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PQR Manufacturing Corporation has $1,500,000 in debt outstanding. The company's before-tax cost of debt is 10%. Sales for the year totaled $3,500,000 and variable costs were 60% of sales. Net income was equal to $600,000 and the company's tax rate was 40%. If PQR's degree of total leverage is equal to 1.40, what is its degree of operating leverage?


A) 1.2174
B) 1.3422
C) 1.2783
D) 1.1565
E) 1.0987

F) A) and C)
G) B) and E)

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S. Claus & Co. is planning a zero coupon bond issue that has a par value of $1,000 and matures in 2 years. The bonds will be sold today at a price of $826.45. If the firm's marginal tax rate is 40%, what is the annual after-tax cost of debt to the company on this issue?


A) 5.70%
B) 6.00%
C) 6.30%
D) 6.61%
E) 6.95%

F) B) and E)
G) A) and C)

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A company currently sells 75,000 units annually. At this sales level, its EBIT is $4 million, and its degree of total leverage is 2.0. The firm's debt consists of $15 million in bonds with a 9.5% coupon. The company is considering a new production method which will entail an increase in fixed costs but a decrease in variable costs, and will result in a degree of operating leverage of 1.600. The president, who is concerned about the stand-alone risk of the firm, wants to keep the degree of total leverage at 2.0. If EBIT remains at $4 million, what dollar amount of bonds must be retired to accomplish this?


A) $6,250,000
B) $6,907,895
C) $6,578,947
D) $5,937,500
E) $5,640,625

F) None of the above
G) B) and E)

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A company has an EBIT of $4 million, and its degree of total leverage is 2.4. The firm's debt consists of $20 million in bonds with a YTM of 10%. The company is considering a new production process that will require an increase in fixed costs but a decrease in variable costs. If adopted, the new process will result in a degree of operating leverage of 1.4. The president wants to keep the degree of total leverage at 2.4. If EBIT remains at $4 million, what dollar amount of bonds must be outstanding to accomplish this (assuming the yield to maturity remains at 10%) ?


A) $16,666,667
B) $20,258,438
C) $19,293,750
D) $18,375,000
E) $17,500,000

F) A) and E)
G) B) and D)

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Bell Brothers has $3,000,000 in sales. Fixed costs are estimated to be $100,000 and variable costs are equal to 50% of sales. The company has $1,000,000 in debt outstanding at a before-tax cost of 10%. If Bell Brothers' sales were to increase by 20%, how much of a percentage increase would you expect in the company's net income?


A) 20.83%
B) 19.79%
C) 21.92%
D) 23.08%
E) 18.80%

F) B) and D)
G) A) and B)

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The use of financial leverage by the firm has a potential impact on which of the following? (1) The risk associated with the firm. (2) The return experienced by the shareholder. (3) The variability of net income. (4) The degree of operating leverage. (5) The degree of financial leverage.


A) 1, 2, 3, 5
B) 2, 3, 5
C) 1, 3, 5
D) 2, 3, 4, 5
E) 1, 2, 5

F) B) and E)
G) A) and E)

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Which of the following statements is most CORRECT?


A) The primary test of feasibility in a reorganization is whether every claimant agrees with the reorganization plan.
B) The basic doctrine of fairness states that all debt holders must be treated equally.
C) Since the primary issue in bankruptcy is to determine the sharing of losses between owners and creditors, the "public interest" is not a relevant concern.
D) While the firm is in bankruptcy, the existing management is always allowed to remain in control of the firm, though the court monitors its actions closely.
E) To a large extent, the decision to dissolve a firm through liquidation or to keep it alive through reorganization depends upon the value of the firm if it is rehabilitated versus its value if its assets are sold off individually.

F) C) and E)
G) C) and D)

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A 4-year, zero coupon Treasury bond sells at a price of $762.8952. A 3-year, zero coupon Treasury bond sells at a price of $827.8491. Assuming the expectations theory is correct, what does the market believe the price of 1-year, zero coupon bonds will be in 3 years?


A) $921.54
B) $939.97
C) $958.77
D) $977.94
E) $997.50

F) A) and D)
G) A) and E)

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If you receive $15,000 today and can invest it at a 5% annual rate compounded continuously, what will be your ending value after 20 years?


A) $38,735.52
B) $40,774.23
C) $42,812.94
D) $44,953.59
E) $47,201.27

F) C) and D)
G) A) and D)

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Kulwicki Corporation wants to determine the effect of an expansion of its sales on its operating income (EBIT) . The firm's current degree of operating leverage is 2.50. It projects new unit sales to be 170,000, an increase of 45,000 over last year's level of 125,000 units. Last year's EBIT was $60,000. Based on a degree of operating leverage of 2.5, what is this year's expected EBIT with the increase in sales?


A) $108,300
B) $ 97,741
C) $ 92,854
D) $102,885
E) $114,000

F) B) and D)
G) A) and D)

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Using the Security Market Line concept in capital budgeting, which of the following statements is CORRECT?


