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Which of the following is NOT normally regarded as being a good reason to establish an ESOP? Answer To enable the firm to borrow at a below-market interest rate. To make it easier to grant stock options to employees. To help prevent a hostile takeover. To help retain valued employees. To increase worker productivity. Which of the following is NOT normally regarded as being a barrier to hostile takeovers? Answer Targeted share repurchases. Shareholder rights provisions. Restricted voting rights. Poison pills. Abnormally high executive compensation. Which of the following statements is NOT correct? Answer After a 3-for-1 stock split, a company’s price per share should fall, but the number of shares outstanding will rise. Investors can interpret a stock repurchase program as a signal that the firm’s managers believe the stock is undervalued. Companies can repurchase shares to distribute large inflows of cash, say from the sale of a division, to stockholders without paying cash dividends. Stockholders pay no income tax on dividends if the dividends are used to purchase stock through a dividend reinvestment plan. Stock repurchases can be used by a firm as part of a plan to change its capital structure. Which of the following statements is CORRECT? Answer Back before the SEC was created in the 1930s, companies would declare reverse splits in order to boost their stock prices. However, this was determined to be a deceptive practice, and it is illegal today. Stock splits create more administrative problems for investors than stock dividends, especially determining the tax basis of their shares when they decide to sell them, so today stock dividends are used far more often than stock splits. When a company declares a stock split, the price of the stock typically declines¾by about 50% after a 2-for-1 split¾and this necessarily reduces the total market value of the equity. If a firm’s stock price is quite high relative to most stocks¾say $500 per share¾then it can declare a stock split of say 10-for-1 so as to bring the price down to something close to $50. Moreover, if the price is relatively low¾say $2 per share¾then it can declare a “reverse split” of say 1-for-25 so as to bring the price up to somewhere around $50 per share. When firms are deciding on the size of stock splits¾say whether to declare a 2-for-1 split or a 3-for-1 split, it is best to declare the smaller one, in this case the 2-for-1 split, because then the after-split price will be higher than if the 3-for-1 split had been used. Which of the following statements is correct? Answer Capital gains earned in a share repurchase are taxed less favorably than dividends; this explains why companies typically pay dividends and avoid share repurchases. Very often, a company’s stock price will rise when it announces that it plans to commence a share repurchase program. Such an announcement could lead to a stock price decline, but this does not normally happen. Stock repurchases increase the number of outstanding shares. The clientele effect is the best explanation for why companies tend to vary their dividend payments from quarter to quarter. If a company has a 2-for-1 stock split, its stock price should roughly double. Which of the following statements is correct? Answer One nice feature of dividend reinvestment plans (DRIPs) is that they reduce the taxes investors would have to pay if they received cash dividends. Empirical research indicates that, in general, companies send a negative signal to the marketplace when they announce an increase in the dividend, and as a result share prices fall when dividend increases are announced. The reason is that investors interpret the increase as a signal that the firm has relatively few good investment opportunities. If a company wants to raise new equity capital rather steadily over time, a new stock dividend reinvestment plan would make sense. However, if the firm does not want or need new equity, then an open market purchase dividend reinvestment plan would probably make more sense. Dividend reinvestment plans have not caught on in most industries, and today about 99% of all companies with DRIPs are utilities. Under the tax laws as they existed in 2008, a dollar received for repurchased stock must be taxed at the same rate as a dollar received as dividends. Rohter Galeano Inc. is considering how to set its dividend policy. It has a capital budget of $3,000,000. The company wants to maintain a target capital structure that is 15% debt and 85% equity. The company forecasts that its net income this year will be $3,500,000. If the company follows a residual dividend policy, what will be its total dividend payment? Answer $205,000 $500,000 $950,000 $2,550,000 $3,050,000 If a firm adheres strictly to the residual dividend policy, the issuance of new common stock would suggest that Answer the dividend payout ratio is increasing. no dividends were paid during the year. the dividend payout ratio is decreasing. the dollar amount of investments has decreased. the dividend payout ratio has remained constant. Which of the following actions will best enable a company to raise additional equity capital? Answer Declare a stock split. Begin an open-market purchase dividend reinvestment plan. Initiate a stock repurchase program. Begin a new-stock dividend reinvestment plan. Refund long-term debt with lower cost short-term debt. Based on the information below for Benson Corporation, what is the optimal capital structure? Answer Debt = 50%; Equity = 50%; EPS = $3.05; Stock price = $28.90. Debt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20. Debt = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.40. Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.00. Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $26.50. Which of the following statements is CORRECT? Answer The capital structure that minimizes the interest rate on debt also maximizes the expected EPS. The capital structure that minimizes the required return on equity also maximizes the stock price. The capital structure that minimizes the WACC also maximizes the price per share of common stock. The capital structure that gives the firm the best credit rating also maximizes the stock price. The capital structure that maximizes expected EPS also maximizes the price per share of common stock. Which of the following statements is CORRECT? Answer If a firm lowered its fixed costs while increasing its variable costs, holding total costs at the present level of sales constant, this would decrease its operating leverage. The debt ratio that maximizes EPS generally exceeds the debt ratio that maximizes share price. If a company were to issue debt and use the money to repurchase common stock, this action would have no impact on its basic earning power ratio. (Assume that the repurchase has no impact on the company’s operating income.) If changes in the bankruptcy code made bankruptcy less costly to corporations, this would likely reduce