Chapter 08 + 09

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Corporate Finance, 12e (Ross)

Chapter 8 Interest Rates and Bond Valuation
1) A bond that makes no coupon payments and is initially priced at a deep discount is called a
________ bond.
A) Treasury
B) municipal
C) floating-rate
D) junk
E) zero coupon
Answer: E
Difficulty: 1 Easy
Section: 8.1 Bonds and Bond Valuation
Topic: Bond types
Bloom's: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
2) The stated interest payment, in dollars, made on a bond each period is called the bond's:
A) coupon.
B) face value.
C) maturity.
D) yield to maturity.
E) coupon rate.
Answer: A
Difficulty: 1 Easy
Topic: Bond coupons
Bloom's: Remember
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3) The principal amount of a bond that is repaid at the end of the loan term is called the bond's:
A) coupon.
B) face value.
C) maturity.
E) coupon rate.
Answer: B
Difficulty: 1 Easy
Topic: Bond types
Bloom's: Remember
4) The specified date on which the principal amount of a bond is repaid is called the bond's:
A) coupon.
B) face value.
C) maturity.
E) coupon rate.
Answer: C
Difficulty: 1 Easy
Topic: Time to maturity
Bloom's: Remember
5) The rate of return required by investors in the market for owning a bond is called the:
A) coupon.
B) face value.
C) maturity.
E) coupon rate.
Answer: D
Difficulty: 1 Easy
Topic: Bond coupons
Bloom's: Remember
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6) The annual interest paid by a bond divided by the bond's face value is called the:
A) coupon.
B) face value.
C) maturity.
E) coupon rate.
Answer: E
Difficulty: 1 Easy
Topic: Bond coupons
Bloom's: Remember
7) A bond with a face value of $1,000 that sells for $1,000 in the market is called a ________
bond.
A) par value
B) discount
C) premium
D) zero coupon
E) floating rate
Answer: A
Difficulty: 1 Easy
Topic: Bond types
Bloom's: Remember
8) A bond with a face value of $1,000 that sells for less than $1,000 in the market is called a
________ bond.
A) par
B) discount
C) premium
D) zero coupon
E) floating rate
Answer: B
Difficulty: 1 Easy
Topic: Bond types
Bloom's: Remember
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9) A bond with a coupon rate of 6 percent that pays interest semiannually and is priced at par will
have a market price of ________ and interest payments in the amount of ________ each.
A) $1,006; $60
B) $1,060; $30
C) $1,060; $60
D) $1,000; $30
E) $1,000; $60
Answer: D
Difficulty: 2 Medium
Topic: Bond coupons
Bloom's: Understand
10) All else constant, a bond will sell at ________ when the yield to maturity is ________ the
coupon rate.
A) a premium; greater than
B) a premium; equal to
C) at par; greater than
D) at par; less than
E) a discount; greater than
Answer: E
Topic: Bond yields and returns
Bloom's: Understand
11) All else constant, a coupon bond that is selling at a premium, must have:
A) a coupon rate that is equal to the yield to maturity.
B) a market price that is less than par value.
C) semiannual interest payments.
D) a yield to maturity that is less than the coupon rate.
E) a coupon rate that is less than the yield to maturity.
Answer: D
Bloom's: Understand
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12) The market price of a bond increases when the:

A) face value decreases.
B) coupon rate decreases.
C) discount rate decreases.
D) par value decreases.
E) coupon is paid annually rather than semiannually.
Answer: C
Topic: Bond valuation
Bloom's: Understand
13) Aspens is preparing a bond offering with a coupon rate of 5.5 percent. The bonds will be
repaid in 10 years. The company plans to issue the bonds at par value and pay interest annually.
Which one of the following statements is correct? Assume a face value of $1,000.
A) The bonds will pay 19 interest payments and one principal payment.
B) The bonds will initially sell at a discount.
C) At maturity, the bonds will pay a final payment of $1,027.50.
D) The bonds will pay twenty equal coupon payments.
E) At issuance, the bond's yield to maturity is 5.5 percent.
Answer: E
Bloom's: Understand
14) A par value bond offers a coupon rate of 7 percent with semiannual interest payments. The
effective annual rate provided by these bonds must be:
A) equal to 3.5 percent.
B) greater than 3.5 percent but less than 4 percent.
C) equal to 7 percent.
D) greater than 7 percent but less than 8 percent.
E) equal to 14 percent.
Answer: D
Bloom's: Understand
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15) Rosina purchased one 15-year bond at par value when it was initially issued. This bond has a
coupon rate of 7 percent and matures 13 years from now. If the current market rate for this type
and quality of bond is 7.5 percent, then Rosina should expect:
A) the bond issuer to increase the amount of all future interest payments.
B) the yield to maturity to remain constant due to the fixed coupon rate.
C) to realize a capital loss if she sold the bond at today's market price.
D) today's market price to exceed the face value of the bond.
E) the current yield today to be less than 7 percent.
Answer: C
Topic: Interest rate risk
Bloom's: Analyze
AACSB: Analytical Thinking
16) Interest rate risk ________ as the time to maturity decreases and ________ as the coupon
rate decreases.
A) decreases; increases
B) decreases; decreases
C) increases; increases
D) increases; decreases
E) increases; is unaffected
Answer: A
Bloom's: Analyze
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17) A zero coupon bond:

A) is sold at a large premium.
B) has a price equal to the future value of the face amount given a positive rate of return.
C) can only be issued by the U.S. Treasury.
D) has less interest rate risk than a comparable coupon bond.
E) has a market price that is computed using semiannual compounding of interest.
Answer: E
Bloom's: Understand
AACSB: Knowledge Application
18) Which one of these bonds is the most interest-rate sensitive?

A) 5-year zero coupon bond
B) 10-year zero coupon bond
C) 5-year, 6 percent, annual coupon bond
D) 10-year, 6 percent, semiannual coupon bond
E) 10-year, 6 percent, annual coupon bond
Answer: B
Bloom's: Understand
19) The yield to maturity:

A) that is expected will be realized any time a bond is sold.
B) will exceed the coupon rate when the bond is selling at a premium.
C) equals the current yield for all annual coupon bonds.
D) can only be realized if a bond is purchased on the issue date at par value.
E) equals both the current yield and the coupon rate for par value bonds.
Answer: E
Bloom's: Understand
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20) If a bond's yield to maturity is less than its coupon rate, the bond will sell at a ________, and
increases in market interest rates will:
A) discount; decrease this discount.
B) discount; increase this discount.
C) premium; decrease this premium.
D) premium; increase this premium.
E) premium; not affect this premium.
Answer: C
Bloom's: Understand
21) The longest term bonds ever issued had an initial maturity date of:
A) 25 years.
B) 50 years.
C) 100 years.
D) 1,000 years.
E) never as the bonds are perpetual.
Answer: E
Bloom's: Understand
22) All else held constant, interest rate risk will increase when the time to maturity:
A) decreases or the coupon rate increases.
B) decreases or the coupon rate decreases.
C) increases or the coupon rate increases.
D) increases or the coupon rate decreases.
E) decreases and the coupon rate equals zero.
Answer: D
Difficulty: 1 Easy
Bloom's: Understand
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23) Which one of these combinations of bond ratings represents a crossover situation?
A) BBB; Baa
B) BB; Ba
C) Ba; B
D) Baa; BB
E) B; CCC
Answer: D
Difficulty: 1 Easy
Section: 8.2 Government and Corporate Bonds
Topic: Bond ratings and credit risk
Bloom's: Understand
24) The interest paid on any municipal bond is:

A) free of default risk.
B) subject to default risk and is exempt from state income taxation.
C) free of both default risk and federal income taxation.
D) exempt from federal income taxation and may or may not be exempt from state taxation.
E) taxable at the federal level and tax exempt at the state and local level.
Answer: D
Difficulty: 1 Easy
Topic: Bond features
Bloom's: Understand
25) The interest rate for a tax-exempt bond that equates to the rate paid on a taxable bond is
computed as:
A) Taxable rate/(1 − T*).
B) Tax-exempt rate × (1 − T*).
C) Taxable rate − (1 + T*).
D) Taxable rate × (1 − T*).
E) Tax-exempt rate/(1 + T*).
Answer: D
Difficulty: 1 Easy
Bloom's: Understand
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26) Bond dealers report all of their trading information using the system known as:
A) SEC-Bond.
B) NASDAQ.
C) FED trades.
D) FINRA.
E) TRACE.
Answer: E
Difficulty: 1 Easy
Section: 8.3 Bond Markets
Topic: Bond market reporting
Bloom's: Understand
27) Most of the trading in bonds is conducted:

A) in person on the floor of the NYSE.
B) by dealers located in Chicago.
C) by brokers on various trading floors.
D) electronically.
E) on the trade floor in Washington, DC.
Answer: D
Difficulty: 1 Easy
Topic: Bond quotes and trading
Bloom's: Understand
28) Which entity provides a daily snapshot of bond prices for the most active issues?
A) Federal Reserve Bank
B) US Treasury Department
C) SEC
D) FINRA
E) NYSE
Answer: D
Difficulty: 1 Easy
Topic: Bond market reporting
Bloom's: Understand
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29) The dirty price of a bond is defined as the:

