Insurance costs.
 C. Shipping costs.
 D. Cost of obsolescence.

Paint Corporation expects to use 48,000 gallons of paint per year costing $12 per
gallon. Inventory carrying cost is equal to 20% of the purchase price. The company
uses its inventory at a constant rate. The lead time for placing the order is 3 days, and
Paint Corporation holds 2,400 gallons of paint as safety stock. If the company orders
2,000 gallons of paint per order, what is the cost of carrying inventory?
 A. $5,280
 B. $5,760
 C. $2,400
 D. $8,160

The amount of inventory that a company would tend to hold in safety stock would
increase as the
 A. Sales level falls to a permanently lower level.

 B. Cost of running out of stock decreases.
 C. Cost of carrying inventory decreases.
 D. Variability of sales decreases.

Edwards Manufacturing Corporation uses the standard economic order quantity (EOQ)
model. If the EOQ for Product A is 200 units and Edwards maintains a 50 unit safety
stock for the item, what is the average inventory of Product A?
 A. 150 units.
 B. 125 units.
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 C. 250 units.
 D. 100 units.

When the Economic Order Quantity (EOQ) model is used for a firm that manufactures
its inventory, ordering costs consist primarily of
 A. Obsolescence and deterioration.

 B. Insurance and taxes.
 C. Storage and handling.
 D. Production set-up.

Moore Company's budgeted sales and budgeted cost of sales for the coming year are
$54,000,000 and $36,000,000, respectively. Moore has made changes in its inventory
system that will increase turnover from its current level of nine times per year to 12
times per year. If short-term interest rates average 8%, Moore's cost savings in the
coming year will be
 A. $120,000.
 B. $40,000.
 C. $80,000.
 D. $20,000.

James Smith is the new manager of inventory at American Electronics, a major
retailer. He is developing an inventory control system, and knows he should consider
establishing a safety stock level. The safety stock can protect against all of the
following risks, except for the possibility that
 A. shipments of merchandise from the manufacturers is delayed by as much as one week.

 B. new competition may open in the company's market area.
 C. the distribution of daily sales will have a large variance, due to holidays, weather,
advertising, and weekly shopping habits.
 D. customers cannot find the merchandise they want, and they will go to the competition.

All of the following are inventory carrying costs except
 A. Insurance.
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 B. Opportunity cost of inventory investment.
 C. Inspections of received inventory.
 D. Storage.

The amount of inventory that a company would tend to hold in stock would increase as
the
 A. Cost of carrying inventory decreases.

 B. Variability of sales decreases.
 C. Cost of running out of stock decreases.
 D. Sales level falls to a permanently lower level.

If a company implements a just-in-time inventory management program, it would expect
that its inventory turnover ratio will
 A. increase, and its days' sales in inventory will decrease.

 B. decrease, and its days' sales in inventory will increase.
 C. increase, and its days' sales in inventory will increase.
 D. decrease, and its days' sales in inventory will decrease.

All of the following are carrying costs of inventory except
 A. shipping costs.
 B. insurance.
 C. opportunity costs.
 D. storage costs.

Handy operates a chain of hardware stores across Ohio. The controller wants to
determine the optimum safety stock levels for an air purifier unit. The inventory manager
compiled the following data: The annual carrying cost of inventory approximates 20% of
the investment in inventory. The inventory investment per unit averages $50. The
stockout cost is estimated to be $5 per unit. The company orders inventory on the
average of 10 times per year. Total cost = carrying cost + expected stockout cost. The
probabilities of a stockout per order cycle with varying levels of safety stock are as
follows:
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Safety stock Stockout Probability
200 0 0%
100 100 15%
0 100 15%
0 200 12%
The total cost of safety stock on an annual basis with a safety stock level of 100 units is:
 A. $1,950
 B. $1,750
 C. $2,000
 D. $550

Valley Inc. uses 400 lbs. of a rare isotope per year. The isotope costs $500 per lb., but
the supplier is offering a quantity discount of 2% for order sizes between 30 and 79 lbs.,
and a 6% discount for order sizes of 80 lbs. or more. The ordering costs are $200.
Carrying costs are $100 per year per lb. of material and are not affected by the
discounts. If the purchasing manager places eight orders of 50 lbs. each, the total cost
of ordering and carrying inventory, including discounts lost, will be
 A. $12,100.
 B. $1,600.
 C. $6,600.
 D. $4,100.
Trade Credit
298. Question ID: CMA 1295 1.15 (Topic: Trade Credit)
Which one of the following provides a spontaneous source of financing for a firm?
 A. Debentures.
 B. Accounts payable.
 C. Accounts receivable.
 D. Mortgage bonds.

If a retailer's terms of trade are 3/10, net 45 with a particular supplier, what is the cost
on an annual basis of not taking the discount? Assume a 360-day year.
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 A. 37.11%
 B. 36.00%
 C. 24.00%
 D. 31.81%
300. Question ID: ICMA 10.P2.178 (Topic: Trade Credit)

A firm is given payment terms of 3/10, net 90 and forgoes the discount, paying on the
net due date. Using a 360-day year and ignoring the effects of compounding, what is
the effective annual interest rate cost?
 A. 13.9%.
 B. 12.4%.
 C. 13.5%.
 D. 12.0%.

Which one of the following statements concerning cash discounts is correct?
 A. The cost of not taking the discount is higher for terms of 2/10, net 60 than for 2/10, net
30.
 B. With trade terms of 2/15, net 60, if the discount is not taken, the buyer receives 45 days
of free credit.
 C. The cost of not taking a 2/10, net 30 cash discount is usually less than the prime rate.
 D. The cost of not taking a cash discount is generally higher than the cost of a bank loan.

Which one of the following statements about trade credit is correct? Trade credit is
 A. not an important source of financing for small firms.

 B. usually an inexpensive source of external financing.
 C. subject to risk of buyer default.
 D. a source of long-term financing to the seller.

If a firm's credit terms require payment within 45 days but allow a discount of 2% if paid
within 15 days (using a 360-day year), the approximate cost or benefit of the trade credit
terms is
 A. 24.49%.
 B. 48%.
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 C. 2%.
 D. 16%.

When a company offers credit terms of 2/10, net 30, the annual interest cost, based on
a 360-day year, is
 A. 35.3%.
 B. 24.0%.
 C. 36.0%.
 D. 36.7%.

