A)

B)
C)
D)
E)

2. When the value of a firm's assets exactly equals the value of its debt, the firm:
Is economically bankrupt.
Is technically insolvent.
Is legally bankrupt.
Is in liquidation.
Is in default.

3. When shareholders pursue selfish strategies such as taking large risks or paying
excessive dividends, these will result in:
A)
no action by debtholders since these are equity holder concerns.
B)
positive agency costs, as bondholders impose various restrictions and covenants,
which will diminish firm value.
C)
investments of the same risk class that the firm is in.
D)
undertaking scale enhancing projects.
E)
lower agency costs, as shareholders have more control over the firm's assets.
4. Which of the following defensive tactics to resist a merger involve a firms repurchase of its own
shares?
A)Poison pill
B)Golden parachutes
C)Exclusionary self-tender
D)Standstill agreement
E) c and d
5. When graphing firm value against debt levels, the debt level that maximizes the value of the firm
is the level where:
A)
the increase in the present value of distress costs from an additional dollar of debt is greater
than the increase in the present value of the debt tax shield.
B)
the increase in the present value of distress costs from an additional dollar of debt is equal to
the increase in the present value of the debt tax shield.
C)
the increase in the present value of distress costs from an additional dollar of debt is less
than the increase of the present value of the debt tax shield.
D)
distress costs as well as debt tax shields are zero.
E)
distress costs as well as debt tax shields are maximized.
6. Inclusion of bond covenants in the bond contract leads to
A)
higher agency costs
B)
higher bankruptcy costs
C)
higher interest costs
D)
none the above

7. The increase in the stock price after a dividend increase is called the information content effect
because:
A)
the change in dividend was expected by shareholders.
B)
the dividend increase signaled investors to adjust the expectations of future earning upward.
C)
the dividend change signaled investors to adjust the risk of the firm downward.
D)
the dividend change signaled shareholders that the firm could now payout more as they

enter the mature phase of their business.

E)
none of the above.
8. What are some of the possible consequences of financial distress?
A)
Debtholders, who face the prospect of getting only part of their money back, are likely to
want the company to take additional risks.
B)
Debtholders would like equity holders to put up more money, even if it is invested in zeroNPV projects.
C)
Equity investors would like the company to cut its dividend payments to conserve cash
D)
Equity investors would like the firm to shift toward less risky lines of business

10. The acquisition of stock has the advantage of:

A)
no shareholder meeting to vote is necessary.
B)
minority shareholders may exist.
C)
opening the bidding to others.
D)
all of the above.
E)
none of the above.
11. Which of the following factors influence the choice between merger and an acquisition of stock?
A)
Shareholders are dealt with directly to bypass target management and board of directors.
B)
In a tender offer, usually some minority shareholders do not tender stopping complete firm
absorption.
C)
Target management may be unfriendly and resist an offer. Resistance usually make the
stock price higher.
D)
all of the above.
E)
none of the above.
12. Which of the following are features of the purchase method of accounting?
I. The balance sheets of the acquirer and the acquired are just added together.
II. Since the new firm is jointly owned by the shareholders of the old firms, no goodwill
exists.
III. The assets of the target firm must be shown at their fair market value on the books of
the bidder.
IV. The difference between the purchase price and the estimated fair market value of the
net assets of the target firm must be classified as goodwill and recorded on the balance sheet.
A)
I and II only
B)
II and IV only
C)
III and IV only
D)
II and III only
E)
I and IV only

23. A financial lease is likely to be most beneficial to both parties when:

A)
the lessor's tax rate is lower than the lessee's.
B)
the lessor's tax rate is higher than the lessee's.
C)
the lessor's tax rate is equal to the lessee's.
D)
a financial lease cannot be beneficial to both parties.
E)
a financial lease always has zero NPV, so both parties always break even.
25. Prior to CICA 3065, "Accounting for Leases", lease activity was only reported in financial
footnotes. This off-balance-sheet-financing made firms with

A)
operating leases appear healthier than those with no leases.
B)
financial leases appear to have greater liabilities than firms using operating leases.
C)
operating leases appear to have greater liabilities than firms using financial lease.
D)
financial leases appear to be financially stronger than if the leases were on-balance-sheetfinancing.
E)
all of the above.
26. For accounting purposes, which of the following conditions would not automatically cause a
lease to be a financial lease?
A)
The lessee can purchase the asset for its fair market value at the end of the lease.
B)
The lease transfers ownership of the asset to the lessee by the end of the lease.
C)
The lease term is more than 75% of the asset's economic life.
D)
The PV of the lease payments is more than 90% of the asset's market value at lease
inception.
E)
All of the above would lead to the lease being considered a financial lease.