A) market price minus any taxes due on the accrued interest.
B) market price minus the accrued interest.
C) clean price minus the accrued interest.
D) quoted price plus the accrued interest.
E) clean price minus any taxes due on the accrued interest.
Answer: D
Difficulty: 1 Easy
Bloom's: Understand
30) A newspaper listing of bond prices has an "Asked yield" column. This yield is based on the
asked price and represents the:
A) yield to maturity.
B) difference between the current yield and the yield to maturity.
C) difference between the bond's yield and the yield of a comparable Treasury issue.
D) coupon rate.
E) current yield.
Answer: A
Difficulty: 1 Easy
Bloom's: Understand
31) A bond is listed in a newspaper at a bid of 105.4844. This quote should be interpreted to
mean:
A) the bond will pay semiannual interest payments of $105.4844 per $1,000 of face value.
B) you can sell that bond at a price equal to 105.4844 percent of face value.
C) the bond will pay annual interest payments of $105.4844 per $1,000 of face value.
D) you can buy that bond at a price equal to 105.4844 percent of face value.
E) the bond dealer is willing to sell that bond for a price equal to 105.4844 percent of par.
Answer: B
Difficulty: 1 Easy
Bloom's: Understand
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32) The total price you pay to purchase a premium bond is referred to as the:
A) dirty price or the full price.
B) clean price or the invoice price.
C) invoice price or the par value.
D) dirty price or the par value.
E) clean price or the par value.
Answer: A
Difficulty: 1 Easy
Bloom's: Understand
33) The profit that is earned on a bond trade by a bond dealer is called the:
A) asked price.
B) spread.
C) bid price.
D) accrued interest.
E) quote value.
Answer: B
Difficulty: 1 Easy
Bloom's: Understand
34) The Fisher formula is expressed as ________ where R is the nominal rate, r is the real rate,
and h is the inflation rate.
A) r = Rh
B) R = rh
C) 1 + h = (1 + r)/(1 + R)
D) 1 + R = (1 + r)/(1 + h)
E) 1 + R = (1 + r)(1 + h)
Answer: E
Difficulty: 1 Easy
Section: 8.4 Inflation and Interest Rates
Topic: Fisher effect
Bloom's: Understand
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35) An increase in the rate of inflation will:

A) increase both the real and the nominal rate of interest.
B) decrease both the real and the nominal rate of interest.
C) increase the nominal interest rate while lowering the real interest rate.
D) increase the real interest rate but not affect the nominal interest rate.
E) increase the nominal interest rate but will not affect the real interest rate.
Answer: E
Difficulty: 1 Easy
Topic: Nominal and real returns
Bloom's: Understand
36) If you want to increase your purchasing power by investing in a bond, then:
A) you must purchase that bond at a discount.
B) the nominal rate of return on that bond must be less than the inflation rate.
C) you should purchase a premium bond.
D) the nominal rate of return must equal or exceed the rate of inflation.
E) you must earn a positive real rate of return on that bond.
Answer: E
Difficulty: 1 Easy
Bloom's: Understand
37) The promised coupon payments on a US TIPS bond are specified in:
A) euros.
B) Canadian dollars.
C) nominal terms.
D) inflated terms.
E) real terms.
Answer: E
Difficulty: 1 Easy
Bloom's: Understand
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38) The monthly returns on US Treasury bills over the past 50 years have:
A) exceeded inflation for all periods.
B) provided consistently positive monthly rates of return for investors.
C) ranged between zero and five percent on an annualized basis.
D) always been positive on a real basis.
E) sometimes been less than the monthly rate of inflation.
Answer: E
Difficulty: 1 Easy
Bloom's: Understand
39) The relationship between nominal rates, real rates, and inflation is known as the:
A) Miller and Modigliani theorem.
B) Fisher effect.
C) Gordon growth model.
D) term structure of interest rates.
E) interest rate risk premium.
Answer: B
Difficulty: 1 Easy
Bloom's: Remember
40) The relationship between nominal interest rates on default-free, pure discount securities and
the time to maturity is called the:
A) liquidity effect.
B) Fisher effect.
C) term structure of interest rates.
D) inflation premium.
E) interest rate risk premium.
Answer: C
Section: 8.5 Determinants of Bond Yields
Topic: Term structure of interest rates
Bloom's: Remember
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41) The ________ premium is that portion of a nominal interest rate or bond yield that represents
compensation for expected future loss in purchasing power.
A) default risk
B) taxability
C) liquidity
D) inflation
E) interest rate risk
Answer: D
Difficulty: 1 Easy
Bloom's: Remember
42) The ________ premium is that portion of the bond yield that represents compensation for
potential difficulties that might be encountered should the bond holder wish to sell the bond prior
to maturity.
A) default risk
B) taxability
C) inflation
D) liquidity
E) interest rate risk
Answer: D
Difficulty: 1 Easy
Bloom's: Remember
43) The term structure of interest rates reflects the:

A) real rate of interest.
B) real rate of interest plus the inflation premium.
C) nominal interest rate plus the interest rate risk premium.
D) pure time value of money.
E) real rate, inflation premium, interest rate risk premium, and the liquidity premium.
Answer: D
Difficulty: 1 Easy
Bloom's: Understand
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44) An upward-sloping term structure of interest rates indicates that:

A) longer-term rates are higher than shorter-term rates.
B) investors should expect interest rates to decline in the future.
C) short and intermediate term rates are real rates while long term rates are nominal rates.
D) the Fed is expected to decrease rates in the near term.
E) the larger the investment in dollars, the higher the interest rate paid.
Answer: A
Difficulty: 1 Easy
Bloom's: Understand
45) The term structure of interest rates:

A) plots interest rates against bond ratings.
B) is just another name for the yield curve.
C) ignores interest rate risk premiums while the Treasury yield curve includes those premiums.
D) ignores both inflation and interest rate risk premiums.
E) is based on pure discount bonds while the Treasury yield curve is based on coupon bond
yields.
Answer: E
Difficulty: 1 Easy
Bloom's: Understand
46) The term structure of interest rates:

