Review for Exam 3

Instructions: Please read carefully

• The exam will have 25 multiple choice questions and 5 work problems.
• Questions in the multiple choice section will be either concept or calculation
questions. The calculation questions will be similar to those in the homework and
review. However, the concept questions will be related to any topic we have
covered in the class. The concept questions in the review are only some sample
questions. You should NOT study only topics in the review.
• For the work problems, you need to solve the problems without knowing the
possible answers. The questions will be similar to those in the homework and the
review except that the possible solutions are not given.
• You can bring a formula sheet to the exam.
• Final Exams for Classes Meeting Tu-Th at 3:30pm Tuesday, May 19
11:30 AM - 2:30 PM

Chapter 11
1. Assume the U.S. government was to decide to increase its budget deficit. This
will cause __________ to increase.
A) interest rates
B) the output of the economy
C) both a and b
D) neither a nor b

2. A big increase in government spending is an example of __________.

A) a demand shock
B) a supply shock
C) an unsurprising shock
D) none of the above

3. If you expect a larger interest rate increase than other market participants do, you
would
A) buy long-term bonds
B) buy short-term bonds
C) buy long-term government bonds only
D) buy short-term government bonds only

4. Which of the following would not be considered a supply shock?

A) a change in the price of imported oil
B) frost damage to the orange crop
C) a change in the level of education of the average worker
D) an increase in the level of government spending

5. A trough is __________.
A) a transition from an expansion in the business cycle to the start of a
contraction
B) a transition from a contraction in the business cycle to the start of an
expansion
C) only something used by farmers to feed pigs and is not a term in investments
D) none of the above

6. The ___ stage of the business cycle would be a good time to invest in firms
engaged in natural resource extraction and processing such as minerals and
petroleum.
A) Peak
B) Contraction
C) Trough
D) Expansion

7. __________ the ratio of the number of people classified as unemployed to the

total labor force.
 A) The capacity utilization rate is
B) The participation rate is
C) The unemployment rate is
D) None of the above are

8. An analyst starts by examining the broad economic environment and then

considers the implications of the outside environment on the industry in which the
firm operates. Finally, the firm's position within the industry is examined. This is
called __________ analysis.
A) bottom-up
B) outside-inside
C) top-down
D) upside-down

Chapter 12

9. __________ is defined as the present value of all cash proceeds to the investor in
the stock.
A) dividend payout ratio
B) intrinsic value
C) market capitalization rate
D) plow-back ratio

10. __________ are analysts who use information concerning current and prospective
profitability of a company to assess its fair market value.
A) credit analysts
B) fundamental analysts
C) systems analysts
D) technical analysts

11. You wish to earn a return of 10% on each of two stocks, A and B. Each of the
stocks is expected to pay a dividend of $4 in the upcoming year. The expected
growth rate of dividends is 6% for stock A and 5% for stock B. Using the
constant growth DDM, the intrinsic value of stock A __________.
A) will be higher than the intrinsic value of stock B
B) will be the same as the intrinsic value of stock B
C) will be less than the intrinsic value of stock B
D) more information is necessary to Answer this question

12. The market capitalization rate on the stock of Aberdeen Wholesale Company is
10%. Its expected ROE is 12% and its expected EPS is $5.00. If the firm's plow-
 back ratio is 40%, its P/E ratio will be __________.
A) 8.33
B) 11.54
C) 19.23
D) 50.00

13. Rose Hill Trading Company is expected to have EPS in the upcoming year of
$6.00. The expected ROE is 18.0%. An appropriate required return on the stock
is 14%. If the firm has a plowback ratio of 60%, its growth rate of dividends
should be __________.
A) 2.5%
B) 4.0%
C) 8.4%
D) 10.8%

14. Grott and Perrin, Inc. has expected earnings of $3 per share for next year. The
firm's ROE is 20% and its earnings retention ratio is 70%. If the firm's market
capitalization rate is 15%, what is the present value of its growth opportunities?
A) $20
B) $70
C) $90
D) $115