29. Given realistic estimates of the probability and cost of bankruptcy, the future costs of a
possible bankruptcy are borne by:
A)
by all investors in the firm.
B)
debtholders only because if default occurs interest and principal payments are not made.
C)
equityholders because debtholders will pay less providing less cash for the equityholders.
D)
management because if the firm defaults they will lose their jobs.
E)
none of the above.

35.
A)
B)
C)
D)
E)

A successful merger requires that the:

P/E ratio maintains its pre-merger value.
Debt-equity ratio of the firm remains at its pre-merger level.
Book value per share must remain constant.
Book value per share must increase.
Value of the whole exceeds the value of the sum of the parts.

45. The payoff diagram for a put with the same exercise price and premium as the call on the
same underlying asset with the same maturity is:
A)
the inverse of the call diagram along the put price.
B)
unrelated to the call diagram no matter what the exercise price.
C)
the mirror image of the call diagram around the exercise price.
D)
exactly the same as the call diagram for the given exercise price.
E)
None of the above.

47.Investing in combinations of options may result in:

A)
no difference in payoff patterns.
B)
a mirror image of past results.
C)
offsetting positions resulting in a riskless return.
D)
a and b.
E)
b and c.

1. Although the use of debt provides tax benefits to the firm, debt also puts pressure on the firms
to:
A)
meet interest and principal payments which if not met can put the company into financial
distress.
B)
make dividend payments which if not met can put the company into financial distress.
C)
meet both interest and dividend payments which when met increase the firm cashflow.
D)
meet increased tax payments thereby increasing firm value.
E)
none of the above.

2. One of the indirect costs of bankruptcy is the incentive for managers to take large risks. When
following this strategy, the firm will:
A)
rank all projects and take the project which results in the highest expected value of the firm.
B)
rank all projects and take the project which results in the highest expected value of the
firm's bonds.
C)
rank all projects and take the project which results in the highest expected value of the
firm's stock.
D)
always take the low risk project.
E)
both a and b.

4. One of the indirect costs to bankruptcy is the incentive toward under investment. Following this
strategy may result in:
A)
the firm always choosing projects with the positive NPVs.
B)
the firm turning down positive NPV projects.
C)
stockholders contributing the full amount of the investment, but both stockholders and
bondholders sharing in the benefits of the project.
D)
both a and c.
E)
both b and c.

6. The pecking order states how financing should be raised. In order to avoid asymmetric
information problems and misinterpretation of whether management is sending a signals on
security overvaluation the firm's first rule is to:
A)
finance with internally generated funds as there is no market interaction.
B)
always issue debt then the market won't know when management thinks the security is
overvalued.
C)
reduce asymmetry before any financing activity.
D)
increase the financial slack to reduce the reliance on internally generated funds.
E)
none of the above.

7. You purchased 200 shares of ABC stock on July 15th. On July 20th, you purchased
another 100 shares and then on July 22st you purchased your final 200 shares of ABC
stock. The company declared a dividend of $1.10 a share on July 5th to holders of

record on Friday, July 23rd. The dividend is payable on July 31st. How much dividend
income will you receive on July 31st from ABC?
A)
$0
B)
$220
C)
$330
D)
$440
E)
$550