A) must be upward-sloping.
B) can be humped in the middle.
C) is downward-sloping when inflation is expected to rise.
D) obtains its slope from the real rate of return.
E) generally has the same degree of steepness each year.
Answer: B
Difficulty: 1 Easy
Bloom's: Understand
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47) Which of these is included in the return on a municipal bond but excluded from the return on
a US Treasury bond?
A) Inflation premium and liquidity premium
B) Taxability premium and interest rate risk premium
C) Default risk premium and interest rate risk premium
D) Inflation premium and default risk premium
E) Liquidity premium and taxability premium
Answer: E
Difficulty: 1 Easy
Bloom's: Understand
48) Consider a bond with a coupon rate of 8 percent that pays semiannual interest and matures in
eight years. The market rate of return on bonds of this risk is currently 11 percent. What is the
current value of a $1,000 face value bond?
A) $830.58
B) $843.07
C) $893.30
D) $929.17
E) $854.08
Answer: B
Explanation: Bond value = [.08($1,000)/2]{[1 − 1/(1 + .11/2)8(2)]/(.11/2)} + $1,000/(1 + .
11/2)8(2)
Bond value = $843.07
Bloom's: Apply
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49) What is the value of a 20-year, zero-coupon bond with a face value of $1,000 when the
market required rate of return is 9.6 percent, compounded semiannually?
A) $153.30
B) $192.40
C) $195.26
D) $168.31
E) $172.19
Answer: A
Explanation: Bond value = $1,000/[1 + (.096/2)]20(2)
Bond value = $153.30
Difficulty: 1 Easy
Bloom's: Apply
50) The bonds issued by Manson and Son bear a coupon of 6 percent, payable semiannually. The
bond matures in 15 years and has a $1,000 face value. Currently, the bond sells at par. What is
the yield to maturity?
A) 5.87 percent
B) 5.97 percent
C) 6.00 percent
D) 6.09 percent
E) 6.17 percent
Answer: C
Explanation: Since the bond is selling at par, the yield to maturity will equal the coupon rate of 6
percent.
Bloom's: Apply
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51) A corporate bond has a coupon of 7.5 percent and pays interest annually. The face value is
$1,000 and the current market price is $1,108.15. The bond matures in 14 years. What is the
yield to maturity?
A) 6.31 percent
B) 7.82 percent
C) 8.00 percent
D) 8.04 percent
E) 8.12 percent
Answer: A
Explanation: $1,108.15 = [.075($1,000)]{[1 − 1/(1 + YTM)14]/YTM} + $1,000/(1 + YTM)14
YTM = 6.31%
Bloom's: Analyze
52) Otto Enterprises has a bond issue outstanding with a coupon of 8 percent that matures in 15
years. The bond is currently priced at $923.60 and has a par value of $1,000. Interest is paid
semiannually. What is the yield to maturity?
A) 8.67 percent
B) 9.93 percent
C) 9.16 percent
D) 8.93 percent
E) 8.45 percent
Answer: D
Explanation: $923.60 = (.08/2)($1,000){[1 - 1/(1 + YTM/2)15(2)]/(YTM/2)} + $1,000/(1 +
YTM/2)15(2)
YTM = 8.93%
Bloom's: Analyze
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53) Chocolate and More offers a bond with a coupon rate of 6 percent, semiannual payments,
and a yield to maturity of 7.73 percent. The bonds mature in 9 years. What is the market price of
a $1,000 face value bond?
A) $889.29
B) $963.88
C) $1,008.16
D) $924.26
E) $901.86
Answer: A
Explanation: Bond price = (.06/2)($1,000){[1 − 1/(1 + .0773/2)9(2)]/(.0773/2)} + $1,000/(1 + .
0773/2)9(2)
Bond price = $889.29
Bloom's: Analyze
54) Westover's has an outstanding bond with a coupon rate of 5.5 percent that matures in 12
years. The bond pays interest semiannually. What is the market price of one $1,000 face value
bond if the yield to maturity is 7.13 percent?
A) $934.59
B) $880.86
C) $870.01
D) $905.92
E) $947.87
Answer: C
Explanation: Bond price = (.055/2)($1,000){[1 − 1/(1 + .0713/2)12(2)]/(.0713/2)} + $1,000/(1 +
.0713/2)12(2)
Bloom's: Analyze
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55) Guggenheim offers a bond with annual payments and a coupon rate of 5 percent. The yield to
maturity is 5.62 percent and the maturity date is 9 years away. What is the market price of one
$1,000 face value bond?
A) $942.66
B) $868.67
C) $869.67
D) $957.12
E) $1,009.59
Answer: D
Explanation: Bond price = .05($1,000)[(1 − 1/1.05629)/.0562] + $1,000/1.05629
Bloom's: Analyze
56) The Lo Sun Corporation offers a bond with a current market price of $1,029.75, a coupon
rate of 8 percent, and a yield to maturity of 7.52 percent. The face value is $1,000. Interest is
paid semiannually. How many years is it until this bond matures?
A) 8.5 years
B) 8.0 years
C) 9.0 years
D) 17 years
E) 16 years
Answer: A
Explanation: $1,029.75 = (.08/2)($1,000){[1 − 1/(1 + .0752/2)t(2)]/(.0752/2)} + $1,000/(1 + .
0752/2)t(2)
t = 17 semiannual periods, or 8.5 years
Bloom's: Analyze
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57) Moon Lite Cafe has a semiannual, 5 percent coupon bond with a current market price of
$988.52. The bond has a par value of $1,000 and a yield to maturity of 5.68 percent. How many
years is it until this bond matures?
A) 1.5 years
B) 1.8 years
C) 2.1 years
D) 2.2 years
E) 1.6 years
Answer: B
Explanation: $988.52 = (.05/2)($1,000){[1 − 1/(1 + .0568/2)t(2)]/(.0568/2)} + $1,000/(1 + .
0568/2)t(2)
t = 3.6 semiannual periods, or 1.8 years
Bloom's: Analyze
58) A firm offers a zero coupon bond with a face value of $1,000 that matures in 10 years. What
is the current market price if the yield to maturity is 7.6 percent, given semiannual
compounding?
A) $474.30
B) $473.26
C) $835.56
D) $919.12
E) $1,088.00
Answer: A
Explanation: Price = $1,000/(1 + .076/2)10(2)
Price = $474.30
Bloom's: Analyze
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59) TJ's offers a $1,000 face value, zero coupon bond with a yield to maturity of 11.3 percent,
given annual compounding. The bond matures in 16 years. What is the current price?
A) $178.78
B) $180.33
C) $188.36
D) $190.09
E) $192.18
Answer: B
Explanation: Price = $1,000/1.11316
Price = $180.33
Bloom's: Analyze
60) The zero coupon bonds of Mark Enterprises have a market price of $394.47, a face value of
$1,000, and a yield to maturity of 6.87 percent based on semiannual compounding. How many
years is it until this bond matures?
A) 11.08 years
B) 10.49 years
C) 13.77 years
D) 12.64 years
E) 15.42 years
Answer: C
Explanation: $394.47 = $1,000/(1 + .0687/2)t(2)
t = 13.77 years
Bloom's: Analyze
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61) A $1,000 face value coupon bond will pay 5 percent interest annually for 12 years. What is
the percentage change in the price of this bond if the market yield rises to 6 percent from the
current level of 5.5 percent?
A) −5.28 percent
B) −4.26 percent
C) −2.38 percent
D) 1.13 percent
E) 4.13 percent
Answer: B
Explanation: Price5.5% = .05($1,000)[(1 − 1/1.05512)/.055] + $1,000/1.05512
Price5.5% = $956.91
Price6% = .05($1,000)[(1 − 1/1.0612)/.06] + $1,000/1.0612
Price6% = $916.16
%Δ in price = ($916.16 − 956.91)/$956.91
%Δ in price = −.0426, or − 4.26%
Bloom's: Analyze
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62) Mason's has 5-year, 8 percent annual coupon bonds outstanding with a par value of $1,000.
Dixon's has 10-year, 8 percent annual coupon bonds outstanding with a par value of $1,000. Both
bonds currently have a yield to maturity of 8 percent. Which one of the following statements is
correct if the market rate decreases to 7 percent?
A) Both bonds will decrease in value by 4.10 percent.
B) Mason's bond will increase in value by $52.10.
C) Dixon's bond will increase in value by 4.61 percent.
D) Mason's bond will increase in value by $41.
E) Dixon's bond will increase in value by 6.87 percent.
Answer: D
Explanation: Both bonds are currently priced at $1,000 because the yield to maturity equals the
bond's coupon rate.
PriceMason's = .08($1,000)[(1 − 1/1.075)/.07] + $1,000/1.075
PriceMason's = $1,041.00
PriceDixon's = .08($1,000)[(1 − 1/1.0710)/.07] + $1,000/1.0710
PriceDixon's = $1,070.24
%Δ in priceMason's = ($1,041.00 − 1,000)/$1,000
%Δ in priceMason's = .0410, or 4.10%
%Δ in priceDixon's = ($1,070.24 − 1,000)/$1,000
%Δ in priceDixon's = .0702, or 7.02%
Bloom's: Analyze
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63) A zero coupon bond with a face value of $1,000 is issued with an initial price of $430.84
based on semiannual compounding. The bond matures in 20 years. What is the implicit interest,
in dollars, for the first year of the bond's life?
A) $19.08
B) $22.56
C) $18.53
D) $21.47
E) $25.25
Answer: C
Explanation: $430.84 = $1,000/(1 + r/2)20(2)
r = .042547, or 4.2547%
Price = $1,000/(1 + .042547/2)19(2)
Price = $449.37
Implicit interestYear 1 = $449.37 − 430.84
Implicit interestYear 1 = $18.53
Topic: Accrued and implicit interest
Bloom's: Analyze
64) Allison's wants to raise $12.4 million to expand its business. To accomplish this, it plans to
sell 25-year, $1,000 face value, zero-coupon bonds. The bonds will be priced to yield 6.5
percent, with semiannual compounding. What is the minimum number of bonds the firm must
sell to raise the $12.4 million it needs?
A) 59,864
B) 52,667
C) 61,366
D) 60,107
E) 60,435
Answer: C
Explanation: Number of bonds = $12,400,000/[$1,000/(1 + .065/2)25(2)]
Number of bonds = 61,366 bonds
Bloom's: Analyze
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65) Jackson's has $1,000 face value, zero-coupon bonds outstanding that mature in 13.5 years.
What is the current value of one of these bonds if the market rate of interest is 7.6 percent?
Assume semiannual compounding.
A) $365.32
B) $401.12
C) $360.49
D) $378.17
E) $384.07
Answer: A
Explanation: Price = $1,000/(1 + .076/2)13.5(2)
Price = $365.32
Bloom's: Analyze
66) A corporate bond with a face value of $1,000 matures in 4 years and has a coupon rate of
6.25 percent. The current price of the bond is $932 and interest is paid semiannually. What is the
yield to maturity?
A) 9.05 percent
B) 6.67 percent
C) 8.58 percent
D) 8.28 percent
E) 7.92 percent
Answer: D
Explanation: $932 = (.0625/2)($1,000){[1 − 1/(1 + YTM/2)4(2)]/(YTM/2)} + $1,000/(1 +
YTM/2)4(2)
YTM = .0828, or 8.28%
Bloom's: Analyze
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67) A bond has a coupon rate of 8.2 percent, a $1,000 par value, matures in 11.5 years, has a
yield to maturity of 7.67 percent, and pays interest annually. What is the current yield?
A) 7.89 percent
B) 8.21 percent
C) 8.43 percent
D) 7.67 percent
E) 8.52 percent
Answer: A
Explanation: Price = .082($1,000)[(1 − 1/1.076711.5)/.0767] + $1,000/1.076711.5
Price = $1,039.56
Current yield = [.082($1,000)]/$1,039.56
Current yield = .0789, or 7.89%
Bloom's: Analyze
68) Suzette owns a corporate bond with a yield to maturity of 7.45 percent. She is in the 12
percent tax bracket. What is her equivalent rate of return on a municipal bond? Ignore state taxes.
A) 6.17 percent
B) 5.89 percent
C) 6.56 percent
D) 8.26 percent
E) 8.47 percent
Answer: C
Explanation: T* = .0745(1 − .12)
T* = .0656, or 6.56%
Difficulty: 1 Easy
Bloom's: Apply
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69) Currently, you own a municipal bond with a yield to maturity of 4.86 percent. If you are in