the average corporation’s debt ratio. Increasing financial leverage is one way to increase a firm’s basic earning power (BEP). Which of the following is NOT associated with (or does not contribute to) business risk? Recall that business risk is affected by a firm’s operations. Answer Sales price variability. The extent to which operating costs are fixed. The extent to which interest rates on the firm’s debt fluctuate. Input price variability. Demand variability. Which of the following would increase the likelihood that a company would increase its debt ratio, other things held constant? Answer An increase in the corporate tax rate. An increase in the personal tax rate. The Federal Reserve tightens interest rates in an effort to fight inflation. The company’s stock price hits a new low. An increase in costs incurred when filing for bankruptcy Which of the following statements is CORRECT? Answer Since debt financing is cheaper than equity financing, raising a company’s debt ratio will always reduce its WACC. Increasing a company’s debt ratio will typically reduce the marginal cost of both debt and equity financing. However, this action still may raise the company’s WACC. Increasing a company’s debt ratio will typically increase the marginal cost of both debt and equity financing. However, this action still may lower the company’s WACC. Since a firm’s beta coefficient it not affected by its use of financial leverage, leverage does not affect the cost of equity. Since debt financing raises the firm’s financial risk, increasing a company’s debt ratio will always increase its WACC Which of the following statements is CORRECT? Answer The optimal capital structure simultaneously maximizes EPS and minimizes the WACC. The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price. The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, and the WACC. The optimal capital structure simultaneously maximizes stock price and minimizes the WACC. As a rule, the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS. Which of the following statements is most consistent with efficient inventory management? The firm has a Answer low incidence of production schedule disruptions. below average total assets turnover ratio. relatively high current ratio. relatively low DSO. below average inventory turnover ratio. Which of the following is NOT commonly regarded as being a credit policy variable? Answer Collection policy. Credit standards. Cash discounts. Payments deferral period. Credit period A lockbox plan is most beneficial to firms that Answer have widely dispersed manufacturing facilities. have a large marketable securities portfolio and cash to protect. receive payments in the form of currency, such as fast food restaurants, rather than in the form of checks. have customers who operate in many different parts of the country. have suppliers who operate in many different parts of the country. Which of the following is NOT directly reflected in the cash budget of a firm that is in the zero tax bracket? Answer Depreciation. Cumulative cash. Repurchases of common stock. Payment for plant construction. Payments lags. Which of the following actions should Reece Windows take if it wants to reduce its cash conversion cycle? Answer Take steps to reduce the DSO. Start paying its bills sooner, which would reduce the average accounts payable but not affect sales. Sell common stock to retire long-term bonds. Sell an issue of long-term bonds and use the proceeds to buy back some of its common stock. Increase average inventory without increasing sales. Which of the following will cause an increase in net working capital, other things held constant? Answer A cash dividend is declared and paid. Merchandise is sold at a profit, but the sale is on credit. Long-term bonds are retired with the proceeds of a preferred stock issue. Missing inventory is written off against retained earnings. Cash is used to buy marketable securities. Suppose a foreign investor who holds tax-exempt Eurobonds paying 9% is considering investing in an equivalent-risk domestic bond in a country with a 28% withholding tax on interest paid to foreigners. If 9% after-tax is the investor’s required return, what before-tax rate would the domestic bond need to pay to provide the required after-tax return? Answer 9.00% 10.20% 11.28% 12.50% 13.57% In Japan, 90-day securities have a 4% annualized return and 180-day securities have a 5% annualized return. In the United States, 90-day securities have a 4% annualized return and 180-day securities have an annualized return of 4.5%. All securities are of equal risk, and Japanese securities are denominated in terms of the Japanese yen. Assuming that interest rate parity holds in all markets, which of the following statements is most CORRECT? Answer The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 180-day forward market. The yen-dollar exchange rate in the 90-day forward market equals the yen-dollar exchange rate in the 180-day forward market. The spot rate equals the 90-day forward rate. The spot rate equals the 180-day forward rate. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market. In 1985, a given Japanese imported automobile sold for 1,476,000 yen, or $8,200. If the car still sold for the same amount of yen today but the current exchange rate is 144 yen per dollar, what would the car be selling for today in U.S. dollars? Answer $5.964 $8,200 $10,250 $12,628 $13,525 Suppose one U.S. dollar can purchase 144 yen today in the foreign exchange market. If the yen depreciates by 8.0% tomorrow, how many yen could one U.S. dollar buy tomorrow? Answer 155.5 yen 144.0 yen 133.5 yen 78.0 yen 72.0 yen Suppose 90-day investments in Britain have a 6% annualized return and a 1.5% quarterly (90-day) return. In the U.S., 90-day investments of similar risk have a 4% annualized return and a 1% quarterly (90-day) return. In the 90-day forward market, 1 British pound equals $1.65. If interest rate parity holds, what is the spot exchange rate? Answer 1 pound = $1.8000 1 pound = $1.6582 1 pound = $1.0000 1 pound = $0.8500 1 pound = $0.6031 Suppose the exchange rate between U.S. dollars and Swiss francs is SF 1.41 = $1.00, and the exchange rate between the U.S. dollar and the euro is $1.00 = 1.64 euros. What is the cross-rate of Swiss francs to euros? Answer 0.43 0.86 1.41 1.64 2.27 Suppose it takes 1.82 U.S. dollars today to purchase one British pound in the foreign exchange market, and currency forecasters predict that the U.S. dollar will depreciate by 12.0% against the pound over the next 30 days. How many dollars will a pound buy in 30 days? Answer 1.12 1.63 1.82 2.04 3.64 A box of chocolate candy costs 28.80 Swiss francs in Switzerland and $20 in the United States. Assuming that purchasing power parity (PPP) holds, what is the current exchange rate? Answer 1 U.S. dollar equals 0.69 Swiss francs 1 U.S. dollar equals 0.85 Swiss francs 1 U.S. dollar equals 1.21 Swiss francs 1 U.S. dollar equals 1.29 Swiss francs 1 U.S. dollar equals 1.44 Swiss francs