8. The use of homemade dividends allows stockholders to:

A)
change the return pattern of the firm by leveraging their position like the firm.
B)
change the cash dividend payout received by selling off shares to receive current dividends
or purchasing added shares with the dividends, as desired.
C)
change the value of the company by sending dividend require letters to the home office of the
corporation.
D)
a and c.
E)
b and c.
9. A firm plans to pay dividends of $12.50 at time 0 and $14 at time 1. Ignoring transaction costs
and assuming that the investor can earn 8% on investments, which statement is true?
A)
An investor can spend up to $25.46 from dividends at time 0, and without decreasing the
present value of all dividends received.
B)
An investor can spend up to $27.50 from dividends at time 0, and without decreasing the
present value of all dividends received.
C)
An investor can spend up to $25.46 from dividends at time 0, but will decrease the present
value of all dividends received.
D)
An investor can spend up to $27.50 from dividends at time 0, but will decrease the present
value of all dividends received.
E)
None of the above.
10. In the presence of personal taxes the MM irrelevance proposition does not hold because:
A)
managers have an incentive to seek alternative uses for these funds.
B)
personal taxes always increase the value of dividends.
C)
personal taxes reduce the value of dividends but are not sufficient to eliminate all dividends.
D)
a and b.
E)
a and c.
The main difference between a positive and negative covenants is(are):
A)
a positive covenant is one you must not do while a negative covenant must be carried out.
B)
actions that you must do regularly versus periodically.
C)
a positive covenant is one you must do while a negative covenant is to limit actions the firm
can take.
D)
no difference as they are both restrictive.
E)
none of the above.

16. The WACC is not used in the lease versus purchase decision because:
A)
the WACC was used in the decision to acquire the asset, this is only a financing decision.
B)
the WACC is used only when a lease alone is considered and not a lease versus purchase.
C)
the WACC does not include the lease cost of capital and therefore should not be used.

D)
E)

tax rates of the lessor may be different than the lessee and therefore the WACC is incorrect.
when a bank arranges a lease they do not consider the lessee's cost of capital.

17. Some assets are leased more than others because:

A)
the value of the asset under a lease is not highly affected by term of use or maintenance
decisions.
B)
a lease may be used to fool clients into "buying" high priced assets above market value.
C)
leasing allows sellers to attract clients with low prices as the basis for setting the contract.
D)
Both a and b.
E)
Both a and c.
18. Capital leases would show up on the balance sheet of the firm in which manner for a six year
machinery lease worth $700,000:
A)
capital leases do not have to be put on the balance sheet only financial leases do.
B)
Asset Machinery $700,000; Liabilities Long Term debt $700,000 because of debt
displacement.
C)
Asset Assets under Capital Lease $700,000; Liabilities Obligations under Capital Lease
$700,000.
D)
Assets Assets under Capital Lease $700,000; Liabilities Long Term Debt $700,000
because of debt displacement.
E)
none of the above.
19. An out-of-the-money call option is one that:
A)
has an exercise price below the current market price of the underlying security.
B)
should not be exercised.
C)
has an exercise price above the current market price of the underlying security.
D)
both a and b.
E)
both b and c.
20. Which of the following statements is true?
A)
At expiration the maximum price of a call is the greater of (ST - Exercise) or 0.
B)
At expiration the maximum price of a call is the greater of (Exercise - ST) or 0.
C)
At expiration the maximum price of a put is the greater of (ST - Exercise) or 0.
D)
At expiration the maximum price of a put is the greater of (Exercise - ST) or 0.
E)
Both a and d.
Answer: E

22. The higher the exercise price:

A)
the higher the call price.
B)
The lower the call price.
C)
Has no effect on call price.

D) The higher the stock price.

E) The lower the stock price.

23. Which of the following statements is true?

A)
For both calls and puts an increase in the exercise price will cause an increase in the option
price.
B)
For both calls and puts an increase in the time to expiration will cause an increase in the
option price.

C)
For calls, but not for puts, an increase in the time to expiration will cause an increase in the
option price.
D)
For puts, but not for calls, an increase in the time to expiration will cause an increase in the
option price.
E)
Both a & d.

24. The delta of a call measures:

A)
the change in the ending stock value.
B)
the change in the ending option value.
C)
the ratio of the change in the stock price to the change in the option
price.
D)
the ratio of the change in the option price to the change in the stock price.
E)
none of the above.