the 24 percent tax bracket, what is your equivalent corporate tax rate? Ignore state taxes.
A) 7.17 percent
B) 6.61 percent
C) 6.39 percent
D) 6.59 percent
E) 6.82 percent
Answer: C
Explanation: T* = .0486/(1 − .24)
T* = .0639, or 6.39%
Difficulty: 1 Easy
Bloom's: Apply
70) A corporate bond has a coupon rate of 6 percent, a $1,000 face value, and matures two years
from today. The corporation is in a serious financial situation and has announced that no future
annual interest payments will be paid and that only 50 percent of the face value will be repaid but
that payment will be delayed by one year. What is the current value of this bond to a bondholder
with a required rate of return of 14 percent?
A) $374.31
B) $358.40
C) $299.02
D) $337.49
E) $325.08
Answer: D
Explanation: Bond value0 = [.5($1,000)]/1.143
Bond value0 = $337.49
Difficulty: 1 Easy
Bloom's: Apply
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71) A corporate bond has a coupon rate of 5.5 percent, a $1,000 face value, and matures three
years from today. The corporation is in a serious financial situation and has announced that no
future annual interest payments will be paid and that the probability the entire face value will be
repaid is only 75 percent. If the entire face value cannot be paid, then 60 percent of the face
value will be repaid. All payments will be made three years from now. What is the current value
of this bond at a discount rate of 15 percent?
A) $591.76
B) $603.10
C) $611.90
D) $617.48
E) $622.04
Answer: A
Explanation: Bond value0 = {(.75($1,000) + .25[.60($1,000)]}/1.153
Bond value0 = $591.76
Difficulty: 1 Easy
Bloom's: Apply
72) Aivree is buying a $1,000 face value bond at a quoted price of 99.486. The bond carries a
coupon rate of 5.6 percent, with interest paid semiannually. The next interest payment is four
months from today. What is the clean price of this bond?
A) $994.86
B) $1,004.19
C) $1,013.53
D) $987.21
E) $1,005.73
Answer: A
Explanation: Clean price = 99.486%($1,000)
Clean price = $994.86
Difficulty: 1 Easy
Bloom's: Apply
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73) Nathan is buying a $1,000 face value bond at a quoted price of 101.364. The bond carries a
coupon rate of 7.75 percent, with interest paid semiannually. The next interest payment is two
months from today. What is the dirty price of this bond?
A) $1,039.47
B) $1,042.15
C) $1,056.02
D) $1,028.18
E) $1,026.56
Answer: A
Explanation: Dirty price = 101.364%($1,000) + .0775($1,000)(4/12)
Dirty price = $1,039.47
Difficulty: 1 Easy
Bloom's: Apply
74) Casey just purchased a $1,000 face value bond at an invoice price of $1,288.16. The bond
has a coupon rate of 6.2 percent, semiannual interest payments, and the next interest payment
occurs one month from today. Of the amount paid for the bond, what was the dollar amount of
the accrued interest?
A) $25.83
B) $5.17
C) $31.00
D) $27.39
E) $6.20
Answer: A
Explanation: Accrued interest = .062($1,000)(5/12)
Accrued interest = $25.83
Difficulty: 1 Easy
Topic: Accrued and implicit interest
Bloom's: Apply
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75) A corporate bond is currently quoted at 101.633. What is the market price of a bond with a
$1,000 face value?
A) $1,000.28
B) $1,002.77
C) $1,016.33
D) $1,102.77
E) $1,276.70
Answer: C
Explanation: Market price = 101.633%($1,000)
Market price = $1,016.33
Difficulty: 1 Easy
Bloom's: Apply
76) The 5-year bond of XYZ Corp. has a bid quote of 131.2891 and an asked quote of 131.3047.
Assume you purchase one of these bonds with a face value of $5,000 and a coupon rate of 7.4
percent, paid semiannually. The next interest payment will be paid two months from today. What
will be your invoice price for this purchase?
A) $7,220.01
B) $6,690.68
C) $6,809.47
D) $7,001.32
E) $6,549.30
Answer: B
Explanation: Invoice price = 131.347%($5,000) + (.074/2)(4/6)($5,000)
Invoice price = $6,690.68
Difficulty: 1 Easy
Section: 8.3 Bond price and quotes
Topic: Bond price and quotes
Bloom's: Apply
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77) Last year, a bond yielded a nominal return of 7.37 percent while inflation averaged 3.26
percent. What was the real rate of return?
A) 3.42 percent
B) 3.27 percent
C) 3.98 percent
D) 3.71 percent
E) 3.86 percent
Answer: C
Explanation: r = 1.0737/1.0326 − 1
r = .0398, or 3.98%
Difficulty: 1 Easy
Bloom's: Apply
78) A $1,000 par value bond carries a coupon rate of 6.5 percent and has a yield to maturity of
7.29 percent. The inflation rate is 3.13 percent. What is the bond's real rate of return?
A) 3.27 percent
B) 4.03 percent
C) 3.37 percent
D) 4.42 percent
E) 3.86 percent
Answer: B
Explanation: r = 1.0729/1.0313 − 1
r = .0403, or 4.03%
Difficulty: 1 Easy
Bloom's: Apply
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79) If a bond provides a real rate of return of 2.89 percent at a time when inflation is 3.21
percent, what is the nominal rate of return on the bond?
A) 6.10 percent
B) 6.13 percent
C) 6.16 percent
D) 6.19 percent
E) 6.22 percent
Answer: D
Explanation: R = 1.0289/1.0321 − 1
R = .0619, or 6.19%
Difficulty: 1 Easy
Bloom's: Apply
80) The nominal rate of return on a bond is 7.28 percent while the real rate is 3.09 percent. What
is the rate of inflation?
A) 4.06 percent
B) 4.28 percent
C) 4.09 percent
D) 4.13 percent
E) 4.17 percent
Answer: A
Explanation: h = 1.0728/1.0309 − 1
h = .0406, or 4.06%
Difficulty: 1 Easy
Bloom's: Apply
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81) Stu wants to earn a real return of 3.4 percent on any bond he acquires. The inflation rate is
2.8 percent. He has determined that a particular bond he is considering should have an interest
rate risk premium of .27 percent, a liquidity premium of .08 percent, and a taxability premium of
1.69 percent. What nominal rate of return is Stu demanding from this particular bond?
A) 8.34 percent
B) 7.19 percent
C) 8.40 percent
D) 7.38 percent
E) 8.74 percent
Answer: A
Explanation: Nominal return = [(1.034)(1.028) − 1] + .0027 + .0008 + .0169
Nominal return = .0834, or 8.34%
Difficulty: 1 Easy
Bloom's: Apply
82) Define what is meant by interest rate risk. Also, assume the manager of a $100 million
portfolio of corporate bonds predicts interest rates will rise in the near future. What adjustments
should be made to the portfolio assuming the market has not already adjusted for this prediction?
Answer: Interest rates and bond prices have an inverse relationship. It is this effect on bond
prices caused by changes in market interest rates that is referred to as interest rate risk. All else
the same, if interest rates are expected to rise, bond prices should be expected to decline. Since
short-term, high-coupon bonds are less sensitive to interest rate risk, the portfolio should be
moved into these types of securities to limit the downside risk.
Bloom's: Evaluate
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83) Interest rate risk is often explained by using the concept of a teeter-totter. Explain interest
rate risk and how it is related to the movements of a teeter-totter.
Answer: Interest rates sit on one end of the teeter-totter while bond prices sit on the other end.
As interest rates move up, bond prices move down as seen by the movements of a teeter-totter.
Likewise, as interest rates move down, bond prices move up. In addition, short-term bonds are
located a short distance from the fulcrum while long-term bonds are situated towards the end of
the teeter-totter, illustrating that long-term bonds move further in reaction to a change in interest
rates than do short-term bonds.
Bloom's: Analyze
84) Why do corporations issue 100-year bonds, knowing that interest rate risk is highest for very
long-term bonds? How does the interest rate risk affect the issuer?
Answer: Essentially, the issuer takes the opposite side of the interest rate risk position. By
issuing long-term bonds, the corporation is essentially betting that rates won't fall significantly. If
rates do decline, the corporation will incur a loss due to borrowing at rates higher than the future
market rates. On the other hand, if rates rise, the corporation benefits by having locked in its
borrowing rate for up to 100 years. In addition, these bonds are a source of long-term financing
where the interest is tax deductible. If the firm should issue stocks, the dividends would not be
tax deductible.
Bloom's: Analyze
85) Normally, the Treasury yield curve is upward-sloping. Explain the conditions required for a
downward-sloping yield curve to exist.
Answer: A downward-sloping yield curve exists when the expected inflation premium is
declining over time. The decline in the inflation premium must be significant enough to
overcome the interest rate risk premium, which increases with time.
Bloom's: Analyze
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86) Explain liquidity risk, default risk, and taxability risk. How does each of these risks affect the
yield of a bond?
Answer: Liquidity problems exist in thinly traded bonds making some bonds difficult to sell at
their actual value. The greater this difficulty, the higher the liquidity risk, and the higher the
premium demanded. Default risk is the likelihood the issuer will default on its bond obligations.
The higher this probability, the higher the default risk, and the higher the premium demanded.
Taxability risk reflects the fact that some bonds have their interest taxed at the federal, state, and
local levels, while others are taxed by only some, or none, of these governmental levels. The
more taxes that are applied to a bond's interest payments, the higher the premium demanded.
Bloom's: Analyze
87) Should investors be indifferent between two bonds which have equal market yields to
maturity as long as the bonds have the same bond rating? Can you think of any real-world factors
which might make a given investor prefer one of these bonds over the other?
Answer: The question only states the bonds have the same market yield to maturity and bond
rating. The market yield is comprised of several factors which may be valued differently by
different investors. One key difference is the taxability premium that each investor applies to a
bond. Since investors face different tax situations and tax rates, this premium can vary. Also, an
investor who plans on holding a bond until maturity will not place as much emphasis on the
liquidity premium as will an investor who plans to sell prior to maturity. Individual investors
may also differ in their outlook for inflation, causing each to assign a different inflation premium
to the same bond. Likewise, individual investors may have differing opinions on a bond's rating
as they may view the probability of default differently. Any one of these differences may cause
an investor to assign a discount rate to the bond that varies from that assigned by the overall
market. This can cause investors to have differing preferences on which bonds they prefer as
each bond's value depends on the discount rate used to value the bond's cash flows.
Bloom's: Evaluate
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Corporate Finance, 12e (Ross)