Richardson Supply has a $100 invoice payable with payment terms of 2/10, net 60.
Richardson can either take the discount or place the funds in a money market account
paying 6% interest. Using a 360-day year, Richardson's cost of not taking the cash
discount is
 A. 6.2%.
 B. 6.4%.
 C. 8.7%.
 D. 12.2%.
306. Question ID: CMA 697 1.8-Adapted (Topic: Trade Credit)

Garo Company, a retail store, is considering foregoing cash discounts offered by its
suppliers for paying within the discount period in order to delay using its cash. Supplier
credit terms are 2/10, net 30. Assuming a 360-day year, what is the annual cost of credit
if the cash discount is not taken and Garo pays net 30?
 A. 36.0%
 B. 36.7%
 C. 24.0%
 D. 24.5%

Global Manufacturing Company has a cost of borrowing of 12%. One of the firm's
suppliers has just offered new terms for purchases. The old terms were cash on delivery
and the new terms are 2/10, net 45. Should Global pay within the first ten days?
 A. No, the cost of not taking the discount exceeds the cost of borrowing.
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 B. No, the use of debt should be avoided if possible.
 C. The answer depends on whether the firm borrows money.
 D. Yes, the cost of not taking the discount exceeds the cost of borrowing.

Dudley Products is given terms of 2/10, net 45 by its suppliers. If Dudley forgoes the
cash discount and instead pays the suppliers 5 days after the net due date, what is the
annual interest rate cost (using a 360-day year)?
 A. 18.4%.
 B. 24.5%.
 C. 21.0%.
 D. 18.0%.

Which one of the following financial instruments generally provides the largest source of
short-term credit for small firms?
 A. Bankers' acceptances.
 B. Installment loans.
 C. Commercial paper.
 D. Trade credit.

Using a 360-day year, what is the opportunity cost to a buyer of not accepting terms of
3/10, net 45?
 A. 55.67%
 B. 31.81%
 C. 22.27%
 D. 101.73%
Short-term Bank Loans and Other S-T Financing

311. Question ID: ICMA 10.P2.182 (Topic: Short-term Bank Loans and Other S-T
Financing)
Approximately what amount of compensating balance would be required for a stated
interest rate of 10% to equal an effective interest rate of 10.31% on a $100,000,000
one-year loan?
 A. Not enough information is given.

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 B. $3,000,000.
 C. $310,000.
 D. $3,100,000.
312. Question ID: CIA 594 IV.51 (Topic: Short-term Bank Loans and Other S-T
Financing)
A manufacturing firm wants to obtain a short term loan and has approached several
lending institutions. All of the potential lenders are offering the same nominal interest
rate but the terms of the loans vary. Which of the following combinations of loan terms
will be most attractive for the borrowing firm?
 A. Discount interest, no compensating balance.

 B. Simple interest, 20% compensating balance required.
 C. Simple interest, no compensating balance.
 D. Discount interest, 20% compensating balance required.
313. Question ID: CMA 1294 1.23 (Topic: Short-term Bank Loans and Other S-T
Financing)
If a firm borrows $500,000 at 10% and is required to maintain $50,000 as a minimum
compensating balance at the bank, what is the effective interest rate on the loan?
 A. 11.1%
 B. 9.1%
 C. 12.2%
 D. 10.0%
Financing)
The Frame Supply Company has just acquired a large account and needs to increase
its working capital by $100,000. The controller of the company has identified a number
of sources. One of them is:
Issue $110,000 of 6-month commercial paper to net $100,000. (New paper would be
issued every 6 months.)
Assume a 360-day year in all of your calculations.
The cost of this alternative is
 A. 18.2%
 B. 20.0%
 C. 9.1%
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 D. 10.0%
Financing)
A manufacturer with seasonal sales would be most likely to obtain which one of the
following types of loans from a commercial bank to finance the need for a fixed amount
of additional working capital during the busy season?
 A. Installment loan.
 B. Unsecured short-term term loan.
 C. Insurance company term loan.
 D. Transaction loan.
Financing)
Todd Manufacturing Company needs a $100 million loan for one year. Todd’s banker
has presented two alternatives as follows:
Option #1 - $100 million loan with a stated interest rate of 10.25%. No compensating
balance required.
Option #2 - $100 million loan with a stated interest rate of 10.00%. Non-interest bearing
compensating balance required.
Which of the following compensating balances, withheld from the loan proceeds, would
result in Option #2 having an effective interest rate equal to the 10.25% rate of Option
#1?
 A. $10,250,000.
 B. $2,440,000.
 C. $250,000.
 D. $2,500,000.
Financing)
Dexter Products receives $25,000 worth of merchandise from its major supplier on the
15th and 30th of each month. The goods are sold on terms of 1/15, net 45, and Dexter
has been paying on the net due date and foregoing the discount. A local bank offered
Dexter a loan at an interest rate of 10%. What will be the net annual savings to Dexter if
it borrows from the bank and utilizes the funds to take advantage of the trade discount?
 A. $1,575.
 B. $2,250.
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 C. $525.
 D. $1,050.
Financing)
Mandel Inc. has a zero-balance account with a commercial bank. The bank sweeps any
excess cash into a commercial investment account earning interest at the rate of 4%
per year, payable monthly. When Mandel has a cash deficit, a line of credit is used
which has an interest rate of 8% per year, payable monthly based on the amount used.
Mandel expects to have a $2 million cash balance on January 1 of next year. Net cash
flows for the first half of next year, excluding the effects of interest received or paid, are
forecasted (in millions of dollars) as follows.
Jan Feb Mar Apr May Jun

Net cash inflows (millions of dollars) +2 +1 −5 −3 −2 +6
Assuming all cash flows occur at the end of each month, approximately how much
interest will Mandel incur for the first half of next year?
 A. $195,000 net interest paid.

 B. $76,000 net interest paid.
 C. $53,000 net interest paid.
 D. $16,000 net interest paid.
Financing)
A company obtained a short-term bank loan of $250,000 at an annual interest rate of
6%. As a condition of the loan, the company is required to maintain a compensating
balance of $50,000 in its checking account. The company's checking account earns
interest at an annual rate of 2%. Ordinarily, the company maintains a balance of
$25,000 in its checking account for transaction purposes. What is the effective interest
rate of the loan?
 A. 5.80%
 B. 7.00%
 C. 6.66%
 D. 6.44%
Financing)
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What is the effective annual interest rate for a one-year $100 million loan with a stated
interest rate of 8.00%, if the lending bank requires a non-interest bearing compensating
balance in the amount of $5 million?
 A. 8.00%.
 B. 7.62%.
 C. 8.42%.
 D. 13.00%.
Financing)
A company has received a one-year commercial bank loan of 7.5% discounted interest
with a 12.5% compensating balance. The effective annual cost of the bank loan is
closest to
 A. 9.38%.
 B. 8.11%.
 C. 9.27%.
 D. 8.57%.
Financing)
Burke Industries has a revolving credit arrangement with its bank which specifies that
Burke can borrow up to $5 million at an annual interest rate of 9% payable monthly. In
addition, Burke must pay a commitment fee of 0.25% per month on the unused portion
of the line, payable monthly. Burke expects to have a $2 million cash balance and no
borrowings against this line of credit on April 1, net cash inflows of $2 million in April, net
outflows of $7 million in May, and net inflows of $4 million in June. If all cash flows occur
at the end of the month, approximately how much will Burke pay to the bank during the
second quarter related to this revolving credit arrangement?
 A. $60,200.
 B. $52,600.
 C. $47,700.
 D. $62,500.
Financing)
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 Borrow $110,000 from a bank at 12% interest. A 9% compensating balance would
be required.
 Assume a 360-day year in all of your calculations.
The cost of this alternative is:
 A. 12.0%
 B. 9.0%
 C. 21.0%
 D. 13.2%
Financing)
A commercial bank offered a $100,000 one-year loan with an annual interest rate of 6%
and a 10% compensating balance. What is the effective annual interest rate of this
loan?
 A. 6.00%.
 B. 6.67%.
 C. 5.45%.
 D. 7.00%.
Financing)
The principal advantage of using commercial paper as a short-term financing instrument
is that it
 A. Is readily available to almost all companies.

