True/False with proper reasons
Problem 1. In limited liability partnerships, the liability protection does not protect partners from their individual acts of malpractice.
Problem 2. Unlike an S corporation, the limited liability corporation (LLC) can own more than 80 percent of another corporation, and corporations, partnerships, or non-U.S. residents can own limited liability corporation shares.
Problem 3. Two assets whose returns move in the same direction and have a correlation coefficient of 1 are both very risky assets.
Problem 4. A portfolio of two negatively correlated assets has less risk than either of the individual assets.
Problem 5. The higher the debt ratio, the more financial leverage a firm has and, thus, the greater will be its risk and return.
Problem 6. In general, with an amortized loan, the payment amount remains constant over the life of the loan, the principal portion of each payment grows over the life of the loan, and the interest portion of each payment declines over the life of the loan.
Problem 7. The value of an asset depends on the historical cash flow(s) up to the present time.
Problem 8. When the required return equals the coupon interest rate, the bond's value will remain at par until it matures.
Problem 9. The constant growth model is an approach to dividend valuation that assumes a constant future dividend.
Problem 10. As credit standards are relaxed, sales are expected to increase and the investment in accounts receivable is expected to decrease.
Problem 11. All of the following are key strengths of a corporation EXCEPT
(a) access to capital markets.
(b) limited liability.
(c) flow organization costs.
(d) readily transferable ownership.
Problem 12. A common approach of estimating the variability of returns involving forecasting the pessimistic, most likely, and optimistic returns associated with the asset is called
(a) marginal analysis.
(b) sensitivity analysis.
(c) break even analysis.
(d) financial statement analysis.
Problem 13. The present value of $200 to be received 10 years from today, assuming an opportunity cost of
10 percent, is
(a) $ 50.
(b) $200.
(c) $518.
(d) $ 77.
Problem 14. Dan plans to fund his individual retirement account (IRA) with the maximum contribution of $2,000 at the end of each year for the next 10 years. If Dan can earn 10 percent on his contributions, how much will he have at the end of the tenth year?
(a) $12,290
(b) $20,000
(c) $31,874
(d) $51,880
Problem 15. The major factor(s) affecting the cost, or interest rate, on a bond is (are) its
(a) maturity.
(b) size of the offering.
(c) issuer risk.
(d) basic cost of money.
(e) All of the above.
Problem 16. In the present value model, risk is generally incorporated into the
(a) cash flows.
(b) timing.
(c) discount rate.
(d) total value.
Problem 17. At year end, Tangshan China Company balance sheet showed total assets of $60 million, total liabilities (including preferred stock) of $45 million, and 1,000,000 shares of common stock outstanding. Next year, Tangshan is projecting that it will have net income of $1.5 million. If the average PE multiple in Tangshan's industry is 15, what should be the price of Tangshan's stock?
(a) $15.00
(b) $22.50
(c) $52.50
(d) $75.00
Problem 18. A(n) _________ in current assets _________ net working capital, thereby _________ the risk of technical insolvency.
(a) decrease; increases; increasing
(b) increase; decreases; increasing
(c) increase; increases; reducing
(d) decrease; decreases; reducing
Problem 19. _________ involves the sale of accounts receivable.
(a) A trust receipt loan
(b) Factoring
(c) A field warehouse arrangement
(d) Pledging of accounts receivable
Problem 20. The _________ financing strategy requires the firm to pay interest on excess funds borrowed but not needed throughout the entire year.
(a) aggressive
(b) conservative
(c) permanent
(d) seasonal
Problem 21. Champion Breweries must choose between two asset purchases. The annual rate of return and related probabilities given below summarize the firm's analysis.
Asset A Asset B
Rate of Return Probability Rate of Return Probability
10% 30% 5% 40%
15 40 15 20
20 30 25 40
For each asset, compute
(a) the expected rate of return.
(b) the standard deviation of the expected return.
(c) the coefficient of variation of the return.
(d) Which asset should Champion select?
Problem 22. During her four years at college, Rose received the following amounts of money at the end of each year from her grandmother. She deposited her money in a saving account paying 6 percent rate of interest. How much money will Rose have on graduation day?
Year $
1 100
2 200
3 300
4 400
Problem 23. Suzy wants to buy a house but does not want to get a loan. The average price of her dream house is $500,000 and its price is growing at 5 percent per year. How much should Suzy invest in a project at the end of each year for the next 5 years in order to accumulate enough money to buy her dream house with cash at the end of the fifth year? Assume the project pays 12 percent rate of return.
Problem 24. To expand its business, the Kingston Outlet factory would like to issue a bond with par value of $1,000, coupon rate of 10 percent, and maturity of 10 years from now. What is the value of the bond if the required rate of return is 1) 8 percent, 2) 10 percent, and 3) 12 percent?
Problem 25. In response to the stock market's reaction to its dividend policy, the Paper Company has decided to increase its dividend payment at a rate of 4 percent per year. The firm's most recent dividend is $3.25 and the required rate of interest is 9 percent. What is the maximum you would be willing to pay for a share of the stock?