Chapter 9 Stock Valuation
1) Which one of these applies to the dividend growth model of stock valuation?
A) The dividend must be for the same time period as the stock price.
B) The growth rate must be less than the discount rate.
C) The rate of growth must be positive.
D) The model cannot be applied if the growth rate is zero.
E) The dividend amount must be constant over time.
Answer: B
Difficulty: 1 Easy
Section: 9.1 The Present Value of Common Stocks
Topic: Constant-growth stock
Bloom's: Understand
2) If a stock pays a constant annual dividend then the stock can be valued using the:
A) fixed coupon bond present value formula.
B) present value of an annuity due formula.
C) payout ratio formula.
D) present value of an ordinary annuity formula.
E) perpetuity present value formula.
Answer: E
Difficulty: 1 Easy
Topic: Stock valuation
Bloom's: Understand
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3) In the formula, P3 = Dx/(R − g), the dividend is for period:

A) two.
B) five.
C) four.
D) three.
E) one.
Answer: C
Difficulty: 1 Easy
Bloom's: Understand
4) The differential growth model of stock valuation:

A) makes allowance for one change in the discount rate.
B) uses DT + 1 as the dividend amount throughout the formula.
C) requires g2 to be less than the discount rate.
D) assumes the second growth rate will be zero.
E) assumes the first growth rate will be zero.
Answer: C
Difficulty: 1 Easy
Topic: Nonconstant-growth stock
Bloom's: Understand
5) The constant dividend growth model:

A) is more complex than the differential growth model.
B) requires the growth period be limited to a set number of years.
C) is never used because firms rarely attempt to maintain steady dividend growth.
D) can be used to compute a stock price at any point in time.
E) most applies to stocks with differential growth rates.
Answer: D
Difficulty: 1 Easy
Bloom's: Understand
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6) The underlying assumption of the dividend growth model is that a stock is worth:
A) the same amount to every investor regardless of their desired rate of return.
B) the present value of the future income that the stock is expected to generate.
C) an amount computed as the next annual dividend divided by the market rate of return.
D) the same amount as any other stock that pays the same current dividend and has the same
required rate of return.
E) an amount computed as the next annual dividend divided by the required rate of return.
Answer: B
Difficulty: 1 Easy
Bloom's: Understand
7) Assume you are using the dividend growth model to value stocks. If you expect the market
rate of return to increase across the board on all equity securities, then you should also expect
the:
A) market values of all stocks to increase.
B) market values of all stocks to remain constant as the dividend growth will offset the increase
in the market rate.
C) market values of all stocks to decrease.
D) stocks that do not pay dividends to decrease in price while the dividend-paying stocks
maintain a constant price.
E) dividend growth rates to increase to offset this change.
Answer: C
Difficulty: 1 Easy
Bloom's: Understand
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8) Latcher's is a relatively new firm that is still in a period of rapid development. The company
plans on retaining all of its earnings for the next six years. Seven years from now, the company
projects paying an annual dividend of $.25 a share and then increasing that amount by 3 percent
annually thereafter. To value this stock as of today, you would most likely determine the value of
the stock ________ years from today before determining today's value.
A) 4
B) 5
C) 6
D) 7
E) 8
Answer: C
Difficulty: 1 Easy
Bloom's: Understand
9) Phillips Co. currently pays no dividend. The company is anticipating dividends of $.02, $.05,
$.10, $.20, and $.30 over the next 5 years, respectively. After that, the company anticipates
increasing the dividend by 3.5 percent annually. One common step in computing the value of this
stock today is to compute the value of:
A) P1.
B) P3.
C) P4.
D) P5.
E) P6.
Answer: D
Difficulty: 1 Easy
Bloom's: Understand
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10) Next year's annual dividend divided by the current stock price is called the:
A) yield to maturity.
B) total yield.
C) dividend yield.
D) capital gains yield.
E) earnings yield.
Answer: C
Difficulty: 1 Easy
Section: 9.2 Estimates of Parameters in the Dividend Discount Model
Topic: Stock dividends and yields
Bloom's: Remember
11) The rate at which a stock's price is expected to appreciate (or depreciate) is called the
________ yield.
A) current
B) total
C) dividend
D) capital gains
E) earnings
Answer: D
Difficulty: 1 Easy
Topic: Stock dividends and yields
Bloom's: Remember
12) For a firm with a constant payout ratio, the dividend growth rate can be estimated as:
A) Payout ratio × Return on equity.
B) Return on assets × Retention ratio.
C) Return on equity × (1 + Retention ratio).
D) Payout ratio × Return on assets.
E) Return on retained earnings × Retention ratio.
Answer: E
Difficulty: 1 Easy
Topic: Growth rates
Bloom's: Understand
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13) The total return on a stock is equal to the:

A) dividend yield minus the capital gains yield.
B) dividend growth rate minus the dividend yield.
C) dividend yield plus the dividend growth rate.
D) growth rate of the dividends.
E) dividend divided by the sum of the dividend yield and capital gains yield.
Answer: C
Difficulty: 1 Easy
Topic: Stock returns and yields
Bloom's: Understand
14) A stock's PE ratio is primarily affected by which three factors?

A) Accounting practices, opportunities, and the market rate of return
B) Dividend yield, capital gains yield, and opportunities
C) Market rate of return, risk, opportunities
D) Accounting practices, market rate of return, risk
E) Risk, opportunities, accounting practices
Answer: E
Difficulty: 1 Easy
Bloom's: Understand
15) Which one of these factors generally has the greatest impact on a firm's PE ratio?
A) Required rate of return
B) Current dividends
C) Future opportunities
D) The overall risk level of the current firm
E) Depreciation method used by the firm
Answer: C
Difficulty: 1 Easy
Section: 9.3 Comparables
Topic: Price-earnings ratio
Bloom's: Understand
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16) The closing price of a stock is quoted at 32.08, with a PE of 21 and a net change of .36.
Based on this information, which one of the following statements is correct?
A) The closing price on the previous day was $.36 higher than today's closing price.
B) A dealer will buy the stock at $32.08 and sell it at $32.44 a share.
C) The current earnings per share equal $32.08/21 + $.36.
D) The current stock price is equivalent to 21 years of the firm's current earnings per share.
E) The earnings per share have increased by $.36 this year.
Answer: D
Difficulty: 1 Easy
Bloom's: Understand
17) A forward PE is generally based on the projected:

A) average earnings for the next five years.
B) average earnings for the next three years.
C) earnings for the upcoming quarter.
D) earnings for the next year.
E) stock price in one year.
Answer: D
Difficulty: 1 Easy
Bloom's: Understand
18) A stock that is considered to be low risk is most apt to have:

A) a low PE ratio.
B) unlimited growth.
C) a dividend yield of zero.
D) a high PE ratio.
E) a growth rate of zero.
Answer: D
Difficulty: 1 Easy
Bloom's: Understand
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19) Enterprise value equals the:

A) combined market value of debt and equity minus excess cash.
B) market value of equity minus the market value of debt plus excess cash.
C) market value of debt plus the book value of equity minus excess cash.
D) combined market value of debt and equity.
E) combined book value of debt and equity minus excess cash.
Answer: A
Difficulty: 1 Easy
Topic: Enterprise value and ratios
Bloom's: Understand
20) One advantage of the EV/EBITDA ratio over the PE ratio is the:
A) inclusion of depreciation charges.
B) increased reliance on leverage.
C) averaging of annual sales.
D) inclusion of all the firm's cash reserves.
E) lessened impact of leverage on the ratio.
Answer: E
Difficulty: 1 Easy
Bloom's: Understand
21) What amount of a firm's cash should be included in the enterprise value?
A) Only the amount needed to run the business
B) None of the cash should be included
C) Somewhere between 25 and 50 percent at the user's discretion
D) Only the amount necessary to maintain a constant EV/EBITDA ratio
E) The average cash balance over the past three years
Answer: A
Difficulty: 1 Easy
Bloom's: Understand
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22) The free cash flow model is most helpful for firms:
A) that have similar investment opportunities as other firms in their industry.
B) that pay steady dividends and have excess cash.
C) that are financially sound and thus pay constant, high dividends.
D) with external financing needs that are not paying dividends.
E) that are projected to grow at a constant, steady pace while increasing their dividends.
Answer: D
Difficulty: 1 Easy
Section: 9.4 Valuing Stocks Using Free Cash Flows
Topic: Free cash flow models and valuations
Bloom's: Understand
23) If the issuer of a stock receives the proceeds from a sale of that issuer's stock, then the sale:
A) had to have occurred on the floor of an exchange.
B) was a secondary market transaction.
C) was transacted on the NYSE.
D) was conducted in the primary market.
E) had to have been a limit order.
Answer: D
Difficulty: 1 Easy
Section: 9.5 The Stock Markets
Topic: Primary and secondary markets
Bloom's: Understand
24) Which one of these statements is correct?

A) Investors earn a return called a spread.
B) Dealers pay a fee, called the spread, to brokers.
C) Investors sell at the ask price.
D) Dealers buy at the bid price.
E) Brokers maintain an inventory of securities.
Answer: D
Difficulty: 1 Easy
Topic: Stock exchanges and markets
Bloom's: Understand
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25) Supplemental liquidity providers (SLPs):

A) act as floor brokers.
B) only represent stock purchasers.
C) seek the best price for their customers.
D) do not operate on the floor of a stock exchange.
E) have been replaced by designated market makers.
Answer: D
Difficulty: 1 Easy
Bloom's: Understand
26) A stop order to sell at $46 will be executed:

A) at a price of $46 at the end of the day on which the order was placed.
B) at $46 following the first trade with a price below $46.
C) as a market order once a trade occurs at a price of $46 or less.
D) immediately at a price of $46.
E) as a market order once a trade occurs at a price of $46 or higher.
Answer: C
Difficulty: 1 Easy
Bloom's: Understand
27) A limit order to buy:

A) guarantees the quantity purchased but not the price.
B) guarantees both the purchase price and the order fulfillment.
C) is executed only if the purchase price is less than the limit amount.
D) guarantees the purchase price but not the order execution.
E) will be executed either at the limit price or at the end-of-day price.
Answer: D
Difficulty: 1 Easy
Topic: Stock trading and strategies
Bloom's: Understand
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28) A day order to sell at a limit of $32 will be:

A) executed at the next available price once a trade occurs at the limit price.
B) cancelled at the end of the day if not executed.
C) executed only if the purchase price is less than the limit amount.
D) executed at the end-of-day price if $32 has not been obtained.
E) transferred to a market order on the following day if not executed at the limit price.
Answer: B
Difficulty: 1 Easy
Bloom's: Understand
29) NASDAQ:
A) has a single trading floor located in Chicago, Illinois.
B) has multiple trading floors.
C) is a designated market maker system.
D) has a multiple market maker system.
E) is closed to all electronic communications networks (ECNs).
Answer: D
Difficulty: 1 Easy
Bloom's: Understand
30) You recently contacted a brokerage firm and purchased 100 shares of stock. The brokerage
firm acquired the shares for you by making a deal with a floor broker who represented one of the
stock issuer's shareholders. Given this, you know your purchase:
A) was conducted in the secondary market.
B) occurred over-the-counter.
C) was for shares of a stock listed on NASDAQ.
D) occurred on an ECN.
E) involved the issuance of new shares.
Answer: A
Difficulty: 1 Easy
Topic: Primary and secondary markets
Bloom's: Understand
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31) Inside quotes on a stock are:

A) the prices available only to corporate insiders.
B) prices obtained only on the actual floor of an exchange.
C) prices available only to stock market employees.
D) the lowest asked quote and the highest bid quote.
E) prices paid that lie between yesterday's closing price and today's closing price.
Answer: D
Difficulty: 1 Easy
Topic: Stock market prices and reporting
Bloom's: Understand
32) Rosita's announced that its next annual dividend will be $1.65 a share and all future
dividends will increase by 2.5 percent annually. What is the maximum amount you should pay to
purchase a share of this stock if you require a rate of return of 12 percent?
A) $13.75
B) $17.80
C) $15.46
D) $16.94
E) $17.37
Answer: E
Explanation: P0 = $1.65/(.12 − .025)
P0 = $17.37
Bloom's: Apply
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33) How much are you willing to pay for one share of stock if the company just paid an annual
dividend of $1.03, the dividends increase by 3 percent annually, and you require a rate of return
of 15 percent?
A) $8.58
B) $9.49
C) $10.40
D) $8.84
E) $6.87
Answer: D
Explanation: P0 = [$1.03(1.03)]/(.15 − .03)
P0 = $8.84
Bloom's: Apply
34) Upland Motors recently paid a per share dividend of $1.48. Dividends are expected to
increase by 2.5 percent annually. What is one share of this stock worth today if the appropriate
discount rate is 14 percent?
A) $12.87
B) $13.04
C) $14.16
D) $13.19
E) $12.25
Answer: D
Explanation: P0 = [$1.48(1.025)]/(.14 − .025)
P0 = $13.19
Bloom's: Apply
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35) MJ Enterprises stock traditionally provides an average rate of return of 11.6 percent. The
firm's next annual dividend is projected at $2.40 with future increases of 3 percent per year. What
price should you pay for this stock if you are satisfied with the firm's average rate of return?
A) $28.74
B) $22.50
C) $27.91
D) $28.89
E) $21.31
Answer: C
Explanation: P0 = $2.40/(.116 − .03)
P0 = $27.91
Bloom's: Apply
36) Unique Stores common stock pays a constant annual dividend of $1.75 a share. What is the
value of this stock at a discount rate of 13.25 percent?
A) $12.50
B) $13.33
C) $13.21
D) $12.88
E) $14.18
Answer: C
Explanation: P0 = $1.75/.1325
P0 = $13.21
Bloom's: Apply
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37) Martin's Yachts is expected to pay annual dividends of $1.40, $1.75, and $2.00 a share over
the next three years, respectively. After that, the dividend is expected to remain constant. What is
the current value per share at a discount rate of 14 percent?
A) $12.22
B) $13.57
C) $13.08
D) $12.82
E) $13.39
Answer: B
2 2
Explanation: P0 = $1.40/1.14 + $1.75/1.14 + ($2.00/.14)/1.14
P0 = $13.57
Bloom's: Analyze
38) Weisbro and Sons common stock sells for $21 a share and pays an annual dividend that
increases by 5 percent each year. The rate of return on this stock is 9 percent. What is the amount
of the last dividend paid?
A) $.77
B) $.80
C) $.84
D) $.87
E) $.88
Answer: B
Explanation: $21 = D0(1.05)/(.09 − .05)
D0 = $.80
Bloom's: Analyze
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39) The common stock of Energy Saver pays an annual dividend that is expected to increase by 4
percent annually. The stock commands a market rate of return of 12 percent and sells for $58.25
a share. What is the expected amount of the next dividend to be paid?
A) $4.87
B) $5.02
C) $5.10
D) $4.66
E) $4.33
Answer: D
Explanation: $58.25 = D1/(.12 − .04)
D1 = $4.66
Bloom's: Analyze
40) The Reading Co. has adopted a policy of increasing the annual dividend on its common stock
at a constant rate of 3 percent annually. The last dividend it paid (T = 0) was $.90 a share. What
will be the company's dividend six years from now?
A) $.90
B) $.93
C) $1.04
D) $1.07
E) $1.11
Answer: D
6
Explanation: D6 = $.90(1.03 )
D6 = $1.07
Bloom's: Analyze
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41) You have decided to purchase shares of GHC but need an expected 12 percent rate of return
to compensate for the perceived risk of such ownership. What is the maximum price you should
pay per share if the company pays a constant $2.70 annual dividend per share?
A) $23.04
B) $22.50
C) $32.67
D) $34.29
E) $21.59
Answer: B
Explanation: P = $2.70/.12
P = $22.50
Bloom's: Apply
42) T&P common stock sells for $23.43 a share at a market rate of return of 11.65 percent. The
company just paid its annual dividend of $1.20. What is the dividend growth rate?
A) 5.87 percent
B) 6.43 percent
C) 5.91 percent
D) 6.07 percent
E) 6.21 percent
Answer: E
Explanation: $23.43 = [$1.20(1 + g)]/(.1165 − g)
g = .0621, or 6.21%
Bloom's: Analyze
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43) S&P Enterprises will pay an annual dividend of $2.08 a share on its common stock next year.
The firm just paid a dividend of $2.00 a share and adheres to a constant rate of growth dividend
policy. What will one share of S&P common stock be worth ten years from now if the applicable
discount rate is 8 percent?
A) $71.16
B) $74.01
C) $76.97
D) $80.05
E) $83.25
Answer: C
Explanation: g = ($2.08 − 2.00)/$2.00
g = .04
10
P10 = [$2.08(1.04 )]/(.08 − .04)
P10 = $76.97
Bloom's: Analyze
44) The Merriweather Co. just announced that it will pay a dividend next year of $1.60. The
company will then increase its dividend by 10 percent per year for two years after which it will
maintain a constant 2 percent dividend growth rate. What is one share worth today at a required
rate of return of 14 percent?
A) $21.60
B) $15.17
C) $23.14
D) $23.95
E) $24.79
Answer: B
2 2 3 2
Explanation: P0 = $1.60/1.14 + [$1.60(1.10)]/1.14 + [$1.60(1.10 )]/1.14 + {[$1.60(1.10 )
3
(1.02)]/(.14 − .02)}/1.14
P0 = $15.17
Bloom's: Analyze
20