 B. Is usually cheaper than a commercial bank loan.
 C. Can be purchased without commission costs.
 D. Offers security, i.e., collateral, to the lender.
Financing)
The Duoplan Company is determining the most appropriate source of short-term
funding. Trade credit terms from suppliers are 2/30, net 90. The rate for borrowing at the
bank is 12%. The company has also been approached by an investment banker offering
to issue Duoplan's commercial paper. The commercial paper would be issued quarterly
in increments of $9.1 million with net proceeds of $8.8 million. Which option should the
firm select?
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 A. The trade discount, because it provides the lowest cost of funds.
 B. The costs are so similar that the decision is a matter of convenience.
 C. Bank borrowing, because it provides the lowest cost of funds.
 D. Commercial paper, because it provides the lowest cost of funds.
Financing)
 Borrow $125,000 from a bank on a discount basis for one year at 20%. No
compensating balance would be required.
 Assume a 360-day year in all of your calculations.
The cost of this alternative is:
 A. 20.0%
 B. 40.0%
 C. 25.0%
 D. 50.0%
328. Question ID: CMA Sample Q1.7 (Topic: Short-term Bank Loans and Other S-T
Financing)
On January 1, Scott Corporation received a $300,000 line of credit at an interest rate of
12% from Main Street Bank and drew down the entire amount on February 1. The line
of credit agreement requires that an amount equal to 15% of the loan be deposited into
a compensating balance account. What is the effective annual cost of credit for this loan
arrangement?
 A. 12.94%
 B. 14.12%
 C. 12.00%
 D. 11.00%
Financing)
Elan Corporation is considering borrowing $100,000 from a bank for 1 year at a stated
interest rate of 9%. What is the effective interest rate to Elan if this borrowing is in the
form of a discounted note?
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 A. 9.00%
 B. 8.19%
 C. 9.89%
 D. 9.81%
Financing)
A company obtained a short-term bank loan of $500,000 at an annual interest rate of
8%. As a condition of the loan, the company is required to maintain a compensating
balance of $100,000 in its checking account. The checking account earns interest at an
annual rate of 3%. Ordinarily, the company maintains a balance of $50,000 in its
account for transaction purposes. What is the effective interest rate of the loan?
 A. 7.77%
 B. 8.22%
 C. 9.25%
 D. 8.56%
Financing)
Megatech Inc. is a large publicly-held firm. The treasurer is making an analysis of the
short-term financing options available for the third quarter, as the company will need an
average of $8 million for the month of July, $12 million for August, and $10 million for
September. The following options are available.
I. Issue commercial paper on July 1 in an amount sufficient to net Megatech $12 million at
an effective rate of 7% per year. Any temporarily excess funds will be deposited in
Megatech's investment account at First City Bank and earn interest at an annual rate of
4%.
II. Utilize a line of credit from First City Bank with interest accruing monthly on the amount
utilized at the prime rate, which is estimated to be 8% in July and August and 8.5% in
September.
Based on this information, which one of the following actions should the treasurer take?
 A. Use the line of credit, since it is approximately $15,000 less expensive than issuing
commercial paper.
 B. Issue commercial paper, since it is approximately $14,200 less expensive than the line
of credit.
 C. Issue commercial paper, since it is approximately $35,000 less expensive than the line
of credit.
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 D. Use the line of credit, since it is approximately $5,800 less expensive than issuing
commercial paper.
Financing)
The effective annual interest rate to the borrower of a $100,000 one-year loan with a
stated rate of 7% and a 20% compensating balance is
 A. 7.0%.
 B. 13.0%.
 C. 8.4%.
 D. 8.75%.
Financing)
Corbin, Inc. can issue 3-month commercial paper with a face value of $1,000,000 for
$980,000. Transaction costs will be $1,200. The effective annualized percentage cost of
the financing, based on a 360-day year, will be
 A. 8.66%.
 B. 8.17%.
 C. 2.00%.
 D. 8.00%.
Financing)
Lang National Bank offered a one-year loan to a commercial customer. The instrument
is a discounted note with a nominal rate of 12%. What is the effective interest rate to the
borrower?
 A. 13.64%
 B. 10.71%
 C. 12.00%
 D. 13.20%
Financing)
Gates Inc. has been offered a one-year loan by its commercial bank. The instrument is
a discounted note with a stated interest rate of 9%. If Gates needs $300,000 for use in
the business, what should the face value of the note be?
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 A. $275,229.
 B. $327,000.
 C. $329,670.
 D. $327,154.
Financing)
The treasury analyst for Garth Manufacturing has estimated the cash flows for the first
half of next year (ignoring any short-term borrowings) as follows.
Cash (millions)
Inflows Outflows
January $2 $1
February 2 4
March 2 5
April 2 3
May 4 2
June 5 3
Garth has a line of credit of up to $4 million on which it pays interest monthly at a rate of
1% of the amount utilized. Garth is expected to have a cash balance of $2 million on
January 1 and no amount utilized on its line of credit. Assuming all cash flows occur at
the end of the month, approximately how much will Garth pay in interest during the first
half of the year?
 A. $132,000
 B. $61,000
 C. Zero.
 D. $80,000
Financing)
The Altmane Corporation was recently quoted terms on a commercial bank loan of 7%
discounted interest with a 20% compensating balance. The term of the loan is 1 year.
The effective cost of borrowing is (rounded to the nearest hundredth)
 A. 9.59%.
 B. 8.75%.
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 C. 7.53%.
 D. 9.41%.
Financing)
Keller Products needs $150,000 of additional funds over the next year in order to satisfy
a significant increase in demand. A commercial bank has offered Keller a one-year loan
at a nominal rate of 8%, which requires a 15% compensating balance. How much
would Keller have to borrow, assuming it would need to cover the compensating
balance with the loan proceeds?
 A. $176,471.
 B. $130,435.
 C. $194,805.
 D. $172,500.
Financing)
The Dixon Corporation has an outstanding 1-year bank loan of $300,000 at a stated
interest rate of 8%. In addition, Dixon is required to maintain a 20% compensating
balance in its checking account. Assuming the company would normally maintain a zero
balance in its checking account, the effective interest rate on the loan is
 A. 6.4%
 B. 10.0%
 C. 8.0%
 D. 20.0%
Financing)
A company had total sales of $500,000 in the first quarter of the year, which was the
same amount as it recorded in the first quarter of the prior year. However, its accounts
receivable balance increased from $230,000 last year to $300,000 this year. Which one
of the following is the most likely explanation for the increase in the accounts receivable
balance?
 A. The company discontinued the use of factoring in the current year.