A) If the expected rate of return on a given capital project lies above the SML, the project should be accepted even if its beta is greater than the beta of the firm's average project.
B) If a project's return lies below the SML, it should be rejected if it has a beta greater than the firm's existing beta but accepted if its beta is below the firm's beta.
C) If two mutually exclusive projects' expected returns are both above the SML, the project with the lower risk should be accepted.
D) If a project's expected rate of return is greater than the expected rate of return on an average project, it should be accepted.
E) None of the statements is correct.

F) B) and D)
G) B) and C)

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Assume that the State of Florida sold tax-exempt, zero coupon bonds with a $1,000 maturity value 5 years ago. The bonds had a 25-year maturity when they were issued, and the interest rate built into the issue was a nominal 8%, compounded semiannually. The bonds are now callable at a premium of 4% over the accrued value. What effective annual rate of return would an investor who bought the bonds when they were issued and who still owns them earn if they were called today?


A) 7.73%
B) 8.13%
C) 8.56%
D) 9.01%
E) 9.46%

F) A) and E)
G) A) and B)

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U.S. Delay Corporation, a subsidiary of the Postal Service, must decide whether to issue zero coupon bonds or quarterly payment bonds to fund construction of new facilities. The $1,000 par value quarterly payment bonds would sell at $795.54, have a 10% coupon rate, and mature in 10 years. At what price would the zero coupon bonds with a maturity of 10 years have to sell to earn the same effective annual rate as the quarterly payment bonds?


A) $220.77
B) $232.39
C) $244.62
D) $257.50
E) $270.37

F) A) and B)
G) A) and C)

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Chapter 7 of the Bankruptcy Act is designed to do all of the following EXCEPT:


A) Provides safeguards against the withdrawal of assets by the owners of the bankrupt firm.
B) Allows insolvent debtors to discharge all of their obligations and to start over unhampered by a burden of prior debt.
C) Provides for an equitable distribution of the assets among the creditors.
D) Details the procedures to be followed when a firm is liquidated.
E) Establishes the rules of reorganization for firms with projected cash flows that eventually will be sufficient to meet debt payments.

F) None of the above
G) C) and D)

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You need a down payment of $19,000 in order to purchase your first home 4 years from today. You currently have $14,014 to invest. In order to achieve your goal, what nominal interest rate, compounded continuously, must you earn on this investment?


A) 7.61%
B) 7.99%
C) 8.39%
D) 8.81%
E) 9.25%

F) B) and E)
G) A) and D)

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You just purchased a 12-year, $1,000 face value, zero coupon bond with a yield to maturity of 9%. If your tax rate is 25%, how much in taxes will you have to pay at the end of the first year of holding the bond?


A) $6.86
B) $7.22
C) $7.60
D) $8.00
E) $8.40

F) A) and E)
G) B) and E)

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Stromburg Corporation makes surveillance equipment for intelligence organizations. Its sales are $75,000,000. Fixed costs, including research and development, are $40,000,000, while variable costs amount to 30% of sales. Stromburg plans an expansion which will generate additional fixed costs of $15,000,000, decrease variable costs to 25% of sales, and also permit sales to increase to $100,000,000. What is Stromburg's degree of operating leverage at the new projected sales level?


A) 3.7500
B) 4.5581
C) 4.3411
D) 4.1344
E) 3.9375

F) A) and B)
G) C) and E)

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Which of the following methods involves calculating an average beta for comparable firms and using that beta to determine a project's beta?


A) Risk premium method
B) Pure play method
C) Accounting beta method
D) CAPM method
E) Discounted cash flow model

F) A) and E)
G) A) and D)

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Which of the following statements is most CORRECT?


A) Our bankruptcy laws were enacted in the 1800s, revised in the 1930s, and have remained unaltered since that time.
B) Federal bankruptcy law deals only with corporate bankruptcies. Municipal and personal bankruptcy are governed solely by state laws.
C) All bankruptcy petitions are filed by creditors seeking to protect their claims on firms in financial distress. Thus, all bankruptcy petitions are involuntary as viewed from the perspective of the firm's management.
D) Chapters 11 and 7 are the most important bankruptcy chapters for financial management purposes. If a reorganization plan cannot be worked out under Chapter 11, then the company will be liquidated as prescribed in Chapter 7 of the Act.
E) "Restructuring" a firm's debt can involve forgiving a certain portion of the debt but does not involve changing the debt's maturity or its contractual interest rate.

F) A) and B)
G) A) and C)

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Stock X and the "market" have had the following rates of returns over the past four years.  Year  Stock X  Market 112.00%14.00%25.00%2.00%311.00%14.00%4−7.00%−3.00%\begin{array} { c r r } \text { Year } & \text { Stock X } & \text { Market } \\\hline 1 & 12.00 \% & 14.00 \% \\2 & 5.00 \% & 2.00 \% \\3 & 11.00 \% & 14.00 \% \\4 & - 7.00 \% & - 3.00 \%\end{array}


A) 1.72
B) 1.91
C) 2.10
D) 2.31
E) 2.54

F) C) and D)
G) B) and C)

Correct Answer

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