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45) The Bell Weather Co. is a new firm in a rapidly growing industry. The company is planning
on increasing its annual dividend by 20 percent next year and then decreasing the growth rate to
a constant 5 percent per year. The company just paid its annual dividend in the amount of $1 per
share. What is the current value of a share if the required rate of return is 14 percent?
A) $13.28
B) $13.42
C) $13.33
D) $13.19
E) $13.24
Answer: C
Explanation: P0 = [$1(1.20)]/1.14 + {[($1(1.20)(1.05)]/(.14 − .05)}/1.14
P0 = $13.33
Topic: Supernormal growth stock
Bloom's: Analyze
46) New Corp. just paid a per share annual dividend of $1.50. The company is planning on
paying $1.62, $1.68, $1.75, and $1.80 a share over the next four years, respectively. After that
the dividend will be a constant $2.00 per share per year. What is the market price of this stock if
the market rate of return is 15 percent?
A) $6.00
B) $8.49
C) $12.48
D) $11.57
E) $9.09
Answer: C
2 3 4 4
Explanation: P0 = $1.62/1.15 + $1.68/1.15 + $1.75/1.15 + $1.80/1.15 + ($2.00/.15)/1.15
P0 = $12.48
Bloom's: Analyze
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47) Alpha Industries is going to pay annual dividends of $.35, $.50, and $.80 a share over the
next three years, respectively. After that, the dividend will be $1.25 per share indefinitely. What
is this stock worth today at a discount rate of 13.45 percent?
A) $6.20
B) $9.48
C) $10.88
D) $7.61
E) $5.06
Answer: D
2 3 3
Explanation: P0 = $.35/1.1345 + $.50/1.1345 + $.80/1.1345 + ($1.25/.1345)/1.1345
P0 = $7.61
Bloom's: Analyze
48) City Movers announced its next annual dividend will be $.40 a share. The following
dividends will be $.60, and $.75 a share annually for the following two years, respectively. After
that, dividends are projected to increase by 3.5 percent per year. How much is one share of this
stock worth at a rate of return of 12 percent?
A) $8.45
B) $6.84
C) $7.87
D) $8.06
E) $7.03
Answer: C
2 3
Explanation: P0 = $.40/1.12 + $.60/1.12 + $.75/1.12 + {[$.75(1.035)]/(.12 − .
3
035)}/1.12
P0 = $7.87
Bloom's: Analyze
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49) DC Motors recently paid $1.10 as its annual dividend. Future dividends are projected at
$1.06, $1.02, and $1.00 over the next three years, respectively. After that, the dividend is
expected to decrease by 2 percent annually. What is one share of this stock worth at a rate of
return of 17 percent?
A) $5.62
B) $5.50
C) $5.21
D) $5.33
E) $5.98
Answer: B
2 3
Explanation: P0 = $1.06/1.17 + $1.02/1.17 + $1.00/1.17 + ({$1.00[1 + (−.02)]}/(.17
3
− (−.02))/1.17
P0 = $5.50
Bloom's: Analyze
50) Ancient Industries just paid a dividend of $1.03 a share. The company announced today that
it expects to pay $.90 a share next year and a final liquidating dividend of $18.44 in two years.
What is one share of this stock worth today if the required rate of return is 16 percent?
A) $14.94
B) $14.48
C) $13.23
D) $13.44
E) $13.60
Answer: B
2
Explanation: P0 = $.90/1.16 + $18.44/1.16
P0 = $14.48
Bloom's: Apply
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51) A company plans to pay an annual dividend of $.30 a share for two years commencing two
years from today. After that time, a constant $1 a share annual dividend is planned indefinitely.
Given a required return of 14 percent, what is the current value of this stock?
A) $4.82
B) $5.25
C) $5.39
D) $5.46
E) $5.58
Answer: B
2 3 3
Explanation: P0 = $.30/1.14 + $.30/1.14 + ($1/.14)/1.14
P0 = $5.25
Bloom's: Analyze
52) The Elder Co. is in downsizing mode. The company paid an annual dividend of $2.50 last
year. The company has announced plans to lower the dividend by $.50 a year. Once the dividend
amount becomes zero, the company will cease all dividends permanently. The required rate of
return is 14.5 percent. What is one share of this stock worth?
A) $3.85
B) $3.48
C) $4.87
D) $4.13
E) $4.39
Answer: A
2 3 4
Explanation: P0 = $2.00/1.145 + $1.50/1.145 + $1.00/1.145 + $.50/1.145
P0 = $3.85
Bloom's: Analyze
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53) M&D Enterprises paid its first annual dividend yesterday in the amount of $.28 a share. The
company plans to double each annual dividend payment for the next three years. After that time,
it plans to pay a constant $2.25 per share indefinitely. What is one share of this stock worth today
if the market rate of return on similar securities is 11.5 percent?
A) $19.41
B) $18.40
C) $17.46
D) $16.93
E) $17.13
Answer: E
Explanation: Dividends for the next three years are $.56, $1.12, and $2.24.
2 3 3
P0 = $.56/1.115 + $1.12/1.115 + $2.24/1.115 + ($2.25/.115)/1.115
P0 = $17.13
Bloom's: Analyze
54) BC 'n D just paid its annual dividend of $.60 a share. The projected dividends for the next
five years are $.30, $.50, $.75, $1.00, and $1.20, respectively. After that time, the dividends will
be held constant at $1.40 per share. What is this stock worth today at a discount rate of 14
percent?
A) $7.56
B) $10.60
C) $8.02
D) $9.28
E) $9.43
Answer: A
2 3 4 5
Explanation: P0 = $.30/1.14 + $.50/1.14 + $.75/1.14 + $1.00/1.14 + $1.20/1.14 +
5
($1.40/.14)/1.14
P0 = $7.56
Bloom's: Analyze
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55) JK Inc. is a very cyclical type of business which is reflected in its dividend policy. The firm
pays a dividend of $2.00 a share every other year with the last payment having just been paid.
Five years from now, the company is repurchasing all of the outstanding shares at a price of $50
a share. What is the current value of one share at a discount rate of 12 percent?
A) $34.03
B) $31.24
C) $33.78
D) $27.89
E) $34.99
Answer: B
2 4 5
Explanation: P0 = $2/1.12 + $2/1.12 + $50/1.12
P0 = $31.24
Bloom's: Analyze
56) Yesterday, Railway Tours paid its annual dividend of $1.20 per share. The company has been
reducing the dividends by 10 percent each year. What is the value of this stock at a discount rate
of 13 percent?
A) $4.70
B) $3.71
C) $8.31
D) $36.00
E) $27.00
Answer: A
Explanation: P0 = {$1.20[1 + (−.10)]}/[.13 − (−.10)]
P0 = $4.70
Bloom's: Analyze
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57) Nu-Tech is expecting a period of intense growth and has decided to reduce its annual
dividend by 10 percent a year for the next two years. After that, it will maintain a constant
dividend of $.70 a share. The company just paid $1.80 per share. What is the value of this stock
if the required rate of return is 13 percent?
A) $6.99
B) $6.79
C) $8.22
D) $8.87
E) $7.62
Answer: B
2 2
Explanation: P0 = {$1.80[1 + (−.10)]}/1.13 + {$1.80[1 + (−.10)] }/1.13 +
2
($.70/.13)/1.13
P0 = $6.79
Bloom's: Analyze
58) What would be the maximum an investor should pay for the common stock of a firm that has
no growth opportunities but pays a dividend of $1.36 per year? The required rate of return is 12.5
percent.
A) $9.52
B) $10.88
C) $11.24
D) $10.64
E) $11.47
Answer: B
Explanation: P0 = $1.36/.125
P0 = $10.88
Bloom's: Apply
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59) The Felix Corp. will pay an annual dividend of $1.00 next year. The dividend will increase
by 12 percent a year for the following two years before growing at 4 percent indefinitely
thereafter. If the required rate of return is 10 percent, what is the stock's current value?
A) $13.38
B) $14.05
C) $19.11
D) $9.80
E) $10.38
Answer: C
2 2 3 2
Explanation: P0 = $1.00/1.10 + $1.12/1.10 + $1.12 /1.10 + {[$1.12 (1.04)]/(.10 − .
3
04)}/1.10
P0 = $19.11
Bloom's: Analyze
60) A company just paid an annual dividend of $.40 a share and plans to increase the dividend by
7 percent a year for the next 6 years and then increase it by 4 percent annually thereafter. What is
the value of this stock at the end of Year 6 if the discount rate is 11 percent?
A) $10.63
B) $8.92
C) $9.68
D) $10.21
E) $9.37
Answer: B
6
Explanation: P6 = [$.40(1.07 )(1.04)]/(.11 − .04)
P6 = $8.92
Bloom's: Analyze
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61) Wilbert's Clothing Stores just paid an annual dividend of $1.20 and increases its dividend by
2.5 percent annually. You would like to purchase 100 shares of stock in this firm but realize that
you will not have the funds to do so for another three years. If you desire a rate of return of 10
percent, how much should you expect to pay for 100 shares when you can afford to buy this
stock? Ignore trading costs.
A) $1,640
B) $1,681
C) $1,723
D) $1,766
E) $1,810
Answer: D
4
Explanation: P3 = [$1.20(1.025 )]/(.10 − .025)
P3 = $17.66
Purchase cost = 100($17.66)
Purchase cost = $1,766
Bloom's: Analyze
62) Uptown Clothing just paid $1.50 as its annual dividend and increases its dividend by 2.5
percent each year. What will Uptown's stock price be in ten years at a discount rate of 12.25
percent?
A) $19.46
B) $22.08
C) $20.19
D) $19.70
E) $21.50
Answer: C
11
Explanation: P10 = [$1.50(1.025 )]/(.1225 − .025)
P10 = $20.19
Bloom's: Analyze
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63) Merriweather's has a policy of increasing its annual dividend by 1.75 percent each year. How
much will one share be worth five years from now if the required rate of return is 15 percent and
the next dividend will be $3.40?
A) $28.48
B) $27.99
C) $34.84
D) $28.60
E) $32.78
Answer: B
5
Explanation: P5 = [$3.40(1.0175 )]/(.15 − .0175)
P5 = $27.99
Bloom's: Analyze
64) A stock pays a constant annual dividend and sells for $31.11 a share. If the dividend yield of
this stock is 9 percent, what is the dividend amount?
A) $1.40
B) $1.80
C) $2.20
D) $2.40
E) $2.80
Answer: E
Explanation: .09 = D/$31.11
D = $2.80
Bloom's: Apply
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65) The common stock of Fine China sells for $38.42 a share. The stock is expected to pay an
annual dividend of $1.80 next year and increase that amount by 4 percent annually thereafter.
What is the market rate of return on this stock?
A) 9.04 percent
B) 9.13 percent
C) 8.69 percent
D) 9.22 percent
E) 8.36 percent
Answer: C
Explanation: R = $1.80/$38.42 + .04
R = .0869, or 8.69%
Bloom's: Apply
66) Logistics just paid an annual dividend of $2.20 and announced that all future dividends
would be $2.25 a share indefinitely. What is your required rate of return if you are willing to pay
$15.25 a share for this stock?
A) 14.75 percent
B) 16.07 percent
C) 13.88 percent
D) 13.67 percent
E) 14.50 percent
Answer: A
Explanation: R = $2.25/$15.25
R = .1475, or 14.75%
Bloom's: Apply
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67) Martha's recently paid an annual dividend of $3.60 on its common stock. This dividend
increases by 2.5 percent per year. What is the market rate of return if the stock is selling for
$32.65 a share?
A) 12.57 percent
B) 13.45 percent
C) 15.55 percent
D) 16.05 percent
E) 13.80 percent
Answer: E
Explanation: R = [$3.60(1.025)]/$32.65 + .025
R = .1380, or 13.80%
Bloom's: Analyze
68) Bikes and More just announced its next annual dividend will be $2.42 a share and all future
dividends will increase by 2.5 percent annually. What is the market rate of return if this stock is
currently selling for $22 a share?
A) 13.62 percent
B) 13.84 percent
C) 13.58 percent
D) 13.50 percent
E) 13.46 percent
Answer: D
Explanation: R = $2.42/$22 + .025
R = .1350, or 13.50%
Bloom's: Analyze
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69) Shares of the Samson Co. offer an expected total return of 12 percent. The dividend is
increasing at a constant 3.25 percent per year. What is the value of the next dividend if the stock
is selling at $28 a share?
A) $2.50
B) $2.45
C) $2.78
D) $2.34
E) $2.10
Answer: B
Explanation: .12 = D1/$28 + .0325
D1 = $2.45
Bloom's: Analyze
70) A stock had a total return of 9.62 percent last year. The dividend amount was $.70 a share
which equated to a dividend yield of 2.39 percent. What is the dividend growth rate?
A) 7.06 percent
B) 4.03 percent
C) 7.23 percent
D) 5.48 percent
E) 2.48 percent
Answer: C
Explanation: g = .0962 − .0239
g = .0723, or 7.23%
Bloom's: Apply
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71) Lory Company had net earnings of $127,000 this past year of which $46,200 was paid out in
dividends. The company's equity was $1,587,500. Lory has 200,000 shares outstanding with a
current market price of $11.63 per share. Both the number of shares and the dividend payout
ratio are constant. What is the required rate of return if the growth rate is 5.6 percent?
A) 8.42 percent
B) 6.67 percent
C) 7.70 percent
D) 7.39 percent
E) 8.24 percent
Answer: C
Explanation: R = [($46,200/200,000)(1.056)]/$11.63 + .056
R = .0770, or 7.70%
Topic: Required return
Bloom's: Analyze
72) Engine Builders stock sells for $24.20 a share. The firm just paid an annual dividend of $2
per share and has a long-established record of increasing its dividend by a constant 2.5 percent
annually. What is the market rate of return on this stock?
A) 10.97 percent
B) 14.41 percent
C) 10.70 percent
D) 12.34 percent
E) 11.46 percent
Answer: A
Explanation: R = [$2(1.025)]/$24.20 + .025
R = .1097, or 10.97%
Bloom's: Analyze
34