 B. The company initiated the use of factoring in the current year.
 C. The company shortened its payment terms in the current year from 60 days to 30 days.
 D. The company hired more people in its credit and collections department.
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Financing)
Hagar Company's bank requires a compensating balance of 20% on a $100,000 loan. If
the stated interest on the loan is 7%, what is the effective cost of the loan?
 A. 5.83%
 B. 8.40%
 C. 7.00%
 D. 8.75%
Financing)
A company enters into an agreement with a firm that will factor the company's accounts
receivable. The factor agrees to buy the company's receivables, which average
$100,000 per month and have an average collection period of 30 days. The factor will
advance up to 80% of the face value of receivables at an annual rate of 10% and
charge a fee of 2% on all receivables purchased. The controller of the company
estimates that the company would save $18,000 in collection expenses over the year.
Fees and interest are not deducted in advance. Assuming a 360-day year, what is the
annual cost of financing?
 A. 17.5%
 B. 12.0%
 C. 14.0%
 D. 10.0%
Financing)
Which one of the following responses is not an advantage to a corporation that uses the
commercial paper market for short-term financing?
 A. The borrower avoids the expense of maintaining a compensating balance with a

commercial bank.
 B. This market provides more funds at lower rates than other methods provide.
 C. There are no restrictions as to the type of corporation that can enter into this market.
 D. This market provides a broad distribution for borrowing.
Financing)
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A firm that often factors its accounts receivable has an agreement with its finance
company that requires the firm to maintain a 6% reserve and charges 1% commission
on the amount of receivables. The net proceeds would be further reduced by an annual
interest charge of 10% on the monies advanced. Assuming a 360-day year, what
amount of cash (rounded to the nearest dollar) will the firm receive from the finance
company at the time a $100,000 account that is due in 90 days is turned over to the
finance company assuming the firm withdraws the full amount of cash available
immediately?
 A. $93,000
 B. $90,000
 C. $83,700
 D. $90,675
Financing)
Frame Industries has arranged a revolving line of credit for the upcoming year with a
commercial bank. The arrangement is for $20 million, with interest payable monthly on
the amount utilized at the bank's prime rate and an annual commitment fee of one-half
of 1 percent, computed and payable monthly on the unused portion of the line. Frame
estimates that the prime rate for the upcoming year will be 8%, and expects the
following average amounts to be borrowed by quarter.
Amount
Quarter Borrowed
First $10,000,000
Second 20,000,000
Third 20,000,000
Fourth 5,000,000
How much will Frame owe to the bank next year in interest and fees?
 A. $1,118,750.
 B. $1,168,750.
 C. $1,200,000.
 D. $1,131,250.
Working Capital Policy

346. Question ID: ICMA 10.P2.161 (Topic: Working Capital Policy )
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Atlantic Distributors is expanding and wants to increase its level of inventory to support
an aggressive sales target. They would like to finance this expansion using debt.
Atlantic currently has loan covenants that require the current ratio to be at least 1.2. The
average cost of the current liabilities is 12% and the cost of the long-term debt is 8%.
Below is the current balance sheet for Atlantic.
Current assets $200,000 Current Liabilities $165,000

Fixed assets 100,000 Long-term debt 100,000
Equity 35,000
Total assets $300,000 Total debt & equity $300,000
Which one of the following alternatives will provide the resources to expand the
inventory while lowering the total cost of debt and satisfying the loan covenant?
 A. Collect $25,000 accounts receivable; use $10,000 to purchase inventory and use the
balance to reduce short-term debt.
 B. Borrow short-term funds of $25,000, and purchase inventory of $25,000.
 C. Increase both accounts payable and inventory by $25,000.
 D. Sell fixed assets with a book value of $20,000 for $25,000 and use the proceeds to
increase inventory.
347. Question ID: CMA 692 1.25 (Topic: Working Capital Policy )
Net working capital is the difference between
 A. Total assets and total liabilities.

 B. Shareholders' investment and cash.
 C. Current assets and current liabilities.
 D. Fixed assets and fixed liabilities.
Which one of the following transactions does not change the current ratio and does not
change the total current assets?
 A. Short-term notes payable are retired with cash.

 B. A fully depreciated asset is sold for cash.
 C. A cash advance is made to a divisional office.
 D. A cash dividend is declared.
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Shaw Corporation is considering a plant expansion that will increase its sales and net
income. The following data represent management's estimate of the impact the
proposal will have on the company:
Current Proposal
Cash $100,000 $120,000
Accounts payable 350,000 430,000
Accounts receivable 400,000 500,000
Inventory 380,000 460,000
Marketable securities 200,000 200,000
Mortgage payable (current) 175,000 325,000
Fixed assets 2,500,000 3,500,000
Net income 500,000 650,000
The effect of the plant expansion on Shaw's working capital will be a(n)
 A. Decrease of $30,000.
 B. Increase of $120,000.
 C. Decrease of $150,000.
 D. Increase of $30,000.
Which one of the following would increase the working capital of a firm?
 A. Cash payment of payroll taxes payable.

 B. Cash collection of accounts receivable.
 C. Purchase of a new plant financed by a 20-year mortgage.
 D. Refinancing a short-term note payable with a two-year note payable.
Which group of measures would be useful in evaluating the effectiveness of working
capital management?
 A. Acid-test ratio, inventory turnover ratio, and average collection period.

 B. Inventory turnover ratio, times interest earned, and debt-to-equity ratio.
 C. Profit margin, acid-test ratio, and return on assets.
 D. Acid-test ratio, current ratio, and return on equity.
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As a company becomes more conservative about its working capital management
policy, it would most likely tend to have a(n)
 A. increase in the ratio of current assets to noncurrent assets.