27. A reason for acquisitions is synergy. Synergy includes:

A)
revenue enhancements.
D) all of these.
B)
cost reductions.
E) none of the above.
C)
lower taxes.
28. ..What is the synergy from the merger of V and A. V was worth $450 and A had a market value
of $375. V acquired A for $425 because they thought the combination of VA was worth $925.
A)
$ 50. B) $100. C) $500. D) $475. E) None of the above.

29. What is the NPV from the merger of V and A. V was worth $450 and A had a market value of
$375. V acquired A for $425 because they thought the combination of VA was worth $925.
A)
$ 0. B) $ 50. C) $450. D) $425. E) None of the above.

30. What is the cost of acquiring A if the V and A merge. V is worth $450 and has 100 shares
outstanding. A has a market value of $375 and has 40 shares outstanding. V to acquire A will swap
80 shares of V for the 40 shares of A. V believes the combination of VA was worth $925.
A)
$325. B) $100. C) $ 36. D) $ 0. E) none of the above.

5. Which of the following are beneficial attributes of leveraged buyouts?

I. Leveraged buyouts often create entrepreneurial incentives for managers.
II. The required repayment of the debt used in the buyout induces reduced managerial
efficiencies.
III. Conflicts of interest between shareholders and managers are increased.
IV. Bureaucratic obstacles are often eliminated.
A)
I only
B)
I and III only
C)
I and IV only
D)
I, II, and III only
E)
I, II, III, and IV

Options
1.The special contractual nature giving the owner the right to buy or sell an asset at a fixed price on
or before a given date is the basis of:
A)
a common stock.
D) an option.
B)
a capital investment.
E) None of the above.
C)
a futures.
3.Which of the following statements is true?
A)
American options are options on securities of U. S. corporations, and the options are traded
on American exchanges. European options are options on securities of U.S. corporations, but the
options are traded on European exchanges.
B)
American options are options on securities which are traded on American exchanges.
European options, also traded on American exchanges, are options on European corporations.
C)
American options give the holder the right to the dividend payment. European options do
not.
D)
American options may be exercised anytime up to expiration. European options may be
exercised only at expiration.
E)
None of the above.
4.A call gives the owner the right:
A)
and the obligation to buy an asset at a given price.
B)
and the obligation to sell an asset at a given price.
C)
but not the obligation to buy an asset at a given price.
D)
but not the obligation to sell an asset at a given price.
E)
none of the above.
6.You own a call option with time to expiration. The common stock is selling for $15 and your
exercise price is $12, this option:
A)
must be sold to the writer.
D) must be offset by a put.
B)
is in-the-money.
E) none of the above.
C)
is out-of-the-money.

8.Pay-off diagrams for a call options versus stock prices are called:
A)
vertical tower diagrams.
D) cumulative frequency diagrams.
B)
hockey stick diagrams.
E) none of the above.
C)
fulcrum diagrams.

1. Distributions to shareholders from capital are called:

A. earnings dividends.
B. a stock split.
C. liquidating dividends.
D. stock dividends.
E. regular cash dividends.

3. You purchased 200 shares of ABC stock on July 15th. On July 20th, you purchased
another 100 shares and then on July 22st you purchased your final 200 shares of ABC
stock. The company declared a dividend of $1.10 a share on July 5th to holders of record
on Friday, July 23rd. The dividend is payable on July 31st. How much dividend income
will you receive on July 31st from ABC?
A. $0
B. $220
C. $330
D. $440
E. $550
4. Which of the following is true?
A. A 10% stock dividend would increase stockholder wealth by $5 if the current price of
stock is $50 (ignoring transaction costs).
B. Stock dividends are not true dividends.
C. Stock splits involve a small increase (splintering) in total stock outstanding.
D. The most common dividend policy involves regular cash payments with year-end
bonuses.
5. The ability of shareholders to undo the dividend policy of the firm and create an
alternative dividend payment policy via reinvesting dividends or selling shares of stock is
called (a):
A. MM Proposition I.
B. capital structure irrelevancy.
C. homemade leverage.
D. homemade dividends.
8. In an efficient market, ignoring taxes and time value,
A. the price of stock should decrease by the amount of the dividend immediately on
declaration date.
B. the price of stock should decrease by the amount of the dividend immediately on
ex-dividend date.
C. the price of stock should increase by the amount of the dividend immediately on
declaration date.
D. the price of stock should increase by the amount of the dividend immediately on exdividend date.
15. Two important elements of the dividend policy irrelevance proposition are:
A. all investors have homogeneous dividend needs and time horizons.
B. dividends are paid even if a positive NPV opportunity exists and investors can rearrange their own dividend streams