15. Cache Creek Manufacturing Company is expected to pay a dividend of $4.20 in

the upcoming year. Dividends are expected to grow at the rate of 8% per year.
The riskfree rate of return is 4% and the expected return on the market portfolio is
14%. Investors use the CAPM to compute the market capitalization rate on the
stock, and the constant growth DDM to determine the intrinsic value of the stock.
The stock is trading in the market today at $84.00. Using the constant growth
DDM and the CAPM, the beta of the stock is __________.
A) 1.4
B) 0.9
C) 0.8
D) 0.5

16. Westsyde Tool Company is expected to pay a dividend of $2.00 in the upcoming
year. The risk-free rate of return is 6% and the expected return on the market
 portfolio is 12%. Analysts expect the price of Westsyde Tool Company shares to
be $29 a year from now. The beta of Westsyde Tool Company's stock is 1.20.
Using a one-period valuation model, the intrinsic value of Westsyde Tool
Company stock today is __________.
A) $24.29
B) $27.39
C) $31.13
D) $34.52

17. Ace Frisbee Corporation produces a good that is very mature in their product life
cycles. Ace Frisbee Corporation is expected to pay a dividend in year 1 of $3.00,
a dividend in year 2 of $2.00, and a dividend in year 3 of $1.00. After year 3,
dividends are expected to decline at the rate of 2% per year. An appropriate
required return for the stock is 8%. Using the multistage DDM, the stock should
be worth __________ today.
A) $13.06
B) $13.38
C) $18.25
D) $18.78

18. A firm is expected to produce $3.00 per share in earnings next year. If the firm
plans to plow back 30% of those earnings at a reinvestment rate of 25%, what will
be the expected growth in dividends?
A) 7.50%
B) 15.0%
C) 25.0%
D) 30.0%

19. Next year's earnings are estimated to be $5.00. The company plans to reinvest
20% of its earnings at 15%. If the cost of equity is 9%, what is the present value
of growth opportunities?
A) $9.09
B) $10.10
C) $11.11
D) $12,21
20. Janet Ludlow’s firm requires all its analysts to use a two-stage DDM and the CAPM
to value stocks. Using these measures, Ludlow has valued QuickBrush Company at $63
per share. She now must value SmileWhite Corporation.

a. Calculate the required rate of return for SmileWhite using the information in the
following table:

(K)

b. Ludlow estimates the following EPS and dividend growth rates for SmileWhite:

(K)

Estimate the intrinsic value of SmileWhite using the table above, and the two-
stage DDM. Dividends per share in 2007 were $1.72.

Chapter 13

21. Which of the following balance sheet items is not considered an asset?
A) inventory
B) accounts receivable
C) accrued taxes
D) All of the above are assets

22. A firm has a ROE of 20% and a market-to-book ratio of 2.38. Its P/E ratio is
__________.
A) 8.40
B) 11.90
C) 17.62
D) 47.60

Use the following to answer questions 32-41:

The financial statements of Shuswap Lake Manufacturing Company are given below.
Note: The common shares are trading in the stock market for $160 each.

23. The firm's current ratio for 2005 is __________.

A) 0.90
B) 1.44
C) 1.89
D) 2.80

24. The firm's leverage ratio for 2004 is __________.

A) 0.90
B) 1.56
C) 1.89
D) 3.13
25. The firm's fixed asset turnover ratio for 2005 is __________. Please keep in mind
that when a ratio involves both income statement and balance sheet numbers, the
balance sheet numbers for the beginning and end of the year must be averaged.
A) 3.39
B) 3.60
C) 6.00
D) 12.00

26. The firm's asset turnover ratio for 2005 is__________. Please keep in mind that
when a ratio involves both income statement and balance sheet numbers, the
balance sheet numbers for the beginning and end of the year must be averaged.
A) 0.90
B) 1.56
C) 1.92
D) 2.80

