Quiz 1 & 2

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Question : (TCO C) Pate & Co. has a capital budget of $3,000,000. The company wants to maintain a target capital structure that is 15 percent debt and 85 percent 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? (a) $205,000

(b) $500,000
(c) $950,000
(d) $2,550,000
(e) $3,050,000
Instructor Explanation: Answer is: c
Text: pp. 570-572 - Residual Dividends, Chapter 14
The amount of new investment which must be financed with equity is: $3,000,000 x 85% = $2,550,000.
Since the firm has $3,500,000 of net income, $950,000 = $3,500,000 - $2,550,000 will be left for dividends. 2. Question : (TCO F) The following data applies to Saunders Corporation's convertible bonds: Maturity: 10

Stock price: $30.00
Par value: $1,000.00
Conversion price: $35.00
Annual coupon: 5.00%
Straight-debt yield: 8.00%
What is the bond's conversion value?
(a) $698.15
(b) $734.89
(c) $773.57
(d) $814.29
(e) $857.14
Instructor Explanation: Answer is: e
Chapter 19: pp. 770-774
Conversion value = Conversion ratio x Market price of stock = $857.14 3. Question : (TCO B) The Congress Company has identified two methods for producing playing cards. One method involves using a machine having a fixed cost of $10,000 and variable costs of $1.00 per deck of cards. The other method would use a less expensive machine (fixed cost = $5,000), but it would require greater variable costs ($1.50 per deck of cards). If the selling price per deck of cards will be the same under each method, at what level of output will the two methods produce the same net operating income (EBIT)? (a) 5,000 decks

(b) 10,000 decks
(c) 15,000 decks
(d) 20,000 decks
(e) 25,000 decks
Instructor Explanation: Answer is: b
Chapter 15: pp. 603- 606
Total cost Method 1 = $1.00Q + $10,000.
Total cost Method 2 = $1.50Q + $5,000.
Set equal and solve for Q:
Q + $10,000 = $1.50Q + $5,000; $5,000 = $0.5Q; 10,000 = Q
4. Question : (TCO B) Firm L has debt with a market value of $200,000 and a yield of nine percent. The firm's equity has a market value of $300,000, its earnings are growing at a five percent rate, and its tax rate is 40 percent. A similar firm with no debt has a cost of equity of 12 percent. Under the MM extension with growth, what would Firm L's total value be if it had no debt? (a) $358,421

(b) $377,286
(c) $397,143
(d) $417,000
(e) $437,850
Instructor Explanation: Answer is: c
Chapter 26, pp. 1011-1015
Debt: $200,000 Equity: $300,000
rd: 9% rsU : 12%
T: 40% g: 5%
Firm L has a total value of $200,000 + $300,000 = $500,000. A similar firm with no debt should have a smaller valu(e) Here is the calculation: VTotal = VU + VTS, so VU = VTotal - VTS = D + S - VTS.

Value tax shelter = VTS = rdTD/(rsU - g) = 0.09(0.40)($200,000)/(0.12 - 0.05) = $102,857 VU = $300,000 + $200,000 - $102,857 = $397,143
5. Question : (TCO A) Which of the following statements is CORRECT? (a) If the underlying stock does not pay a dividend, it makes good economic sense to exercise a call option as soon as the stock’s price exceeds the strike price by about 10%, because this permits the option holder to lock in an immediate profit. (b) Call options generally sell at a price less than their exercise value. (c) If a stock becomes riskier (more volatile), call options on the stock are likely to decline in value. (d) Call options generally sell at prices above their exercise value, but for an in-the-money option, the greater the exercise value in relation to the strike price, the lower the premium on the option is likely to be. (e) Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock. Instructor Explanation: Answer is: d

Chapter 8, pp. 322-325
6. Question : (TCO F) Suppose the September CBOT Treasury bond futures contract has a quoted price of...
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