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73) Dexter's has a fixed dividend payout ratio of 40 percent, current net income of $5,200, total
assets of $56,400, and total equity of $21,600. Given this information, what estimate would you
use as the dividend growth rate if the last dividend paid was $.464 per share?
A) 9.63 percent
B) 3.69 percent
C) 12.84 percent
D) 8.61 percent
E) 14.44 percent
Answer: E
Explanation: g = (1 − .40)($5,200/$21,600)
g = .1444, or 14.44%
Topic: Growth rates
Bloom's: Analyze
74) The dividend yield on Alpha's common stock is 5.2 percent. The company just paid a $2.10
dividend. The rumour is that the dividend will be $2.30 next year. The dividend growth rate is
expected to remain constant at the current level. What is the required rate of return on Alpha's
stock?
A) 14.72 percent
B) 12.31 percent
C) 18.29 percent
D) 20.01 percent
E) 24.21 percent
Answer: A
Explanation: R = .052 + ($2.30 − 2.10)/$2.10
R = .1472, or 14.72%
Bloom's: Analyze
35

lOMoARcPSD|36730661
75) Lester's has a return on equity of 11.6 percent, a profit margin of 6.2 percent, and a payout
ratio of 35 percent. What is the firm's growth rate?
A) 13.74 percent
B) 7.54 percent
C) 11.09 percent
D) 8.77 percent
E) 9.71 percent
Answer: B
Explanation: g = .116(1 − .35)
g = .0754, or 7.54%
Topic: Growth rates
Bloom's: Analyze
76) Rudy's stock is currently valued at $28.40 a share. The firm had earnings per share of $1.86
last year and projects earnings of $2.09 a share for next year. What is the trailing twelve month
price-earnings ratio?
A) 13.59
B) 14.38
C) 12.84
D) 16.67
E) 15.27
Answer: E
Explanation: PETTM = $28.40/$1.86
PETTM = 15.27
Bloom's: Apply
36

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77) L&R's stock is currently valued at $32.70 a share. The firm had earnings per share of $1.88
last year and projects earnings of $2.10 a share for next year. What is the forward price-earnings
ratio?
A) 15.57
B) 14.38
C) 17.39
D) 16.43
E) 15.06
Answer: A
Explanation: PEForward = $32.70/$2.10
PEForward = 15.57
Bloom's: Apply
78) Russell's has annual revenue of $387,000 with costs of $216,400. Depreciation is $48,900
and the tax rate is 21 percent. The firm has debt outstanding with a market value of $182,000
along with 9,500 shares of stock that is selling at $67 a share. The firm has $48,000 of cash of
which $29,500 is needed to run the business. What is the firm's EV/EBITDA ratio?
A) 5.57
B) 4.69
C) 3.39
D) 3.93
E) 6.20
Answer: B
Explanation: EV/EBITDA = [$182,000 + 9,500($67) − ($48,000 − 29,500)]/
($387,000 − 216,400)
EV/EBITDA = 4.69
Bloom's: Apply
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79) Kurt's Interiors has annual revenue of $506,000 with costs of $369,400. Depreciation is
$64,900 and the tax rate is 21 percent. The firm has debt outstanding with a market value of
$240,000 along with 7,500 shares of stock that is valued at $87 a share. The firm has $51,200 of
cash, all of which is needed to run the business. What is the firm's EV/EBITDA ratio?
A) 6.37
B) 6.53
C) 5.39
D) 6.15
E) 6.28
Answer: B
Explanation: EV/EBITDA = [$240,000 + 7,500($87) − ($51,200 − 51,200)/
($506,000 − 369,400)
EV/EBITDA = 6.53
Bloom's: Apply
80) Jaxon's has total revenue of $418,300, earnings before interest and taxes of $102,600,
depreciation of $59,200, and a tax rate of 21 percent. The firm is all-equity financed with 15,000
shares outstanding at a book value of $38.03 a share and a price-to-book ratio of 3.2. What is the
firm's EV/EBITDA ratio if the firm has excess cash of $49,300?
A) 9.67
B) 11.28
C) 8.39
D) 9.15
E) 10.98
Answer: E
Explanation: EV/EBITDA = [15,000($38.03)(3.2) − $49,300]/($102,600 +
59,200)
EV/EBITDA = 10.98
Bloom's: Apply
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81) Allison's is expected to have annual free cash flow of $62,000, $65,400, and $68,900 for the
next three years, respectively. After that, the free cash flow is expected to increase at a constant
rate of 2 percent per year. At a discount rate of 14.5 percent, what is the present value of this
firm?
A) $469,118
B) $603,509
C) $577,088
D) $524,467
E) $497,364
Answer: D
2 3
Explanation: PV = $62,000/1.145 + $65,400/1.145 + $68,900/1.145 + [$68,900(1.02)/
3
(.145 − .02)]/1.145
PV = $524,467
Bloom's: Analyze
82) Danielsen's has 15,000 shares of stock outstanding and projected annual free cash flows of
$48,200, $57,900, $71,300, and $72,500 for the next four years, respectively. After that, the cash
flows are expected to increase at a constant annual rate of 1.6 percent. What is the current value
per share of stock at a discount rate of 15.4 percent?
A) $31.57
B) $29.06
C) $28.99
D) $26.14
E) $34.08
Answer: A
2 3 4
Explanation: P0 = {$48,200/1.154 + $57,900/1.154 + $71,300/1.154 + $72,500/1.154 +
4
[$72,500(1.016)/(.154 − .016)]/1.154 }/15,000
P0 = $31.57
Bloom's: Analyze
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83) A number of publicly traded firms pay no dividends yet investors are willing to buy shares in
these firms. How is this possible? Does this violate our basic principle of stock valuation?
Explain.
Answer: Our basic principle of stock valuation is that the value of a share of stock is simply
equal to the present value of all the expected future cash flows from the stock. According to the
dividend growth model, an asset that has no expected cash flows has a value of zero, so if
investors are willing to purchase shares of stock in firms that pay no dividends, they evidently
expect that the firms will begin paying dividends at some point in the future. If no dividends are
ever expected, investors are most likely expecting the firm will be sold in the future and a cash
flow will occur at that time.
Bloom's: Analyze
84) What are the components of the required rate of return on a share of stock? Briefly explain
each component.
Answer: The two components are dividend yield, which measures the annual percentage income
return on a stock from its dividend payments, and the capital gains yield, which is the annual
percentage of price appreciation or depreciation.
Difficulty: 1 Easy
Bloom's: Understand
85) Explain whether it is easier to find the required return on a publicly traded stock or a publicly
traded bond, and explain why.
Answer: Bonds, unlike stocks, have a final maturity date and promised payments at fixed
periods of time. Thus, once an appropriate discount rate is established, valuing a bond is
relatively simple. For stocks, the only valuation model we have up to this point in the text is the
dividend growth model which requires estimation of a dividend growth rate and also requires
that certain conditions be met before the dividend growth model can be applied. Normally, all of
the information required to find the yield on a publicly traded bond is publicly available while
only the price and the most current dividend are available for stocks.
Bloom's: Analyze
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86) What is the difference between the EV/EBITDA ratio and the PE ratio?
Answer: The PE ratio is an all-equity ratio whereby the numerator is the price per share of stock
and the denominator is the earnings per share of stock. The enterprise value includes both debt
and equity components for a total firm valuation. In the enterprise value to EBITDA ratio, the
numerator is the market value of the firm's equity plus the market value of the firm's debt minus
excess cash. The denominator, EBITDA, is the earnings before interest, taxes, depreciation, and
amortization. Using EV/EBITDA allows the analyst to account for total firm value, taking into
account both debt and equity, thereby adjusting for leverage when comparing firms in the same
industry.
Bloom's: Analyze
87) Explain the differences between a market order, a limit order, and a stop order.
Answer: A market order will be executed immediately at the best price available, which is
unknown before order execution. A limit order will be executed only at the limit price, or better,
but whether or not the order will be executed is unknown. A stop order will convert to a market
order once the market price hits the stop order price.
Bloom's: Analyze
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Corporate Finance, 12e (Ross)

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12) The market price of a bond increases when the:

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17) A zero coupon bond:

18) Which one of these bonds is the most interest-rate sensitive?

19) The yield to maturity:

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24) The interest paid on any municipal bond is:

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27) Most of the trading in bonds is conducted:

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29) The dirty price of a bond is defined as the:

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35) An increase in the rate of inflation will:

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43) The term structure of interest rates reflects the:

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44) An upward-sloping term structure of interest rates indicates that:

45) The term structure of interest rates:

46) The term structure of interest rates:

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Corporate Finance, 12e (Ross)

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3) In the formula, P3 = Dx/(R − g), the dividend is for period:

4) The differential growth model of stock valuation:

5) The constant dividend growth model:

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