 B. decrease in the quick ratio.
 C. increase in the ratio of current liabilities to noncurrent liabilities.
 D. decrease in the operating cycle.
If a firm increases its cash balance by issuing additional shares of common stock,
working capital
 A. Increases and the current ratio decreases.

 B. Increases and the current ratio remains unchanged.
 C. Remains unchanged and the current ratio remains unchanged.
 D. Increases and the current ratio increases.

Of the following, the working capital financing policy that would subject a firm to
the greatest level of risk is the one where the firm finances
 A. fluctuating current assets with long-term debt.

 B. permanent current assets with short-term debt.
 C. fluctuating current assets with short-term debt.
 D. permanent current assets with long-term debt.

Which one of the following combined transactions would cause net working capital to
decrease?
 A. A $1 million decrease in cash, and a $1 million increase in fixed assets.

 B. A $1 million decrease in cash, and a $1 million decrease in accounts payable.
 C. A $1 million decrease in cash, and a $1 million increase in inventory.
 D. A $1 million increase in cash, and a $1 million increase in long-term debt.
Which one of the following transactions would increase the current ratio and decrease
net profit?
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 A. Uncollectible accounts receivable are written off against the allowance account.
 B. A stock dividend is declared.
 C. Vacant land is sold for cash for less than the net book value.
 D. A federal income tax payment due from the previous year is paid.
A firm's current ratio is 1.75 to 1. According to a working capital restriction in the firm's
bond indenture, the firm will technically default if the current ratio falls below 1.5 to 1. If
current liabilities are $250 million, the maximum new commercial paper that can be
issued to finance inventory expansion an equivalent amount without a technical default
is
 A. $125.00 million.
 B. $375.00 million.
 C. $62.50 million.
 D. $437.50 million.
MFC Corporation has 100,000 shares of stock outstanding. Below is part of MFC's
Statement of Financial Position for the last fiscal year.
MFC Corporation
Statement of Financial Position - Selected Items
December 31
Cash $455,000
Accounts receivable 900,000
Inventory 650,000
Prepaid assets 45,000
Accrued liabilities 285,000
Accounts payable 550,000
Current portion, long-term notes payable 65,000
What is the maximum amount MFC can pay in cash dividends per share and maintain a
minimum current ratio of 2 to 1? Assume that all accounts other than cash remain
unchanged.
 A. $2.50
 B. $2.05
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 C. $3.80
 D. $3.35
Determining the appropriate level of working capital for a firm requires
 A. Maintaining short-term debt at the lowest possible level because it is generally more
expensive than long-term debt.
 B. Offsetting the benefit of current assets and current liabilities against the probability of
technical insolvency.
 C. Changing the capital structure and dividend policy of the firm.
 D. Maintaining a high proportion of liquid assets to total assets in order to maximize the
return on total investments.
In general, as a company increases its amount of short-term financing relative to long-
term financing, the
 A. leverage of the firm increases.

 B. likelihood of having idle liquid assets increases.
 C. current ratio increases.
 D. greater will be the risk that it will be unable to meet principal and interest payments.
All of the following statements in regard to working capital are correct except
 A. Current liabilities are an important source of financing for many small firms.
 B. The hedging approach to financing involves matching maturities of debt with specific
financing needs.
 C. Profitability varies inversely with liquidity.
 D. Financing permanent inventory buildup with long-term debt is an example of an
aggressive working capital policy.
Starrs Company has current assets of $300,000 and current liabilities of $200,000.
Starrs could increase its working capital by the
 A. Purchase of $50,000 of temporary investments for cash.

 B. Prepayment of $50,000 of next year's rent.
 C. Refinancing of $50,000 of short-term debt with long-term debt.
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 D. Collection of $50,000 of accounts receivable.
During the year, Mason Company's current assets increased by $120, current liabilities
decreased by $50, and net working capital
 A. Did not change.

 B. Decreased by $170.
 C. Increased by $70.
 D. Increased by $170.
Finan Corporation's management is considering a plant expansion that will increase its
sales and have commensurate impact on its net working capital position. The following
information presents management's estimate of the impact the proposal will have on
Finan.
Current Proposal
Cash $100,000 $110,000
Accounts payable 400,000 470,000
Accounts receivable 560,000 690,000
Inventory 350,000 380,000
Marketable securities 200,000 200,000
Fixed assets 2,500,000 3,500,000
Net income 500,000 650,000
The impact of the plant expansion on Finan's working capital would be
 A. A decrease of $100,000.
 B. An increase of $100,000.
 C. A decrease of $950,000.
 D. An increase of $950,000.
When a firm finances each asset with a financial instrument of the same approximate
maturity as the life of the asset, it is applying
 A. Return maximization.
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 B. A hedging approach.
 C. Working capital management.
 D. Financial leverage.
As a company becomes more conservative in its working capital policy, it would tend to
have a(n)
 A. Increase in the ratio of current assets to units of output.

 B. Increase in the ratio of current liabilities to noncurrent liabilities.
 C. Decrease in its acid-test ratio.
 D. Increase in funds invested in common stock and a decrease in funds invested in
marketable securities.
367. Question ID: CIA 1192 IV.52 (Topic: Working Capital Policy )
The following are the January 1 and June 30 balance sheets of a company, in millions:
January 1 June 30
Cash $ 3 $ 4
Accounts receivable 5 4
Inventories 8 10
Fixed assets 10 11
Total assets $26 $29
Accounts payable 2 3
Notes payable 4 3
Accrued wages 1 2
Long-term debt 9 11
Stockholders' equity 10 10
Total liabilities and stockholders' equity $26 $29
From January 1 to June 30, the net working capital:
 A. Decreased by $1 million.
 B. Increased by $2 million.
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 C. Stayed the same.
 D. Increased by $1 million.
A firm's current ratio is 2 to 1. Its bond indenture states that its current ratio cannot fall
below 1.5 to 1. If current liabilities are $200,000, the maximum amount of new short-
term debt the firm can assume in order to finance inventory without defaulting is:
 A. $66,667
 B. $150,000
 C. $266,667
 D. $200,000
As a company becomes more conservative with respect to working capital policy, it
would tend to have a(n)
 A. Decrease in the operating cycle.

