Objective questions on shareholders' interest and ROA and ROI

1.   Which of the following actions would be likely to encourage a firm's managers to make decisions that are in the best interest of shareholders?

1. The percentage of executive compensation that comes the form of cash is increased and the percentage from than long-term stock options is reduced.
2. The state legislature passes a law that makes it more difficult to successfully complete a hostile takeover.
3. The percentage of the firm's stock that is held by institutional investors such as mutual funds, pension funds, and hedge funds rather than by small individual investors rises from 10% to 60%.
4. The firm's founder, who is also president and chairman of the board, sells 90% of her shares.
5. The firm's board of directors gives the firm's managers greater freedom to take whatever actions they decide to take.

2.  Johnson Battery Systems Metals recently reported $9,000 of sales, $6,000 of operating costs other than depreciation, and $1,500 of depreciation. The company had no amortization charges, it had $4,000 of bonds that carry a 7% interest rate, and its federal-plus-state income tax rate was 40%. In order to sustain its operations and thus generate sales and cash flows in the future, the firm was required to make $800 of capital expenditures on new fixed assets and to invest $500 in net operating working capital. What was its free cash flow?

1. $1,000
2. $1,100
3. $1,200
4. $1,300
5. $1,400

3. Last year, Owen Technologies reported (1) a negative net cash flow from operations, (2) a negative free cash flow, and (3) an increase in cash as reported on its balance sheet. Which of the following factors could explain this situation?

1. The company had a sharp increase in its depreciation and amortization expenses.
2. The company had a sharp increase in its inventories.
3. The company sold a new issue of common stock.
4. The company had a sharp increase in its accrued liabilities.
5. The company made a large capital investment early in the year.

4.  On its 2004 balance sheet, Sherman Books showed $510 million of retained earnings, and exactly the same amount was shown the following year. Assuming that no earnings restatements were issued, which of the following statements is CORRECT?

1. The company must have had zero net income in 2005.
2. The company must have paid no dividends in 2005.
3. Dividends could have been paid in 2005, but they would have had to equal the earning for the year.
4. If the company lost money in 2005, they must have paid dividends.
5. The company must have paid out half of its earnings as dividends.

5.  Companies J and K each reported the same earnings per share (EPS), but Company J?s stock trades at a higher price. Which of the following statements is correct?

1. Company J must have a higher P/E ratio.
2. Company J must have a higher market-to-book ratio.
3. Company J must be riskier.
4. Company J must have fewer growth opportunities.
5. Company J must pay a lower dividend.

6.  Companies HD and LD have the same sales, tax rate, interest rate on their debt, total assets, and basic earning power. Both companies have positive net incomes. Company HD has a higher debt ratio, and, therefore, a higher interest expense. Which of the following statements is CORRECT?

1. Company HD has a higher ROA.
2. Company HD has a higher times interest earned (TIE)ratio.
3. Company HD has more net income.
4. Company HD pays less in taxes.
5. Company HD has a lower equity multiplier.

7.  If the Treasury yield curve is downward sloping, how would the yield to maturity on a 10-year Treasury coupon bond compare to that on a 1-year T-bill?

1. The yield on a 10-year bond would be less than that on a 1-year bill.
2. The yield on a 10-year bond would have to be higher than that on a 1-year bill because of the maturity risk premium.
3. It is impossible to tell without knowing the coupon rates of the bonds.
4. The yields on the two securities would be equal.
5. It is impossible to tell without knowing the relative risks of the two securities.

8.  Walker Corporation is planning to issue new 20-year bonds.

Initially, the plan was to make the bond non-callable. If the bond were made callable after 5 years with a 5% call premium, how would this affect the bond's required rate of return?

1. It is impossible to say without more information.
2. Because of the call premium, the required rate of return would decline.
3. There is no reason to expect a change in the required rate of return.
4. The required rate of return would decline because the bond would then be less risky to a bondholder.
5. The required rate of return would increase because the bond would then be more risky to a bondholder.

9.  Which of the following statements is CORRECT?

1. Long-term bonds have less interest rate price risk but more reinvestment rate risk than short-term bonds.
2. Long-term bonds have less interest rate price risk and also less reinvestment rate risk than short-term bonds.
3. Relative to a coupon-bearing bond with the same maturity, a zero coupon bond has more interest rate risk but less reinvestment rate risk.
4. If interest rates increase, all bond prices will increase, but the increase will be greater for bonds that have less interest rate risk.
5. One advantage of a zero coupon Treasury bond is that no one who owns the bond has to pay any taxes on it until it matures or is sold.

10. Which of the following statements best describes what would be expected to happen as you randomly select stocks and add them to your portfolio?

1. Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk.
2. Adding more such stocks will reduce the portfolio's beta.
3. Adding more such stocks will increase the portfolio's expected return.
4. Adding more such stocks will reduce the portfolio's market risk.
5. Adding more such stocks will have no effect on the portfolio's risk.

11. Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5. The market is in equilibrium, with required returns equaling expected returns. Which of the following statements is CORRECT?

1. Since the market is in equilibrium, the required returns of the two stocks should be the same.
2. If expected inflation remains constant but the market risk premium (rM - rRF) declines, the required return on Stock HB will decline but the required return of Stock LB will increase.
3. If expected inflation remains constant but the market risk premium (rM - rRF) declines, the required return of Stock LB will decline but the required return of Stock HB will increase.
4. If both expected inflation and the market risk premium (rM - rRF) increase, the required returns of both stocks will increase by the same amount.
5. If both expected inflation and the market risk premium (rM - rRF) increase, the required return on Stock HB will increase by more than that on Stock LB.