27. The net income of the company is $970. Taxes payable decrease by $120,
depreciation is $85, and fixed assets are sold for $90. If the firm's inventories also
decline by $65, what is the total change in cash for the firm for all activities?
A) Increase of $970
B) Increase of $1090
C) Decrease of $970
D) Decrease of $1090

28. A firm has an ROE of 3%, a debt/equity ratio of 0.5, a tax rate of 40%, and the
interest rate on its debt is 10%. Its ROA is __________.
A) 4%
B) 6%
C) 6.67%
D) 7.50%

29. A firm purchases goods on credit worth $150. The same firm pays off $100 in old
credit purchases. An investment is made via the purchase of a new facility and
equity is issued in the amount of $300 to pay for the purchase. What is the change
in net cash provided by operations?
A) $50 increase
B) $100 increase
C) $150 increase
D) $250 increase
30. What ratio will definitely increase when a firm increases its annual sales with no
corresponding increase in assets?
A) Asset turnover
B) Current ratio
C) Liquidity ratio
D) Quick ratio

31. Alumbat Corporation has $800,000 of debt outstanding, and it pays an interest
rate of 10 percent annually on its bank loan. Alumbat's annual sales are
$3,200,000; its average tax rate is 40 percent; and its net profit margin on sales is
6 percent. If the company does not maintain a TIE ratio of at least 4 times, its
bank will refuse to renew its loan, and bankruptcy will result. What is Alumbat's
current TIE ratio?
a. 2.4
b. 3.4
c. 3.6
d. 4.0
e. 5.0

Chapter 19

32. The Dow theory proposes that several forces simultaneously affect stock prices.
Which of the following is not one of these forces?
a. the primary trend
b. contrary trends
c. intermediate trends
d. minor trends

33. When a stock's market price breaks through its moving average line from below, a
technical analyst interprets this as a(n) ______________.

a. bullish signal
b. bearish signal
c. hold recommendation
d. uncertain signal requiring confirmation

34. Technical analysts ______________.

a. never incorporate fundamental information into their analysis
b. do not deny the value of fundamental information
c. believe that fundamental analysis must support their conclusions
d. None of the above
35. A relatively low value of Barron's confidence index is a(n):
a. bullish signal.
b. bearish signal.
c. hold recommendation.
d. uncertain signal requiring further confirmation.
36. When stock price falls below a support level, technical analysts interpret this as a(n):
a. bullish signal.
b. bearish signal.
c. hold recommendation.
d. uncertain signal requiring further confirmation.

37. If stock advances exceed declines by a wide margin, then technical analysts perceive
the market as ______________.
a. vulnerable to a sell-off
b. likely to remain stable
c. stronger because of the widespread movement
d. weaker because of the widespread movement

38. The ratio of the price of a particular security to a price index for its industry is
referred to as the ______________.
a. trin statistic
b. primary trend
c. breadth ratio
d. relative strength

39. A high amount of short interest is typically considered as a __________ and

contrarians may consider it as a _________.
a. Bearish signal; bullish signal
b. Bullish signal; bearish signal
c. Bearish signal; false signal
d. Bullish signal; false signal
40. The Dow Theory is a technique that attempts to identify ___________________.
a. Only long-term trends in stock market prices
b. Only short-term trends in stock market prices
c. Both long-term and short-term trends in stock market prices
d. Trends in arbitrage trading opportunities

41. A support level is ___________________.

a. A level beyond which the market is unlikely to rise
b. A level below which the market is unlikely to fall
c. An equilibrium price level justified by characteristics such as earnings and cash flows
d. The peak of a market wave or cycle

42. Technical analysts consider a decrease in the put/call ratio as __________.

a. A bearish signal
b. A bullish signal
c. A trend reversal signal
d. A signal to enter the options market