 B. Increase in the ratio of current liabilities to noncurrent liabilities.
 C. Increase in the ratio of current assets to noncurrent assets.
 D. Decrease in the quick ratio.
Corporate Restructuring
370. Question ID: ICMA 1603.P2.027 (Topic: Corporate Restructuring)
Clear Displays Inc. manufactures display screens for mobile devices and is looking to
expand their business through acquisition. Clear Displays has a weighted average cost
of capital of 10%. They are evaluating the opportunity to acquire one of their
competitors, Bright Screens Inc. Cash flows for Bright Screens are forecasted to be
$110,000 in each of the next four years, and net income for Bright Screens is forecasted
to be $90,000 in each of the next four years. The projected terminal value for Bright
Screens at the end of that four-year period is $1,250,000. Utilizing the discounted cash
flow method, the valuation for Bright Screens is expected to be
 A. $1,202,450.
 B. $1,535,300.
 C. $1,139,050.
 D. $1,598,700.
371. Question ID: CMA 1296 1.26 (Topic: Corporate Restructuring)

An example of a "poison pill," a form of takeover defense, is
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 A. The act of substantially increasing a company's debt.
 B. The selling off of profitable units in an attempt to dissuade the hostile corporate raider.
 C. An agreement to buy back from the hostile raider a large block of stock at a premium.
 D. The issuance of rights that allow shareholders to purchase stock in the proposed
merged company at a substantial discount.
372. Question ID: CIA 593 IV.59 (Topic: Corporate Restructuring)

If a company is experiencing cash flow problems, it will most likely attempt a
reorganization involving
 A. Replacing some of the common stock outstanding with debt.

 B. Replacing some of the debt outstanding with preferred stock.
 C. Replacing some of the common stock outstanding with preferred stock.
 D. Replacing some of the debt outstanding with common stock.

A corporation would receive cash if it enters into a(n)
 A. equity carve-out divestiture.

 B. spin-off divestiture.
 C. reverse stock split program.
 D. stock repurchase program.

BigCo, a large conglomerate, has a division that has developed a new and highly
promising technology. BigCo would like to retain control of this division, but also raise
additional capital to support the further development of this technology. BigCo also
realizes this promising technology is different than its usual business lines and will
require a new management style and incentive program to attract and maintain talent.
Which one of the following would best allow BigCo to achieve these objectives?
 A. A spin-off of the division.

 B. Sale of the division to another firm.
 C. A management buy-out of the division.
 D. An equity carve-out of the division.

A publicly-traded company is planning to divest its Division A for $100 million. Private
investors have pooled their capital of $10 million and plan to finance the balance of $90
million via debt financing with Division A's assets as collateral. The new owners plan to
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give the new management a bigger stake in the company by providing stock options.
They also redesigned performance measures and incentive schemes for employees to
minimize inefficiencies and bureaucracy. This scenario most closely describes a
 A. leveraged buyout.
 B. leveraged recapitalization.
 C. management buyout.
 D. management recapitalization.
International Finance
376. Question ID: CMA 1287 1.28 (Topic: International Finance)
If the value of the U.S. dollar in foreign currency markets changes from $1 = 1.15 Swiss
francs to $1 = 0.95 Swiss francs,
 A. U.S. exports to Switzerland should decrease.

 B. The Swiss franc has depreciated against the dollar.
 C. U.S. tourists in Switzerland will find their dollars will buy more Swiss products.
 D. Swiss imported products in the U.S. will become more expensive.

Caroline Brown, the product manager for a U.S. computer manufacturer, is being asked
to quote prices of desktop computers to be used in Kuwait. The Kuwaiti government
wants the price in British pounds, for delivery next year. Brown knows that the general
price level in the United States will increase by 3%. Her banker forecasts that the British
pound will depreciate about 5% this year with respect to the U.S. dollar. If Brown is able
to quote 700 pounds for immediate delivery, the price that should be quoted for delivery
to Kuwait next year is about
 A. £757.
 B. £737.
 C. £721.
 D. £759.

If consumers in Japan decide they would like to increase their purchases of consumer
products made in the United States, in foreign currency markets there will be a
tendency for:
 A. The supply of dollars to increase.

 B. The supply of dollars to decrease.
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 C. The Japanese yen to appreciate relative to the U.S. dollar.
 D. The demand for dollars to increase.
379. Question ID: ICMA 1603.P2.054 (Topic: International Finance)

A U.S. company has an account receivable from a Swiss company for 100,000 Swiss
Francs (CHF) due in three months. At the time of contract, the exchange rate was 1.0
CHF = 1.0 USD. The U.S. company wishes to manage its foreign exchange exposure
and therefore
 A. sells a Swiss Franc interest rate swap.

 B. sells Swiss Franc futures.
 C. buys Swiss Franc futures.
 D. buys a currency swap.

Country A's currency would tend to appreciate relative to Country B's currency when
 A. Country A has a slower rate of growth in income that causes its imports to lag behind
its exports.
 B. Country B switches to a more restrictive monetary policy.
 C. Country A has a higher rate of inflation than Country B.
 D. Country B has real interest rates that are greater than real interest rates in Country A.

Given a spot rate of $1.8655 and a 90-day forward rate of $1.8723, the pound sterling in
the forward market is:
 A. Undervalued.
 B. Being quoted at a premium.
 C. Being quoted at a discount.
 D. Overvalued.

If the U.S. dollar declines in value relative to the currencies of many of the U.S. trading
partners, the likely result is that
 A. U.S. exports will tend to increase.

 B. Foreign currencies will depreciate against the dollar.
 C. The U.S. balance of payments deficit will become worse.
 D. U.S. imports will tend to increase.
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The dominant reason countries devalue their currencies is to:
 A. Slow what is regarded as too rapid an accumulation of international reserves.

 B. Improve the balance of payments.
 C. Curb inflation by increasing imports.
 D. Discourage exports without having to impose controls.

One U.S. dollar is being quoted at 120 Japanese yen on the spot market and at 123
Japanese yen on the 90-day forward market; hence, the annual effect in the forward
market is that the
 A. U.S. dollar is at a premium of 2.5%.

 B. U.S. dollar is at a discount of 10%.
 C. U.S. dollar is at a premium of 10%.
 D. U.S. dollar is at a premium of 0.025%.

FreezeIt Inc. is a manufacturer of refrigeration systems based out of the United States
with one subsidiary in Canada. The Canadian subsidiary exports all of its manufactured
products to the United States and does not currently sell any of its manufactured
products in Canada. The Canadian subsidiary incurs all of its expenses in Canadian
dollars and all of its revenues are in U.S. dollars. The U.S. operations are conducted
only in U.S. dollars. What financial impact will a rise in the Canadian dollar against the
U.S. dollar have on the Canadian subsidiary assuming no operational changes?
 A. A reduction in revenues.
 B. A reduction in expenses.
 C. An increase in profit margins.
 D. An increase in cash flows.
386. Question ID: CIA 1196 IV.64 (Topic: International Finance)

A company has a foreign-currency-denominated trade payable, due in 60 days. In order
to eliminate the foreign currency exchange-rate risk associated with the payable, the
company could
 A. Borrow foreign currency today, convert it to domestic currency on the spot market, and
invest the funds in a domestic bank deposit until the invoice payment date.
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 B. Wait 60 days and pay the invoice by purchasing foreign currency in the spot market at
that time.
 C. Buy foreign currency forward today.
 D. Sell foreign currency forward today.