C. investors can re-arrange their own dividend streams and the investment policy
is set and unaltered by the change in dividend policy.
D. all investors have homogeneous dividend needs and dividends are paid even if a
positive NPV opportunity exists.
E. investors can re-arrange their own dividend streams and the source of financing must
be debt.
16. A firm plans to pay dividends of $12.50 at time 0 and $14 at time 1. Ignoring
transaction costs and assuming that the investor can earn 8% on investments, which
statement is true?
A. An investor can spend up to $25.46 from dividends at time 0, and without
decreasing the present value of all dividends received.
B. An investor can spend up to $27.50 from dividends at time 0, and without decreasing
the present value of all dividends received.
C. An investor can spend up to $25.46 from dividends at time 0, but will decrease the
present value of all dividends received.
D. An investor can spend up to $27.50 from dividends at time 0, but will decrease the
present value of all dividends received.
19. Dividends are relevant and dividend policy irrelevant when:
A. cash dividends are always constant and dividend policy is changed as management
needs.
B. cash dividends are increased for one payment while others are held constant and
dividend policy establishes the trade-off between dividends at different dates
C. cash dividends are always constant and dividend policy establishes the trade-off
between dividends at different dates.
D. cash dividends are increased for one payment while others are held constant and
dividend policy is changed as management needs.
22. The observed empirical fact that stocks attract particular investors based on the
firm's dividend policy and the resulting tax impact on investors is called the:
A. information content effect.
B. clientele effect.
C. efficient markets hypothesis.
D. MM Proposition I.
24. An open market purchase is:
A. an arrangement to buy back short term financial instruments sold to an investment
dealer at a fixed price.
B. the buying back of shares from a particular group, usually large shareholders
disenchanted with management.

C. the buying back of shares because management has few profitable investment
opportunities.
D. arrangement in which company buys back its shares just like any other trader I
the market.
28. If dividends are taxed at higher rates than are capital gains, then high dividend
payout stocks should sell at lower prices, everything else equal, compared to low
dividend paying stocks. One implication of this is that investors in _____ tax brackets
will tend to prefer high dividend payout stocks.
A. slightly higher than averag
B. average
C. slightly lower than average
D. zero
32. If stockholders care about taxes, then stocks should attract clienteles based on
dividend yields. Surveys support this by showing that the highest dividend yield stocks
are held by investors in the:
A. highest tax bracket.
B. average tax bracket.
C. lowest tax bracket.
35. For a firm to develop a sensible, useful dividend policy, the three things that should
be considered are:
A. dividends should not be paid if positive NPV projects are available, stock should
always be issued to pay dividends, repurchases with surplus cash should be considered
if positiveNPV projects exist.
B. dividends should not be paid if positive NPV projects are available, stock should
always not be issued to pay dividends, repurchases with surplus cash should be
considered if no positive NPV projects exist.
C. dividends should be paid if positive NPV projects are available, stock should always
be issued to pay dividends, repurchases with surplus cash should be considered if
positiveNPV projects exist.
D. dividends should be paid if positive NPV projects are available, stock should always
not be issued to pay dividends, repurchases with surplus cash should be considered if no
positive NPV projects exist.
E. dividends should not be paid if positive NPV projects are available, stock should
always not be issued to pay dividends, repurchases with surplus cash should be
considered if positive NPV projects exist.
Long Answer Questions
19.2, 17.3, 30.3, 22.1 (All from HWsets)

Exact same question as Maverick but different name for Chapter 23.