43. On day 1, the stock price of Ford was $81 and the automotive stock index was 324.
On day 2, the stock price of Ford was $85 and the automotive stock index was 335.
Consider the ratio of Ford to the automotive stock index at day 1 and day 2. Ford is
__________ the automotive industry and technical analysts who follow relative strength
would advise __________ the stock.
a. Outperforming, buying
b. Outperforming, selling
c. Underperforming, buying
d. Underperforming, selling

44. On a particular day, there were 890 stocks which advanced on the NYSE and 723
which declined. The volume in advancing issues was 80,846,000 and the volume in
declining issues was 70,397,000. The common measure of market breadth is
__________.
a. -10,449,000
b. -167
c. 167
d. 10,449,000
Answers

1. Answer: C
2. Answer: A
3. Answer: B
4. Answer: D
5. Answer: B
6. Answer: A
7. Answer: C
8. Answer: C
9. Answer: B
10. Answer: B
11. Answer: A
12. Answer: B Difficulty: Medium
P 1 − .40
= = 11.54
E .10 − .12(.40)
13. Answer: D

g = .18(.60) = .1080

14. Answer: B
3(1 − .7 ) 3
PVGO = − = 70
.15 − .2(.7 ) .15
15. Answer: B
4.20
k= + .08 = .1300
84.00

.13 − .04
β= = .90
.14 − .04
16. Answer: B
2.00 + 29.00
V0 = = 27.39
1 + .1320
17. Answer: A
1.00(1 − .02 )
V3 = = 9.80
.08 − (− .02 )

V0 = 3.00(.926 ) + 2.00(.857 ) + (1.00 + 9.80 )(.794 ) = 13.06

18. Answer: A
g = 0.30 x 0.25 = .075

19. Answer: C
g = .20 x .15 = .03. P = 4.0 / (.09 - .03) = 66.67. PVGO = 66.67 - (5/.09) = 11.11
20.
a. k = rf + β [Ε(rM) – rf ] = 4.5% + 1.15(14.5% − 4.5%) = 16%

b. Year Dividends
2007 $1.72
2008 $1.72 × 1.12 = $1.93
2009 $1.72 × 1.12 2
= $2.16
2010 $1.72 × 1.123 = $2.42
2011 $1.72 × 1.12 × 1.09
3
= $2.63
Present value of dividends paid in years 2008 to 2001:
Year PV of Dividends
2008 $1.93/1.161 = $1.66
2009 $2.16/1.162 = $1.61
2010 $2.42/1.163 = $1.55
Total: $4.82
D 2011 $2.63
P2010 = = = $37.57
k − g 0.16 − 0.09
PV (in 2007) of P2010 = $37.57/(1.163) = $24.07
Intrinsic value of stock = $4.82 + $24.07 = $28.89

21. Answer: C

22. Answer: B
P 2.38
= = 11.9
E .20
23. Answer: B

1,150,000
CR = = 1.44
800,000
24. Answer: D
2,500,000
L= = 3.13
200,000 + 600,000
25. Answer: A
5,000,000
FAT = = 3.39
1,400,000 + 1,550,000
2
26. Answer: C
 5,000,000
AT = = 1.92
2,500,000 + 2,700,000
2
27. Answer: B
cash flow = 970 - 120 + 85 + 90+ 65 = 1090

28. Answer: C
1 ⎛ .03 ⎞ .50
ROA = ⎜ ⎟+ (.10 ) = .0667
1.50 ⎝ 1 − .40 ⎠ 1.50
29. Answer: A
30. Answer: A
31. ANS: E
TIE = EBIT/I, so find EBIT and I.
Interest = $800,000 × 0.1 = $80,000.
Net income = $3,200,000 × 0.06 = $192,000.
Taxable income = EBT = $192,000/(1 – T) = $192,000/0.6 = $320,000.
EBIT = $320,000 + $80,000 = $400,000.
TIE = $400,000/$80,000 = 5.0 times.

32. B
33. A
34. B
35. B
36. B
37. C
38. D
39. A
40. C
41. B
42. B
43. A
44. C