Which of the following economic policies would not tend to correct a balance of
payments deficit in the U.S.?
 A. Increase value of U.S. currency in relation to foreign currencies.

 B. A reduction in the economic aid and humanitarian aid provided to other nations.
 C. More effective use of monetary and fiscal policies to reduce inflation.
 D. Increase productivity in the manufacturing of U.S. exports.

The U.S. dollar has a free-floating exchange rate. When the dollar has fallen
considerably in relation to other currencies, the
 A. Trade account in the U.S. balance of payments is neither in a deficit nor in a surplus
because of the floating exchange rates.
 B. Capital account in the U.S. balance of payments is neither in a deficit nor in a surplus
because of the floating exchange rates.
 C. Fall in the dollar's value cannot be expected to have any effect on the U.S. trade
balance.
 D. Cheaper dollar helps U.S. exporters of domestically produced goods.

One may characterize the current international monetary system developed by the
industrialized countries as a
 A. managed or dirty float. Central banks intervene in the foreign exchange market to
influence the exchange rates.
 B. clean float. Freely floating exchange rates are determined solely by the forces of
demand and supply.
 C. stable-rate system.
 D. gold-based system.

Country R's currency would tend to depreciate relative to Country T's currency when
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 A. Country T has a rapid rate of growth in income that causes imports to lag behind
exports.
 B. Country R has a rate of inflation that is lower than the rate of inflation in Country T.
 C. Country R switches to a more restrictive monetary policy.
 D. Country R has real interest rates that are lower than real interest rates in Country T.

If the central bank of a country raises interest rates sharply, the country's currency will
most likely
 A. Decrease sharply in value at first and then return to its initial value.
 B. Remain unchanged in value.
 C. Decrease in relative value.
 D. Increase in relative value.

A bill of lading is a document that
 A. Summarizes data relating to a disbursement and represents final authorization for

payment.
 B. Is sent with the goods giving a listing of the quantities of items included in the shipment.
 C. Is used to transfer responsibility for goods between the seller of goods and a common
carrier.
 D. Reduces a customer's account for goods returned to the seller.

The value of the U.S. dollar in relation to other foreign currencies is
 A. Determined by the forces of supply and demand on the foreign exchange markets.
 B. Set by the U.S. government in consultation with other foreign governments.
 C. Determined directly by the price of gold because the value of the U.S. dollar is tied to
the price of gold.
 D. Set along with the value of other currencies held by the International Monetary Fund.

If risk is purposely undertaken in the foreign currency market, the investor in foreign
currency then becomes
 A. A speculator.
 B. Involved in hedging.
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 C. An arbitrageur.
 D. An exporter.

A short-term speculative rise in the world-wide value of domestic currency could be
moderated by a central bank decision to
 A. Sell foreign currency in the foreign exchange market.

 B. Sell domestic currency in the foreign exchange market.
 C. Increase domestic interest rates.
 D. Buy domestic currency in the foreign exchange market.

Consider a world consisting of only two countries, Canada and the United Kingdom.
Inflation in Canada in 1 year was 5%, and in the United Kingdom it was 10%. Which one
of the following statements about the Canadian exchange rate (rounded) with the U.K.
pound sterling during that year will be true?
 A. Inflation has no affect on the exchange rates.

 B. The Canadian dollar will depreciate by 5% against the pound sterling.
 C. The Canadian dollar will depreciate by 15% against the pound sterling.
 D. The Canadian dollar will appreciate by 5% against the pound sterling.

If the exchange rate has changed from 1 U.S. dollar being worth 0.75 euro to a rate of 1
U.S. dollar being worth 0.90 euro,
 A. The U.S. dollar has depreciated by 20%.

 B. The euro has depreciated by 10%.
 C. The U.S. dollar has appreciated by 20%.
 D. The euro has appreciated by 10%.

A firm involved in major international market trading can best minimize foreign
exchange risk by
 A. factoring in the cost of interest in the commodity price.

 B. requiring collect on delivery payment from customers to avoid exchange rate
fluctuations.
 C. entering into a forward rate contract.
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 D. having customers use the spot rate.

Which one of the following is least likely to be a reason why U.S. multinational
corporations utilize the foreign exchange market?
 A. To hedge the currency risk of accounts receivable transactions in foreign currencies.

 B. To improve the return on investments of a foreign subsidiary.
 C. To offset accounts payable transaction exposure to foreign firms.
 D. To counter some of the currency risk of dividend payments from foreign subsidiaries to
the U.S. parent.

In foreign currency markets, the phrase "managed float" refers to the
 A. Fact that actual exchange rates are set by private business people in trading nations.
 B. Tendency for most currencies to depreciate in value.
 C. Discretionary buying and selling of currencies by central banks.
 D. Necessity of maintaining a highly liquid asset, such as gold, to conduct international
trade.

If the U.S. dollar appreciated against the British pound, other things being equal, we
would expect that
 A. U.S. demand for British products would decrease.

 B. the British demand for U.S. products would increase.
 C. U.S. demand for British products would increase.
 D. trade between the U.S. and Britain would decrease.

The purchasing-power parity exchange rate
 A. holds constant the relative price levels in two countries when measured in a common
currency.
 B. is a fixed (pegged) exchange rate.
 C. is always equal to the market exchange rate.
 D. results in an undervalued currency of countries that are net importers.

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Suppose that Swiss wrist watches priced in Swiss Francs become very popular among
U.S. consumers while at the same time Britain experiences relatively higher inflation
than the United States. Assuming that all other economic parameters remain constant,
which one of the following statements is most accurate?
 A. The U.S. dollar will depreciate relative to the Swiss Franc and appreciate relative to the
British pound.
 B. The U.S. dollar will depreciate relative to both the Swiss Franc and the British pound.
 C. The U.S. dollar will appreciate relative to the Swiss Franc and depreciate relative to the
British pound.
 D. The U.S. dollar will appreciate relative to both the Swiss Franc and the British pound.

When the U.S. dollar is expected to rise in value against foreign currencies, a U.S.
company with foreign currency denominated receivables and payables should
 A. Speed up collections and speed up payments.

 B. Slow down collections and slow down payments.
 C. Slow down collections and speed up payments.
 D. Speed up collections and slow down payments.

A publicly-traded company based in Japan is planning on expanding its operations into
Germany. The expansion is estimated to cost ¥500 million, but the company needs
euros to implement the expansion. The company is not well known in Germany and
therefore hesitant to issue a euro-denominated bond in the German marketplace. If the
company were to issue a yen- denominated twenty-year bond in Japan, which one of
the following contracts should the company use?
 A. Currency swap.
 B. Currency forward.
 C. Currency options.
 D. Currency futures.

Given a spot exchange rate for the U.S. dollar against the pound sterling of 1.4925 and
a 90-day forward rate of 1.4775:
 A. The forward pound sterling is selling at a premium against the dollar in the forward
market.
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 B. The pound sterling is selling at a discount against the dollar and is undervalued in the
forward market.
 C. The forward pound sterling is selling at a discount against the dollar in the forward
market.
 D. The pound sterling is selling at a premium against the dollar and is overvalued in the
forward market.

Under a floating exchange rate system, which one of the following should result in a
depreciation of the British pound sterling?
 A. British interest rates rise relative to the U.S. rates.

 B. U.S. income levels improve relative to the British.
 C. Decrease in outflows of British capital to the U.S.
 D. U.S. inflation declines relative to British inflation.

Countries sometimes privatize their state-owned enterprises. U.S. firms considering
investing in these formerly state-owned enterprises must consider many factors prior to
making investments in these countries. Which one of the following is
of least importance to U.S. investors when considering the acquisition of one of these
former state-owned enterprises?
 A. Stability of the foreign currency.

 B. Transfer of technology back to the U.S.
 C. Restrictions on capital flows out of the foreign country.
 D. Political stability of the country.

Assuming exchange rates are allowed to fluctuate freely, which one of the following
factors would likely cause a nation's currency to appreciate on the foreign exchange
market?
 A. A slower rate of growth in income than in other countries, which causes imports to lag
behind exports.
 B. Domestic real interest rates that are lower than real interest rates abroad.
 C. A high rate of inflation relative to other countries.
 D. A relatively rapid rate of growth in income that stimulates imports.

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A U.S. company has an account payable it must pay in six months with one Japanese
company, and an account receivable to be received in six months with another
Japanese company. The U.S. company would not have transaction exposure if
 A. both the account payable and the account receivable are denominated in Japanese
Yen and the Yen account receivable is less than the Yen account payable.
 B. the account payable is denominated in dollars and the account receivable is
denominated in Yen.
 C. both the account payable and the account receivable are denominated in Japanese
Yen and the Yen account receivable is greater than the Yen account payable.
 D. both the account payable and account receivable are denominated in U.S. dollars.

An American importer of English clothing has contracted to pay an amount fixed in
British pounds three months from now. If the importer worries that the U.S. dollar may
depreciate sharply against the British pound in the interim, it would be well advised to:
 A. Sell dollars in the forward exchange market.

 B. Buy dollars in the forward exchange market.
 C. Sell pounds in the forward exchange market.
 D. Buy pounds in the forward exchange market.

Section B Questions

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Hock P2 2020

Section B - Corporate Finance.

Risk and Return

2. Question ID: CIA 589 IV.49 (Topic: Risk and Return)

4. Question ID: CIA 1187 IV.66 (Topic: Risk and Return)

5. Question ID: HOCK CMA P2 SDV1 (Topic: Risk and Return)

6. Question ID: CIA 1192 IV.48 (Topic: Risk and Return)

7. Question ID: HOCK RRI 120 (Topic: Risk and Return)

What is the return to the market according to this graph?

8. Question ID: ICMA 10.P2.113 (Topic: Risk and Return)

9. Question ID: HOCK RRI 96 (Topic: Risk and Return)

10. Question ID: HOCK RRI 97 (Topic: Risk and Return)

 A. the market risk premium.

13. Question ID: ICMA 10.P2.114 (Topic: Risk and Return)

What is the slope of the Security Market Line?

15. Question ID: ICMA 19.P2.021 (Topic: Risk and Return)

 A. Credit risk and strategic risk.

16. Question ID: HOCK RRI 91 (Topic: Risk and Return)

 A. is riskier than others that provide the same return.

18. Question ID: ICMA 10.P2.110 (Topic: Risk and Return)

 A. standard deviation of the security's rate of return.

19. Question ID: ICMA 1603.P2.072 (Topic: Risk and Return)

 A. the risk premium on the market.

Beta of Investment A 1.4

21. Question ID: HOCK RRI 8 (Topic: Risk and Return)

23. Question ID: HOCK RRI 9 (Topic: Risk and Return)

 A. approximately the return on a perfectly diversified portfolio.

27. Question ID: HOCK RRI 98 (Topic: Risk and Return)

29. Question ID: ICMA 1603.P2.073 (Topic: Risk and Return)

 A. overall expected market return for equities decreases.

31. Question ID: ICMA 19.P2.022 (Topic: Risk and Return)

 A. Strategic risk, financial risk.

32. Question ID: HOCK RRI 99 (Topic: Risk and Return)

34. Question ID: HOCK CFMQ5 (Topic: L-T Financial Management-Financial

 A. The share price would go up to $2.53.

35. Question ID: ICMA 19.P2.076 (Topic: L-T Financial Management-Financial

36. Question ID: CMA 695 P1 Q9 (Topic: L-T Financial Management-Financial

 A. tend to be a lower percentage of earnings for mature firms.

 A. $1.80 per share

41. Question ID: ICMA 10.P2.123 (Topic: L-T Financial Management-Financial

42. Question ID: ICMA 10.P2.117 (Topic: L-T Financial Management-Financial

 A. Preferred shareholders' claims take precedence over the claims of common

 A. By promising a return to the bondholder, an income bond is junior to preferred and

45. Question ID: HOCK CFMQ4 (Topic: L-T Financial Management-Financial

47. Question ID: ICMA 19.P2.078 (Topic: L-T Financial Management-Financial

 A. The amount of cash not needed for operations.

49. Question ID: ICMA 10.P2.118 (Topic: L-T Financial Management-Financial

Preferred stock ($100 par value) $ 8,000,000

 A. 2,000 additional shares.

52. Question ID: CFM Sample Q. 10 (Topic: L-T Financial Management-Financial

 A. The combination alternative carries the risk of increasing dividend payments.

54. Question ID: ICMA 13.P2.070 (Topic: L-T Financial Management-Financial

 A. Two-for-one stock split.

56. Question ID: ICMA 10.P2.073 (Topic: L-T Financial Management-Financial

Long-term debt (8% interest rate) $10,000,000

58. Question ID: ICMA 10.P2.119 (Topic: L-T Financial Management-Financial

I. Receiving the trustee's permission prior to selling the property.